First Midwest Bancorp's (FMBI) CEO Mike Scudder on Q4 2015 Results - Earnings Call Transcript

| About: First Midwest (FMBI)

First Midwest Bancorp, Inc. (NASDAQ:FMBI)

Q4 2015 Earnings Conference Call

January 27, 2016 10:00 AM ET

Executives

Nicholas Chulos - EVP, Corporate Secretary and General Counsel

Mike Scudder - President and Chief Executive Officer

Mark Sander - SEVP and Chief Operating Officer

Paul Clemens - EVP and Chief Financial Officer

Analysts

Emlen Harmon - Jefferies

Chris McGratty - KBW

Operator

Good morning, ladies and gentlemen. And welcome to the First Midwest Bancorp 2015 Fourth Quarter and Full Year Earnings Conference Call. At this time, I would like to inform you that this conference is being recorded. And that all participants are in a listen-only mode. [Operator Instructions] At the request of the company, we will open the conference up for questions-and-answers for analysts only.

It is now my pleasure to turn the floor over to Nick Chulos, Executive Vice President, Corporate Secretary and General Counsel of First Midwest Bancorp. Sir, you may begin.

Nicholas Chulos

Good morning, everyone. And thank you for joining us today. Following the close of the market yesterday we released our earnings results for the fourth quarter and full year of 2015. If you have not received a copy of this press release, it’s available on our website or you may obtain it by calling us at area code 630-875-7463.

During the course of the discussion today, our comments may include forward-looking statements. These statements are not historical facts and are based on our current beliefs. Our comments also are subject to certain assumptions, risks and uncertainties and are not guarantees of future performance or outcomes. The risks, uncertainties and Safe Harbor information contained in our most recent 10-K and other SEC filings should be considered for our call today. Lastly, we will not be updating any forward-looking statements following our call.

Here this morning to discuss our fourth quarter 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

Thanks, Nick. Good morning, everyone. As always thanks for joining us here today. Let me start as we typically do with covering the highlights and then I'll turn it over to Mark and Paul and they can certainly offer some select additional color. It was certainly an active quarter and year for us that at its core reflected strong progress on a number of business fronts. And we feel very strongly that it positions us pretty well as we enter 2016. Net income for the fourth quarter of 2015 was $16.3 million or $0.21 per share but as we've previously shared the quarter's performance both this year and last year was impacted by pretax acquisitions and integration related expenses that added or certainly subtracted from this quarter about a $0.01 and about $0.07 from the same quarter a year ago. At the same time, we also shared earlier in this month that we had undertaken certain strategic branch initiatives that would result in us incurring pretax valuation adjustments of about $8.5 million or $0.07 after tax. And I'll certainly talk about that little bit more later.

But after you add these back, earning per share was $0.29 for the fourth quarter of 2015, that's compared to $0.27 a year ago, that's an increase of 7% and down roughly about a $0.01 from where we were in the third quarter. As we think about the quarter and as I shared there is a number of highlights that I think will serve us well in terms of revenue expansion and efficiency here over the next year. Last quarter we talked about this. We talked about generating more balance sheet leverage here in the fourth quarter in part because of our expectation that our production which is loan production which has stayed pretty steady throughout the year and solid would be there, and we would see lesser pay downs or certainly prepayments than what we had experienced in prior quarters. And certainly that was a case this quarter as well.

But also in part because we felt our liquidity position and rate sensitivity was growing and we would have the opportunity to leverage that additionally. So consistent with that when you look at the quarter, you can see that we had strong loan growth about $250 million versus the third quarter, about 80% of that was generated by our teams and 20% came from our December acquisition of Peoples Bank. We also added about $150 million in longer duration securities and I've asked Mark to expand on that in the business line portion of his remarks and certainly Paul can cover that further when we talk about the asset liability side of the equation. But in combination these actions added about $400 million in higher-yielding assets during the quarter with the interest income benefit of those really masked in large part by their timing. They came on pretty late in the quarter.

Because the growth was also relatively balanced in terms of fixed versus floating characteristics, it was weighted more heavily to floating. Our overall rate sensitivity did not really change and continues to remain very solid as we enter the year. Secondly, away from that we were very pleased to receive regulatory approval to move forward with our combination with National Bank and Trust of Sycamore. We expect the NB&T opportunity to close in mid-March and that will add about $430 million in loans and another $150 million in securities and that’s all supported by an extremely strong core deposit base. So the combination of those elements really gives us some nice flexibility as we operate in 2016 and certainly navigate what we expect to be kind of an evolving rate environment over that time.

