First Midwest Bancorp's (FMBI) CEO Michael Scudder on Q3 2016 Results - Earnings Call Transcript

| About: First Midwest (FMBI)

First Midwest Bancorp, Inc. (NASDAQ:FMBI)

Q3 2016 Results Conference Call

October 19, 2016 11:00 ET

Executives

Nicholas Chulos - EVP, Corporate Secretary & General Counsel

Michael Scudder - President & CEO

Mark Sander - Senior EVP & COO

Paul Clemens - EVP & CFO

Analysts

Brad Milsaps - Sandler O'Neill

Terry McEvoy - Stephens

Kevin Reevey - D.A. Davidson

Chris McGratty - KBW

Nathan Race - Piper Jaffray

Operator

Good morning, ladies and gentlemen, and welcome to the First Midwest Bancorp 2016 Third 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 questions-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 third 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 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 upon 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 third 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

Thank you, Nick. Good morning, everyone. Thanks for joining us today. As we look at the quarter overall, we're very pleased with the performance for the quarter. Across virtually all of our business line, performance was very solid, particularly so when you consider against a very active backdrop of activity during the quarter. That performance came in either right in line with or exceeding our expectations, as I said for the most of the businesses.

Earnings per share was $0.35, that's up about 13% from the second quarter of 2016 and 17% from the same quarter a year ago. Earnings were skewed higher in this quarter in part by the net contribution of about $0.03 that resulted from a gain that came from our sale lease back of certain properties and that was in part offset by the timing of integration cost intended to our pending acquisition of our standard bank shares. Earnings also reflected what we would describe as the short-term drag of higher loan provisions that resulted from this quarter's really strong loan production.

With that, let me segue into some of the business highlights for the quarter. As I mentioned loan production was very strong; total loans outstanding increased to $8.2 billion, up almost $200 million or 10% annualized from last quarter, reflecting particularly strong C&I growth as we continue to leverage our ongoing investment in our teams and capabilities across those platforms. Compared to last year, loans are up over $1.2 billion or 18%, largely benefiting from these same factors, as well as our acquisition of National Bank and Trust.

As we have discussed throughout the year, we have expected that our overall level of loan loss reserves relative to loans outstanding would remain relatively stable. This combined with the fact that charge-offs were comparable to last quarter so our reserve provisioning for the quarter increased by approximately $2 million pretax, largely due to portfolio growth. And obviously as I said before, this weighed down the quarter in the short run, but it's important to recognize that future quarters will obviously see the long-term benefit of $200 million in growth and earning assets.

Net interest margin came in at 3.60%, that's up slightly from a year ago, seasonally down from the second quarter. I'll leave it to Paul to help with the mechanics and underlie this, but those essentially reflects the seasonal inflow we've typically seen in our municipal deposit base during this time of the year. It also reflects some of the variations in the timing of credit accretion as well as the fact that a greater proportion of our loan growth is coming from variable rate assets.

Fee-based revenues grew to $38.5 million, that's an increase of 7% from last quarter, 16% from the second quarter of 2015. Higher revenues also allowed us to better leverage our cost structure and held our efficiency ratio at 61%, improve from 63% a year ago. And finally, we added $150 million in subordinated debt to our capital stack, essentially swapping maturing senior debt, $40 million of which roughly came into the first quarter, about $115 million that will mature in mid-November and swapping that into a 10-year fixed at the same cost.

With that as a backdrop, let me turn it over to Mark for some additional color.

Mark Sander

Thanks, Mike. Starting with loans, the nearly $200 million increase this quarter that Mike referenced was actually a bit stronger than we anticipated as production rose and pay downs were slightly below our forecast.

New loan production was up about 20% from the solid levels we saw in the first half of this year, driven by increases across a wider range of our teams. As we previously discussed in these calls, we have made significant investments in talent the last few years. As more of these teams hit the stride, we expected and have guided to our bill to generate slightly outsized growth on a percentage basis without compromising our credit standards.

Specifically on the corporate side, we had strong production in middle market, commercial real estate, healthcare, leasing and structured finance, all of which posted good growth this quarter. This diverse production was largely driven by higher net new relationships and was granular in nature. In retail, our solid production was offset by a portfolio sale of about $40 million from our back book in mortgage, leaving total consumer loans relatively flat at 9.30% despite solid demand in the markets.

