First Midwest Bancorp Management Discusses Q1 2013 Results - Earnings Call Transcript

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 |  About: First Midwest Bancorp, Inc. (FMBI)
by: SA Transcripts

Operator

Good morning, ladies and gentlemen, and welcome to the First Midwest Bancorp, Inc. 2013 First Quarter Earnings Conference Call. At this time, I would like to inform you that this conference is being recorded. [Operator Instructions] It is now my pleasure to turn the floor over to Nick Chulos, Executive Vice President and Corporate Secretary of First Midwest Bancorp, Inc. Sir, you may begin.

Nicholas J. Chulos

Good morning, everyone, and thank you for joining us today. Earlier today, First Midwest released its results for the first quarter of 2013. If you haven't already received a copy of the press release, you may obtain it on our website or by calling (630) 875-7463.

During the course of the discussion today, our comments may contain forward-looking statements, which are based on management's existing expectations and the current economic environment. These statements regarding future results or events are subject to certain risks and are not a guarantee of future performance, and actual results may differ materially from those described or implied by our statements. Our SEC filings contain a full discussion of the risks that could affect any forward-looking statements. We will not be updating any forward-looking statements to reflect facts or circumstances that arise after this call.

Here this morning to discuss First Midwest's first quarter results and outlook are Mike Scudder, President and Chief Executive Officer of First Midwest Bancorp; Mark Sander, Executive -- Senior Executive Vice President and Chief Operating Officer of First Midwest Bancorp, as well as President of First Midwest Bank; and Paul Clemens, Executive Vice President and Chief Financial Officer of First Midwest Bancorp and First Midwest Bank.

With that, I will now turn the floor over to Mike Scudder.

Michael L. Scudder

Thanks, Nick. Good morning, everyone. Thank you for joining us here this morning. What I want to do is jump right into it and talk about the quarter. It was a solid quarter for us, and it reflected continued improvement on our earnings and was right in line with our plan and general expectations. So I'll cover the highlights by way of organization here. And then ask Mark and Paul to provide some color on the overall business and the financials themselves.

So let's start off with some of the highlights. We earned $0.20 for the quarter, that's up 11% from the fourth quarter and 82% from where we were a year ago. Our total revenue was up about 2% versus the same quarter a year ago and that was largely on targeted growth in our fee businesses, which we've highlighted as an important offset to net interest income pressures that come in today's environment.

Our loan footings were stable in what is typically a slower quarter from a growth standpoint. Overall, yes, we were pretty happy with our corporate loan growth. That was about 2% annualized as I said in generally a slower kickoff point for the beginning of the year. And our underlying C&I growth was actually pretty good as well. So our pipelines are solid and we're looking -- and pointing towards stronger second half growth as the momentum in the quarter was really starting to build as we closed the quarter. Having said that, and as I'm sure all of you have heard a number of times, it remains a very competitive environment. Mark certainly will expand on this, but we're sticking to our credit and pricing discipline so that's important to highlight. As we operate in an extremely competitive environment, I think it's important those discipline hold, and they certainly have some influence on volume levels. But again, we felt very good about our loan growth and feel solid about our pipelines and our progress from this point.

Our credit profile is much improved and that has reflected in lower credit costs -- those are certainly down. Our first quarter net charge offs equated to an annualized 53 basis points. That's in line with where we were in the fourth quarter and about a 1/3 of where we were a year ago. We remain very focused on our overhead costs. I think those are reflected in our numbers as well. Paul certainly will expand on that a little more, but the quarter reflected about $1 million in severance expense, and as we talked about, we've been working to align both our credit remediation as well as our staffing levels consistent with where we're seeing changes in volumes. So as our credit metrics continue to improve, we expect to see sequential improvement in our overhead. Again, which is right in line with where we're trying to drive them.

And then, finally, our capital metrics are quickly returning to what I'll call pre-bulk-sale level. Recall we did the third quarter 2012 bulk sale. Our Tier 1 common capital ratio is recovered in just about 2 quarters over half of the dilution caused by the bulk sale, and we continue to make solid progress as our earnings have stabilized there. So as I said, a solid overall quarter and in line with our expectations.

