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First Midwest Bancorp, Inc. (NASDAQ:FMBI)

Q4 2013 Earnings Call

January 22, 2014 10:00 am ET

Executives

Mike Scudder – President & Chief Executive Officer

Mark Sander – Senior Executive Vice President & Chief Operating Officer

Paul Clemens – Executive Vice President & Chief Financial Officer

Nicholas Chulos – Executive Vice President, Corporate Secretary & General Counsel

Analysts

Brad Milsaps – Sandler O’Neill

David Long – Raymond James

Stephen Geyen – D.A. Davidson

Chris McGratty – Keefe Bruyette & Woods

Emlen Harmon – Jefferies & Co.

Terry McEvoy – Oppenheimer & Co.

Bryce Rowe – Robert W. Baird & Co.

Operator

Good day and welcome to the Q4 2013 First Midwest Bancorp, Inc. Earnings Conference Call and webcast. (Operator instructions.) Please note today’s event is being recorded. At this time I would like to turn the conference call over to Mr. Nicholas J. Chulos. Please go ahead.

Nicholas Chulos

Good morning, everyone, and thank you for joining us today. Following the close of the market yesterday we released our results for Q4 and full year 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 include statements that are not historical facts. These forward-looking statements are based on management’s existing beliefs and expectations as well as the current economic environment. These statements are subject to certain assumptions, risks, and uncertainties and are not guarantees of future performance.

Actual results or outcomes may differ materially from those described or implied by our statements. The risks and uncertainties contained in our most recent 10(k) and other filings with the SEC should be considered when evaluating any forward-looking statements. In addition, we will not be updating any forward looking statements to reflect facts or circumstances that may arise after this call.

Here this morning to discuss our Q4 2013 and full year results 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.

Mike Scudder

Thank you, Nick, and good morning everyone. I would add my thanks as Nick did for your joining us here today. We were very pleased with our performance for the quarter and pleased with our performance for the full year, and when we talk about that we do that from my perspective not just in terms of our operating performance but also in terms of how we’ve executed our strategic plan and how we’ve positioned our company as we go forward.

So all in all you’ll hear this as somewhat of a recurring theme today – in our view we simply did what we said we were going to do over the course of the year, and we did all of that certainly against a backdrop of what I would describe as a challenging and somewhat uneven operating environment.

As I said essentially our performance was right in line with where we expected to be and what we’ve been saying throughout the year. We’ve been consistently focused on building our lending and fee-based platforms to profitably grow and at the same time diversify our revenue streams. So at the same time we’ve been making investments on those fronts we’ve been tightly managing our expenses generally and leveraging a much improved credit risk profile.

So progress on all of those fronts from my perspective has helped drive steady, significant earnings growth over the course of the year and certainly greater returns for our shareholders which is really what it’s all about.

So for Q4 net income totaled $19 million. That’s up 46% versus a year ago. For the full year we earned $78 million, that’s an improvement of $100 million over the prior year which produced a return on average assets for the year of about 96 basis points. Our total loans excluding covered grew 10% annualized for the quarter and 8% year-over-year, and that was led both by what I’ll call our legacy as well as some of our specialized lending platforms.

Mark’s going to speak to this further but I wanted to highlight our C&I and agricultural lending portfolio performance particularly. Both of those areas posted double digit growth year-over-year in 2013. Our C&I, if you look more broadly than just 2013 and go back to 2012, is up about 25% over the last two years.

Our agricultural lending platform, which is a nice niche business for us, closed the year at about $320 million and that ranks it among one of the largest among Illinois banks – so very solid performance out of that group as a whole. So combined, those two portfolios or platforms have increased to represent about 40% of our overall portfolio. So again, that goes to the theme of more diversification within our lending mix.

Our fee-based businesses have also performed very well. Our full-year revenues were up some 10% year-over-year. Comparative quarterly performance was also solid but, and Mark will certainly speak to this as well, it was masked by lower mortgage revenues and a decline in certain lower-margin merchant fee activity which also has an offset within the expense categories.

So our wealth management business continues to shine and was a bright spot for the year – that was up about 10% year-over-year. And our trust business now stands as third largest among Illinois-based banks when you look at it in terms of revenue streams generated. So again, very strong performance out of that group as a whole and a continuation of strong performance here over the last number of years.

From a credit perspective we closed the year with both our nonperforming and our performing potential problem categories – those were improved about 30% year-over-year which in turn resulted in substantially lower credit costs for the year. Our net charge-offs for the quarter and the year were down about 25% and 82% from last year respectively, and again that bodes well as we certainly find ourselves positioned for 2014.

