First Midwest Bancorp, Inc.
Q2 2017 Earnings Call Transcript

Published: 26 Jul 2017

[Operator:]

Good morning ladies and gentlemen, and welcome to the First Midwest Bancorp 2017 Second Quarter Earnings Conference Call. [Operator Instructions] It is now my pleasure to turn the floor over to Jim Roolf, Senior Vice President, Corporate Relations Officer of First Midwest Bancorp. Sir, you may begin

[James Roolf:]

Thank you. Good morning, everyone and thank you for joining us this morning. Following the close of the market yesterday, we released our earnings results for the second 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 are also 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 filings with the SEC 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 outlooks 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:]

Thank you. Good morning everyone, thanks again for joining us here today. Performance for the quarter was solid and encouraging on a number of fronts. As I go through those levels of performance and cover the highlights, as is our practice I will leave the additional detail and color to Mark and Pat as they walk you with a little more granularity. The quarter overall was generally in line with where we thought it would come in and certainly reflective of what we have described as our ongoing business priorities. We reported earnings for the quarter $0.34 per share that’s versus $0.31 for the 2016 second quarter and $0.23 from the first quarter of this year. Excluding costs that were largely response to that acquisition and our pace of organizational growth were primarily reflected in last quarter's numbers. Our earnings came in at $0.35 which would put us up 9% versus a year ago and 3% or 12% annualized versus the linked quarter. Our key profitability metrics continue to improve on a core basis as our top-line revenue growth and the operating leverage from our acquisition of Standard Bank in early January of this year continues to take hold. Our core return on average tangible equity for the first half of 2017 stood at 13.8% that's some 250 basis points higher than what it was a year ago and our efficiency move to sub 60% with the quarter coming in at less than 59%. Our pace of loan growth improved from last quarter was up 7% on an annualized basis with the volumes coming on later in the quarter and that certainly provide some additional momentum for next quarter. Overall, credit remains solid with relative reserve levels essentially unchanged. Net charge-offs continued to operate below the low end of our expectations. Non-performing levels picked up for the quarter, primarily due to a single larger credit and that's largely reflective of today's benign environment which can be distortive particularly as we manage larger credits in the workout process generally. Overall, our underlying portfolio quality continues to improve and we feel pretty good about that and as we remain focused on maintaining our credit disciplines in what continues to be a very competitive market we continue to except to see some performance there. Margins also continue to improve as we benefit from growth, higher rates and the strength of our core deposit base away from accretion which Pat will get into, our margin increased to 3.6% that's 9 basis points higher than what it was last quarter. Our fee based businesses also had strong results. Fees were up 15% from last quarter with wealth management continuing to lead the pack here as we benefited from the full run rate of our acquisition of Premier Asset Management in the first quarter of 2017. So with that let me turn it over to Mark and he can pick it up for some additional business colors. Mark?

[Mark Sander:]

Thanks Mike. And as Mike mentioned, loan growth came in at 7% annualized in the second quarter which was as we expected. Though it was generated late to the benefit of income in this quarter was less but rather will show up in the current quarter. Our retail businesses lead the way in Q2 driven by our strategic efforts to diversify and make lending a more meaningful part of our strong and growing consumer franchise. The result of these efforts mortgage, online consumer and transactional activities all increased at nice levels. Commercial loans also grew modestly driven largely by strong performance and certain C&I teams most notably in our specialized industry verticals. Looking out to the rest of the year our expectations for loan growth are really unchanged. We expect to see similar increases in each of the next couple of quarters as we posted in Q2, although the mix will likely change and shift to more corporate based on our current pipelines. Fee income again was a bright spot in Q2. As revenue growth of 15% as Mike mentioned year-over-year was at the high end of our expectations. Our Standard and Premier acquisitions drove the bulk of this growth as they delivered very close to the projected levels. We are pleased business team met objectives of course and we remain encouraged about the future opportunities in both of these businesses. Away from acquisitions, we were also very pleased with our organic growth in several client segments. Our wealth management platform again posted solid results consistent with the above market growth we have posted in wealth for several years now. Our card services revenue continued its steady year-over-year mid single-digit growth rate largely driven by our consumer client base. Treasure management services to our commercial clients posted nearly 7% organic growth in the quarter driven by continuing penetration gains and improved pricing. And we believe there are further growth opportunities for us here in both product and certain client segments. So summarizing fee income was up 14% in the first six months of the year. The Durban air change caps that went into effect as of July 1, will slow our growth rate nonetheless, we expect second half fee revenues in total should be very close to what we posted in the first six months. Moving to credit, our credit performance in the quarter was also favorable. Again reflective of the current benign credit environment as charge-offs of 16 basis points were well below what we would call our normalized range of 25 to 40 basis points. Our non-performing assets increase in the quarter was driven by the lumpiness inherent in managing some larger exposures. But overall, we continue to see significant improvement in our potential problem categories. As a result we feel good about continuing to operate at or below our full year charge-off forecast. Given our current visibility we expect the second half would see us closer to the lower end of that normalized range. So now I will turn the call over to Pat.