So now, what I'll do is turn it over to Mark, and he can certainly expand on some of the business activities.

Mark G. Sander

Thanks, Mike. I'll start with a few comments on credit performance for the quarter, but spend the bulk of my time discussing the momentum we see in all of our lines of business and of course, provide guidance on all of these topics for the remainder of 2013.

We had a relatively benign quarter in credit remediation, I would say. NPAs remain level, but adverse performing credits fell 7% as we continued to work at-risk credits out of the bank -- and I'd point out not just in categories we reported in the Q, but across all of our higher risk categories. You will likely see further progress on working adverse performing credits down the remainder of this year. Certainly, we expect some specific credits to improve into pass ratings, but we will also continue to move our backlog of higher risk credits into NPAs or TDRs. Given this focus on moving certain specific credits out, and the remaining risk in our consumer book, we are sticking with our full year net charge off guidance of 60 to 80 basis points. As Mike pointed out, our charge-off levels in the first quarter of $7.5 million did reflect slightly better performance than that range would indicate.

I would note that consumer loans and the portion of our small business segment that is characterized by a heavy reliance on residential real estate for credit support represented half of our gross charge-offs in the quarter. We think we need a few more quarters before those segments can return to more normalized credit performance.

Given this remaining headwind and our continued aggressive remediation of all at-risk categories, our charge-off forecast again remains as we guided to in our last 2 calls.

So now, let me turn to the business units, and as Mike indicated, we had a solid quarter, I would say. The loan book had several moving pieces, which netted to an overall unchanged level from 12/31. As seen across the industry, loan demand was pretty tepid to start the year. The first quarter is typically the slowest in our commercial business anyway and the strong December that I referenced in our last call drove a slower start this year than we would have liked.

As in Q4, we saw a modest loan production to start this quarter, but the trajectory changed significantly in March such that corporate loans totaled -- in total grew about $20 million from year end.

We had a slight pressure in the quarter from a decline on outstandings -- from a decline in existing lines of credit. In conversations with clients, they can't point to any specific causes other than they're flush with cash and they don't have great ways to deploy it.

Further as I said last quarter, we are not chasing loan volumes to simply increase assets. We are booking loans as part of a long-term full relationship. So in light of all that, I would say we were pleased with several aspects of our loan performance this quarter.

C&I grew 2% from 12/31 and 11% year-over-year as we continue to redistribute the portfolio. Agricultural lending continues to be a consistent growth engine for us, up 2.5% linked quarter and 15% year-over-year. Asset-based lending met expectations, grew about $10 million, $11 million -- a little more than $10 million this quarter.

And lastly, 1-4 mortgage production of $50 million was stable from the fourth quarter, but almost double the year-earlier level. While refinanced activity made up the bulk of our mortgage production, we do see further growth in our mortgage volumes in 2013 as we finish filling out our franchise, a topic we discussed in our last call. We nearly completed our planned additions of mortgage lenders this quarter all of which are paid on production. These additional personnel resources and expanded product offerings should allow us to capture more purchase activity, and frankly our fair share of the remaining refinance activity out there.

Again, our expectation is for higher mortgage volumes for the remainder of 2013 owing partially to correcting our previous under-resourcing in this area and the resultant modest penetration levels.

To wrap all this up, given our solid pipelines in commercial and the expectation that our held mortgage book will grow slightly despite sales levels similar to what we moved in the first quarter, we foresee loan growth for the remainder of 2013.

We previously provided guidance of mid- to high-single-digit loan growth for this year. We still feel optimistic about loan growth in the near term particularly given the 90-day funding forecasts that we constantly review, but our Q1 performance would indicate that we are trending towards the lower end of that range.