So combined, those efforts worked to offset the asset yield drag and the reality of just the low interest rate environment – what continues to be a very heavy, competitive environment; and the reality and the expected decline that we’re going to see in our covered loan portfolio which is generally higher yielding. So all of those served to pressure loan yields with the offset being the business initiatives that I just listed. So as we closed the year our net interest margin held relatively steady on a linked quarter basis and was a solid 3.62%.

And then lastly as it relates to capital, we’ve positioned ourselves for continued growth. We rebuilt our tangible capital, continue to build it – effectively again doing what we said we were going to do following the loan actions of 2012. So and we’ve done that while enhancing our dividend, and then opportunistically – and we saw some of that in Q4 – are retiring some longer-term, higher-priced debt that’s out there.

So with that as a general backdrop of highlights let me turn it over to Mark and then ultimately to Paul to get some additional color.

Mark Sander

Thanks, Mike, and as usual I will add some color around these strong results we achieved in all of our lines of business to give a sense of what strategies we’re delivering on both in the quarter and the year. In all of our business units our results are either in line with or exceeded the expectations we set out for you in our various calls over the course of the year.

Loan production was again a highlight in Q4. Growth of 2% in the quarter excluding covered was a continuation of steady progress we’d made over the course of the year. Again we saw contributions from many different areas. Mike highlighted a couple; I’ll talk a little bit further about those as well but we really saw production widely diversified across several platforms.

Corporate loans grew $86 million this quarter in line with guidance we provided in our last call. As we look at total commercial loan production for the quarter it was comprised of 50% C&I, 30% investor real estate, 15% from our recently added healthcare group and 5% from our agricultural group. These totals are in line with our strategic goals to accelerate growth in C&I generally as well as in certain segments where we’ve added specialized expertise. A look at our linked quarter comparison illustrates the targeted diversity we achieved as five different commercial segments grew 10% or more in Q4.

I talked at length about our teams last call. It bears repeating just for a moment. We had a strong base of legacy relationship managers. We undertook a repositioning to upgrade talent where necessary and then we expanded into a few industry specializations. To reiterate the team continues to perform well and growth in the quarter is attributable principally to the addition of new profitable relationships.

In retail, retail loans in aggregate grew $45 million in the quarter. Our mortgage production was down 20% which combined with our decision to sell virtually all of the new loans we generated resulted in a slight drop in 1:4 mortgages outstanding at quarter-end. Given this decision we chose to purchase a geographically diverse home equity portfolio as an alternative to other investment securities available. We bought a very high-quality granular book of approximately $50 million in HELOCs priced at Prime floating with all the lines individually reviewed by our consumer credit teams.

Installment loans also grew in the quarter driven both by increased branch results as well as some new sales programs that we put in place out of our call center. We expect our loan momentum to continue going forward. Based on our personnel investments and our current solid pipelines we believe loan growth this year will be in the range of what we saw in 2013.

Core deposits continue to be a competitive advantage of our franchise that we often don’t talk a lot about. Total transactional deposits in all segments were up $380 million on average for the year driven by net household growth in retail, new commercial relationships and higher average balances in all of our business lines. This deposit generation and liquidity remains a key strength of our company and an area we can leverage more in the future.

Fee revenue: fee revenue met our expectations with strong growth in a few areas offsetting pressures that we saw elsewhere. The story here is almost identical to what we talked about on last quarter’s call. We saw declines again this quarter in NSF fees and mortgage banking income driven by lower volumes. We again saw very strong growth in wealth management, up 3% from last quarter and 11% from a year ago. This is an area we highlight every quarter, I never get tired of highlighting it due to the continued strong results. We have a great leadership team there with a strong sales discipline and really high client retention.

Along with wealth management we’ve also emphasized our expectations around card and treasury management revenues. Our card-based fees grew 4.5% and our commercial deposit service charges 7.0% from the same period a year ago. These results again are consistent with both our expectations and with what we have seen throughout 2013.

Our sales of swaps were again strong in the quarter at about $1 million, albeit down from an unusually strong Q3 result. We generated $3.5 million in this area in 2013, a real strong introduction of this product offering as well as a nice offset to some of the margin pressures that are out there.

We would expect 2014 to be another strong year in both wealth management and treasury management. We see opportunities to generate at least upper single digit revenue growth in these areas. NSF fees we expect to remain under pressure due to improving market conditions as well as given some enhancements we’ve made to client relationships such as our internet and mobile banking offerings.

