First Midwest Bancorp's (FMBI) CEO Michael Scudder on Q2 2016 Results - Earnings Call Transcript

| About: First Midwest (FMBI)

First Midwest Bancorp, Inc. (NASDAQ:FMBI)

Q2 2016 Results Earnings Conference Call

July 20, 2016, 11:00 AM ET

Executives

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

Michael Scudder – President and Chief Executive Officer

Mark Sander – Senior Executive Vice President and Chief Operating Officer

Paul Clemens – Executive Vice President and Chief Financial Officer

Analysts

Emlen Harmon - Jefferies

Brad Milsaps - Sandler O'Neill

Chris McGratty - KBW

Terry McEvoy - Stephens

Kevin Reevey - D.A. Davidson

Nathan Race - Piper Jaffray

Operator

Good morning, ladies and gentlemen, and welcome to the First Midwest Bancorp 2016 Second Quarter Earnings Conference Call. At this time, I would like to inform you that this conference is being recorded, and that all participants are in a listen-only mode. At the request of the company, we will open the conference up for question-and-answers for analysts only after the presentation.

It is now my pleasure to turn the floor over to Nick Chulos, Executive Vice President, Corporate Secretary and General Counsel of First Midwest 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 second quarter of this year. If you have not received a copy of this press release, it is available on our website or you may obtain it by calling us at 630-875-7463.

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

Here this morning to discuss our second quarter results and outlook are Mike Scudder, President and Chief Executive Officer of First Midwest; Mark Sander, our Senior Executive Vice President and Chief Operating Officer; and Paul Clemens, our Executive Vice President and Chief Financial Officer.

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

Michael Scudder

Thanks Nick. Good morning everyone. As always, thanks for joining us today. As is our practice, my intend is to cover the highlights, and then I'll let Mark and Paul, offer some select additional color here.

Overall we were very pleased with the quarter, very pleased with our performance in what you know, can easily be described as a very active quarter for us. Our performance across our business lines was very solid, was either right in line with or exceeded our general expectations for most of our business lines.

This exceeding or achievement of the expectations, combined with the full quarter impact from our mid-March close on our acquisition of National Bank and Trust of Sycamore really drove the quarter and provided good momentum for us.

Our earnings per share was $0.32, that’s up about 19% from the first quarter of 2016 and 10% from the same quarter a year ago. Thought that performance excludes acquisition and integration related expenses from both periods.

Underlying our performance for the quarter were certain business highlights that I would emphasize. Our total loans outstanding increased to $8 billion, that’s up 8% annualized from last quarter and 17% from June, 30, 2015. We continue to show solid organic growth across our platforms as we continue to leverage our ongoing investment in talent.

Importantly, we grew average core deposits to $7.7 billion, again that’s up about 9% from the first quarter of 2016 and 13% from the second quarter of 2015. The resulting balance sheet growth helped our overall revenues increased by about 10% linked quarter.

Our net interest margin came in at 3.72% as contrasted to 3.66% last quarter and 3.76% a year ago. Paul certainly will help with the mechanics underlying this; but essentially we've defended our margin pretty well in what remains a difficult interest rate environment.

At the same time we grew our fee based revenues to $36 million, and that’s an increase of 7% from the first quarter of 2016 and 14% from the second quarter of 2015. Notably our wealth management fees have now grown to $8.6 million or almost $35 million annualized. That’s almost 25% of our total fee based revenues which really shows the progress and the tremendous results out of that line of business.

Higher revenues also allowed us to better leverage our cost structure and improve our efficiency ratio to 61% as compared to 65% for the first quarter of 2016 and 62% for the second quarter of 2015.

As a final highlight this quarter, I would also remind you that we announced our entry into a definitive agreement with Standard Bancshares. I won't spend a lot of time on that here, as we held a separate call to review that opportunity about 3 weeks ago.

