First Midwest Bancorp, Inc.
Q4 2017 Earnings Call Transcript

Published: 30 Jan 2018

[Operator:]

Good morning, ladies and gentlemen, and welcome to the First Midwest Bancorp 2017 Fourth Quarter and Full Year 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. At the request of the company, we will open the conference up for a 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.

[Nick 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 fourth quarter all the full year of 2017. This morning, we also issued presentation materials that we will refer to during our call which provide historical financial highlights as well as our outlook for 2018. If you would like a copy of our earnings release or the presentation deck, they are available on the Investor Relations section of our website or you may obtain it by calling us at area code 630-875-7463. During the course of discussion today, our comments and the presentation materials 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 our other filings with the SEC should be considered for our call today. And lastly, I'd like to mention it that we will not be updating any forward-looking statements following this call. Here this morning to discuss our fourth quarter and full year results and our outlook for the year are Mike Scudder, Chairman, President and Chief Executive Officer for 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. Let me add my thanks for joining us here today. It's great to be with you. Looking back on 2017, we closed what was truly a transformations year for our company. That was a year of tremendous growth, improved profitability and organizational transition. So before I start, recognizing the kind of distortive impacts that are pace of growth and the distortive impact the operating environment generally has on reported numbers can be challenging, we wanted to try and enhance our communication process for both performance and trends as well as our outlook this quarter. Hopefully all have noticed we've added a supplemental presentation for you to follow along with and with that we believe will helpful as we talk about and provide inside and overall performance. Let me start then with the highlights and we'll follow our typical practice Mark and Pat can walk you through the components of the components of the presentation. For some time, our strategic priorities I have centered on improving our returns and our strategic pillars of building our team, growing and diversifying our revenues, well also investing in our business, while we keep an every watchful eye on management of risk. In 2017, we made substantial progress on all of those front. Now again before I kick off further, let me remind you the magnitude and timing of the Tax Act certainly clouds 2017 results largely through the downward revaluation of differed tax asset. At the same time now, it also represents significant earnings momentum for 2018 as of effective tax rate is expected to fall through about 25%. So, if I take if I could away from what I'll call the infrequent, our adjusted earnings per share and profitability improved significantly in 2017. Adjusted EPS was $0.34 for the fourth quarter, $1.35 for the full year, that's up 6% and 11% respectively versus a year ago. Those levels represent a return on our tangible common equity of almost 12.5% and a little over 13% for the quarter and the year respectively, that's 80 and 106 basis points stronger from an overall performance standpoint than in 2016. In looking back, our performance continues to benefit from disciplined sales success across our business lines, as well as the accretive impact that are risen from acquisitions that occurred over the course of the year. Expansion of our lending teams has broadened our capabilities, allowing us both the build and diversify our commercial lending. Our acquisition of Standard Bank and Trust Company which was closed in January and so our system conversions towards the tail end of our first quarter rather represented asset growth of some 25% but also significant team and client integration particularly across our self-metro Chicago marketplace. This acquisition and transition has gone extremely well. The teams have been great, our colleague and client retention has met or well exceeded our expectations and all of our class saved targets were achieved. In March, we also acquired Premier Asset Management that help to add $550 million in assets under management to our wealth management platform. Combined with Standard, this helped us grow our full wealth business to nearly $11 billion in assets under care. Our wealth revenues for 2017 are up over 25% from last with the last three quarters of 2017 annualizing to a revenue stream that's over $42 million. Importantly, expanded revenues and improved efficiency have quickly rebuilt or built capital. Our levels are now back either proximate two or an access of those levels that exceeded prior to our announced acquisition of Standard early in January. Adding to this, our teams were able to navigate the fourth quarter drag on earnings from tax reform, liquidate all of our legacy CDOs at close to breakeven. And by doing so, increased our regulatory capital levels by some 20 basis points on a linked quarter basis. This was all achieved against the backdrop as I said of organizational transition and alignment as 2017 saw us become subject to the impacts of crossing $10 billion. Our Durban expenses kicked in cost us about 6 million in the second half of 2017. Our first initial DFAS [ph] filing was completed along with the substantial expansion of our internal risk programs, structures in various level for regulatory oversights. Our leadership team has also been significantly strengthened through key hires over the course of the last couple of years. So as I'd again certainly a year and a quarter that's our strong performance again against a backdrop of what I would refer to as a transformational year. Now let me turn it over to Mark and Pat and they are certainly offer addition color.