Card income, driven by a continuation of our solid retail household growth that we’ve seen this year and that we expect in ’14 should again offset NSF fee pressures. As home prices continue to improve in our markets we should see a stabilization of mortgage volumes and related revenue levels approximately equal to or above our Q4 results. So in total, we see fee income growing in the low- to mid-single digit range for 2014.

Shifting for a moment to credit and asset quality, we noted last call that we expected still further improvement in future quarters. I would say we exceeded those expectations as charge-offs were lower than we forecasted and we achieved some ambitious targets that we put out there for several credit metric improvements.

Charge-offs were lower than guidance driven by a number of factors. Simply we moved some loans out at a lower loss than we anticipated, recoveries were higher than we anticipated and strong loan growth helped the estimate that we had provided in terms of basis points. Specific to the credit metric improvements we saw NPAs decline over 10% and performing potential loans declined nearly 17% in Q4 alone.

Again, we had good movement of assets including two large relationships which were upgraded based on their improved sustained financial performance. As we look to 2014 we would expect charge-offs away from covered loans for the full year to fall in the range we saw this year of between 35 to 55 basis points.

In summary, as we look at our year in total, we undertook several new initiatives and investments in 2013 which we paid for by reducing expenses elsewhere. Aside from large decreases in provision and remediation costs, since mid-2012 we’ve consolidated 10% of our branches and our FTEs company-wide are down 7%. We have already taken the tough steps to drive our costs down to a level that can provide sustainable higher returns even while we look to lower our occupancy costs further in the future.

2014 is thus about further delivering on these personnel and technology investments, leveraging our existing strengths. So with that Paul will now speak in more detail on expenses as well as margins and other income.

Paul Clemens

Great, thanks Mark and good morning. I always enjoy following that story.

As far as net interest income and margins are concerned, we saw our net interest margin decline a single basis point in Q3 to 3.62%, still very strong as compared to the previous two or three quarters where it declined 7 basis points in each quarter. The increase in our investment yield this past quarter, the improved earning asset mix coupled with slightly lower funding costs substantially offset the decline in the loan yield mix.

We had expected margin to actually increase slightly, the margin while net interest income not so much in Q4 simply because we normally see the seasonal runoff of municipal deposits. And while that did occur primarily and substantially as we expected we did see, as Mark talked about, the generation of retail and commercial deposits that replaced a large part of that. So we still have approximately $600 million worth of on average excess cash for the quarter and that’s higher than what we would have thought. That’s a good story.

I would remind you though that we will see those play out over the next quarter. The way this trend happens, tax receipts start to show up again then and later in Q2 and Q3 and then they pay out. So we would expect to see margin impacted beneficially because of pay down of some of those or pay out of some of those, a reduction in those deposits.

We saw a 14 basis point margin decline in our $5.6 billion loan portfolio from [Q4] which was in line with Q3 and reflected the impact of re-pricing, the greater shift to floating rate loans and the continued decline of our higher-yielding covered loan balances. A 23 basis point improvement in yield on our investment portfolio helped offset the loan yield pressure and was the result of extensions given in the rising rate forecast.

Net interest income was flat for Q4 compared to an increase of $1.7 million the previous two quarters as the $27.0 million increase in average earning assets for the quarter was offset by the single basis point decline in margin. Otherwise we would have been up several hundred thousand dollars.

As in prior years, linked quarter earning asset growth was greater in Q2 and Q3, roughly 2% for each – i.e., 10% annualized in both of those quarters – compared to less than 0.5% in Q4. And our earning asset growth in those quarters generated net income growth despite greater margin decline.

As we look to 2014 and talk about an interest margin in income, Mark talked about mid- single digit loan growth. We would expect margin and net margin to build over the quarter as we will hopefully see net interest income at a pace slightly less than that for a number of factors. The steepening yield curve certainly will help our fixed rate loan book which is about half of our commercial book.

We have some floors that we will burn off if you will, or run off on our floating rate loans over the first part of the year and then we’ll have the decline in covered loans again – obviously a high-yielding portfolio although getting much smaller every year – that will reduce the yield somewhat or the net interest income somewhat. Likewise we expect our investment portfolio to continue to generate stable and improving yields over 2014.

And then finally we will see the full benefit of the $23 million worth of 6.95% trust preferred debt that we’ve repurchased in December. We didn’t see much impact hardly at all in Q4; we’ll get the full benefit of that in all of 2014.