Shifting gears, we have not talked much about deposits lately in this low rate environment, but we continue to focus on driving down our funding costs by every basis point we can squeeze out. The continued migration from CDs to money markets and now accounts that we again saw this quarter reflects those efforts. We also grew core retail households in the quarter, which is a key metric, of course, for our retail team. While we did see a modest decline in commercial deposits due to the expiration of TAG at year-end, nonetheless our total transaction deposits are up over $400 million from a year ago. We clearly believe this core funding advantage will be of even greater value again some time in the future.

So shifting to fees for a minute. Our total fee-based revenues were up 14% from the year earlier period, mostly due to yet another strong quarter by our wealth management team and the continuation of mortgage sales as we began last year. In wealth, our platform continues to grow 8% to 9% quarter after quarter after quarter, and we see that continuing throughout 2013. Sales recently booked are strong in this business unit, which gives us a high confidence level for the remainder of this year. We also added a couple of key sales colleagues to some of our under-penetrated markets in wealth. Early sales results and referrals across the teams from these new resources have been very positive.

In terms of mortgage sales, income of $2 million was slightly below Q4, but in line with expectations. While gain on sale margins returned to more normalized levels, we have baked those rates into our forecast of continuing consistent mortgage sales income levels for the remainder of 2013 as was seen in this quarter. We also added interest rate hedging products for the first time this quarter, which accounted for the 37% growth you see in other fees year-over-year.

To summarize our fee income outlook, we had good -- we have really good momentum in those 3 income streams I mentioned. Given a couple of other things, first, that this should be our final quarter of unfavorable NSF fee comparisons and also given that our run rate in business deposit service charges as well as price increases effective April 1 for most of our commercial treasury management products and clients. In light of those 2 things, we expect to drive good noninterest income growth in the remainder of this year.

So with that, let me turn it over to Paul to talk about margins and expenses.

Paul F. Clemens

Okay, thanks, Mark, and good morning, everyone. Compared to fourth quarter 2012, our net interest margin declined to 3.77% or 7 basis points, which was in line with our prior year change from fourth quarter to first quarter. Net interest income declined $2.7 million due to a number of factors: Fewer days in the quarter for one, repricing loans and securities that saw their yields drop 6 and 17 basis points respectively, and the temporary deployment of the late fourth quarter bulk sale proceeds into short-term investments.

By reducing our quarterly funding cost specifically time -- related to time deposits, once again this quarter we were able to offset some of the decline in interest income and believe there's still room to do so again in future periods.

Although loan growth was slow in the early part of the quarter, as Mark said, we saw loan demand building in the latter part with March accounting for half of our growth, which provides us much momentum going into the second quarter.

As we look at the remainder of 2013, we expect net interest income to increase each succeeding quarter -- similar to what we saw in 2012. Expected loan growth should generate net interest income that outpaces the margin pressures from repricing and renewals and lowered spreads on new loans. Now, I would remind you that apart from loan growth earning assets in the form of short-term investments trend up in the middle of quarter each year for our company as we see real estate tax revenues come in from our municipal clients. This provides some small amount of additional income, not much, but depresses [ph] Our margin during that period.

Now let me move on to expenses. On last quarter's call, we suggest a quarterly noninterest expense run rate for 2013 of $64 million to $65 million. First quarter expense was within that range of $64.8 million, but it included, as Mike said, $980,000 of severance costs related to the consolidation of certain support and sales staff and also $1.1 million related to the company's nonqualified deferred comp plan. I'll remind you every time, I guess, that this last item is offset by a like amount shown as net trading gains in our revenue section and fluctuates with the change in the company's stock price.

Noninterest expense is down 11.9% from the fourth quarter 2012, a quarter that was distorted by a number of unusual items including costs associated with the bulk sale and integration of an acquisition. Compared to first quarter a year ago, we are up approximately 2% excluding the severance and nonqualified planned expense items. This increase was primarily due to higher defined -- significantly higher defined benefit pension cost, higher marketing expenses and annual merit wage increases, which were offset by lower loan remediation and IT costs.

As we look at the -- for the remainder of 2013, we are lowering, I would repeat, we are lowering our quarterly expense run rate. The second quarter should be slightly less than the first quarter as we absorbed some additional severance costs. However, we expect subsequent quarters to improve consecutively from this level and average roughly $62 million to $63 million, down from the $64.8 million for first quarter.