As we look to the future, we think we have nice momentum in C&I and we should post another solid quarter there. Our commercial real estate segment is likely to be relatively flat in Q4 as we see a higher level of pay downs on the horizon from refinance and/or sale activities. Our consumer businesses including mortgage should resume their growth trajectory, given the lack of forecasted portfolio sales. As a result of all that, we think we will see solid loan growth in Q4, albeit at a lower rate than Q3 and we should be well-positioned for mid to high single-digit loan growth as we enter 2017.

Fee income results were also very positive in Q3. With organic growth and our NB&T acquisition each driving about half of the 16% year-over-year increase. As the NB&T acquisition was really the primary driver behind wealth management and our card categories as we met our revenue forecast in these new markets, organic growth was the driver behind the mortgage banking and the other fee income categories. Mortgage was aided by the back book sale I mentioned earlier, but we also were pleased with the solid higher production levels we saw from our teams.

Other fee growth was a result of yet another strong quarter in swap revenue and this was driven by a combination of good loan production, greater client interest generally in fixed rate financing and enhanced efforts around penetrating our existing teams. We have well exceeded our target of high single digit year-over-year fee income growth thus far in 2016 and we see good opportunities ahead as well.

Shifting briefly to credit, our story is very similar to the last several quarters and in-line with our guidance. Our NPA and adverse performing levels were largely unchanged and our 24 basis point to charge-offs was at the low-end of our normalized range. Our reserve models are also unchanged, such that while the strong loan growth we posted drove the increase on our loan loss provision in Q3 as Mike mentioned, we would expect provision levels going forward to normalize around where they were in the first two quarters of this year.

Paul will now expand on some of our income drivers.

Paul Clemens

Thank you, Mark, and good morning, everyone. Let me cover net interest margin and interest income first and net interest income. It increased roughly a $1 million or 0.4% annualized in the second quarter of 2016 and $13 million or 16.8% from the third quarter a year ago. The increase in interest income, our net interest income from the linked quarter looks like the benefit approximately $350 million earning asset growth, specifically $185 million average loans and slightly less from amount of investments which more than offset the expected seasonal decline in margin.

The increase from the third quarter a year ago reflects a number of significant double-digit organic loan growth year-to-date which Mark alluded to; $700 million of loans and investments from acquisitions away from that organic growth. Growth on our investment portfolio, the retirement of $38 million of maturing sub-debt Mike mentioned in April, and approximately $2 million of additional accretion from acquired loans. All this drove our increases -- 16% increases or 17% increase year-over-year.

From a margin standpoint, our margin improved two basis points from a year ago despite the continued competitive pressures on margins and the shift to more fully rate loans for the reasons I just outlined. As I suggested during the previous earnings call, we saw the normal seasonal decline in margin from the second quarter, due impart to the temporary buildup of municipal tax deposits, along with the addition of floating rate loans and slightly lower loan fees and loan accretion. Margin declined 12 basis points to 360 from the second quarter of 2016, which compares to an 18 basis point decline from the second and third quarter a year ago.

For the fourth quarter, we would expect net interest income and margin to benefit from higher earning asset levels. However, we will see a short-term offset to this benefit, both in terms of margin and a net interest income that will result from the temporary overlap of $150 million of the sub-debt we issued in very, very late September and which we'll use to retire the $115 million senior debt on November 20. Ultimately, actual level will be driven of course by the pace of loan growth, the time the future rate increases and the change in yield curve and level of accretion. Importantly, since the last quarter end, we are even better-positioned for rising rates with the addition to sub debt as well as the growth in our deposit base and the falling rate loan portfolio.

Let me turn to non-interest expense for just a moment; third quarter expenses were in-line with our expectations and totaled $81.7 million, excluding the integration cost. Our efficiency ratio was 51% for the quarter, improved slightly from the second quarter which both ran into roughly 61% and an improvement from 63% a year ago. The linked quarter increase of $980,000 was primarily due to a seasonal increase in maturity [ph] cost, planned investments we made in our IT and risk infrastructure, and the impact of an expense recovery in the previous quarter for certain FDIC loan remediation cost. The increase in year-over-year expenses was largely driven by acquisition activity.