Overall you know, net interest margin income and income will build over the quarter and over succeeding quarters, and our balance sheet will be more asset-sensitive which is good in a righting rate environment.

Let me go back and cover a couple things on noninterest income. Mark talked about the fee-based revenues which comprised the vast majority of our noninterest income. The other items, primarily the biggest single item is [BOLE] income, and if you’ll recall in Q3 we took actions to reduce the cash surrender value on some single separate accounts, [BOLE] contracts which now will enable us – and we talked about this in Q3 – to invest approximately $85 million in higher-yielding investments over the course of 2014. And we’ll pick our time as we read the markets. We could see somewhere around a 100 to a 125 basis point added yield on that particular portfolio than what we saw in 2013.

That coupled with other miscellaneous transactions and activities that generally happen in the noninterest area away from frees should actually push total noninterest income slightly higher than Mark’s forecast for the fee-based business alone.

Let me turn to expenses quickly. Our Q4 expense was $64.8 million, relatively unchanged from Q3 and generally in line with our expectations and guidance after you exclude the nonqualified deferred comp expense which always distorts things. Remember, it’s offset if you will up in noninterest income. The increase in total compensation expense reflects a year-end true up to our defined benefit pension plan – although this cost, I’ll remind you, is down by $1 million from the prior year because of certain changes we made to that program and certain other performance-based incentive programs. We also had slightly higher severance costs this quarter.

Apart from this the only significant expense category of note that changed from Q3 was our FDIC premium assessment. It was $1.7 million in Q3; it’s about $1.2 million this quarter. About half of that was an adjustment of an over accrual as we looked at the assessment; the other had to do with, as our credit profile continues to improve our assessment has been reduced. On an ongoing basis we should see somewhere around $250,000 of a recurring benefit reduced expense each quarter.

As we look to 2014 you know, I think we’ll see our Q4 is probably a decent run rate after adjusting out the nonqualified deferred comp. In essence we incurred about $256 million to $257 million of expense – we should be somewhat flattish with that for 2014. Mark mentioned some of the activities and some of the initiatives we undertook. He talked about the number of branches, numbers on headcount, other things we did to reposition ourselves in 2012 and particularly in 2013, poised for 2014. So we think we’ll be able to continue to make investments and still cover those investments without much change in our expense profile.

And with that let me turn this over to Mike.

Mike Scudder

Thanks, Paul. So as we look ahead we’re certainly optimistic about continued economic improvement – and again, you’ve got to put that in context as relative to where we were when we started 2013. Ultimately the expectation is that’ll drive overall growth and greater business demand. But as that unfolds and as we look out to 2014 our priorities strategically really haven’t changed.

We’re going to continue to leverage investments in our lending and fee businesses through both our legacy and specialized platforms. We’re going to continue to work to protect and expand our core deposit relationships. I think we’re going to build, not think – I know we’re going to build on the improvement made to our mobile and internet platforms in 2013. And as Mark alluded to our desire is to continue to grow and expand on our treasury management business.

We’re focused on carefully managing the near, what I call the near-term revenue pressures that just come from low interest rates while positioning ourselves for an expected transition to higher rates. As we look out and start to talk about net interest income and net interest margin, you have to do that against the backdrop of the number of variables that we don’t control in that. But fundamentally we have to be respectful of a transitional period there and be prudent as we go through and manage that, much illustrated like you saw in this quarter where we saw a much greater preponderance of floating rate credit come on.

All of those things become, if you will, longer-term opportunities and better positioning. And then lastly but certainly not least we’re going to continue to focus on maximizing our efficiency as we look to invest in our business.

So as we close this year our core business is stronger, our underlying business momentum is solid. We have a strong capital base. I think we have an envied core deposit base. All of those will combine to serve us well here as expectations for rising rates continue to grow. And we have a culture and an engaged workforce and colleagues that I think is a strategic advantage in and of itself. So I strongly believe we’re well positioned to grow and continue to enhance shareholder returns.

So with that as a backdrop let me open it up and we’ll be happy to take your questions.

Question-and-Answer Session

Operator

Ladies and gentlemen, at this time we will begin the Question-and-Answer session. (Operator instructions.) And our first question comes from Brad Milsaps with Sandler O’Neill. Please go ahead with your question.

Brad Milsaps – Sandler O’Neill

Hey, good morning.

Mike Scudder

Hey Brad.