[Mark Sander:]

Thanks Mike. Turning on Slide 4 of the earnings presentation, you can see our loan growth continued its steady pace this year. For the full year, loans are up 26% in total. And our 6.5% organic growth away from the Standard acquisition is right in line with guidance we provided all year. In Q4, we generated strong C&I growth, consistent with our strategies led our sector based business namely healthcare, franchise and structured finance. We also had a very solid quarter in our asset base group. Now we worked hard to strengthen and reposition our portfolio over the last two years. As we align underwriting standards following any acquisition and in an environment where we can accelerate resolution of troubled credits across the portfolio, these diverse growth drivers help offset such repositioning strategies. In our consumer book, we saw solid growth as well, mostly from retention of organic production and also a small increase in transactional activity. As we saw more volatility in investor CRE businesses all year and given our relatively light consumer book as a percentage of our total, we took advantage of good risk return opportunities in consumer loans, attractive assets in now themselves as well as relative to their impact on our overall profile. Our 2018 loan growth outlook is essentially for more the same. Organically we have grown about 6% annually for several years running now. We are guiding to mid-single-digit growth again in 2018 and think the upper of that range is an appropriate target this year as well more concentrated in quarters two and three based on historical trends. Turning to Slide 5. Credit quality improved in the quarter as we reduced potential problem loans another $50 and non-performing assets were stable as we work through some of these assets. Charge-offs also improved in the quarter to 27 basis points right at our guidance level. We began 2017 with our potential problem assets down 33% from the levels immediately following our acquisition a year ago. This give us confidence that as the current environment normalizes, our charge-offs this year can be relatively consistence with 2017 levels. Over the course of 2018, we expect our allowance to build slightly as we provide for charge-offs, loan growth and to cover acquired loan migration. Slide 6 shows deposits which were stable at favorable levels all year. In the face of all the market rate increases over the last 18 months, our cost of deposits increased only slightly to 17 basis points in Q4. This highlights again the stability and strength of our core deposit base particularly relative to our peers. With continued net new client growth, we also expect continued modest quarterly deposit growth. Pat will now walk through net interest income.

[Patrick Barrett:]

Thanks Mark, and good morning, everyone on the call or listening it. Turning to net interest income and margin on Slide 7. Net interest income was stable compared to the third quarter and up $31 million or 36% compared to same period in 2016 consistent with our overall expectations. On a linked quarter basis, the fourth quarter benefited from loan growth and higher loan fees, offset by $1.5 million decline in accretion, higher cost associated with time deposits and modestly lower securities income which reflected the portfolio positioning the record late in the fourth quarter. Compared to the same period in 2016, the increase was driven by higher loan balances, a positive impact of higher rates and higher accretion. Acquired loan accretion contributed $6 million to the quarter, down from $7.5 million in the prior quarter and up from $3 million in the same period 2016. Total accretion in 2017 was $34 million compared to $15 million in 2016. And we are projecting accretion to stabilize this year 2018 with $80 million of scheduled accretion, which we would expect to begin around $5 million a quarter and decline to around $4 million a quarter throughout the course of the four quarters of this year. Having said that I need to remind that some volatility should be expected. Moving to net interest margin. Tax equivalent NIM for the current quarter of 3.84% was in line with expectations, down 2 basis points compared to the prior quarter and up 40 basis points from the same period in 2016. Excluding accretion, margin expanded 2 basis points in the fourth quarter to 364. Compared to the prior quarter, margin benefited from our September repositioning of the securities portfolio and a higher yield in securities, offset by the decline in accretion and an increase in the cost of time deposits. Compared to the same period in 2016, the increase was principally driven by the positive impact of higher rates but also benefited higher accretion and lower senior and subordinated debt balances. Turning to earning assets. Average earning assets were consistent with the prior quarter with growth in average loan balances offset by the temporary decline in the securities portfolio. Compared to the prior year, earning assets were up $2.1 billion, reflecting the standard acquisition and loan growth. As Mike previously mentioned in light of both anticipated tax reform and market conditions, we took further repositioning actions related to our securities portfolio late in the fourth quarter. We're very pleased we're able to fully liquidate the remaining $46 million of legacy CDOs, while also selling around $150 million in agency CMOs and mortgage back securities for a combined loss of just over $4 million. Cash flows were substantially reinvested by the end of the fourth quarter and the ending balance of the portfolios now return to levels similar to those of the end of the second quarter. Fourth quarter repositioning maximize tax deductions related to previously recognized OTTI on CDOs at the higher federal tax rate and improved our total capital to risk weighted asset position by nearly 20 basis points and allowed us to reinvest the proceeds and higher yield in securities to similar durations to our overall book. This repositioning is not expected to meaningfully impact future earnings but should have a positive effect. Fourth quarter results were generally in line with expectations for both net interest income and margin. Looking ahead, we are expecting full year earning asset growth in the mid-single-digit range and GAAP net interest income growth in the mid to high-single-digit range when compared to the full year of 2017. Net interest margin on an FTE basin is expected to be relatively stable year-on-year that the benefits of earning asset growth and higher interest rates were offset by lower annual accretion combined with the impact of tax reform on our tax equivalent adjustment. Excluding accretions, we expect modest expansion in NIM on an FTE basis. You should note however that in the first quarter, we expect the benefit of higher rates on net interest income dollars will likely be outwait by both fewer days and lower accretion. Similarly the benefits of higher rates on our NIM percentage will likely be largely offset by lower accretion and lower FTE adjustment. And timing I'd miss if I didn't remind you that projections are subject to volatility due to movements in interest rates, the pace of loan growth and seasonal municipal deposit flows. Now, I'll turn it back to Mark to discuss our non-interest income.