But I would, by way of just reference, remind you that Standard holds about $2.5 billion in assets, $2.2 billion in deposits, $1.8 billion in loans and as a general reminder, the deal value at the time of announcement there was about $365 million and it is anticipated that we will realize over 12% accretion to our 2018 fully diluted earnings per share based on consensus estimates at the time.

In 2017, we would expect that EPS accretion to be about 8.5%, excluding transaction expenses or again 4.3% if you include our estimate of transaction costs. By way of update, colleague response both within First Midwest and Standard has been extremely positive and local market reaction is been absolutely great.

And all of those are positives as we initiate our integration process and really kick off moving forward with that opportunity. We've continued to target a late 2016, early 2017 close for the Standard transaction.

So with that as a general backdrop, let me turn it over to Mark and he can offer some additional color.

Mark Sander

Thanks, Mike. We had another strong loan growth, consistent with our expectations and guidance. Our 8% annualized growth this quarter was well balanced and diversified as commercial industrial, commercial real estate and retail all posted solid gains.

C&I growth of 10% annualized is really just consistent with the results we've generated over the last several years. As Mike noted and we previously discussed in these calls, this really reflective of our prior investments in talent that we made to drive our strategic objective of increasing our core business lending.

CRE was very active this quarter on all fronts, as some property sales and HUD refinances were more than offset by other categories, principally construction. Construction loans were up a little more than %100 million in Q2, as commitments we established over the last few quarters drew down.

Lastly, relative to loan growth, the continuation of our momentum across several channels drove a strong quarter in consumer lending. This growth was also well balanced, as online loan generation, mortgage volume and branch-based applications all saw solid increases.

Our commercial pipelines remain at similar favorable levels as last quarter and thus we forecast continuing gains in future quarter, particularly in C&I, as well as retail. Given the strong first half, we continue to expect full year loan growth should come in at the upper end of our mid to high single digit range.

Turning to fees, here also we generated results at the upper end of our expectations. Total fees of nearly $36 million in the quarter, as Mike said were up 7% from Q1 and 14% from the prior year’s quarter.

The increase from Q2, 2015 was nearly $4.4 million of which about 45% was organic growth and 55% was a result of our acquisitions. Fee revenue from acquisitions was inline with expectations, generated through the strong wealth management business that NB&T had that we previously highlighted, as well as deposit service charges.

From our legacy teams, we saw organic year-over-year increases in card income of 5% and stronger mortgage banking income reflective of higher sale rates. Capital markets revenue which for us is principally swap sales, accounts for the most of the significant differences in the other income category versus the two comparison periods shown.

While swap income was actually down from the stellar results we posted in the first quarter, it was up sharply from the prior year, responsive to clients reaction to the continued low rate environment.

The other fee category also benefited from continuing solid gain in income from the sale of assets generated by our leasing company. I'd say similar to the loan story, we have good momentum in several fee income areas. In light of these diverse sources and our success in the first half, we continue to feel good about our prospects for solid fee income growth the remainder of the year.

Relative to credit performance, our results in the quarter were in line with Q1 and expectations. We saw pretty much a repeat of previous results, with charge-offs of 26 basis points, non-performing assets of 93 basis points and a consistent level of adverse performing loan. As a result we continue to forecast full year charge-offs in the lower end of our 25 to 40 basis point range.

Paul, will now provide some more detail on our margins and expenses.

Paul Clemens

Okay. Thank you, Mark, and good morning, everyone. Net interest income increased $9.3 million or 10.1% from the first quarter of 2016, which is I should note, slightly higher than the 9% increase in earnings assets, always good sign and $11.1 million or 14% higher than second quarter of 2015 net interest income.

The increases were due to the full quarter benefit from the March acquisition NI Bancshares, our continued strong loan growth that Mark alluded to and the pay off of $38 million of maturing sub debt in April.

In addition, acquired loan accretion was $3.9 million for the quarter compared to $1.4 million and $3.6 million for the first quarter of 2016 and second quarter of 2015 respectively.