Brad Milsaps – Sandler O’Neill

Mike, I was just curious if you could touch on the M&A environment. You know, capital continues to build for you guys and it looks like you’ll continue to accrete capital in ’14 and ’15. If you can just kind of stack rank your thoughts on dividend versus organic growth versus what the M&A environment’s like –what you’re seeing in Chicago and surrounding areas – that’d be great.

Mike Scudder

Sure, happy to, Brad. We’ve been fairly consistent as we talk about this and we’ve been active in going out and talking with our shareholder base about capital building as well. You know, historically within our company and the way we’ve operated over the long term and certainly over my tenure of some thirty years, our focus has always been on organic growth, capital being used to deploy that; maintaining a solid dividend and then excess capital – as one goes to deploy excess capital what provides the best level of return?

That focus really hasn’t changed. Fundamentally as we look at the operating environment there’s a lot of challenges out there. It’s a difficult environment. Certainly the dynamic around consolidation in the industry I would expect to grow. Certainly again in my experience you see a lot of dialog. Dialog doesn’t always translate to action so I think that environment continues to be out there as people consider what their strategic alternatives are.

But we think we have an opportunity to be active in that space but we’re going to be prudent and responsive, and do that with an eye towards what’s in the best interest of our shareholders. So that’s probably as much of a recap as I can give you and probably as vague as I can be.

Brad Milsaps – Sandler O’Neill

No, I appreciate that. And Mike or Mark, and I was running quickly, Mark – I may have missed some of your commentary around sort of the outlook for charge-offs. But I’m just kind of curious on the provision, you didn’t record one this quarter. Sort of pre-cycle you guys had to reserve at around 1.25 of loans; you’re certainly well above 1x coverage of NPLs. As we think about that going out over the next several quarters is that kind of where we need to think about the reserve falling out to, kind of that 1.25 level assuming your NPAs continue to track as they have over the last several years?

Paul Clemens

Brad, this is Paul, I’ll be more than happy to answer that question. I think you know, it depends on what we see obviously in our credit profile. What you see in our charge-offs post bulk sale had been very consistent. It’s reaching new lows for us over the past half dozen years but what you also don’t see, Mark mentioned, are substandard loans. The whole profile continues to improve all the way through our risk rating system for the most part. So as those things continue to improve we’ll continue to see you know, reserve free up basically. It depends on continued progress in our portfolio mix.

Brad Milsaps – Sandler O’Neill

Okay, thank you.

Operator

Our next question comes from David Long from Raymond James. Please go ahead with your question.

David Long – Raymond James

Good morning, guys. You gave a good breakdown of the commercial production in the quarter and I know the growth there has been driven by some of the investments and the expansion into specialty lines. So I was wondering if you can maybe provide a little more detail on which specialty lending areas you’re really seeing some strength.

Mark Sander

The strength in the quarter was principally driven by healthcare and continuing steady progress of ag I would say. Over the course of ’13 it was broader-based than that. We saw a strong 2013 in our asset-based lending platform as well. So you know, I would say those three would be the principals. We also had some decent agro business, kind of first-level processors in food that we saw some strength in during the course of ’13. So those are the areas that I would principally highlight. As I say, our ag business is really solid and we expect another good year in ’14 out of ABL and healthcare.

David Long – Raymond James

Okay, and then as a follow-up, shifting over to the credit side, obviously very good metrics there this quarter but one of them maybe not so good was the substandard credits was up 8% linked quarter. Anything going on there that we should be aware of?

Mark Sander

Really not much of a tory there, right? It went up a few million dollars, some shift of a couple of specific [seven-rig] credits to one more category. But no, I wouldn’t read much in there. We look at that, those two – the line between those two categories is not bright I guess I would say, and so I don’t think that there was any rate deterioration you need to look at there – just a call on a couple credits.

David Long – Raymond James

Okay, great. Thanks.

Operator

Our next question comes from Stephen Geyen with D.A. Davidson. Please go ahead with your question.

Stephen Geyen – D.A. Davidson

Hey, good morning. Maybe just a question on the net interest income, kind of what the growth expectations might be. If I kind of put together some comments from previous quarters and what you’re saying this quarter, margin might be down a little bit, earning assets up a little bit so we get kind of a net interest income growth somewhere in the low single digits – is that kind of a good takeaway?

Paul Clemens

Well, let me put it this way. I think it’ll be tied to our loan growth certainly and our mix, and Mark is guiding above mid-single digits. And we’ll probably, the pace for us will be behind that somewhat and it will build over the course of the year is what I would say.

Stephen Geyen – D.A. Davidson

Okay. Alright. And as far as, just an add-on to the previous question about where the growth is coming from, any expected adds in the commercial group, individuals, FTEs and in specialty lending that you might be thinking about for 2014?