[Mark Sander:]

Moving to Slide 8. Non-interest income came in as expected, flat to Q3 away from the impact of security sales. Our three main drivers, deposit service charges, wealth and card all continued on a consistent organic growth trajectory. Deposit service charges fell slightly versus linked quarter due to seasonality but were up 19% from a year ago from both our expanded footings as well as addition treasury management sales. Wealth continues to be a bright spot for us rising nearly 8% linked quarter base simply but very importantly on the sales disciplines of a very strong team. Card is down year-over-year due to Durban, but in Q4, we're pleased to be able to produce more of the same, steady mid-single-digit growth in organic card as we have in the last few years. Our other fee income items are generally lumpier, but mortgage and capital markets both the results came in as expected in Q4. This year, we expect fees to increase at low-single-digit levels. We face the pressure of another $6 million decline based on the full year effective Durban as well as the ongoing impact, our greater digital offering have on NSF fees. Fortunately, our core businesses remained very healthy and provide good opportunities for us to growth through these challenges. We believe our wealth, treasury management and card businesses can each again generate mid to high-single-digit organic growth rates. And as such, we should see a total modest increase in non-interest income in 2018. [Technical Difficulty]

[Patrick Barrett:]

[Technical Difficulty] and down from 64% for the same period a year ago. The increase compared to the prior quarter was due to an increase in salaries, net occupancy and equipment and advertising and promotions expenses partially offset by a decline in professional services expenses reflecting lower loan remediation costs. Compared to the prior year, the addition of Standards ongoing operating expenses was the primary driver of the increased combined with merit increases and investments in additional talent support growth. For 2018, we expect total non-interest expense to increase modestly compared to 2017, excluding acquisitions and integration expenses. The fourth of 2017 minus the special bonus and charitable contribution and adjusted for modest low single-digit inflation would be a good proxy. One last item on expenses, as you may recall will be adopting a new accounting standard for revenue recognition in Q1 of 2018 along with the rest of the U.S. GAAP world. The main impact you will see reflected in our Q1 2018 results 90 days from now will be a reclassification and a restatement of history for both merchant card expense and cardholder expense to net these costs against the respective fee revenues. Using 2017 full year actuals to illustrate, $7 million of card expense we netted against the 29 million of card based fee revenues, similarly $8 million of merchant expense will be netted against the $10 million of merchant servicing fee revenue. Note that our guidance does not incorporate these changes at this time, the insurer will provide clear and transparent details around this during our Q1 earnings and be happy to answer question either now or at that time. Moving on to capital, Slide 10, not going to spend much time on this slide other than to reiterate what Mike already said which is that we're very pleased with our capital growth and position having returned our capital to pre-standard acquisition levels less than a year as well as strengthening our capital in the fourth quarter while navigating the impact of tax reform. And I'll wrap up on Slide 11 with taxes. Our effective tax rate for the quarter was significantly impacted by the $27 million DTA revaluation charge. Excluding this charge, our effective tax rate would have been 34%. Going forward, for 2108, our effective tax rate is expected to be increased to approximately 25%, reflecting the lower federal tax rate partly offset by the higher Illinois state tax rate enacted in the third quarter of 2107. We've also highlighted the additional actions we took during the fourth quarter in response to tax reform just as a recap. Now I'll turn it back over to Mike for final remarks.