The improved expense outlook reflects better clarity around a number of initiatives including our pension expense, remediation savings, which Mike mentioned, staffing reductions and the related severance and adjustments to our FDIC indemnification asset. The actions we're taking should enable us to make consistent progress to improving our overall efficiency ratio significantly.

And with that, let me turn it over -- back over to Mike.

Michael L. Scudder

Thanks, Paul. So let me recap, and we'll open it up for questions if I could. We continue to make solid progress on our strategic plans. I mean, we're executing and in line with our general levels of expectation. Our fee businesses is growing. Our credit pipelines are in good shape. They're more diverse, and as I said, that helps offset spread pressures in today's environment, or as Paul said.

We're working toward continued improvement in our risk profile. As we look there, we're looking for ongoing reduction in aggregate, both nonperforming as well as performing potential problem -- excuse me, potential problem credits. And I was pleased to hear Mark highlighting in the comments -- and I would reinforce that for those of you on the phone -- our deposit funding base is extremely strong. I looked the other day and saw that we were up, just on checking deposits alone, we're up 30% from where we were 2 years ago. Now that's certainly going to be inflated in today's high liquidity environment, but that is a significant level of overall funding opportunity that we have. So we continue to work and expand that there. We kicked off this quarter, the -- at the first quarter of the year, the upgrade of our internet platform as well as introduced mobile banking to our clients. So those are both initiatives that are designed to help retention, growth and efficiency over the longer term.

Finally, we are focused on driving greater efficiency and expect continued improvement. As our -- as Paul alluded to, our earlier 2013 initiatives make forward progress there.

So with that, let me open it up, and we'll be happy to answer any questions that you may have.

Question-and-Answer Session

Operator

[Operator Instructions] The first question comes from Chris McGratty of KBW.

Christopher McGratty - Keefe, Bruyette, & Woods, Inc., Research Division

Mike, the -- just want to make sure I heard you on the NII comment, or Mark, the growth should pick up, the margins going to be a little bit lower. But did you say that NII's going to grow from first quarter levels for the rest of the year?

Michael L. Scudder

Yes, that would be our expectation but I'll let Paul clarify.

Paul F. Clemens

No, that's right. Like I said, just like you saw in 2012, you'll see a progressive increase in income. Our loan growth, quarter -- strongest quarters are second and third quarter and you should see, like I said, the margin compression in each of our lines within our earning assets will be compressed, but the mix will improve away from short-term investments into loans.

Christopher McGratty - Keefe, Bruyette, & Woods, Inc., Research Division

Okay. And on the fee, the color was helpful, so again, the $26 million or $27.5 million of fee income this quarter, did I hear you right that, that number will grow as well for the balance of the year?

Mark G. Sander

Yes, we expect it -- short answer is, yes, Chris. We expect fee income growth in a number of areas this year.

Christopher McGratty - Keefe, Bruyette, & Woods, Inc., Research Division

Okay. And then, Mike, on the dividend, you've got the bulk sale 6 months behind. What are your thoughts on capital deployment? You've got a ton of capital. Would you consider a buyback? Would you -- what kind of a payout ratio are you targeting? Any help that would be great.

Michael L. Scudder

Sure. We've been fairly consistent in our comments there, Chris. What we've been focused on over the last 2 quarters and we're achieving it is stabilizing earnings, strengthening the credit and then that will put is in a position to return to more normalized, what I'll call capital management practices. I can't offer you any specific color because it's in advance of dialogue with the Board, but that remains an ongoing topic of discussion as to what's the most effective way to utilize that capital.

Operator

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

Brad J. Milsaps - Sandler O'Neill + Partners, L.P., Research Division

Mark, just a question on loan growth, and I apologize if I'm missing your comments, but just kind of curious, the demand you're seeing, is it more being driven by some of the regional type of lending that you're doing as it relates to maybe asset-based lending? Or can you kind of contrast that with what you're seeing within your kind of core Chicago market?