Mike Scudder

I’d frame it this way – we’re always keeping an eye out for ways to augment our efforts I guess I would say and we’ll always selectively hire when the right opportunity presents itself. That said we don’t have plans to add to headcount in commercial. We have a solid base of relationship managers that we think can allow us to achieve our goals for 2014. But there is a certain amount of you know, you see some talent in the marketplace.

We hired three people in commercial banking in Q4, filled some open spots that we had. And one of those people has some expertise in a certain industry segment around steel and metals, so it’s not per se a specialization – it’s just somebody who has a deep amount of knowledge in a certain industry group. We’ll always keep our eyes open for those but for us it’s more about expansion of what we’ve already done and executing further on what we’ve put in place in ’13.

Stephen Geyen – D.A. Davidson

Okay, thanks for your time.

Mike Scudder

Sure.

Operator

Our next question comes from Chris McGratty from KBW. Please go ahead with your question.

Chris McGratty – Keefe Bruyette & Woods

Hey, good morning guys. Mark or Mike, on the expenses I just want to make sure I heard it correctly. The $65 million in the quarter you said that was a fair, obviously there’ll be some seasonal in Q1… I guess what’s the expectation for net expense growth at this level throughout 2014?

Mike Scudder

Yeah, I think what Paul was, and I’ll let Paul speak for Paul here as he’s going through it, but I think what he was generally offering was if you look at the noninterest expense for Q4 and you subtract the nonqualified portion of that – which is really a function of fluctuation in equity prices and is offset by noninterest income – and look at that as an annualized run rate going into next year, you’re going to see relatively flattish noninterest expense. And from my perspective what you’re seeing as that evolves is both a number of initiatives that Paul had alluded to relative to contributors to lower 2014 expense being offset by just business drivers – you know, cost of living increase and other types of things.

Now on a broader expense base you know, the low hanging fruit, if you will, is pretty much gone. What you’re really trying to do is leverage the expense that we have and the structure that we have today into higher revenue growth which is what we’re trying to do. Beyond 2014 I still think there’s some general levers that can be pulled. We’ve talked on a number of occasions about a focus on occupancy expense, not in terms of number of locations but just in terms of how we drive greater efficiency out of that platform. But those initiatives are a little more longer duration as they evolve.

Chris McGratty – Keefe Bruyette & Woods

And is there anything to read into the elevated OREO costs in the back half of the year? I assume part of that was just to set it up for maybe a cleaner ’14, but is that 2.8 run rate that we’ve seen in the back half of the year – I presume that number will come down as your credit conditions continue to improve, right?

Mike Scudder

We would expect that. We would not expect to annualize that number into ’14 and for it to be our run rate, Chris. I agree with you. You know, we had a couple properties, some unique stories with some appraisals. We chose to accelerate a loss with a bulk sale we executed in Q4 with a whole host of small properties. So no, there’s no systemic ongoing run rate at that level. Frankly our largest property we have in OREO, it represents about [20% of our OREO balance] – we think we have a gain on that property. Now, we’re not going to book that and we can’t do anything about that ,but I guess my point is we look at our OREO portfolio and don’t believe that we have the same level of charge-offs into ’14.

Chris McGratty – Keefe Bruyette & Woods

Okay, and just one last one – if I heard you right the excess liquidity will kind of flow out in the first half of the year. And Paul’s commentary on the NIM, if I heard him correctly, we grow from 3.62 or we expand from 3.62; or do we compress first and then kind of lift from there?

Paul Clemens

Well we think, depending on what happens to the excess liquidity in Q1 we’ll grow. Our margin should grow, it should build over the course of the year. And in Q1 it really builds in part because of any mix and in part because of loan growth and asset growth; but also it builds a margin because we have a play down in some of our excess cash. We won’t be devoid of excess cash by the way, but I mean it won’t be sitting at $600 million on average.

Chris McGratty – Keefe Bruyette & Woods

Got it, thanks.

Operator

And our next question comes from Emlen Harmon with Jefferies. Please go ahead with your question.

Emlen Harmon – Jefferies & Co.

Good morning. Paul, I was hoping we could dig a little bit further into long yields and just kind of where those go from here. Obviously you mentioned you’ve got a few floors going away early next year. You guys are adding meaningfully to the loan book and actually the (inaudible) book specifically and I’m just kind of curious as to kind of how you see the pace progression of the loan yields going down and do you feel like at some point next year you’ll reach a bottom? Or what’s the pace of compression there?

