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MB Financial (NASDAQ:MBFI)

Q2 2014 Earnings Call

July 24, 2014 11:00 am ET

Executives

Mitchell S. Feiger - Chief Executive Officer, President, Director, Member of Executive Committee, Chief Executive Officer of MB Financial Bank, President of MB Financial Bank and Director of MB Financial Bank

Jill E. York - Chief Financial Officer, Principal Accounting Officer, Vice President, Chief Financial Officer of MB Financial Bank NA, Executive Vice President of MB Financial Bank NA and Director of MB Financial Bank NA

Thomas Watts -

Analysts

Stephen G. Geyen - D.A. Davidson & Co., Research Division

Terence J. McEvoy - Sterne Agee & Leach Inc., Research Division

Michael Perito - Keefe, Bruyette, & Woods, Inc., Research Division

Operator

Good morning, and welcome to the MB Financial Second Quarter 2014 Earnings Conference Call. [Operator Instructions].

Presenting today are Mitchell Feiger, President and Chief Executive Officer; and Jill York, Chief Financial Officer of MB Financial Inc. Also present are Mark Heckler, Executive Vice President, Wealth Management and Commercial Services; and Thomas Watts, Chief Credit Officer of MB Financial Bank.

Before we begin, I need to remind you that during the course of this call, the company may make forward-looking statements about future events and future financial performance. You should not place undue reliance on any forward-looking statements which speak only as of the date made. These statements are subject to numerous factors that could cause actual results to differ materially from those anticipated or projected.

For a list of some of these factors, please see MB Financials' forward-looking statements disclosure in their 2014 second quarter earnings release. Please note, this event is being recorded.

I would now like to turn the conference over to Mitchell Feiger. Please go ahead, sir.

Mitchell S. Feiger

Thank you, Laura. Good morning, everyone, and thank you for joining us today. I'll begin our call this morning by providing you with a report on our second quarter 2014 operating performance, then Jill will drill down on the numbers. I'll follow with an update on our pending merger with Taylor Capital and then we'll do our best to answer your questions.

Second quarter was a positive one on most fronts for MB. In the quarter, we earned $23.1 million, or $0.42 per diluted share. That compares to $20 million and $0.36 per share in the prior quarter. The main drivers of performance in the quarter were these: loans, excluding covered loans we're up a modest $27 million dollars in the quarter. That's an approximate 2% annual growth rate, better than in some past quarters, but still needing improvement. We're going in the right direction, but there is still work to be done. I'm going to remind you that we haven't been buying loan participations and in fact, the amount of loan participations we have has been steadily declining. That presents a bit of a loan growth headwind for us. It also makes us -- it makes us different. We think better, but certainly, different than many other banks.

In my opinion, loan markets are now overheated. Pricing has tightened by a meaningful amount of credit structures that weakened beyond an acceptable level, by way of example, guarantees are being reduced or eliminated. Advanced rates on working capital equipment and real estate loans are aggressive or very aggressive. Second lien lending is becoming more common. For commercial real estate loans, loan-to-value ratios are higher. Pre-leasing requirements and spec construction are lower. Interest-only periods have been lengthened and more. In the consumer lending space, loan terms have lengthened and interest rates are very low. Subprime lending seems to be back at low rates as well.

But as with all bids for commercial lending, we're seeing more companies make capital investments and, therefore, have more demand for plant expansion and equipment acquisition financing. Also company balance sheets are strong making loans generally safer. Middle-market companies, company revenues and profits and revenue and profit trends are quite good. I suppose, the stronger financial condition of borrowers generally argues for looser loan underwriting standards, but I think, the loosening has gone too far. My prediction is that loan pricing and structure will continue to worsen, perhaps much more. Essentially, the commercial loan market is following the pattern we predicted several years ago. My belief is that this continues until excess liquidity is drained from the market or credit deteriorates meaningfully and scares people. It's amazing to me how fast people return to their old habits.