Our fee based revenue growth continues to be strong highlight for our company. It was up 16% from the fourth quarter a year ago, 8% annualized from the third quarter with the linked quarter growth pretty broad. But we did see notable contributions coming from our leasing, mortgage, wealth management and commercial sales businesses. Again our combination with NB&T is going to grow our wealth management platform assets under care by 10% and we'll certainly see an incremental greater growth in that from a revenue standpoint.

Credit quality was pretty strong, non-performing assets dropped to $62 million, that's down about a third from where they were at the end of last year, and down about 13% from where they were at the end of last quarter.

Moving on to expenses. Certainly as we think about that within the context of our expense platform that's out there, we talked about certain strategic branch initiatives that we undertook at the end of the quarter. We've been working on that for a while, felt we had the opportunity to move forward and improve our distribution. Had opportunities to add locations in down town Naperville, the attractive -- that's a very attractive market here in Illinois, as well as on LaSalle Street in Chicago which really leverages the loan production office, you’ll recall we established in 2010. So both full service operating locations for us. But at the same time we also had the opportunity to improve our efficiency by consolidating four locations in the near by adjacent facilities. And then also move to sell property that we described generally as inactive meaning branches that we had closed either through these consolidations or previously, and we had some inactive vacant property land that we had acquired through the years that we felt we weren't going to be using. So we moved to -- to move that off as well. So in the combination of moving those to we call the held for sale category if you will that created a valuation adjustment of about $8.5 million. Now we expect to recover that very quickly, let's say 2.5 years timeframe that we will see about $3.6 million in lower expense on an annual basis. 60% of that we would expect to realize in 2016 as we move forward to liquidate those assets.

So that area from my perspective remains an ongoing focus for us. And we continue and will continue to look for opportunities to improve the integration of our channels as well as maximize our distribution network.

Now away from all that in acquisition and integration cost, our expenses came in higher on a linked quarter basis, in part reflecting some seasonality. But there are two aspects of expense that I did want to highlight for the quarter. First, we saw higher pension expenses that added the after tax equivalent of about a $0.01 of expense to the quarter. Now again recall we froze our pension plan here a number of years ago. But retiree election for lump-sum distribution were much higher than what we had anticipated and forced an expense adjustment related to those elections that from our perspective was very unusual. And we view that as an anomaly and certainly don't expect to see it again here as we look to the first quarter or even next year given the expected market environment that we plan on operating.

More importantly, we continue to take advantage of opportunities to add talent to our sales team. We were able to take advantage of a handful of those opportunities in the fourth quarter which in turn added on a short-term basis to our short-term recruitment costs and certainly added some staffing cost. But generally it adds depth, talent, additional talent and certainly growth expectations as we look forward to 2016.

So with that, that's a good segue to Mark who can certainly offer some additional color on the business line.

Mark Sander

Thanks Mike. And as Mike shared we posted very strong loan growth this quarter, higher than the expectations we laid out in our last call. Growth was diversified across lines of business and across sectors within business units, demonstrating the success of ongoing efforts to strengthen and expand our teams and our growth engine. Specifically our $250 million of growth came largely as a result of new business booked by various commercial teams in both C&I and CRE. Our C&I growth of $130 million or 5.5% in the quarter was broad based led by our healthcare, asset based lending and leasing businesses.

We remain encouraged by the quality and quantity of new client opportunities generated by our investments in these niches over the last three years. As an example, our leasing business First Midwest Equipment Finance tripled in volume from the levels they reported as an independent company prior to our acquisition just 15 months ago. Incrementally adding such niches have been quite beneficial as this is our fourth consecutive year of double digit organic growth in C&I loans.

As Mike mentioned, we also saw strong production in our commercial real estate business as we did throughout most of 2015, fortunately in Q4 this high production level was not masked by outsized payoff as it was previously during the year and thus we returned to solid growth in CRE again this quarter. Our consumer book also grew by about $70 million driven from several sources. The largest increase was in mortgages mostly due to solid production but also in part by our Peoples acquisition as well as our election to add marginally to our book given our excess liquidity.