[Patrick Barrett:]

Thanks Mark. Turning to net interest income and margin, net interest income was up $2.5 million or 2% compared to the prior quarter and $27 million or 31% compared to the prior year. Compared to the prior quarter the second quarter benefited from the impact of higher rates and loan growth partly offset by drop in accretion. Compared to the prior year the increase was driven by higher balances and accretion resulting from the standard acquisition as well as the positive impact of higher rates. Acquired loan accretion contributed nearly $9 million to the quarter down from $11 million linked quarter. Tax equivalent net interest margin for the current quarter was 388 down one basis point or relatively flat compared to the prior quarter and up 16 basis points from the prior year. Compared to the prior quarter margin reflected a 10 basis point decrease due to lower standard accretion largely offset by an 8 basis point increase due to the positive impact of higher rates. Compared to the prior year the increase in margin was driven by an 8 basis points increase in acquired loan accretion due to the Standard acquisition combined with the positive impact of higher rates. Average interest earning assets were up $155 million compared to the prior quarter driven by loan growth and up $2.4 billion compared to the prior year reflecting the Standard acquisition as well as loan growth and securities purchases. Funding sources were up 2% linked quarter reflecting the beginning of our typical municipal inflows combined with solid DDA growth across the board. We remain very pleased with the strength of our core deposit franchise and the continued very low interest cost associated with it. Second quarter results are very much in line with our expectations for both net interest income and margin. Looking ahead we would expect to see quarterly growth for both net interest income and margin. Looking ahead, we'd expect to see quarterly growth in net interest income similar to this past quarter and stable-to-modest compression in margin as total accretion is expected to decline to $6 million and $5 million in the third and fourth quarters respectively. Excluding accretion, we expect continued margin expansion through the rest of the year reflecting the positive impact of higher rates. And as a caveat to our guidance, keep in mind that the timing of future interest rate hikes, deposit repricing trends, the shape of the curve, timing of the earning asset growth as well as acquired loan accretion can create volatility on a quarter-to-quarter basis. Moving now into expenses, non-interest expense was in line with our expectations declining 15% from the prior quarter, an increasing 23% year-on-year. Excluding acquisition integration expenses, total expenses were flat to the prior quarter and up 22% compared to the prior year, while our efficiency ratio improved to 59%. The addition of standards ongoing operating expenses was the primary driver and the increase is across most categories. In addition to the impact of Standard, salaries were down 2% from the prior quarter reflecting higher deferrals and the absence of certain organizational expenses that were accrued to the first quarter. Professional fees were up in the second quarter, largely due to the finalization of our work around our first defessed filing, while advertising expense was up due to the timing of annual spend. Aside from these items, expenses were very stable. Integration cost dropped to $1 million down from $18.5 million in the prior quarter and expected to be largely completed. Accordingly, we expect expenses to remain relatively stable throughout the remainder of the year in line with our annual outlook with only modest fluctuations around normal seasonality or occasional volatility due to the timing of specific expense categories. And to wrap up with taxes, our effective tax rate for the quarter was 36% returning to just above our annual guidance of 35%. Now, I'll turn it back over to Mike for final remarks.

[Michael Scudder:]

Okay. Thanks, Pat. Before we open it up for questions, there's some quick kind of recap or further remarks. As we reached the midpoint of the year and look back on the first half, it's actually a time period where we've accomplished a tremendous amount. At 14 billion in assets, we are roughly 25% larger than when we started this year and our teams have done an absolutely tremendous job of managing through the distractions and adjustments that naturally come when you grow and you cross $10 billion in assets. So, as you look at that and those if you will distractions and adjustments that make organization, those are largely in the rear view mirror and continue to grow further in the distance. We crossed $10 billion over 15 months ago. Standards closing is now seven months past. We have prepared for in our around the verge of submitting our defessed stress test exhibitions, those are in place. And as Mark alluded to, the interchange estimates that we expected to see relative to the Durban impact looked to be in line with where our estimates put us. And most importantly having done all of that, our underlying business continues and underlying business momentum continues to build. So, as we look at the rest of 2017 and out into 2018, our business in our balance sheet we feel are pretty well positioned for continued growth and our expectations for continued performance that remain high. So, with that as a recap, let's open it up and we'd be happy to take any questions you may have.