Margin increased 6 basis points linked quarter and declined 4 basis points from a year ago. As Mike mentioned, we feel like we continue to defend our margin, excluding acquired and covered loan accretion for all three periods, the margin has remained relatively constant at approximately 355.

For the remainder of 2016, we would expect net interest income to be stable or up modestly compared to the second quarter, with the level ultimately influenced by the pace of loan growth, the time of future rate increases, somewhat the change in the yield curve and the accretion similar to that of the second quarter. This will result in a double-digit increase for the full year over 2015.

Excluding accretion, we expect some seasonal decline in margin for the third quarter due to the impact of the increase in municipal customer deposits we always see this time of year.

And let me turn to non-interest expense for a second. Second quarter expenses, excluding integration costs totaled $80.7 million, an increase of 4.1% from the linked quarter and 9.9% from a year ago. The operations associated with NI Bancshares Sycamore – in other words Sycamore and Peoples transactions accounted for substantially all of the linked quarter increase and approximately two-thirds of the increase from the second quarter of 2015.

Our efficiency ratio improved to 61%, as Mike mentioned compared to 65% for the linked quarter and 62% for the same quarter a year ago. As we look to the future, we would expect expenses for the third quarter to continue in the range of $81 million to $82 million, subject to the timing of certain expenses such as marketing, as well as an increase related to greater sales activity than anticipated.

We believe we have realized substantially all of the expense savings from the NI Bancshares transaction, and likewise you may recall that we recognized an $8.6 million charge in the fourth quarter of 2015 related to closing selective branches.

Year-to-date sales activity of these branches and expense savings are right where we expected and remain on track to recoup that charge over approximately 2.5 years and reduce occupancy [ph] expense.

And with that, let me turn the call back over to Mike.

Michael Scudder

Thanks, Paul. Before we open up for questions, some further remarks. Certainly the first half of the year is notable for the uncertainty surrounding the operating environment. But our priorities and focus really hasn’t changed and doesn’t change as we navigate that world. We remain centered and focused on those actions we believe enhance the value of our franchise and accrete to the long-term benefit of our shareholders.

Most specifically, we're focused on our efforts to continue to build the strongest team of colleagues and bankers here within the markets that we serve and we continue to remain focused on pursing those initiatives and those efforts that allow us to efficiently grow and diversify our revenue streams, both lending and fee-based, which we've shown good progress on over the course of this year.

We continue to maintain and invest in or leverage our investment in our risk discipline, which is critically important in the environment that we're operating in today. So with those priorities really is an undercurrent momentum if you will, our pending acquisition of Standard Bank and Trust further adds to that overall momentum and we believe firmly position us well for future performance and growth.

So with that, as some closing remarks, let's open it up for your questions.

Question-and-Answer Session

Operator

Thank you, sir. The question-and-answer session will begin at this time. [Operator Instructions] And your first question comes from Emlen Harmon of Jefferies. Please go ahead.

Emlen Harmon

Hey, good morning, guys.

Michael Scudder

Morning, Emlen.

Emlen Harmon

Paul, just quickly, what does your interest income outlook incorporate in terms of accretion and rates? And I think you said kind of stable to flattish going forward. Does that incorporate the - I'm assuming that incorporates the fourth quarter as well.

Paul Clemens

That is correct. And I just said that we think the accretion, the 335 is excluding accretion, so we think that will be flat and then in the accretion we expect will be somewhat similar in the third quarter and we'll see how it plays out in the fourth.

Emlen Harmon

Okay. And then on - I just noticed in the loan portfolio, we did see the commercial real estate portfolio decline some this quarter. How should we think about that in terms of kind of regulatory positioning versus maybe kind of some one-off effects in there?

Paul Clemens

Regulatory isn’t an issue at all. We're well within guidelines and well under guidelines I would say. And so the regulatory side really isn’t something we're – while we have to keep them well informed, we're not so worried, and it’s not putting pressure on us in any fashion, really what you're seeing happen in real estate is just reflective of a very active marketplace if you will.