More broadly and encouragingly we generated organic growth across all product types as our online channels continued to post solid quarter-over-quarter comparison. As a result of the strong fourth quarter our net loan growth for the year exclusively of the acquisition exceeded $400 million or little over 6% away from covered. This is our third consecutive year of organic loan growth of 6% to 7% in line with the guidance we delivered at this time in each of those years. We further added to our sales staff in last two quarters as Mike mentioned. And while this adds a little bit of expense, it brings good talent. As a result of these investments when we apply reasonable expectations on per FTE basis, we feel confident that 2016 organic loan growth will again be in the mid to high single digit level.

The income was also a good story in Q4. As our result here continued the robust growth trend we saw all year. As Mike mentioned year-over-year growth was near 16% in Q4 again widely dispersed across businesses and products. Our consumer business saw continuing strength in card income driven by higher utilization rate. We also had more success in capturing our fair share of in-footprint mortgage business in line with our plans as we've discussed in previous call. In addition, we were able to more than offset our historical NSF fee decline with deposit service charges from acquisitions on a year-over-year basis. In our commercial businesses, we had a solid quarter in treasure management fees. They were up 7.5% year-over-year mostly driven by price increases for existing services.

We also had an excellent quarter and providing interest rate protection products and in our sales of leasing paper in line with our strategic initiatives to increase fee income as a percentage of our total revenues. Last but certainly not least our wealth management business delivered again another very strong quarter up 11% year-over-year and continuing excellent sales and client retention. We've several years of favorable quarterly comparison in wealth which continues to generate high levels of growth despite the outsize nature of this line of business within our company. Here again our growth was well diversified led by fiduciary guardianship and our retail investment advisory business.

For the full year, fee income growth was nearly 15% which was at the upper end of the guidance we provided last year at this time. This increase was about two thirds organic and one third from acquisitions. While our prior acquisitions were fully integrated in 2015, the anticipated closing of National Bank and Trust in March will again provide further lift in fees in 2016. Combined with continuing strength in several areas I mentioned, we anticipate high single digit fee growth this year.

We continue to see a nice mix of fee growth opportunities in the ongoing efforts to drive our noninterest revenues even higher. As to asset quality for a second. We had a strong quarter here as well. Charge-off of 19 basis points annualized brought us to the lower end of our range for the year at 29 basis points. With NPAs at the lowest levels in many years, we expect charge-offs in 2016 will continued to be near the low end of the normalized range of 25 to 40 basis points that we've repeated guided to.

And so now I'll turn it over to Paul to talk about margins and expenses.

Paul Clemens

Okay. Thank you, Mark. And good morning, everyone. Net interest income was up $2.2 million or 2.9% from the fourth quarter of 2014 and relatively unchanged from the linked quarter third quarter 2015. The increase from last year was due to 7% growth in average earnings assets comprised primarily of 6% legacy loan growth Mark just discussed and the full quarter's benefit from December 2014 acquisition activity which more than compensated for decline and net interest margin of 17 basis points.

The year-over-year decline in margin reflect the impact of continuing low rate environment, growth in lower yielding variable rate loans and $1.4 million decline in covered and acquired loan accretion which accounts for approximately a third of that 17 basis point decline. For the linked quarter underlying our earnings were a number of significant and positive actions that one wouldn't see left to your own device. The longer term benefits of a December rate hike $250 million of net loan growth and $150 million in additional securities were offset by decline in acquired and covered loan accretion and slightly higher FHLB funding cost. Due to these factors and a normal seasonality in municipal deposits, net interest margin of the quarter improved a single basis point to 3.59% from the third quarter.

As we think about the full year, we expect net interest income expansion in the range of 10% to 15% in 2016 compared to 2015. Keep in mind assuming a mid March close NB&T will add about $580 million or 5% in average earnings assets for the year coupled with another $90 million from Peoples for the full year. Given net margin of roughly 3.75% for these assets allowing for normal accretion the math will drive approximately half the aggregate increase I just discussed. The additional increase will come from loan growth. And of course ultimately the amount of expense would depend upon the pace and timing of current asset growth, interest rate movements and the changes in deposit rates forbade us.