[Operator:]

Thank you, Sir. [Operator Instructions] The first question will come from Michael Young of SunTrust. Please state your question.

[Michael Young:]

Hey, good morning.

[Patrick Barrett:]

Good morning.

[Mark Sander:]

Good morning, Michael.

[Michael Young:]

I wanted to start off just maybe if we could get a little more color on the uptick in nonperformers, just I know you said in the release they weren’t specifically related and where individual issues but this industries product types et cetera. Maybe just a little color there.

[Mark Sander:]

Sure. One both unique sort of answers, one manufacturing, one in distribution and one in multi-bank credit, one a single-bank credit. So, kind of again no pattern between the two I guess I would say. Both were previously in our severely rated at a performing category. So, the move just NPA was not really a surprise. And as I say the increase in NPAs were more than offset by improvement we saw in other potential problem categories.

[Michael Young:]

Okay, great. Thanks for that color. And then just maybe on the CRE side, obviously the growth was a little slower this quarter offset by stronger C&I in consumer but could you give us a little color there if that was a higher pay downs and then obviously given your expectations for the back half. Do you expect that to rebound?

[Mark Sander:]

Sure. We'd like to see CRE growth a little higher in the second half and we expect to see CRE growth a little bit higher in the second half and we then the lack of it if you will in the first half. And you answered the question, thank you, which is a production built nicely in the second quarter but payoffs were higher than we thought they were going to be in the second quarter in CRE specifically. We don’t think that's going to continue, so we think we see net growth going forward from here.

[Michael Young:]

Okay, thanks.

[Mark Sander:]

Thank you.

[Operator:]

Our next question will come from Brad Milsaps with Sandler O'Neill. Please state your question.

[Brad Milsaps:]

Hey, good morning guys.

[Mark Sander:]

Good morning, Brad.

[Patrick Barrett:]

Good morning, Brad.

[Brad Milsaps:]

Mark, just wanted to follow on Michael's CRE question. You guys had nice expansion in your core loan yields this quarter. Just curious if that was held by any prepayment penalties or anything like that or would you expect the loan yields to see a similar kind of expansion in the third quarter stemming from kind of the late June rate high?

[Mark Sander:]

I'll turn it more to Pat for the latter part. Just fundamentally know, I don’t think our yields were boosted by outsized prepayment fees in this quarter.

[Patrick Barrett:]

No. It was largely driven off of just higher rates and repricing of the flooding rate book.

[Brad Milsaps:]

Great. And Mark, where would you say you're seeing new loan yields come on the books at this point?

[Mark Sander:]

Very similar to the last couple of quarters. Our new and renewed spreads have been within a pretty tight range over the last few quarters as similar result in Q2.

[Brad Milsaps:]

Great. And then just one follow-up. I appreciate the guidance around fee income, you allude to in the release maybe some properties that were sold that helped other income this quarter. I was curious if you could maybe quantify that and was curious if that was part of your back half guidance as well if it was a material number.

[Patrick Barrett:]

Yes, that was you're talking about, this is Pat, Brad. That's in the other income, not in the fee-based revenues.

[Brad Milsaps:]

Yes. Just so, it was -- yes.

[Mark Sander:]

And in the guidance that gave us around fee-based revenues.

[Patrick Barrett:]

Right.

[Brad Milsaps:]

Okay, just around that, okay.

[Patrick Barrett:]

So, we definitely were saw an uptick in the other income and it was driven by branch sale gains on disposition kind of old cleanup. There is always a lot of immaterial little things to go into that line item, Bowie is typically the largest. So, I think it was outsized where we would expect last quarter or the last couple of quarters would be much more in line with the normal run rate.

[Brad Milsaps:]

Okay. So, that close to that kind of $3.5 million number?

[Patrick Barrett:]

Think in the press release, it is $3.5 million, so I would have said around two.

[Brad Milsaps:]

Okay, got it. Okay, great. Alright, thank you very much.

[Patrick Barrett:]

Yes. That's the other income line, it was 3.4 for this quarter.

[Brad Milsaps:]

That's right, yes. I think. Got it, perfect. Okay, thank you.

[Operator:]

[Operator Instructions] Our next question will come from Nathan Race of Piper Jaffray. Please state your question.

[Nathan Race:]

Hey guys, good morning.

[Mark Sander:]

Good morning.

[Patrick Barrett:]

Good morning.

[Nathan Race:]

A question on the reserve build this quarter. Mark, if had, can you kind of just help us parse out how much of the reserve build was tied to the two large CNI loans that were moved in on accrual versus year over all loan growth in the quarter?