[Michael Scudder:]

Thanks, Pat. Looking back and before we open it up for questions, as I started obviously a number of things going on relative to operational impact and growth and trends that we can certainly speak to. But in - just some quick remarks before we do so. If I look back a number of our financial institutions that make up First Midwest obviously have histories that go back in the 100 of years, but 2018 will mark our 35th anniversary as First Midwest. And if I think about it over that time, the key to our success in our longevity has been our collective focus on helping our clients achieve financial success and by extension, our communities to be successful. In the quarter we were very pleased to evidence our appreciation really of both. We did that through an increase to our minimum pay rates, colleague bonuses and as Pat alluded to also a doubling of our charitable foundation. From my perspective, delivering on our promise to our clients comes also with a willingness to adapt and invest in ourselves, our business as well as our colleagues, so that we can continue to meet their needs and deliver the excellence that they have come to rely on for us. As we enter 2018, our balance sheet is very strong, our core deposit base is really outstanding, higher interest rates as well as the benefits of a lower corporate tax structure will generate meaningful earnings momentum and further strengthen capital. Further, the natural distraction and noise that comes attendant to both growth obviously behind us. So as a result, we feel we're even better position to deliver on our client promise and build on 2017's momentum. The investments we've made in our teams and scale leave us ready not only for continued growth but the corresponding investment back into our business. 2018 will see two notable efforts evidencing that investment and commitment. First in May, we will complete the previously announced relocation of our headquarters in a portion of our commercial sales teams to a new more centralized and acceptable Chicago location. This will provide both greater client and colleague access across all of the market but also in the longer term, improved operating efficiency. Along that same things, we also kicked off an initiative that we are calling delivering excellence that really started in the late fourth quarter and has expanded into the first quarter from an overall assessment standpoint. This initiative represents a companywide comprehensive review of our processes and distribution. And as we do this and we undertake this review, consistent with our mission and our approach over these many years, our focus will remain on how we can even better and more nimbly and efficiently meet the needs and expectations of our clients. While it remains in what I'll call the early to mid-stages of our effort, our work today would suggest that we have meaningful opportunities to leverage our investments in infrastructure and technology to build better serve our clients and improve our operating efficiency. As this work unfolds over the short forward period, we feel will be even that better position to talk about the revenue and efficiency benefits that we would anticipate and our plans to achieve them, though I also would highlight for you to recognize that the cost of implementation and execution obviously depending on the nature of those activities will precede the full realization of benefits which would likely be targeted more toward the second half of 2018 and into 2109. But with that as a backdrop I would also remind you that the efforts of those initiatives are really not backed into the underlying guidance that we've provided or Pat has shared with you today. So with that as a backdrop, I'd be happy to open it up for questions.

[Operator:]

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

[Christopher McGratty:]

Hi, good morning, everyone.

[Michael Scudder:]

Good morning, Chris.

[Christopher McGratty:]

Hey Mike. I may start with your last comment and I want to delve into that a bit, I think based on the stock's reaction today, I think people were expecting some color on the expense line, it seems like it's more based on your comment a little bit of timing issue. I am wondering if you could elaborate on what specifically might be on the table. I think in the past you talked about credentials, and you've gone through a couple of years of getting through $10 billion and it feels like there's some fairly low hanging fruit on the expense side. Could you elaborate on how we should think about a magnitude of cost?

[Michael Scudder:]

Yeah, I'm happy too. And you're right, unfortunately the reality of operating a business is sometimes activities don't coincide literally when a release dates are things underline. If you look over the course of 2017 and even into 2106 as we've talked with our investors, we simply share that that's a fairly rapid pace of growth. We've also talked about that internally here with all of our colleagues and in various folks. So as you if you use an analogy pack that quickly there's always a certain amount of efficiency that you feel you have the available to get but you also have to keep your priorities focused on as I started with. We have to make sure that we're meeting the financial needs of our clients and delivering on that mission. And that's been our primary focus and the prism through which we evaluate everything. But as you think about it Chris, and as we go through that and we've talked about it generally, we generally talk to our folks about saying look, is it inconceivable that you would look up and within the pace of what we've done that we couldn't be 5% more incrementally efficient as we think about things. And that's generally the starting point from which I started to honor and word through our efforts. I think as you think about it for this year, I would not anticipate significant impact from that perhaps this year, but you'll start to see some evolution of that over the second half as we're in a better position and our teams kind of complete their assessment and their review. But all of that in my judgment is simply the natural cycle of one going through and saying first thing is first, make sure that you got your clients take care of, make sure that we've transitioned and reflected what would be a 40% growth pay rate over the last two years 2016 and 2017 combined and then from there you can go through and make sure that you navigate that and take advantage of the opportunities that are there. And we think those of those will be meaningful.

[Christopher McGratty:]

Thanks for the color. Thanks Mike. If I could just follow-up on how you might be thinking about, if I understood Pat's guide, take the quarter's $102 million less for and then basically assume low single digit expense growth that would suggest the expenses around four to four time this year, is that I interpret that guide like that?

[Patrick Barrett:]

You did probably closer to the lower end.