So you know, we're seeing – we had forecast, I think we talked about it last quarter some significant paydowns in Q2 and Q3 that we anticipate is through some HUD refinances and some building sales that we saw in the horizon. So that’s what you're seeing, where it’s not growing. In this quarter we actually had good activity, but it was offset by some of the paydowns.

Emlen Harmon

Got it. Okay, thanks.

Operator

And our next question comes from Brad Milsaps of Sandler O'Neill. Please go ahead.

Brad Milsaps

Hey, good morning.

Michael Scudder

Hi, Brad.

Brad Milsaps

Mark, just maybe to follow-up on Emlen's question around some of the movement in the loan book this quarter, I think you mentioned some construction projects that funded. Do you expect those to be around for a while? And I'm sure it's all kind of embedded in your kind of high single digit guidance.

But just curious how quickly those will be in place, and do you guys plan to be the permanent financing, just trying to get a sense of kind of any headwinds around paydowns, maybe in the back half of the year?

Mark Sander

We certainly plan to be for the vast majority of those to be the permanent financing. I will say we've had some projects where as soon as it gets built it gets sold, because of the price that they've been able to – unanticipated sales based on favorable condition has caused some paydowns to happen a little sooner than we would have thought.

But the short answer to your quarter is yes, we do – we don’t do construction to be a turnover book. We do construction to perm as a general course. Obviously the borrowers at times might change that dynamic as market conditions warrant. But we expect to be the takeout on the vast majority of our construction book.

Brad Milsaps

Great, and then…

Mark Sander

It is all incorporated into the guidance I gave. Our commercial real estate book actually grew slightly this quarter about 50 million bucks.

Brad Milsaps

Sure. Then maybe for Paul, on the senior debt that you have out there, I think that's a November maturity. Any sense of what you guys may do at this point with that outstanding? Obviously with the Standard deal, kind of might change your thinking around what you do. But just kind of curious; any update there?

Paul Clemens

To be honest, we've not made a decision. We've got a fair amount of flexibility given the cash we have on hand and what – as you can imagine we've talked to a number of investment banker who would like to talk to us. But we've made really no decision on what we're going to do with that $150 million.

But we'll come to that conclusion fairly quickly. We've been running some scenarios given the acquisition of Standard anticipated as early as late this year. But we've not really made a decision on what we're going to do.

Brad Milsaps

Okay. Thank you, guys.

Operator

And our next question comes from Chris McGratty of KBW. Please go ahead.

Chris McGratty

Hey, good morning, everyone. Paul, I just wanted to understand the - just make sure on the NII. I think in the past your guidance has included Fed fund increases. Does the guidance you gave in your prepared remarks contemplate anything from the Fed this year?

Paul Clemens

It does not.

Chris McGratty

Okay, okay. If I look at the securities deals, like most banks there's some pressure. I was wondering if you could give some additional detail on what's driving it. Was it premium amortization, if so, do you have those numbers, and maybe reinvestments, what you're doing in the book?

Paul Clemens

I am sorry - oh, so the securities, okay. Well, we're actually - if you will see in our Q we've been able to take the cash flows and - well, first of all, let me step back, we've had some increases we've had some increases because of the acquisition of course, from both Peoples and then most importantly from Sycamore, that added several hundred million dollars.

We did lever up some of our excess cash and we did so opportunely at the opportune time I'd say over the last six months, that we've been able to maintain the duration in the average life pretty steadily or actually down a little bit from what we've seen. So we continue to plow back our cash flows for the time being, back into CMOs for the most part GSE paper.

Chris McGratty

Okay. Yes, I understand the dollars, the balances are up because of the deal. But the yield on - the blended yield on the portfolio has come down. Is that just a mix of what's being added or is that…

Paul Clemens

It is. I mean, some the latest stuff we put on is been around 185 to 195.

