First Midwest Bancorp, Inc.
Q3 2015 Earnings Call Transcript

Published: 21 Oct 2015

[Operator:]

Good morning, ladies and gentlemen. And welcome to the First Midwest Bancorp 2015 Third Quarter Earnings Conference Call. At this time, I would like to inform you that this conference is being recorded. And that all participants are in a listen-only mode. At the request of the company, we will open the conference up for questions-and-answers for analysts only, after the presentation. It is now my pleasure to turn the floor over to Nick Chulos, Executive Vice President Corporate Secretary and General Counsel of First Midwest Bankcorp. Sir you may begin.

[Nicholas J. 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 third quarter of this year. If you have not received a copy of this press release, it’s available on our website or you may obtain it by calling us at area code 630-875-7463. During the course of the discussion today, our comments may include forward-looking statements. These statements are not historical facts and are based on 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 filings with the SEC should be considered when evaluating any forward-looking statements. And lastly we will not be updating any forward-looking statements following this call. Here this morning to discuss our third quarter and outlook are Mike Scudder, President and Chief Executive Officer of First Midwest Bancorp; Mark Sander, our Senior Executive Vice President and Chief Operating Officer; and Paul Clemens, our Executive Vice President and Chief Financial Officer. With that, I will now turn the floor over to Mike Scudder.

[Michael L. Scudder:]

Thank you, Nick. Good morning and as always thanks everybody for joining us here today. As is our practice is my intend to cover the highlights and then I’ll turn it over to allow Paul and Mark to fill in some additional color. The quarter for us was solid. It reflected continuing execution on our strategic priorities. Earnings for the quarter came in at $0.30 per share which is about 20% higher than a year ago and 5% higher than it was last quarter. Our return on tangible common equity stood at about 12%, that’s almost 200 basis points higher than the same quarter a year ago. Top-line revenues for us this quarter were relatively flat as higher fee-based revenues offset the normalization in the interest accretion we saw from last year’s acquisition. Our fee businesses have continue to perform very well, they’re up 5% linked quarter almost 12% from a year ago. Some of that seasonal, but larger drivers were higher merchant fees, continuing progress that we see in our lease income and derivative product sales. Wealth management continues to be a very strong contributor to our overall performance, it’s up 8% from last year but down slightly from last quarter largely due to the market volatility that we’ve seen. Loan growth compared to last quarter was up about 5% when you annualize that with growth in C&I, Ag and consumer credit leading the way and offset impart by lower commercial real-estate. Mark will talk about this in greater depth as the combination of a couple of business and property sales along with investor CRE activity was a modest headwind and what was otherwise a very solid quarter for us from a loan growth standpoint. Equally important, we remained focused on both building client relationships and maintaining our credit and pricing disciplines around risk adjusted returns, and what continues to be a very competitive market. From a credit quality perspective, the quarter was also very solid. Our non-accrual loans fell to $32 million that’s down almost 30% from last quarter about half of what where we were a year ago. And while the competitive environment for loans is intense, it is getting progressively easier to remediate or move weaker credits. Overall, our credit costs in the form of charge-offs were down about 33% from last quarter, while we held our reserve levels at roughly the same level to loans. Separately, we are very pleased to announce the acquisition of The Peoples' Bank of Arlington Heights, which furthers our running start into the very attractive Arlington Heights market that we got through last year’s PCB acquisition. As well as our plans -- further our plans to build out our footprint in the western and the north western suburbs here in Metro Chicago. The caliber and size of this opportunity allow us to move very quickly through the integration process and all things being equal we would hope to see it close this year, close and integrate this year. With that, let me turn it over to Mark and Paul who can offer some additional color. Mark.