[Christopher McGratty:]

Okay. And if I kind of merger with Mike's comments of 5%. With 5% Mike as a starting point in reference, is that like a 5% reduction in the court on rate of expenses is kind of the magnitude of what you're thinking for 2018?

[Michael Scudder:]

Chris, as you think about it that becomes difficult. If I were in a position to be that specific, I would have done so as we started off the call. What we've simply given some sharing off of that is understanding that those opportunities are there, I'm kind of couching I'm in that turn of whether you think about it in terms of incremental efficiency or an expense, it comes to about the same incremental contribution. So you can give it some general thought, but we're not going to get literal or provide clear guidance on that so we're just in a position to be able to do that and we think that will be occurring sometime here over the next short forward period.

[Christopher McGratty:]

Okay. Great. Thank you for that. And maybe just one more modeling question for Pat. I think you guide the low single digit deposit growth higher into mid-single digit loan growth. But in your prepared remarks you said mid-single-digit earning asset growth, maybe not heard it right, but what's the - is earning asset growth going to be a little bit of remix the story this year?

[Patrick Barrett:]

No, it shouldn't be. It should be relatively similar to where we're now, which is like 80/20 loans to securities portfolio. And the nuances of spoken words versus the printed bullet I think is just maybe create a little confusion. So earning asset growth from a loan perspective should reflect the same loan growth guide that has said. So it's a mid-single digit and historically we've been able to achieve on the higher end of that. Overall earning asset growth when you factor in kind of securities growth to keep it at that level would probably be more in the middle part of that mid-single-digits range, because securities portfolio stay flat would grow a little bit less maybe 3 percentage points. Now that assumes all other things are held constant which we all know they won't be. So at some point, we will reach a point in the interest rate environment where we do think that it might behoove us to start putting on more interest risk. So you know another two to three rate hikes will probably get us to that point. So I think our securities portfolio from stable as a percentage of total with a bias towards probably increasing once we do get little closer to where we think the fed's terminal rates are.

[Christopher McGratty:]

In your Pat, what is three hikes?

[Patrick Barrett:]

Yes, three hikes this year with the last one December. I think then we got three more in '19 to reach where we think you know right to 300. We think that's going to proxy for a terminal rate is we can guess towards right now is pretty consistent with what the Street thinks.

[Christopher McGratty:]

Great, thank you.

[Operator:]

The next question comes from Terry McEvoy with Stephens. Please state your question.

[Terry McEvoy:]

Hi, good morning, everyone.

[Michael Scudder:]

Hi Terry.

[Terry McEvoy:]

Just could you - I want to dig into the loan growth outlook for 2018, could you maybe discuss your thoughts around C&I, CRE and consumer? And specifically within the CRE category, do you expect you continue to see elevating levels of pay downs?

[Mark Sander:]

Short answer is yes, Terry. It's Mark here. The - we are good production in CRE. The reality is there's been a lot of good news payoffs for our clients. It's good for them and necessarily great for us in terms of the portfolio but properties are selling at attractive prices and some of our clients who frankly weren't looking to sell, I have been made an offer they couldn't refuse so to speak. So, I think we'll continue to face that headwind into 2018. I think we can hit those obviously guidance levels that we gave. But I think you'll see concentrated in C&I and consumer and CRE maybe grow slightly but at a lesser pace than the other two categories.

[Terry McEvoy:]

And then a follow-up on for Mike. I went through your presentation from the annual meeting last year and you talked about one of your priority is being leverage infrastructure to drive performance and I just wanted to hear your thoughts around how you measure performance, any specific targets that you have for the company either of the near term or long term and how we can monitor the success around performance over the next year and two years?

[Michael Scudder:]

Terry, the way we think about it and the way we incent and talk about within our proxies and the like is on a short term basis, we're obviously targeting where we are from an incremental year-over-year standpoint in growth rate off of earnings and EPS and the like. But on a longer term basis, it's also thinking about the contacts of what's our return on tangible common equity. And we strive and have longer term aspirations to continue to be sustainably in that upper third of return relatively to the operating use of our capital which we think is in the best long term interest of our shareholders. But that's the way we think about it.

[Terry McEvoy:]

Thank you.

[Operator:]

[Operator Instructions] The next question comes from Nathan Race with Piper Jaffray. Please state your question.

[Nathan Race:]

Hey guys, good morning. I just think about credit cost, I appreciate the guidance where net charge-offs kind of modelling to the 20 basis point range. I guess I am just curious you know with criticized class trends in the quarter if you could provide some color on that front and then just how we should be thinking about you know the absolute level of the reserve as we go through 2018?