So let me move to interest expense briefly. As Mike shared fourth quarter expenses excluding integration cost and property valuation adjustment total $76.7 million. For the year adjusted interest, noninterest expense totaled $297 million or an average of $74.3 million per quarter. The increase from the linked quarter was primarily due to $1.1 million in pension settlement cost that resulted from elevated retiree election for lump-sum distribution that resulted at the end of the year. And as Mike mentioned we don't expect to see that replicate in 2016 any single quarter or perhaps for the whole year in total due to what we think would be a lower -- while there lower pool of retirees and certainly the expectations for higher rates. Secondarily, the timing of staff recruitment and related expenses as well as seasonal marketing cost added almost $1 million to the quarter. While we continue to actually recruit talent for the organization, we do not believe this level of cost will be an ongoing part of the quarterly core run rate.

For the year our efficiency ratio improved to 63.6% or nearly 100 basis points. To put that in dollars and cents which is always little bit more meaningful, this 100 basis point improvement equates to $4.4 million in expenses we either saved or didn't incur compared to what we did last year. This despite the low rate environment which obviously pressured revenue growth. As we look to 2016, we would expect further efficiency improvement as we leverage our acquisition of NB&T and Peoples, major distribution channels as Mike mentioned and grow our revenue to offset annual cost increase and business investments.

We expect expenses to increase 2% to 3% excluding cost for NB&T and Peoples since it allows for annual merit increases and other cost increases and business investment which we will continue to make. While we are still working to the integration of NB&T, we estimate these entities will add approximately $3 million to $3.5 million in expense per quarter. And then finally for the first quarter of 2016, some portion of integration cost will flow through our noninterest expense. Our current estimate is approximately $4.5 million.

With that let me turn it back over to Mike.

Mike Scudder

Okay. Thanks, Paul. Before we open up for questions let me offer some closing remarks. Certainly as we look ahead to 2016 the year itself looks to shape up as what I described a year of transition on a number of front not just for First Midwest but also the industry. And we feel that's an environment that we will do and expect to do very well. As Paul shared our margin expansion we expect to see coming from certainly the fourth quarter leverage, the full run rate, the impact of the Fed's late 2015 move, rate move and the acquisition of NB&T. So those are first quarter benefits that we should realize. As we look past that quarter additional earning asset growth as well as an upper great environment, we believe will provide further revenue expansion as we leverage our asset sensitivity and core deposit base. But not surprisingly that's also going to require balanced financial management as the pace and timing of all that unfold here over the course of the next several quarters. We do expect growth opportunities to be there as Mark alluded to, first and foremost driven by our ongoing investment in talent and our businesses. And secondly, where it makes sense through what I described as aligned opportunities for consolidation. With NB&T on pace to close in the first quarter, we believe we remain well positioned to pursue those opportunities that might become available to us and that we are in the best interest of our shareholders.

Our credit positioning remains very strong with the expectation for low problem asset levels and cost. But we have to point that we are also in a world where our lending will also require additional reserve funding as I believe reserve releases are probably run their course for us, as they have for the industry. I continue to believe that we are going to have further opportunities to optimize and integrate our -- both our distribution but really focus on improving our operating efficiencies as well and that will continue to be a point of emphasis for us over the course of 2016 as well.

So we are very excited. Feel we are very well prepared to enter into 2016. We've taken the right step to navigate the environment and the transition that we expect to see out there. The strength of our balance sheet, our funding base, our investments that we made in our infrastructure and most importantly and this is something that we try not to loose sight of; we have a very engaged team of colleagues out there in both our business and support areas that really drive the strength of the company. And we believe those are advantageous that few enjoy the capacity that we do. And we feel they positioned us very well to grow and enhance overall return.

So with that let's open it up for your questions.

Question-and-Answer Session

Operator

[Operator Instructions]

The first question comes from Emlen Harmon with Jefferies. Please go ahead.

Emlen Harmon

Good morning, guys. If we could maybe just start with the NII guide, what are your expectations for rates in the NII guide? Just kind of curious how you're thinking about both the short and the long end of the yield curve there.

Paul Clemens

Well, sure. Let me just bracket around our range. I gave you a 10% to 15% range in increase in net interest income and the bracket re - extends from zero additional rate hikes to four additional rate hikes. That's really the scope of that ranges there. So anybody's guess obviously, we would expect to see five to perhaps eight or nine basis point increase in the first quarter in margin and a couple, and about 3% increase in net interest income from there. And then what we try to do is what I try to do is break off for you the additional benefit of the acquisition of NB&T and Peoples; of the 10% to 15% half of that's going to come from those acquisitions the acquired assets we have on the books.