As we look ahead away from acquisition-related activities, we would expect expense for the fourth quarter to remain in-line with the third quarter, subject to the time to certain expenses in marketing as well as variables increase resulting from greater sales activity and of course all with the snow, the question mark in Chicago in December.

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

Michael Scudder

Thanks, Paul. Before we open it up for questions and further remarks, our pending acquisition of Standard Bank shares is progressing very well and right in line with what we expected. I recall that Standard represents roughly about $2.5 billion in assets, $2.2 billion in deposits, $1.8 billion in loans and as a reminder in 2017, we continue to target a late 2016 early 2017 close date and our EPS accretion expectations as well as related transactional assumptions all remain in line with our earlier guidance.

Our local market reaction continues to be great and we remain very excited to be moving forward. I also would want to take the opportunity at this point to thank our colleagues who listen to this call, both at First Midwest and Standard, for their client commitment and their hard work, they've been absolutely tremendous and certainly are the key to our successful efforts here.

As we look ahead to what remains an evolving operating environment, we continue to remain focused on what we call the blocking and tackling of banking. Those actions of which we believe enhance the value of our franchise and ultimately accrete to the long-term benefit of our shareholders. So for us, key to those efforts is enhancing the strength of our balance sheet and capital flexibility, which we did significantly during the quarter both through -- both our announced sale lease back transaction and debt issuance that was earlier referred to.

So as a result, we feel we're very well-positioned for continued execution on our strategic priorities and that's to build the strongest team of colleagues to drive the company forward as we look to grow and diversify our revenues, both lending and fee-based, all of which you saw evidence in this particular quarter's activities. And that throughout all of that, we remain committed to making the ongoing investments to maintain our risk disciplines as we do so. Standard Bank and Trust will further add to that momentum and we feel strongly that that positions us very well for continued future performance and growth.

So with that, let me open it up for questions.

Question-and-Answer Session

Operator

Thank you, sir. [Operator Instructions]. And the first question comes from Brad Milsaps of Sandler O'Neill. Please go ahead.

Brad Milsaps

Hey, good morning, guys.

Michael Scudder

Good morning, Brad.

Brad Milsaps

Maybe a question for Mark. Obviously, you guys had great loan production during the quarter. Can you talk about a little bit about pricing? It looks like maybe the loan yields are down 10 basis points. Just kind of curious what you're seeing. Are you starting to see pricing stabilize? Do you think there is -- you've got maybe further contraction here in terms of what new opportunities we're seeing in the market?

Mark Sander

I think we are seeing pricing stabilize. It ticked down ever so slightly over the course of 2015 on new and renewed spreads, but very marginally and I would say it stabilized in the last couple of quarters. You see more of the pressure on the fixed rate side. Our new production is about 75% floating, but the 25% that's fixed, you've seen a little compression in spreads there over the course of the year.

Brad Milsaps

Sure. And maybe just a lead in to Paul. I appreciate all that color around the margin, I know there is a lot of moving parts this quarter, but next quarter, but typically you recover around 10 basis points coming out of the higher liquidity quarter, all is equal. Is that kind of what you would expect as you get through the double sort of debt that you're going to have in place for the month of -- for the first half of the quarter? Is that kind of on par with what you guys would expect in terms of margin recovery?

Paul Clemens

Yes. I would think excluding the debt impact, we'd recover five to eight basis points, we might guess, somewhere in there.

Brad Milsaps

Okay. All right. Great, guys. Thank you.

Operator

The next question will be from Terry McEvoy of Stephens. Please go ahead.

Terry McEvoy

Hi. Thanks, good morning.

Paul Clemens

Good morning, Terry.

Terry McEvoy

Just a question for Paul. Could you just remind me what impact the 25 basis point increase in late December had on the margin in the first quarter and then should we get something let's say late December this year as you think about adding in the Standard balance sheet to yours? How does that impact the rate sensitivity and should we get a similar boost to them [ph] again if we see another 25 basis points?