[Michael Scudder:]

Pat, I'll tact him that. What I'll start with charge-offs. Nathan, you know again we for a long time said that we think our normalized range of charge-offs is in that 25 basis points to 40 basis points and we think we'll continue to stay at the low end of that range, so we're guiding to the mid 20's here. And again reflective of kind of a normalized portion of the point in the cycle is how we look at it. So our criticizing classified as I talked about came down rather dramatically all year, another nice improvement in Q4 at good long term levels good what I'll call the normalized long term levels and so that's what a part that leads us to the guidance that we've given relative to net charge-offs.

[Mark Sander:]

Yeah, and I'll just maybe add to that Terry, if you are back to the slide that we have on asset quality and Slide 5, you see the graph that I think most folks are familiar with on our allowed for credit losses. And we said in the past, we're real comfortable with the levels of allowance we have and we continue to be. But as loans grow and charge-offs occur, we will replenish those levels and this is the part where it gets a little bit tricky as acquired loans rollover and turn into legacy loans, provisions have to be or allowance has to be built for those. And so as time passes, we would expect for this year anyway for the allowance for credit losses as a percentage of total loans to pick up modestly mid-single-digit level. So let's talk about that that's the yellow line where we ended the year at 93.93 basis points as a percentage of total loans that when we would expect that would pick up into the sort of the higher 90's simply by virtue of the behavior of the acquired loan book.

[Nathan Race:]

Okay. Got it. That's helpful color. And then question for Mike, just kind of thinking about M&A prospects, in terms of depository acquisitions this year. I guess as you guys are kind of go into this expense assessment over the next few weeks or months, I guess I'm just curious with this perhaps expense cutting or anything along those lines, is that prohibit you guys from thing about M&A in 2018 or how do you kind of parse those to factors as you begin to begin to help the outlook for this year?

[Michael Scudder:]

It's a great question. Let me offer a couple of elements. You're thinking about it in the context of expense cutting, I tend of think about it in terms of efficiency and the efficiency of the revenue that that we generate. So often times that comes in the form of revenue as well as expense. So I wouldn't get too focused on the expense cutting side but I think you get to about the same result with improved efficiency. In terms of the impact or influence it would have relative to any acquisition activity that's out there, I would not envision of having any. We fully anticipate and have progressed along this path with an eye toward accomplishing and think we have the team to be able to do both. And candidly to success that we would anticipate as this would unfold, I think makes our acquisition opportunities and strategies even more effective. So, because I think that the incremental return we would expect to see on a more efficient operating base as I said makes that even more compelling as we give consideration to that. So I view it as good news on two fronts, the opportunity to do things more efficiently, take care of our clients, be more nimble as we do that and then likewise the opportunity as we think about through M&A activity to the extent that aligns with what we're doing strategically to leverage that and accelerate it.

[Nathan Race:]

Got it. And then just going to thinking about activity on that front, I mean is M&A conversations picked up of late, obviously we saw a couple of smaller sales deals announced late last year, so just curious how conversations and what the outlook looks like for potential transaction in 2018?

[Michael Scudder:]

Acquisition activity is as we all know is not a linear set of activities and tends to align with what's going on in the markets generally. Dialogue remains active across the various forms of institutions that are out there and the various sizes, but the different levels of ownership also create different pace and considerations as they think about that. I would suggest that certainly some of the level of activity relative to taxes and how that was going to unfold over the fourth quarter, obviously had some influence on the pace just as it has some influence on how investors value the space as well because there's just a lot of moving pieces. I think as that calm and becomes clear, you'll see that stuff you certainly see that start to pick-up.

[Nathan Race:]

Okay. I appreciate all the color.

[Michael Scudder:]

Right.

[Operator:]

The next question comes from Nathan Race with Piper Jaffray. Please state your question.

[Michael Scudder:]

Well, that was a quick follow-up. He just asked.

[Mark Sander:]

I think we're looking for Brad Milsaps.

[Brad Milsaps:]

Am I online?

[Michael Scudder:]

Yeah, you're online.

[Brad Milsaps:]

Alright, great, I've been called worse.

[Michael Scudder:]

You are not alone Brad, you are not alone.

[Brad Milsaps:]

Your guys have addressed most everything, just kind of curious, my experience in Chicago can be one of the toughest deposit markets out there, it's great continue to arise, how much of each increase in fed fund do you think you'll capture in your NIM going forward?