All that said, we feel pretty good about our loan pipeline. We're trying to be careful, if we have to a lower loan pricing to win important long-term customers. But we have an advantage relative to some competitors in that regard. We spent the last 5 years building new products and services that were cross-selling to commercial customers. Those products and services include international banking, capital market services, and advice a variety of debit and credit card products, highly specialized and customized treasury management services, private banking, asset management services and more. Those fee products, each are growing business on it's own, can add considerable revenue to a middle-market commercial banking relationship. It can easily be the difference these days between having a profitable and unprofitable relationship.

Consistent with improvement in the financial strength of middle-market companies, credit performance for our company was excellent in the quarter. Basically every credit metric at our bank improved, many by a meaning full amount. As a result, we had a small negative loan provision in the quarter. As a side note, that small negative loan provision was mostly offset by an increase in clawback liability because credit performance of FDIC-acquired assets was good as well.

Positive flows in the second quarter were exceptionally good. Continuing a long string of good deposit quarters, low cost, now these are low cost deposits, increased $335 million in the quarter. That's a 5.5% growth rate, not annualized. That growth pushed our total assets to $9.8 billion at quarter end, absent our pending Taylor transaction, we would be concerned about going over $10 billion later this year. We will, of course, go well over $10 billion once we complete the merger.

Noninterest-bearing deposits reached 34% of total deposits, a very high level for a Chicago Bank.

Strong deposit growth combined with modest loan growth, reduced our loan-to-deposit ratio below 70%. That's lower than I would like to see it. With regard to noninterest income, we saw a good growth in the quarter. Leasing revenues returned to more normal levels. Capital markets, international banking, and trust and asset management did well in the quarter, also gratifying with strong growth in card revenues as a result of new client acquisition.

Our key fee initiatives are all tracking well this year.

Finally, regarding expenses, expenses were up in the quarter for a variety of reasons, but I will let Jill -- I'll let Jill give you the details on that. All right, Jill, turn it over to you.

Jill E. York

All right. Thanks, Mitch. And good morning, everyone. As Mitch noted, net income for the second quarter totaled $23.1 million or $0.42 per fully diluted share, up from $0.36 per share last quarter. Included in our result this quarter was $488,000 in merger costs related to our pending Taylor transaction and some smaller non-core items related to securities losses and OREO impairments. After-tax, these non-core expenses reduced our earnings by about a $0.01 per share.

I thought that this was a straightforward quarter, so I'll just highlight a few of the key items. First of all, I was happy to see our net interest income expand modestly in the quarter by $840,000. Our net interest margin declined by 11 basis points. While this sounds negative, it was primarily due to our very strong deposit growth, that largely was reflected in cashes deferred on the asset side of the balance sheet.

Average cash at the fed increased by $261 million in the quarter, and as of quarter end, totaled $466 million. While these deposit inflows had a minimal impact on net interest income, it impacted the margin by 11 basis points, essentially accounting for all of the margin decline. Another positive in the quarter was credit. We experienced improvement across the board, special mention credits improved by $24 million, potential problem loans improved by $5 million, nonperforming loans improved by $10 million, other real estate loans improved by $7 million, and we resolved $39 million of covered loans. As a result, the provision for credit losses was negative $1.95 million compared to a positive $1.15 million last quarter.

Of course, the income was up meaningfully in the quarter by 9.7%, not annualized, driven by improvement in revenues, generated by our key fee initiatives. I was pleased to see lease revenues rebound by $1.7 million this quarter, driven by strong equipment maintenance revenues. Card fees increased by about $600,000 dollars due to the impact of new customers, and capital markets revenue increased by $400,000 due to merger and acquisition advisory fees earned, and trust and asset management revenues increased by about $200,000, due to the impact of new customers, as well as the benefit of higher equity values on fees.