[Patrick Barrett:]

Yes. I would say, Mark, you can correct me that it was not a material driver, think the reserve build was still in line with where we are from a balance perspective.

[Mark Sander:]

That's right. Because our charge of forecast guidance for the year really hasn’t changed.

[Nathan Race:]

Got it. And then just think about deposit cost and the back of this year, it doesn’t sound like you guys are seeing a whole lot of pressure in terms of increasing pricing and so forth. If that's the case --.

[Patrick Barrett:]

I'm knocking on wood.

[Mark Sander:]

We're really not. Ours is a very granular heavy consumer deposit base, really very light an institutional versus no -- what you call really the hardcore institutional money. So, we're seeing very little pressure on our deposit cost at this point.

[Nathan Race:]

Got it. And can you remind us just how much of your deposit base is tied to consumer deposits, retail deposits?

[Patrick Barrett:]

About 60%. We are seeing very little pressure on our deposit cost at this point.

[Nathan Race:]

And can you remind us just how much of your deposit base is tied to consumer deposits, retail deposits?

[Patrick Barrett:]

About 60%.

[Nathan Race:]

Good. If I can just sneak one last question in. It sounds like one of the MPLs this quarter was snick, can you just remind us how much of your loan book is tied to shared national credits?

[Michael Scudder:]

A very small portion, just not a big part of what we do, it's probably about 5% or so of our commercial book a rough estimate.

[Nathan Race:]

Got it, I appreciate all the color guys.

[Operator:]

Our next question will come from Terry McEvoy with Stephens Inc. please state your question.

[Unidentified Analyst:]

Good morning, Christian for Mike, just to follow-up on your closing comments. You are well over $10 billion today. Do you stop and catch your breaths and achieve the cost saves in front of the rented revenue synergies or do you take advantage to what sounds like a heightened level of M&A opportunities really across the Midwest?

[Michael Scudder:]

It's a great question. What we have said consistently over the last couple of quarters is there is a certain maturation that goes with having crossed and the pace of growth that we have had. Having said that we largely pass that and certainly anything that you look at in the space of opportunities that come have to be evaluated against very large. So we deliberately been a little slower and less focused on that. We have been more focused internally as to what we needed to accomplish. Certainly, as we start to move that into the rear view mirror our ability to forward our willingness to move forward growth.

[Unidentified Analyst:]

Thanks and then a question for Mark. You mentioned the specialized industry verticals were behind some of the commercial growth. Could you just comment on healthcare I believe that falls under the specialized vertical, the size of that portfolio today and any other comments with regards to growth and/or credit trends?

[Mark Sander:]

The size of that portfolio today is give or take about $500 million. It's been a nice growth vehicle for us and returned to good performance in Q2 repeating what it did, what the group did throughout much of 2016. So we are still as much as it's been nice outsize growth for the last couple of years for us it's still a modest part of our overall booking and therefore we see good amount of opportunities there. As you may recall we hired a group, a small group in Ohio last year to further expand it. So we have high hopes and expectations for it going forward.

[Unidentified Analyst:]

Okay. Thanks guys.

[Operator:]

Your next question will come from Christopher McGratty of KBW. Please state your question.

[Christopher McGratty:]

Hey good morning everybody. Mark, maybe question for you on pipelines and activity in Chicago, there has been a lot of M&A activity in the market. Any success in hiring from competitors given the disruption as you have seen?

[Mark Sander:]

We have had a little success there. We haven't been overly aggressive in trying to add bodies there, but as we still, many times good commercial bankers will always pay for themselves and we are always going to keep an eye out on disruption always provides those opportunities. So we have hired a couple Chris, and that will up. We will continue to look to do so.

[Christopher McGratty:]

Right and Mike on M&A, I think in the past you have talked about broader aspirations just beyond Chicago, can you kind of, if the markets that you are looking at potentially to grow, have changed dramatically since your last year would you be kind of willing to step across the borders and maybe size of acquisitions that you might contemplate given that you are not wealth return? Thanks.

[Michael Scudder:]

Yes. From our perspective we follow the same general philosophy and strategy as we’ve evaluated opportunities. I have said it on a number of occasions the M&A space is not a strategy in and of itself, it’s an extension of the strategy. So broadly as those things that align with what we are doing strategically become available or out there for us. We feel we are in a position to pursue those as long as they meet that criteria for us. Having said that the strategy that we have been deploying certainly would see our opportunity to opportunities to move into adjacent markets and adjacent to where we operate and build on our franchise we certainly would have an interest in that to the extent they meet our criteria for what we are doing and they fit culturally of what we are trying to do.