Mark G. Sander

Sure. I would say the loan growth that we expect and frankly, the new loans that we put on the first quarter was pretty diverse, Brad. So let me give a little color there. For instance, our commercial real estate, if you look at it, we -- our net didn't grow. We actually had a good production quarter. We saw a few loans taken out by buildings that sold or some insurance companies that came in and refinancing. So we had nice production actually in commercial real estate. Our niche businesses had a nice solid quarter both asset-based, as I highlighted, this agribusiness and our agriculture continues to grow solidly quarter-after-quarter. So we're happy there. But then our core markets, I would say that most of our growth that we expect going forward would be from our core middle [ph] market and small business segments, which have a really nice pipeline as I sit here today. So it's pretty diverse across the platforms.

Brad J. Milsaps - Sandler O'Neill + Partners, L.P., Research Division

Great. And, Mark, any new teams hired during the quarter or your expectations for additional teams as you kind of move throughout the year?

Mark G. Sander

A little bit, Brad. We hired a new area sales manager, which is one of our -- that's what we call our -- one of our business unit leaders. We hired him at the end of last year. He's filling out his team. So a couple, he hired one person in the first quarter. I think he's got -- and I think -- he has 2 more to add here, we think, shortly. So a couple of resources, but not a great deal. We feel really good with -- about the team we have on the field right now. Again, we'll always selectively be talking to people that are in the marketplace, a great relationship manager pays for themselves very quickly. And so we'll always keep our ears to the ground, but it's not like we feel like we need to add staff to meet our loan growth numbers.

Brad J. Milsaps - Sandler O'Neill + Partners, L.P., Research Division

Okay. And then just final question on the nonperforming loans, it looked like the increase was from several different categories. I know you got the reduction in potential problem loans, but anything out there you're seeing that's specific to a certain type of loan or why maybe a few more migrated over this quarter? Just kind of anything you're seeing in the market that would give you a little pause, et cetera.

Mark G. Sander

I wouldn't say there's pause. What I highlighted, I think, is what we're most concerned about is the consumer side of things still has a little bit to run, I would say. There's still some in the Chicago land residential real estate market has lagged the rest of the country. And so while it's not declining, it's not -- prices aren't increasing like they are in other markets that you see nationally. And so some of that just still has to work its way through. I would say that, that would be the biggest area of pause to -- as you phrased it. Other than that, other things are recovering nicely. The industrial segments in real estate are recovering nicely. The apartment business continues to be very strong, clearly. The suburban office market is relatively soft still. It's not declining, but it's not real robust right now. So that -- we'd like to see a little pick up there that we haven't quite seen yet. In the C&I world, I think you're seeing nice progress. So we're feeling good about that book. So that'd be kind of like an overview of all the various segments.

Operator

The next question will come from Emlen Harmon of Jefferies.

Emlen B. Harmon - Jefferies & Company, Inc., Research Division

Mark, you alluded to some kind of customer effects in the first quarter that led to not much loan growth. I guess, were you guys seeing anything in terms of kind of year-end tax concerns? Was there loan growth pulled forward into the fourth quarter? Just any kind of color you have around that would be helpful.

Mark G. Sander

We certainly had a very strong December, as I think the industry did and we had a December that was better in total, better than in total our October and November production. So you had to feel like there was some pull forward. We don't do as much -- we do very little leverages -- leverage lending so some of that companies that were giving themselves dividends financed with debt. We don't really participate in that marketplace. But we definitely saw -- I wouldn't say rush, but a push at year end to fund some outstandings. So I think that carried over into the beginning part of this year.

Emlen B. Harmon - Jefferies & Company, Inc., Research Division

Got you. And then, Paul, quick question for you. Just we have seen some adjustments, the fairly minor adjustments to the indemnification asset the last couple of quarters. Could you maybe give us just a little bit of a sense of how your cash flow expectations are changing there? And do you feel like you're pretty much on pace to run that indemnification asset down by the end of the [indiscernible] periods on your assisted deals?