Chris McGratty

Okay. And then maybe on the accretable, the 3.9 that was a full quarter's impact of the deal, how much of that, if you have it, is scheduled versus accelerated?

Paul Clemens

About $3 million of that was actually scheduled.

Chris McGratty

Okay, okay.

Paul Clemens

And what I would say is routinely in the first couple of quarters we have – we're confronted with better than expected, our conservative marks on these things. We tend try to not get too carried away and we will adjust our marks in the existing and remaining book rather than take the whole thing. But some of them just to make a lot of sense to go and do.

Chris McGratty

No, understood. And so the remaining dollars, Paul, if you have it, of the accretable, the scheduled accretion? Do you have that as of the quarter?

Paul Clemens

The remaining is I think about $25 million, but it will be in the – to be honest with you, I'll have to look it up. It's in the Q, but I don't have in front of me.

Chris McGratty

Okay. Thanks a lot.

Operator

And our next question comes from Terry McEvoy of Stephens. Please go ahead.

Terry McEvoy

Hi, good morning.

Michael Scudder

Good morning, Terry.

Terry McEvoy

In the release you talk about the growth in C&I was expansion in the sector-based lending areas, structured finance, asset-based lending, and equipment. Could you just talk about how big are those portfolios? And then, how did the yields in those areas compare to just your more general middle-market C&I book?

Mark Sander

The yield – I'll go in reverse order, the yields are higher in those areas than in our general C&I book generally. The growth – the size of the books, the structured finance is still pretty modest business for us, it’s less than $2 million.

Our leasing books similarly is about 250 right now. Healthcare is in the neighborhood of about 400, asset based is in the neighborhood of about $300 million. Did you ask about - I'm trying to think about if I them all, Terry.

Terry McEvoy

I think you did; thanks. Then, Mark, just your outlook for fee income, you said you had momentum in most areas. If you could be a little bit more specific. And then within wealth management, is there any seasonalities in terms of when certain fees are captured that could either impacted Q2 or Q1 at all?

Mark Sander

Again, I'll go in reverse order, in wealth management the answer to that is no, most things are on a quarterly billing, so within months there is, but from a quarterly perspective there is really not seasonality.

Now the market can derive some cyclicality in that relative to, again, as a percentage of assets which is what most of that is driven off of. In terms of the areas that where we see growth, I'd have to say everyone of them Terry, fundamentally, going top to bottom we've seen nice consistent growth in our card income of 5%, 6% organic, exclusive of acquisitions for a number of quarters now and we continue to get more cards out there.

Mortgage banking should see some nice healthy growth, given the environment that’s out there and the revamping of the team that we've undertaken. We've highlighted wealth management, treasure management for a number of quarters. We just think there is good solid growth there. We've got strong teams on both of those. So see nice opportunities there.

Leasing, we've talked about has been a really nice pick for us. When we bought that company they were doing $40 million in originations, they did about a 120 last year. We expect them to do at least, I'd say 60%, maybe 50%, 60% higher than that this year.

So nice income there. We may elect to hold some more of that paper, but again we should still see gains in sales of paper there. Did I leave any out?

Paul Clemens

I think the swaps is the last one.

Michael Scudder

Yes, and all of those go through and really leverage what Mark had talked about in his comments and what we try to highlight. This is simply investment in talents that we've made in addition to the specific business sectors that are just continuing to produce and leverage the cost that we already put into place.

Terry McEvoy

Mike, and then maybe just a bigger-picture question for you. I understand you have a large transaction pending later this year. But how do you - or do you want to play more offense in a market where the number eight bank is being bought by a Canadian bank?

You've got the like number 17th bank in terms of deposit size being bought by the 11th. Clearly there's going to be some disruption and how are you positioned to maybe take advantage of that?

Michael Scudder

Well, we positioned ourselves in a number of ways and we've talked about it Terry in the context of certainly the Standard opportunity. I think as you looked here and think about that from our perspective, acquisition opportunities, as I've said before I don’t view as a strategy in and of themselves.