Core expenses increased primarily due to 2 categories, salaries and employee benefits and other operating expense. The increase in other operating expenses was primarily due to the clawback expense, that Mitch mentioned earlier. This relates to our FDIC transactions, and this expense can vary from quarter-to-quarter based on covered loan performance and the pace of loan resolutions. Clawback expense was $1.4 million in the quarter. Salaries and employee benefits increased due to the impact of an extra day in the quarter, salary increases that occurred at the beginning of the second quarter and higher commissions due to the higher leasing revenues.

Lastly, our effective tax rate increased a bit this quarter, as the ratio of non-taxable income to pretax income declined a little bit.

All right, at this point, I will turn the call back over to Mitch.

Mitchell S. Feiger

Okay. Thank you, Jill. Lastly, before we open the call to your questions, I want to give you an update on our pending merger with Taylor Capital Group. As you probably know, on June 30, we received approval from the Federal Reserve to complete the transaction. Immediately following that, we entered into 3 agreements with Taylor Capital and certain selling shareholders that extended our merger agreement and shifted the responsibility for certain potential payments related to the previously disclosed Taylor compliance issue from MB post-merger to those certain selling shareholders. The final bank regulatory approval needed is from the OCC and we are waiting for that.

All right, at this time, we'll be happy to take your questions. I'll turn it back to you, Laura.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question will come from Stephen Geyen of D. A. Davidson.

Stephen G. Geyen - D.A. Davidson & Co., Research Division

You had mentioned the improvement in what you're seeing from commercial customers, just curious what the line utilization was this quarter and how it has changed over the last couple?

Thomas Watts

This is Thomas Watts. I'm not sure, I know what the answer of it. The utilization probably hasn’t increased that much.

Mitchell S. Feiger

I think, it's pretty steady. But we don't put a lot of credence into that, because for a variety of reasons. Let me give you an example. During the recession, line utilization went up because we lowered commitment amounts, as we withdrew availability. I think, now it could very well be going down because we are adding a lot of very high quality customers, who often times don't borrow at all on their on their lines. So we don't pay much attention to it.

Stephen G. Geyen - D.A. Davidson & Co., Research Division

Okay. All right, that make sense. And as far as loan growth and paydowns, just curious, I know you are adding good customers during the quarter, can you give us an idea as far as new relationships and the growth in loans versus the offsetting paydowns during the quarter?

Mitchell S. Feiger

I don't think, we have published that data. So -- no I'm sorry, I can't give you that data. We haven't published it in the past and we have to think about. If we provided it, we would want to provide it in a defined way, so we understand what it is. So I don't think on this call, we can do. We'll think about providing it though, to you in the future.

Operator

And our next question will come from Terry McEvoy of Sterne Agee.

Terence J. McEvoy - Sterne Agee & Leach Inc., Research Division

Mitch, with loans relative to assets continuing to drop to about 55%, and I understand and thank you for sharing your thoughts on the lending environment, but as you look out over the next 12 to 18 months, I'm assuming you would like to see some growth in the loan portfolio despite the environment you discussed. So where do you see opportunities for your company to grow within an acceptable range of credit risk and interest rate risk?

Mitchell S. Feiger

Okay. So -- excellent question and obviously one we've been thinking about an awful lot. One is we do -- we have added quite a few new customers this year, quite a few actually, and at a pretty steady pace, so it's not that we're not adding new customers, we are adding new customers. Many are very high quality and as I mentioned to the previous question, a lot of them don't borrow or they borrow at certain times of the year only. Nevertheless, they're good banking customers, great deposits, great fees. The other thing to keep in mind is, we're doing a -- we're going to merge with Taylor Capital here pretty soon. And our combined commercial banking sales team is going to double. And I think, the Taylor team in particular brings people who are very skilled at originating loans, so we're looking very much forward to that. And Taylor brings with it a national asset-based lending platform, that's had good, steady, high-quality loan growth. And so, I think, that will help as well. Loan growth is definitely top of mind for us. It's very important. We are very working very hard at it. I think, it was okay in the second quarter, the 2%-ish annual run rate was okay, not great. I think, loan growth is going to be okay. Is our loan growth is going to be at the top of the market, where some people are getting in this environment, 10%, 12%, and 15% growth rates. No, I don't think MB alone, it's going to be like that. Could 2% turn into 4%, 5%, or even 6%, sometimes yes, I think it could.