Paul Clemens

I think long story short we do expect loan yield compression to moderate, basically bottom out and fairly quickly to be honest with you because basically what’s happened is our fixed rate loan book is benefiting from the steepening curve and that will pick up its pace. As we said during the quarter we saw a greater shift into new production and renewals to floating base loans. And we had some floors on those which we’ve been burning off all during the year in 2013. We will complete that in 2014 for the most part through the first half of the year on our floating rate book so at that point in time they will start benefiting from the steepening yield curve. And then our investment book continues to benefit through some moderate extension risk base.

Emlen Harmon – Jefferies & Co.

Got it, okay. And then somebody asked about nonaccruals earlier but actually I think the more striking thing to me was just the degree that the potential problem loans came down quarter-over-quarter. Could you walk us through just kind of how you were able to bring that down so quickly, whether there were sales there, remediations; whether there’s any kind of positive migration just within that special mention in substandard book?

Mark Sander

Can I answer and say it’s all of the above I guess. This is the best way to put it. So we had a few properties that we moved out. We had a number of upgrades and we had a couple of specifically large upgrades of credits that had been sitting there for a while that had been improved for a while but we wanted to see sustained financial performance before we upgraded them. And that, you know, when you have more than a year of improved performance we think it justifies the upgrade. So a little bit of all of the above is really the answer.

Emlen Harmon – Jefferies & Co.

Gotcha, okay thanks. And then Mike, if I could, one last quick one on capital. Obviously you saw that the dividend hiked again this quarter – that’s two hikes in pretty close succession here. How were you thinking about just the dividend payout ratio and would you try and – you know, you guys are at kind of a 30% payout ratio right now. Would you try and stick pretty close to that over time or could we potentially see that come up a little bit?

Mike Scudder

You know, obviously this is something we talk about frequently at the Board level and with our shareholders. Longer term as a company we’ve been in the 40% to 50% range over the last thirty years and we’ve talked generally about continuing to evaluate and returning to some of those more normalized practices as earnings have stabilized. But again, that’s an ongoing discussion. Certainly in the shorter run we would view that as a progression as opposed to anything immediate.

Emlen Harmon – Jefferies & Co.

Alright, thanks a lot.

Operator

Our next question comes from Terry McEvoy with Oppenheimer. Please go ahead with your question.

Terry McEvoy – Oppenheimer & Co.

Thanks, good morning. Just a follow-up on Emlen’s question: can you go through the last couple quarters’ loan yields ex the covered loans and the impact there? I’m just trying to get a sense is that getting smaller each quarter in terms of the rate of decline? I’m just trying to get comfortable, Paul, with your comments about getting close to that inflection point where new and renewed loan yields are basically at the booked yields.

Paul Clemens

The loan yields excluding covered have been fairly consistent over the last three quarters in terms of decline. We did see, over that period we have seen more floating rate LIBOR-based loans as opposed to Prime which do tend to be a little bit lower yielding loans. They position us going forward much better for rising rates, so long story short we have seen similar declines over the last several quarters. We think those will play themselves out though.

Terry McEvoy – Oppenheimer & Co.

And then a question for Mark: you talked about NSF fees going down in ’14 and it sounds like you mentioned some new products – mobile banking, etc. Is the tradeoff between pushing your customers away from the branches, is that still accretive to earnings given that you’re shutting branches down and driving less traffic through the branch and through the teller? Is that still how you’re thinking about that tradeoff?

Mark Sander

I think about it a couple ways I guess. NSF fees in and of themselves are kind of an animal that I think the industry as a whole have to think about and we ourselves are off of a little bit. The fact of the matter is economic conditions are improving and we have given our clients more tools to check their balances to make sure they don’t go overdraft; and therefore it allows them to watch it closer. Overall that’s a good thing. In my opinion it does hurt our revenue stream there. I think that you’ll see that across the industry.

As we think about it though, how we monetize the investments we’ve made in mobile and internet is something that again we as a company are thinking about both in terms of product offerings and what we do and don’t charge for in those fronts. So we think between delivering there as well as some new product offerings in retail we think we can drive some more revenue. Most of our fee income in retail though will be driven by card income growth.

Our household growth has grown nicely and our number of transactions per card has grown nicely over the course of ’13, and that’s where we’re focused on as well. So again, it’s household growth and some new products to offset some of the NSF pressures.

Terry McEvoy – Oppenheimer & Co.