Paul F. Clemens

I guess, the quick answer is, yes, we're on pace. The adjustment we made in the second and third -- in the third and fourth quarter kind of reset the run rate, I guess. You saw a much smaller adjustment. That number 2 years ago was $95 million from the FDIC. It came down to $65 million and now it's $37 million, and we've got a pretty good handle on where we think those are going to come out. We have 3 covered loan portfolios -- they'll expire in 2 -- in roughly in 2 years, in 2.5 years, and we have a plan for all those now in terms of how they'll runout. So we have a pretty good handle we think on how we'll run that indemnification out -- asset out.

Operator

[Operator Instructions] The next question will come from Terry McEvoy of Oppenheimer.

Terence J. McEvoy - Oppenheimer & Co. Inc., Research Division

Mark, I was wondering if you could talk about the best opportunities to -- for growth within CRE as you look out over the next few quarters?

Mark G. Sander

I think our team sees a nice -- opportunities in a number of areas. The -- as I said, the rental housing market remains hot. And so we're a little cautious there, I would say, because it just -- any time markets heat up as much as that and cap rates get driven to where they are, it's -- that gives us a little pause, to use that phrase again. The industrial, what we're seeing actually some retail come around and there where it's not as competitive you can get -- and where you can require significant cash equity as part of the deal and still have those transactions close. So we see some opportunities there. We're not doing as much in the office space. We've got enough and that market is still pretty, I'll say stagnant, if you will. And so we're not seeing as much there. The industrial properties are improving nicely. Vacancy rates are coming down. Rental rates are going up a little bit. So we see some good opportunities there. We'd also like to -- sorry if I may, just one last one, the other one is there's some in the healthcare space, senior living is a good space that we would like to do a little bit more in.

Terence J. McEvoy - Oppenheimer & Co. Inc., Research Division

And, Paul, the professional services fees, that $5 million number in the first quarter, is that a good run rate to use over the near-term? Or do you see opportunities for that number to go -- move lower?

Paul F. Clemens

We expect it to go lower. That's part of our payback. Not all of our remediation costs are sitting there obviously. But a chunk of our appraisals, just the foreclosure expenses, attorney fees, that's where a lot of it is housed. And as Mike mentioned, we expect to see a payback as we've forecasted all along. So that number should go down consecutively over the quarter.

Terence J. McEvoy - Oppenheimer & Co. Inc., Research Division

And then just one last question, a follow-up on Brad's question -- just the NPAs going up in the quarter, though the potential problem loans declining. And I want to make sure I understand correctly, that's a reflection of just the suburban Chicago office market ongoing, I guess, conservativeness and flush [ph] concerns on the consumer. I'm just trying to understand why the trends there in the most recent quarters have been a little different than your peers -- in-market peers?

Mark G. Sander

Yes. I'd say 2 things, similarly -- reinforce 2 things, I guess, I would say. Partially it's due to consumer and as I'd say, that small business segment that's had some residential real estate support. Those segments represented half of our charge-offs as well as our inflows into NPAs in the quarter. And the other is just -- I say continued aggressive, trying to move things along. And so if that moves something from our classified categories into NPAs in a quarter, then we'll do that to try to move some of the most at-risk properties that we see. And I think you saw a little bit of that in the quarter. We also just had a few properties that we expected to move in the quarter got pushed out a little bit, out of NPAs. So I wouldn't read too much into that.

Michael L. Scudder

Yes. I would echo that. I would be -- temper any concerns that you really have on that simply because in any 90-day period, you're going to see some movement and some shift. Within the mix of our portfolio, we just probably saw less sales in the first quarter probably for similar reasons that it's a slower commercial activity, it's also generally a slower sales activity. So you're going to see in any 90-day period things up and down, I think you've got to look at the trend a little longer.

Operator

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

Michael L. Scudder

Well my closing comments would simply take the form of thank you. We appreciate you joining us here today. Thank you for your interest in First Midwest Bancorp, and wish everyone a great day.

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.

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