Paul Clemens

25 basis points in a quarter adds about $2.5 million a quarter in earnings roughly, somewhere between $2.5 million and I have to think about -- I'll have $14 billion worth of earning assets, so every $1.4 million will add a basis point, so I'm going to be adding roughly 8 basis points or so, I would think. I don't think the sensitivity will change a whole lot with our standard loan portfolio. I think they have a little greater fixed component than floating.

Mark Sander

Ever so slightly, but it won't material on our total.

Paul Clemens

Yes. We don't think it changed our interest rates sensitivity a whole lot and they don't have a very large investment book relatively speaking, they have roughly $200 million investment book once that we throw in those as well, it will not change our interest sensitivity very much.

Terry McEvoy

Thanks. And then just a follow up, do you have a targeted conversion date in mind? I'm just trying to get a sense for cost saves coming from standard and what quarter we should get to the run rate that had been talked about when you announced the deal?

Michael Scudder

We have -- candidly as we go through and prepare for these types of acquisitions. We have multiple conversion dates set aside, so it's less reflective of what's targeted as more in-line with the guidance that says in terms of closing as we give guidance around -- we expect late this year, early next year -- you can presume the conversion dates will wrap around that same timeframe Terry.

Terry McEvoy

Great. And then I guess one small question; that $40 million sale of mortgages, how much the gain did we see in the $3.4 million mortgage revenue line that was reported?

Mark Sander

That was roughly $1 million of that total.

Terry McEvoy

Okay, cool. Thanks, Mark.

Operator

Thank you. And Sir, your next question will come from Kevin Reevey of D.A. Davidson. Please go ahead.

Kevin Reevey

Good morning.

Mark Sander

Good morning, Kevin.

Kevin Reevey

So my question is revolving around kind of your opportunities that you see if any for future sale lease back transactions?

Michael Scudder

Certainly in terms of the portfolio that we entered into this most recent quarter, that reflects those opportunities that we have available to us today. From the path and growing the environment changes, perhaps other opportunities will arise, but at this juncture, we don't see a significant more amount around that. What it does and I would highlight for you, Kevin, is a way from the sale lease back. Those assets that were not a part of that remain an ongoing focus for us in terms of what are the opportunities to enhance our overall efficiency. So it's both the combination of the flexibility created through the lease back, but also the remaining flexibility that exist within the portfolio. We'll continue to do that as an ongoing optimization effort, if you will.

Kevin Reevey

And then my last question is given all the disruption that's happening in the Chicago area, you're continuing to see opportunities to do a list out of commercial banking teams from other institutions to really grow your platform?

Mark Sander

The pat answer if you will, that we do believe is anytime this disruption as opportunities and we do believe that. We haven't done a lot of team lift outs in our history. I would suggest we're probably more open to them than we might have been in the past or see that there's more opportunities or a little bit of both, I guess I would say. And those could be both in market and in other markets as well.

Kevin Reevey

Okay, thank you.

Operator

And the next question will come from Chris McGratty of KBW. Please go ahead.

Chris McGratty

Hey, good morning, everyone.

Paul Clemens

Hi, Chris.

Chris McGratty

Paul, question on the margin. I just want to make sure I'm fully capturing the guidance for the quarter. The 5-8 basis points that you would expect to get recoups, is that with or without the debt cost?

Paul Clemens

It would be without.

Chris McGratty

Okay, so you would normally see five-eight and then we have to adjust for the double payment, I guess, for the quarter?

Paul Clemens

That's correct.

Chris McGratty

The other question on the earning assets in the margin, the proceeds and the sale lease back, can we talk about or can you help us get a better handle on redeployment strategies? Is that factored in the guidance? Is that just every mixing opportunity over the next few quarters into loans? How should we think about that?

Paul Clemens

It's actually a bit of both. Actually, you'll see that we leveled up partially in the third quarter with anticipation of those proceeds. So we actually did spend some of those proceeds in advance in order to enhance and then it will serve as additional proceeds to fund loan growth going forward.

Chris McGratty

Okay. But the overall message on NII in the fourth quarter is general stability? Is that a fair conclusion?

Paul Clemens

Yes.

Chris McGratty

Okay, great. The last question I have, maybe goes back to the Standard when you announced the deal in June. The guidance was at $0.18 accretion to consensus 2018 numbers, which I think at the time applied a number around $1.60. I think then you just talked about some assumptions on set fund, but also growth; given where we are in rates and then we haven't seen movements, does that accretion number change at all? I think you're assuming $1.50 by the end of 2018.