[Mark G. Sander:]

Thanks, Mike. Starting with loans, total loans excluding covered were up nearly 5% annualized in the quarter as Mike mentioned, driven principally by a couple of targeted initiatives in our retail banking business. Consumer loans were up about $75 million net, about half of this was organic growth across multiple channels. We are seeing a significant increase in online and mobile originations and our investments in the integrated offerings client demand is working well. The other half of consumer loan growth was a result of a portfolio purchase of high quality short duration home equity loans, which we thought was a good use of our excess liquidity. Turning to commercial, commercial loans were up slightly in the quarter as solid growth in our C&I and agricultural businesses was largely offset by paydowns in various sectors from favorable outcomes for some of our clients as well as fall in non-accrual loans as Mike mentioned. We saw higher than normal event driven pay-offs, these came mostly in property sold across several investor real estate categories as well as a few middle market companies who sold their businesses and repaid their significant owner occupied real estate loans and working capital loans. Loan production was in line with expectations across our commercial portfolios including real estate. We were particularly pleased with the production from sectors we expanded in the last 18 months notably healthcare and leasing. While we have consistently grown relationship C&I lending over the last few years in our market this segment continues to be extremely competitive. As a result rather than relying on transactional business to any significant degree we think it is crucial to have niche businesses to turn to for grow. We see good opportunities to expand our already successful niches even further. An example of this will be our leasing company recall we acquired this former client about a year ago, we added some additional colleagues earlier this year as well. The $18 million in lease production that they’ve generated year-to-date is about double what they did as an independent company and has exceeded our expectations. This is a trend we think will continue. In a similar way maybe not quite doubling, but as a dramatic of a fashion, but in a similar way our modest expansion of structured finance, healthcare and asset based personnel should pay for themselves quickly and through loan and fee growth. All year we’ve guided to mid to upper single-digit growth in total loans. Anticipating the strong fourth quarter we think our full year growth rate will be in this range slightly above the level achieved through September. Turning to fees, we had another very strong quarter building on the exceptional results in the Q2. Fee based revenues were up about 5% from June and nearly 12% from a year ago, and now represent about 30% of total revenues. Continuing to grow net interest income as a percentage of revenues is an important part of our strategic plan to diversify our income streams and we’ve been pleased with these results throughout the year. At a high level, organic growth accounted for about 60% and acquisitions 40% of our year-over-year increase in fees this quarter. We saw growth in every category, with particular strength in sales of assets generating from our leasing production, strong sales of swaps and treasury management revenues again up 10% this quarter. Notable as well our wealth management business had yet another strong quarter. Wealth management fees grew nearly 8% year-over-year despite pressure from falling stock markets globally. As organic revenue growth over the course of the last 12 months more than offset these pressures. We see continued momentum across all of these fee income areas as well as future potential in mortgage sales and card income. Briefly turning to credit quality it was a relatively benign quarter, the modest charge-offs we experienced brought year-to-date levels to 33 basis points and reinforces our full year guidance of 25 to 40 basis points. I’ll turn it over to Paul.

[Paul F. Clemens:]

Thanks, Mark and good morning everyone. Let me cover the interest income, margin and expenses briefly. Net interest income declined $1 million from a linked quarter, but increased $6.9 million or 10% from the third quarter, a year ago, obviously reflecting the addition of earning assets from the acquisitions taking place in 2014 as well as some really solid organic loan growth. The linked quarter decrease is primarily due to approximately $2 million lower accretion related to acquired loans partly offset by yield on approximately $70 million or 5% in average loans outstanding in the quarter. The margin for the third quarter was 3.58% as compared to 3.76% for the second quarter and 3.72$ for the second quarter in 2014. The decline from the linked quarter was primarily due to the normal seasonal build up and municipal tax deposits, which I alluded to last call, which cost us approximately 5 or 6 basis points. The expected decline in acquired loan accretion for and it was accounted for another 9 basis points. We’ve seen our accretion normalize we think the level is about where we’ll continue for the foreseeable future and as I said on the call last July we had some unusual accretion that impacted our margin to the benefit of about 8 basis points last quarter, which I foretold. And then we had a small amount of loan compression. At September 30th we had roughly $800 million invested overnight with a significant portion representing seasonal municipal tax deposits as occurs every year. We expect an outflow of some portion of these deposit during the fourth quarter and case in point just in the last two weeks, we’ve had about $150 million worth of these deposits flow out. This outflow along with loan growth will likely improve our margin slightly in the fourth quarter. We don’t expect any significant change in accretion in subsequent quarters. Thus for the remainder 2015, we continue to be positioned for rising rates with growing loan portfolio that is over 50% floating and investment portfolio that continue to shorten and we have substantial liquidity to lever at the appropriate time. Obviously the long running rate increases deferred the longer our net interest income will constraint subject to any further levering we chose to initiate. So let me turn to expenses just a minute. Expense of 744 were elevated approximately $800,000 in previous quarters, reflecting some seasonal increases in benefits primarily health insurance and other production related cost. Merchant processing was the big culprit as well as higher professionals' expenses. The higher professional expenses consist of sourcing cost related to ongoing and opportunistic talent recruitment in our election to proactively assist our cyber risk processes not only based upon our current size, but also as we set our sights in reaching $15 billion and beyond. The year-over-year increase is substantially due to managing roughly 15% asset growth and operating 17 additional banking centers acquired in 2014. We expect non-interest expense for the fourth quarter to revert to prior quarter levels. Excluding approximately $1 million of acquisition integration cost relate to Peoples. Speaking of Peoples, excluding the integration cost the Peoples’ transaction will be earnings neutral for the fourth quarter. And is expect to add $0.01 to earnings in 2016. And with that let me turn it back over to Mike.