Mike Scudder

Emlen, this is Mike. Suffice it to say at this you know the market is expecting a couple of moves, that's ranged anywhere between four moves and a couple that’s been out there within the world that we see today, it's almost anybody's guess is to what will ultimately happen. You kind of peg the midpoint of what we are doing, that's kind of where the market sees it. You peg the upper end of that you are going to see more moves than probably closer to what the Fed's previous guidance was.

Emlen Harmon

Got you. And maybe just -- the second part of my question that was in there, we have obviously seen the long end of the yield curve, the middle of the yield curve comes in some the past several weeks. Does that have any impact on what you guys have been thinking in terms of that outlook?

Mike Scudder

You know a little bit from the standpoint of most of our loan funding as we come back through has been in the floating rate, so a lot of that growth is in that shorter end, you are going to see that impact as well. In terms of the securities portfolio, it's generally a longer duration portfolio. So the immediacy of that you are not going to see. And the leverage that we talked about in the context of this quarter really took place before those rate pulls started to come back. So we've go some flexibility to gauge that but it really doesn't influence the overall forecast that significantly.

Emlen Harmon

Got it, thanks. And then just on the loan growth outlook, I'm sorry if I missed this; are you guys still expecting something in the 6% to 7% range? And then also actually did see for the past few quarters the commercial real estate book has been shrinking. We did see that start to grow again in the fourth quarter. Are you seeing fewer of the pay downs that you have been talking about the last few quarters?

Mark Sander

Sure. So let met take both so what I mentioned was we've grown 6% to 7% each of the last three years. I would expect to see us meet or beat that this year. And so that's why we are guiding to mid to high single digit levels; relative to commercial real estate exactly that. We had a good production really throughout 2015 but in Q2 and Q3 we saw outsized payoffs, we didn't see those this quarter so the production flow through to increase again and again we would certainly expect that to happen over the -- to be the net result of 2016 as well. Any one quarter again it might be little lumpy there but certainly we would expect to see CRE growth over the course of the year.

Operator

[Operator Instructions] Our next question comes from Chris McGratty with KBW. Please go ahead.

Chris McGratty

Good morning, thanks for taking the question. Paul, on the guidance, I just want to make sure I'm starting with the right baseline for the expenses and the fees. What I guess -- with the growth expectation, what are the starting points in terms of dollars that you're starting with, with all the adjustments that may have occurred this year?

Paul Clemens

So it’s 74, five right in there for that -- we average 74 five when you get rid of the integration cost and evaluation adjustment, that's what we roughly average this year. So that's the 2% to 3% on top of that and then whatever NB&T and Peoples brings us.

Chris McGratty

Okay, so 74 five, 2% inflation, deals. Okay, and then you said that was $3 million to $3.5 million a quarter. How about on the fee income?

Mike Scudder

I think the question is what's the expectation for [indiscernible]…

Chris McGratty

The growth expectations, what's the starting point. Thanks Mike.

Mark Sander

Okay. What's the starting point? So, well, I mean the starting point is we are always going to build off of number fee income which is 127 for the full year and so then I build when I talk about high single digit I am building off of that.

Chris McGratty

Okay, that's helpful. Thank you, Mark. Question on the margin. Can you remind us -- a lot of attention has been given to the move in LIBOR. Can you remind us what proportion of your total loans are prime in LIBOR if you have the split and the amount of floor that you need to get through? Thank you.

Paul Clemens

Sure. As far as we have roughly $3.5 billion of variable rate loans, about $2 billion of that is LIBOR based and $1 billion and remainder of course is prime based. So --

Mark Sander

And virtually no floors any longer Chris.

Chris McGratty

Okay, so that would jibe with the margin. I think you said five to nine in the first quarter; you will get the benefit because of the move?

Paul Clemens

Yes.

Operator

[Operator Instructions] If there appears to be no further questions, I would now like to turn the call back over to Mr. Scudder for closing comments.

Mike Scudder

Great. Thanks. Well, as always thank you for joining us today. Thank you for your ongoing interest in First Midwest Bancorp. And we would wish everyone a great day.

Operator

Thank you, sir. Ladies and gentlemen, this concludes the conference for today. Thank you for participating and have a nice day. All parties may now disconnect.

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