And just one last quick question: I look at the run rate of earnings in ’13, does that fully reflect the new regulatory world that you’re operating in and how do you think about ’14? Any potential surprises on the regulatory side that could have an impact on expenses?

Mike Scudder

Having lived through this year-end you never know what might be coming on the regulatory surprise side. I think fundamentally we have an infrastructure here for compliance and regulatory control if you will that it’s there you know, and sustainable into the future. You obviously have to invest in that. You’ve got infrastructure as it relates to operation of mortgage activity and the like but all of those should be baked into what we have. So I don’t anticipate anything large certainly as I stand here today.

Terry McEvoy – Oppenheimer & Co.

Great ,thanks guys.

Operator

(Operator instructions.) And our next question comes from Bryce Rowe from Robert W. Baird. Please go ahead with your question.

Bryce Rowe – Robert W. Baird & Co.

Thanks, good morning. Just maybe to dive a little deeper into the loan yield just to better understand what we might expect going forward: Paul, do you have what the average loan yield was for new production in Q4?

Paul Clemens

No I don’t, I don’t have it offhand.

Bryce Rowe – Robert W. Baird & Co.

Is there any guesstimate as to what it was relative to the portfolio yield?

Paul Clemens

Well, as we saw a shift to floating rate LIBOR-based loans the new production for the floating rate loans probably came down a little bit. Fixed rate loans continue to be holding steady, don’t they, Mark?

Mark Sander

Mm-hmm, yes.

Bryce Rowe – Robert W. Baird & Co.

Okay. So on the floating rate loans are we talking about a two-handle or a three-handle in terms of the yield?

Mike Scudder

It depends on the nature of the credit and it depends on the underlying extension off of it. So we don’t generally get into exactly how we price new credit coming in largely for competitive reasons but fundamentally it depends on the underlying nature of the credit.

Bryce Rowe – Robert W. Baird & Co.

Alright, the next question would be around the expense outlook. Paul, I appreciate the detail there. Any color in terms of the loan remediation costs, what they maybe were for Q4? I didn’t see that detail in the press release. And then just kind of wondering what you expect there in terms of the ability to take some of those costs out in 2014?

Paul Clemens

Well just to put it in perspective, it becomes less of a story for us than it was a year ago of course. We said we’d take out about 30% of our remediation costs over the course of the year and that is what we did – personnel, attorney fees, foreclosures costs, you name it, remediation costs, appraisals. We did bring that down about 30% and that was roughly at the time around $7 million roughly. That, we still look to bring that down some more but not nearly to that extent. Obviously you know, as problem assets continue to improve that will come down. It’s less of a play for us in 2014 but we still expect to see some savings in that area.

Bryce Rowe – Robert W. Baird & Co.

Okay, and then last question just on the wealth management side: can you tell us where you ended the year in terms of assets under management? And then just comment on the growth that you experienced over the year, what was driven by the market and what was driven by new business? Thanks.

Mark Sander

Yeah, so our assets under management are about $6.5 billion. That includes custody – it’s about 50/50 custody versus true managed assets. And while the equity markets’ growth certainly helps the fee income, the fee income there is driven by if I may a great leadership team with strong sales disciplines. I mean we have a rigorous look every month at where our revenues are coming from and are we generating our new sales targets aside from valuations? And we exceed them strongly over the course of the year which sets us up well for the future also. It’s new client relationships.

About two years ago we combined our various investment teams under one leadership group and it’s just working well. You know, we made our other business lines in retail and commercial responsible for generating referrals to the wealth management group so you know, a combination of all that I would say. It’s driven around our sales culture and our client retention culture if I may. There’s a certain stickiness that’s in that business generally, but we measure it… When you see generational wealth pass from one generation to the next and we retain those relationships that means we’re doing the job we need to I think.

Operator

And ladies and gentlemen, if there are no further questions I would now like to turn the conference call back over to Mr. Scudder for any closing comments.

Mike Scudder

Well thank you. I guess before I would sign off I would, as is custom and appropriate I want to take the opportunity. We have a number of our colleagues here at First Midwest who listen to the call as they are stakeholders and shareholders as well, and I would thank them for their efforts over the course of 2013; and in advance for their ongoing commitment and engagement through 2014. So it’s really their engagement and their commitment to our clients that drives our success.

So with that kind of post-closing I would thank all of you for your participation today and for your ongoing interest and support. Have a great day.

Operator

Ladies and gentlemen, that does conclude today’s conference call. We do thank you for participating. Please have a nice day. All parties may now disconnect.

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