We have a business strategy that we're acting on. A culture, philosophy, a way of doing business that really drives what we do, who we are in the results we produce. So the opportunities that become available can accelerate that as long as they are consistent and we talk about that in terms of not just financially accretive, but strategically accretive to what we're trying to do.

So I think we're very well positioned in terms of the investments that we made into our infrastructure. We put a lot of time and energy into putting the resources in place to grow and we're able to leverage that today.

So I think as those opportunities become available we'll continue to be in a position to pursue those that makes sense for us. And I think in a world where perhaps therapy is fewer players in that space, perhaps those opportunities will become more readily available. But fundamentally we think we're an appealing partner in large part for the culture that we're able to offer and just the way we do business.

Terry McEvoy

Thanks, guys.

Operator

And our next question comes from Kevin Reevey of D.A. Davidson. Please go ahead.

Kevin Reevey

Good morning.

Michael Scudder

Morning, Kevin.

Kevin Reevey

I noticed that your ag portfolio was down about 5% linked-quarter. Was this a conscious decision to reduce the portfolio given what we're seeing in commodity prices? Or is this just a one-off type of event?

Michael Scudder

It’s more one-off, I'd say it’s somewhat reflective of the cautious stance given the current environment which is not as favorable for ag in terms of looking for growth. So a little more cautious than we would have been a year ago.

In this case, linked-quarter, this is a period where you see a lot of paydowns, you start to get the end of the grain season and people liquidate, and it carries all over into the second quarter sometimes, and so that’s what you saw there. But really more I'd say cautiousness as opposed to desire to drive it down.

Kevin Reevey

And how are your ag customers feeling, how are they doing financially? Are you starting to see any stress at all in the portfolio?

Michael Scudder

I would say no, we're not seeing elevated stress this quarter. We highlighted that we saw some elevated stress in the first quarter. And so as you saw some of the changes in our adverse performing in Q1, ag was a component of that. We feel good about those exposures.

But there certainly was some elevated stress that carry over into the second quarter. I would not say that it increased, but its still there as a result of - yes, this is a tougher environment for farmers.

Kevin Reevey

Yes, definitely. And then on the tax rate, your tax rate picked up about 200 basis points. For modeling purposes, how should we look at the tax rate going forward?

Paul Clemens

I think – yes, this is Paul. I think you should expect the tax rate to be fairly stable to where it is this past quarter. Obviously it’s really just a matter of the percent of taxes in the income which is really our – in our investment book and our BOLI. It continues to become a smaller portion of our pretax income. But we think it will be around where it is as of the second quarter for the rest of the year.

Kevin Reevey

Okay, great. Thank you.

Michael Scudder

Thanks, Kevin.

Paul Clemens

Thank you, Kevin.

Operator

[Operator Instructions] Our next question comes from Nathan Race of Piper Jaffray. Please go ahead.

Nathan Race

Hey, guys. Good morning.

Michael Scudder

Morning.

Nathan Race

Just a question on the M&A appetite from here. Obviously, you're focused on closing Standard over the next couple quarters. Just curious how the pipeline for additional deals looks at this point and if you would consider announcing another acquisition as you're looking to close Standard over the back half of this year?

Michael Scudder

The pipelines are difficult to describe in what I would call a non-linear space. Certainly therapy is dialogue as a number of institutions consider you know, their options and their opportunities. But I certainly wouldn’t suggest that there is any of those that have reached a level of activity, though you never know in the world of M&A.

Fundamentally, our focus as you suggested is on the opportunity and the desire on our part to ensure a smooth integration from Standard standpoint, so that will likely hold our attention through the rest of this year and then we'll go from there.

Nathan Race

Okay. Thanks. All my other questions have been addressed.

Michael Scudder

Good.

Operator

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

Michael Scudder

Okay, thank you. Once again, I would thank everyone for joining us today. We want to particularly thank you for your interest in First Midwest Bancorp and we would wish everyone to have a great day.

Operator

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

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