[Christopher McGratty:]

Great and maybe just a couple of housekeeping for Pat. In [Indiscernible] you talked about MSR adjustment do you have that and then also the dollar amount of the increase in income that you expect to realize overtime, I got the back half?

[Patrick Barrett:]

So that MSR adjustment was, I would call it a modest negative after having a very modest positive in Q1, so absent that adjustment you would have seen mortgage banking income up about 10%. And I didn't hear the second part of your question Chris. Could you repeat that?

[Christopher McGratty:]

Yes. Just the pool of the accretion that you expect to realize over the life, I think you said it was 6 and 5?

[Patrick Barrett:]

Got it, right. Yes, so the big uptick in our accretion this year was almost entirely due to the Standard acquisition. We are expecting about $30 million of total accretion this year. We have modest favorable outcomes in each of the first two quarters but absent that we would expect the second half of the year to take us to about 32 on the total year. So six and five and each of the third and fourth quarter, total accretion. That's going to likely flatten out. So the bulk of your decrease happens in the first year the way that the scheduling works out and I think we will settle into something in more under four maybe four to five million range on a quarterly basis going forward as we run out through the life of the portfolio.

[Christopher McGratty:]

That's great color. Thanks a lot guys.

[Operator:]

The next question will come from John Rodis of FIG Partners. Please state your question.

[John Rodis:]

Good morning guys.

[Michael Scudder:]

Good morning.

[John Rodis:]

Actually most of my questions have been asked and answered but Pat maybe just a follow-up for you on your net interest income guidance I think you said, you expected a similar increase in the second half of the year relative to the first quarter and second quarter so is that roughly two to three million a quarter is that the right way to look at it?

[Patrick Barrett:]

I think that's fair and I would be remiss if I didn't repeat several of the caveats around timing of things and whether we start to see betas more deposit composition. Clearly, the interest rate hike that we got at the end of June will roll through and benefit the third quarter. So I would expect the third quarter would be in that kind of magnitude and we are not seeing deposit re-pricing yet. Fourth quarter is a little further out so we don't have an interest rate hike expected in September so the fourth quarter growth rate all other things being equal might be a little bit lower. But again, I would caveat that with we are still not seeing meaningful betas and when we do see and we do expect us to start to have a noticeable impact pretty quickly.

[John Rodis:]

Okay and that guidance reflects the lower yield accretion going forward?

[Patrick Barrett:]

Correct.

[John Rodis:]

Okay. Okay. Thank you.

[Operator:]

[Operator Instruction] Our next question will come from Daniel Cardenas with Raymond James. Please state your question.

[Daniel Cardenas:]

Good morning guys. Just couple of quick questions. Going back to your M&A strategy maybe some comments on seller expectations, what are you beginning to see or is the disconnect beginning to shrink or is it kind of expanding given what we have seen with some recent deals?

[Michael Scudder:]

I just celebrated my 30th year with the company, I would say across all 30 years I have never seen the seller bid outspread start to connect. It's an ongoing circumstance [indiscernible] as people look at the operating environment, try and gauge the appreciation that's certainly embedded in the valuations that are out there for the industry as a whole. They try to ascribe those to their own franchise and you just have to differentiate around the quality of the franchise. And then ultimately consideration plays into that as well. But no, I haven't seen it. There are certainly a number of opportunities that we think will present themselves overtime and as we have talked about consistently we view ourselves as having a great franchise and a culture that resonates with a lot of folks that are out there as something they want to be part of, so we think the opportunities will be there. As I said earlier, I want to make sure those fit strategically with what we are trying to accomplish. And keep in mind Chicago in and of itself remains and continues to be a very robust market for business. I mean, it is the center of the Midwest if you will in terms of business activity and economic size. So don't take my comments about adjacent markets as being anything other than just we think those business activity and economic size. Don’t take my comments about adjacent markets as being anything other than just we take those opportunities to expand the franchise, our things that we’ve to think about.

[Daniel Cardenas:]

Okay, great. And then, just one final question here, as I think about the provisioning for you guys really looking forward more just to address growth and charge outs that just kind of a good assumption?

[Michael Scudder:]

Yes, I think that’s a good way to look at it, sorry.

[Daniel Cardenas:]

Alright, great, thanks guys, good quarter.

[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, thank you. Just in closing I want to thank all of you for your interest in and attention to our story as we go through this and participate in this process as we move through and hopefully we’ve shared our belief that First Midwest is our view a great investment and for all that are out there. So with that I’ll close it up, have a great day everybody.

[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.