[Patrick Barrett:]

I guess I'll take the short straw on that one. This is Pat. Hey Brad. Less and less of each progressive one is kind of the high level. And so we've been real fortunate I don't know how much of its fortune, how much of that skill in the first hundred bps of rate hikes, we've only allowed about 7 or 8 basis points to drift in. And that's been a really good story. I think with each successive one, we're expecting the rate of our beta repricing to be probably two to three times what we've seen over the first 100 basis points. So cost of funds are definitely going to go up. We're also terming out deposits in to CDs both one and two year being very popular promotions we've had which will have an effect on our cost certainly the time deposit line items going to get progressively more expensive each quarter. But we are real comfortable with the levels that we have right now in a fund for loan to deposit ratio drifts up a couple of percentage points during the year. We're comfortable managing in that sort of liquidity environment.

[Michael Scudder:]

Let me add Pat spot on, I mean that's the nature of the world and how it's going to unfold. And we don't set the market but we also have a commitment to our clients that we will always be there with pricing and rates that are consistent with what's necessary to be there in the marketplace. Let me add though a reminder, with 86% of our deposits in core transactional, roughly about 65% of that is in demand and savings accounts. So it is fairly granular and sizable portion of our funding base which we think gives us a real advantage as we go through and navigate then.

[Brad Milsaps:]

Thanks for the color. And Pat just kind of a modeling question. Is there a big impact to TEE margin from the Tax Reform Act, I can imagine for the basis point of view, but just want to see kind of what that headwind was?

[Patrick Barrett:]

It's about four actually. Four base points. So we historically run with about $2 million a quarter, $8 million a year on our TE adjustment and with the new and improved tax rates that actually cut in half, so it will only be $1 million. So the million bucks we lose is somewhere between three and four basis points on an FTE margin.

[Brad Milsaps:]

On an annual basis. Okay. Got it. Thank you.

[Operator:]

[Operator Instructions] The next question comes from Michael Young with SunTrust. Please state your question.

[Michael Young:]

Hey, good morning. I just wanted to just go back to delivering excellence, I know you don't want to get too much more into detail there. But just generally as we're thinking about the 5% improvement, is that a 5% sort of net improvement or should we assume sort of some natural inflation that's offsetting that overtime in terms of the cost base?

[Michael Scudder:]

We haven't gotten to the point where as I said Michael we could be that granular. As I think about it, I think it's about more as a net improvement from where we are. Let me also kind of add and reinforce that because one of the questions that I've gotten was how expansive or where does that look or all, it's looking at all segments of what we do. So it is very comprehensive in terms of that. So it is not isolated on consumer versus commercial versus. We're taking the opportunity to look at a process and delivery of service to our clients that as I said we think we can improve and making criminally more efficient as we go through and do that. So we think that's there. And as we think about that and as I have I've kind of guided you toward some level of percentage, I don't consider that to be the number, I consider probably more to be closer to the four. So I think those are the opportunities that are available to us and that's what we're in the process of assessing.

[Michael Young:]

And Mike, could you provide any more color on sort of how you're conducting that review, outside consulting or you know just what the processes in terms of making the evaluations?

[Michael Scudder:]

Well, as anything we would approach and the process that we're going and executing on that it starts first with what's in the best interest of our clients. So that is an internal process that we've got focused teams looking at across the various groups and that also goes with the measured pace in which we're looking at it. We are using and making available resources that are that can give us inside and what are trends and things that we can do. But I think that's just part of our normal MO. Anything that we look at we're going to take a full review and we'll have the benefit of what else is going on in the marketplace and will be base that on not just our resources but also folks from the outside.

[Michael Young:]

Okay. And one last one maybe for Pat. Just within the expense guide this year, what's kind of baked in there in terms of the amount of hiring or on the revenue producing side that you may be expecting this year?

[Patrick Barrett:]

I think across the board, our FTE, sorry not FET, tax equivalent, full time equivalent, our staffing assumptions are relatively stable year-on-year. So the inflation that I referred to is probably just more in terms of market based merit increases but without significant incremental investment or and conversely without significant incremental reductions because as Mike said answering an earlier question, we were fully prepared to continue running the company in the best interest of our customers, to continue to execute against outside opportunities that may come up from an M&A perspective and to execute on this initiative. So we're not scrimping on resources, we've got a lot on our plates and we're continuing to invest in processes and technology, a long list of things already in process and none of that is change.

[Michael Young:]

Okay. Thanks.

[Operator:]

The next question comes from Daniel Cardenas with Raymond James. Please state your question.

[Daniel Cardenas:]

Hey, morning, guys. Just a couple of quick questions. On the M&A front, what is the environment like for additional fee based income type of acquisitions?

[Michael Scudder:]

The environment to be able to do that, certainly much like we did in the case of the investment advisory our IA that was acquired earlier in the year, those opportunities still remain and are active and then there's other avenues of businesses depending on the nature of the fees and the nature of the business that you're considering.