[Michael L. Scudder:]

Thanks, Paul. Before we open it up for questions, just some further remarks. As we’ve talked about for the last several quarters, market conditions are still challenging as we wait for higher rates and certainly navigate a competitive landscape for credit. As we do so it’s critical for us to remain focused on our priorities, strengthening our teams, balancing our business investments and risk as we make progress on growing our loans and as Mark alluded to building our fee based revenue businesses. Further reinforcing what Paul said our net interest income sensitivity continues to grow more positive to rising rates. We believe this is an advantage that we have and that few others enjoy as we move ahead. But also recognizing that that comes at a cost, certainly in today’s world. Again reinforcing Paul’s comments, we do have the capital and liquidity to leverage our balance sheet and can move to do so if we gauge the risk of lower for longer put quotes around that, the world of lower for longer in terms of rates continues out there. As we look ahead we continue to have great opportunities and our judgment to expand our business banking, wealth and treasury management platforms and further leveraging our investment in existing teams and added talent across all of our platforms, both in terms of the support as well as the sale side. We feel we are very well positioned to grow, expand our business and leverage what we believe is a very strong culture and infrastructure as well as a robust capital base to enhance shareholder value much like we’ve done certainly with our returns on tangible common for this quarter. So with that, let me conclude my remarks and turn it back over. And we can 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 Emlin Harmon of Jefferies. Please state your question.

[Travis Potts:]

Hey, good morning guys. This is Travis Potts on for Emlin. Just starting on the margin, I was hoping you could give a little bit more color on the wholesale borrowings and kind of why are you increasing utilizing that given the higher rate it looks like deposit growth didn’t really make it necessary this quarter and it looks like that kind of a loan was 3 basis points of a NIM compression, was that just getting ahead of the expected muni run-off next quarter?

[Paul F. Clemens:]

Yes and no, that’s really a good question. We -- Mike talked about lower rates for longer we actually waited to this about a year and half ago the additional borrowing costs reflects the cost of a $200 million FHLB advance commitment that we came into being this quarter. We actually -- it’s part of a strategy we implemented I guess May of last year where at that time we began enter into hedging transactions to fix about $700 million worth of floating rate loans. And at the same time, and we did that all in steps over about eight-nine months. At the same time we looked to go out in two, three and four years and start putting all in to mitigate that risk we put on some advanced forward borrowings commitments from the FHLB. That’s been a pretty good bet for us we were able to take the interest rate risk for the first year and half and now that first one hit as of the third quarter. So you will see the cost go up there. It really was to mitigate our interest rate risk on the other side of the transaction and really the time we felt we would need the funds. Now we have not taken those funds yet, but it’s there for us. And over the next three-four years we actually have funding aligned as rates eventually will go up and we’ll have funding there for us.

[Travis Potts:]

Thank you, that’s very good color. And just moving to the cyber risk assessment, understand you said it was a little bit more proactive on your end, can you just give any more color kind of what was the incremental expense there, is this something we should assume hedge going forward or is this more of a one-time thing?