Michael Scudder

Kind of the way we look at it Chris, is the accretion number really doesn't change. What happens is both sides of the equation are moving. Right? As you start looking at what's the accretion contribution relative to our stand alone performance as our position increases, as we perform better in a higher or lower interest rate environment, we would expect Standard to mirror that.

Chris McGratty

Okay. But I guess it's me, I'm not fully capturing, Mike. If rates stayed low, then we get one this year and we get one next year -- does the $0.18 still fall through? I mean do you still get to $1.60?

Michael Scudder

I don't know about a literal dollar amount number. We're probably not in a position to give you that fine of guidance. We would expect that the accretion contribution would still hold and then we can make our own judgment on what final 2017-2018 numbers are after we have finished through the planning cycle here for this quarter.

Chris McGratty

Okay, that's helpful. Maybe one more on the tax. Which should we be thinking about for the next few quarters?

Paul Clemens

I'm sorry. The tax rate?

Chris McGratty

Yes.

Paul Clemens

Well, I think what you'll see if we have a conversion this quarter, we'll incur some integration cost that will bring our pretax income down in the relative size of tax of tax exempted income to total, pretax income will be greater. So effective tax rate may come down a little bit in this fourth quarter, but then it just stabilize back out where it is roughly around today.

Chris McGratty

Great. Thanks for taking the question.

Paul Clemens

Great. Thanks, Chris.

Operator

[Operator Instructions] And your next question will come from Nathan Race of Piper Jaffray. Please go ahead.

Nathan Race

Hey, guys. Good morning. Paul, question for you on the securities portfolio yield decrease. Can you help us get a better sense for how much of that was tied to premium amortization versus just reinvestments at lower rates this quarter?

Paul Clemens

It was primarily reinvestment on lower rates. Like I say, we levered up a little bit this quarter and what's rolling off is rolling off a little bit above too, and what's coming on as low as below 2%, primarily the CMO pools?

Nathan Race

Got you. Okay, that's helpful. And maybe just changing gears, thinking about your agricultural portfolio; obviously no charge-offs from that book this quarter. Just curious, kind of what you're seeing on the client level given the drop in commodity prices that we've seen over the last several quarters?

Mark Sander

We're seeing stability after what I'll call was a rough 2015 that you saw manifest itself in our numbers in the early part of this year, as we saw a little deterioration in that book. Since then it's been stability and by that I mean the credits that we were most worried about, we short up or cured and '16 was an okay year for farmers because they're going to get great yields and it's going to help partially offset some of the pricing pressures. So we're conservative Ag lenders by nature, and so we actually feel really good about our Ag book, we don't see any losses in our Ag book coming; so we feel good about that, but certainly new opportunities for growth are pretty limited right now, there is just not a lot of great opportunity out there.

Nathan Race

Okay, I appreciate all the color.

Michael Scudder

Great, thanks.

Operator

[Operator Instructions] And we have a follow-up question from Chris McGratty of KBW. Please go ahead.

Chris McGratty

Great. Thanks for taking the question. Mark, the provisioning comments you talked about in your remarks going back to the first half of the year, were you -- I think you're referring to the provisioning rate around 40 basis points versus 50 or were you more talking dollars?

Mark Sander

I was talking more dollars. So as I think of the -- say the average of Q1 and Q2, you'd be in that kind of range of that average, dollars.

Chris McGratty

Okay. And then the bill to the legacy book, is that kind of a one-time, or is that kind of trajectory where we're going at this point of the cycle?

Mark Sander

The bill of the legacy loan book?

Chris McGratty

Yes, the reserve; I think it went up like two basis points or something like that.

Michael Scudder

Yes Chris, you're going to see it move one or two basis points, just depending on the nature of the modeling and the mix of assets that are moving, up or down. We just don't do it as a material shift and kind of posture if you will, around the loan loss reserving at this juncture.

Chris McGratty

Okay. Thanks a lot for taking it.

Operator

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

Michael Scudder

Great. Well, thank you for joining us today, everyone. We greatly appreciate your interest in First Midwest and we 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.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!