[Daniel Cardenas:]

Good. All right. Conversations are would you say they're fairly robust or is that kind of just have been flow?

[Michael Scudder:]

No, that's more, I would say in that space, it's more aligned with strategically what are you trying to accomplish, then they are what I would call a pan industry element as opposed to certainly consolidation within what I'll call the core banking space continues to be a source of dialogue around various entities depending on their ownership structure.

[Daniel Cardenas:]

Good. And then just on the deposit side really quickly, what was the size of your public funds portfolio this quarter and what were the costs associated, what kind of cost is that carrying right now?

[Michael Scudder:]

So, fourth quarter is typically a lower quarter for us, so we dip down into sub billion balance range, I want to say that was around 900-ish. And from a cost perspective they tend to be probably among our most I'll call it rate sensitive customers. So when rates move, a lot of their rates move as well. I don't think we've actually talked about the actual average rates on across that portfolio.

[Patrick Barrett:]

We haven't talked about that much granularity, but your numbers are right, there are a little bit south of a billion and while it's more rate sensitive than the rest, they've moved up a bit but not significantly impact on our margin.

[Daniel Cardenas:]

Okay. So is this we're in a right in interest rate environment, is there going to be less of a desire to tap the public funds market on a go forward basis?

[Patrick Barrett:]

Well, I think there are price sensitive, but it's been a great stable core deposit base for us for a long period of time. So I don't think that we would are any less interested in it. Again as we think about our mix of deposit, yes it is among the more price sensitive of what we have, but there's a lot of more price sensitive segments that we don't have. So it's still an important part of our quarter funding base we think.

[Michael Scudder:]

Now let me add a little color. It's historically is first and the last in the nature of our underpinnings and foundation, obviously the servicing of those municipal bases are important to us. Our average tenure of those clients is probably pushing in the 20 year range, so that's what we call while it has elements of it that are more price sensitive as it relates to inflows of taxes and other forces of funding. There are also core operating relationships that come along with that and then the natural what I call referral center of influence rates are being a primary account for a number of these municipalities. So it remains an important part of our strategy and important part of our commitment to the community as well.

[Patrick Barrett:]

Now, it'll explode as we get into the tax collections season in the second into the early third quarter as it always does and actual balances can often double sometimes on a weekly basis, but will we drift down to around an $800 million basis of that that we as both Mike and Mark said really do think of is good long term core funding.

[Daniel Cardenas:]

Okay. Great. All right. Thanks guys.

[Patrick Barrett:]

Thank you, Dan.

[Operator:]

The next question comes from John Rodis with FIG Partners. Please state your question.

[John Rodis:]

Good morning, guys.

[Patrick Barrett:]

Hi, John.

[John Rodis:]

Pat, just the follow-up on Brad's question on the FTE adjustment, so you said 4 basis points, so that's about $1 million a quarter, is that correct?

[Patrick Barrett:]

That's correct.

[John Rodis:]

Okay. So I just want to make sure you're NII guidance of mid to high single digits that would be before we had just lowered for that million dollars a quarter, is a correct, sort of apples-to-apples comparison?

[Patrick Barrett:]

That's actually on our GAAP income. So if you take the graphs that we have on Slide 4, 5 or 7 sorry, I haven't internalized all of our slides.

[John Rodis:]

So it's NII growth before the FTE adjustment?

[Patrick Barrett:]

Correct. I think if look you did it after the FTE adjustment, it would be it would start from a lower - it would start from a different base, right, for 2017 actual and then it would reflect that $4 million of lost adjustment. And I think that it would come to something like a high mid-single digit if you have percentage point lower growth rate if you use that.

[John Rodis:]

Okay. Thanks for the clarification. Thanks.

[Patrick Barrett:]

Thanks, John.

[Operator:]

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

[Michael Scudder:]

Great. Thank you. Well, before we leave, let me take the opportunity as I do every quarter and particularly at the end of the year to take the opportunity to thank all of our colleagues for their many contributions and their investment in our performance of 2017. They're the face of our company and our greatest asset. They have done a tremendous job this year, as I said during a period of transformational growth and I'm very proud of what they've accomplished this year. As we think about 2018 and obviously you could tell from the dialogue and the commitment and communication that we've shared relative to 2018, we greatly look forward to 2018 and I feel very confident in our future and what we are looking to accomplish strategically. I would thank all of you for your interest and attention to our story. And certainly as we share our ongoing believe that First Midwest represents a great investment opportunity. So thank you all and have a great day.

[Operator:]

This conference as concluded. Thank you for participating. You can now disconnect your lines.