[Michael L. Scudder:]

No this is Mike. This was a onetime thing. We don’t want to talk about individual fees or commissions that we paid in the particular entity, but it was an investment that we and the Board elected to make aspirationally is the way I look at it. We looked at what we were doing today, we run an extremely strong technology platform. But we’re looking at that aspirationally as we look to grow and expand and making sure that our systems were aligned, but directionally where we were going as appose to where we were at. So no, it was a onetime; we’ve certainly gotten that fee back it reaffirmed and we have an excellent platform and positions us well to move forward.

[Travis Potts:]

Great, thanks a lot.

[Operator:]

[Operator Instructions]. The next question is from Terry McEvoy of Stephens Inc. Please go ahead.

[Terry McEvoy:]

Hi, thanks good morning. Mike, I guess I just want to reconcile the statement of the press release about building and broadening the client relationships when the Bank is kind pressing up against this $10 billion level. So how do you balance that growth given the constraints on the absolute balance sheet size? And then as I look at the loan portfolio, is there a way when you say broadening is there a way to just improve the asset yield and continue to bring down the funding cost as part of that whole process to really maximize profitability with a flattish balance sheet.

[Michael L. Scudder:]

Sure. Terry, our plan and we talked about that all along relative to $10 billion was that we were not fearful of crossing the $10 billion we were respectful of the level. As Paul eluded to our liquidity levels for this quarter stand at about $800 million those are certainly inflated by the municipal balances that are out there. So we have plenty of room to leverage in terms of where we are today, which will further strengthen both our business and our relationship side of our platforms. And also provide additional protection and value against an interest rate environment that seems like it’s going to be lower for longer. So with the combination of those two things certainly get us ample room to expand. And then certainly as opportunities become available for us as we look to cross $10 billion that will further accelerate the earnings performance that will come from growth.

[Terry McEvoy:]

And then a question for Mark. First Midwest has done a really strong job growing fee income and I’m just wondering if you could talk about market penetration on certain fee generating products I guess ex. the leasing business and maybe prioritize where you think the most amount of upside will come from looking out into 2016.

[Mark G. Sander:]

Sure, well thank you first of all for the thought, certainly a strategic -- part of the strategic plan. I don’t know if we’ll have this exact in the order of where the growth would come from, but I would say the penetration rates to get to that part of the question. In wealth management our penetration rates of our commercial clients frankly is still not that great. And so we see good growth opportunities there, a lot of well there is some level of penetration, it’s below what I would think would be the level we could achieve. And so the great result that wealth management has put on has been largely through their relationships and when you delever our commercial more. So I think there is nice opportunity there. In a similar way I think we’ve posted 10% year-over-year growth in treasury management revenues on a quarterly basis for several quarters in a row now. And yet our penetration rate there still have room to go. So I would say those would probably be the top two in terms of penetration rates. More broadly leasing is a good example coming back to that again we had zero in the first nine months last year. So obviously on a year-over-year the growth rate there is quite strong. We still are in the early stages of educating our commercial clients relative to what we can do in leasing and that takes some time. And while again our leasing company generates a good amount on their own, our penetration in the commercial, which with our capital they can do more than they could before. But again our penetration in our commercial business is still in early stages I would say. So -- and then last but not least again swaps for certain segments of our commercial base are a good product and we’re still pretty vanilla in the products that we offer there. So we could get a little more, do a little bit more cap scholars and just interest rate protection products I’d say there is some nice plans there as well. Last but not least I guess, I’ll go last but not least twice, mortgage is still a business that is undersized for us and while it’s not going to be a monumental area ever I don’t think it certainly should be, we should have a higher penetration of mortgages in our marketplace. Maybe a little more than would wanted but thanks Terry.

[Terry McEvoy:]

No, that’s great. And then just a small question for Paul, the commentary around future acquired loan accretion remaining constant does that include the accelerated accretion on the PCI loans?

[Paul F. Clemens:]

Yes, hopefully we won’t have accelerated accretion just being normalized accretion.

[Terry McEvoy:]

Okay, that’s great. Thank you everybody.

[Michael L. Scudder:]

Thanks, Terry.

[Operator:]

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

[Michael L. Scudder:]

Thank you very much. Thank you all for joining us here today. As always we thank you for your interest in First Midwest Bancorp and 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.