Terence J. McEvoy - Sterne Agee & Leach Inc., Research Division

And then just as a follow-up. If I look back at the presentation last July, the merger presentation, you were expecting a pretax merger charger of $50 million and then there was a $116 million credit mark and Taylor's NPAs have gone up a little bit this year and you had put a multiple on their non-accrual loans. So I just was hoping you could confirm the restructuring charge and if that anticipated credit mark is relatively in line with the number disclosed last year?

Jill E. York

I'll take that question. So in terms of the transaction costs, I actually think they're going to come down a little bit. I think, there have been some merger costs that have been incurred along the way that we had factored into that number. So I think, the transaction cost will come down a little bit from what we've previously cited. And then in terms of the loan mark, just to be clear, that loan mark encompasses their existing -- Taylor's existing allowance. So when you think about that mark, you should compare that relative to the allowance. And I don't think that's changed materially. I think, it's possible the mark might be slightly larger, but I think, it's pretty close.

Operator

[Operator Instructions] And our next question will come from Chris McGratty of KBW.

Michael Perito - Keefe, Bruyette, & Woods, Inc., Research Division

It's actually Mike Perito stepping on for Chris. I had a quick question on expenses. We've seen in the regional bank space, a little bit more scrutiny on some compliance-related issues in the past couple of weeks. I was just wondering how you guys feel about your compliance build out today, especially when you consider the pending Taylor acquisition?

Mitchell S. Feiger

Yes, great question. So if your question is, are our compliance expenses going to go up, I think, the answer is -- let me say it this way, go up at a rapid rate or at an accelerated rate due to increasing compliance expectations. I think, the answer is no. I think, they will grow at a pretty regular rate. And the reason for that is, is because they have grown at a very high rate over the last 3 years. And I think, the infrastructure that we've built out is robust, it's sound and it's expensive. So basically, we spent the money already.

Michael Perito - Keefe, Bruyette, & Woods, Inc., Research Division

Okay. And then, apologize if I missed this. But I just have a quick question on the level of provisioning in the quarter. Given, obviously, when Taylor comes over it will be marked, so just more focused on your legacy portfolio and your reserve levels today. Was this more of a one quarter phenomenon on this credit at least for this year, do you expect that this could happen additionally? Just any color you can give me on how you guys are thinking about your reserve levels and going forward would be helpful?

Mitchell S. Feiger

Well if your question is, do we expect to have a negative loan provision in quarters going forward? I would say the answer is no, certainly not in the long run. Obviously, it cannot continue forever. If your question is do we expect to see continued improvement in our loan book? The answer is yes. We still have 1.99% of loans that are nonperforming and that number is going to trend down. I think, the way we record our loans or mark them as nonperforming is rather conservative compared to others, and so I think that, that ratio probably stays elevated compared to others, but the risk that's in them is probably pound for pound less than what other banks have. So I think, the long answer to your question, but I think, we expect to see continued improvement in the credit book, but I think, to expect continued negative loan provisions is, probably too optimistic.

Michael Perito - Keefe, Bruyette, & Woods, Inc., Research Division

So I guess, asking in another ways or just kind of, I don't want to put words in your mouth, but is it fair to assume that you guys are still -- view your reserve levels as in excess today given your credit profile?

Mitchell S. Feiger

No.

Jill E. York

No. I guess, I would say the reserve levels are appropriate and that as credit continues to improve, you will see the allowance continue to drift down.

Operator

[Operator Instructions] I'm showing no further questions. I would like to turn the conference back over to Mitchell Feiger for closing remarks.

Mitchell S. Feiger

Okay, great. Thank you, everyone for joining us this quarter. We look forward to speaking with you again in about 3 months. Have a good day.

Operator

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.

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