FMBI
#Good morning, everyone, and thank you for joining us today.
Following the close of the market yesterday, we released our earnings results for the first quarter of 2018 and also issued presentation materials that we will refer to during our call today.
These provide both historical financial information and our outlook for 2018.
If you would like a copy of our earnings release or the presentation deck, they are available on our website in the Investor Relations section, or you may obtain them by calling us at (630) 875-7463.
During the course of the discussion today, our comments and the presentation materials may include forward-looking statements.
These statements are not historical facts, are based upon our current beliefs and are not guarantees of future performance or outcomes.
The risks, uncertainties and safe harbor information contained in our most recent 10-K and our other filings with the SEC should be considered for our call today.
Lastly, I'd like to mention that we will not be updating any forward-looking statements following this call.
Here this morning to discuss our first quarter results and outlook are Mike <UNK>, Chairman, President and Chief Executive Officer of First Midwest; <UNK> <UNK>, our Senior Executive Vice President and Chief Operating Officer; and Pat <UNK>, our Executive Vice President and Chief Financial Officer.
With that, I will now turn the floor over to Mike <UNK>.
Great.
Thank you, Nick.
Good morning, everyone.
Thanks ---+ let me add my thanks to what Nick started here with, and thank you for joining us today.
It's great to be with you.
As we started or as Nick had shared, in continuation of a practice we really started last quarter, we provided a supplemental presentation for you to follow on with as we move through our remarks.
So let me then start with the highlights, and <UNK> and Pat can walk you through the components.
For the quarter, we earned $0.33 a share as compared to $0.02 last quarter and $0.23 versus 2017's first quarter.
We certainly recognize that the quarter-to-quarter comparisons are challenged by the impact of last year's M&A activity as well as tax reform, and additionally, for this quarter, changes in accounting standard that went into effect.
So we'll do our best to bridge to what I would refer to as core underlying performance.
For the quarter, earnings per share, adjusted for 2017's acquisition costs and most responses to 4Q tax reform, was down in comparison to the linked quarter, largely due to about $0.05 per share after tax and comparatively higher loan loss provision expense.
Overall, we were very pleased with our underlying operating performance, which was strong.
Earning asset growth was solid, up on average about 7% annualized linked quarter.
And that was largely led by loan growth.
Deposit funding, on average, was up 3% versus the same quarter a year ago, and recognize that linked quarter comparisons are seasonally impacted, so the fact that we saw a linked quarter flat relative to the fourth quarter was actually a very positive result for us, given that seasonality.
Our mix of core deposits remain stable, and underlying betas were only up modestly.
While reported margin came in at 3.8%, that's down in comparison to 2017, once you allow for the differential impact of lower accretion and tax equivalency changes that came from tax reform, underlying margin actually expanded.
And if you compare it to what it was year-over-year, it's up about 16 basis points.
Similarly, our fee-based businesses also performed well for the quarter.
Again, adjusting for the year-over-year impact of Durbin as well as the required accounting reclassification of expense this quarter, fees improved 6%.
Expenses were also tightly controlled for the quarter.
<UNK> will review in greater detail our Delivering Excellence initiative, which continues to make strong progress.
I would simply emphasize here, execution provides meaningful improvement from our perspective in service levels and the experience that we delivered to our clients, as well as efficiency.
And by extension, both of those we're excited about because they also make our platform more scalable.
So again, <UNK> can speak to that in a little greater detail.
Then as I started, credit provisioning for the quarter was elevated, largely due to comparatively stronger loan growth.
If you look at our first quarter, we actually had about $250 million worth of linked quarter growth.
If you compare that to the fourth quarter for that same quarter on a linked quarter basis, we saw about $50 million worth of growth.
So we had about $200 million more in overall growth for the quarter.
It was also impacted by higher net charge-offs attended to a remediation of 2 independent problem credits.
Again, <UNK> will cover that further, but I would simply offer the recognition that variability in quarter-to-quarter remediation efforts and, by extension, provisioning is natural, and frankly, to be expected in today's historically benign environment.
So with that, let me turn it over to <UNK> and Pat for additional color.
Thanks, Mike.
So starting on Page 3 of our earnings call presentation, you can see the loan growth that Mike talked about, about $240 million in the first quarter, from solid organic growth across our platforms and some targeted transactional activity.
The first quarter is typically our slowest of the year for loan growth.
Given this, we're pleased to post modest increases across multiple business units, which accounted for nearly half of our total growth in the quarter.
Specifically, our C&I lines in regional, health care, franchise and structured finance all reported growth.
Also, our commercial real estate team was able to more than offset pay-downs resulting from sales of a few office and industrial properties, with some expanded multifamily and construction activity.
We monitor these 2 sectors closely but are currently at very comfortable levels in our view, and thus, willing to expand and further.
Lastly, our consumer book posted a solid organic quarter as well, with mortgage continuing to gain momentum.
We also elected to purchase over $100 million of high-quality transactional credits in consumer and C&I.
We have periodically leveraged our strong deposit base as well as future cash flows this way, all with an eye towards attractive risk return assets, and we will maintain flexibility in this area going forward.
In light of this solid first quarter and given our continuing favorable pipelines, we are slightly raising our loan growth target for the full year.
Turning to asset quality on Page 4, we unfortunately experienced deterioration in 2 credits early this year, which caused us to recognize losses at a higher level than we had anticipated at the end of last year.
In conjunction with our strong loan growth, this led to a $7 million increase in provision in Q1 versus the linked quarter.
The issues in these 2 credits were each unique and isolated.
Going forward, our charge-off guidance is 25 to 30 basis points annualized, with some potential variability by quarter.
Thus, despite being elevated in Q1, for the full year, we still expect total charge-offs to remain within our normalized range of 25 to 40 basis points.
The stability we see in our nonperforming, adverse performing and watch credit categories, as well as the overall favorable macro environment, gives us confidence in that guidance.
Deposits, as demonstrated on Page 5, remain a strength of our company.
Our mix remained strong at 84% core even while we added about $150 million in time deposits in the quarter.
We will continue to be market-competitive across all deposit types.
Our average deposits were up about 3% year-over-year in Q1, reflective of our strong underlying platform, but also an indication of how well our Standard integration went.
So Pat will now cover NII and margins.
Thanks, <UNK>, and good morning to everyone on the call or listening in.
Turning to net interest income and margin on Slide 6, net interest income was stable compared to the fourth quarter and up 3% compared to the same period in 2017, consistent with our overall expectations.
On a linked-quarter basis, the first quarter benefited from higher interest rates and growth in loans and securities, offset by fewer days in the quarter, $1 million decline in accretion and higher cost of funds.
Compared to the same period in 2017, the increase was driven by higher interest rates and loan growth, partly offset by lower loan accretion and higher cost of funds.
Acquired loan accretion contributed $5 million to the quarter, down $1 million from the prior quarter and down $6 million from the same period in 2017.
We continue to project relatively stable accretion levels in 2018, with $18 million scheduled for the entire year, $13 million remaining after the first quarter, and quarterly amounts declining from $5 million per quarter in the first half of the year to $4 million a quarter in the second half of the year.
Having said that, we need to remind you that some volatility should be expected.
Moving to net interest margin.
Tax equivalent NIM for the current quarter of 3.80% was in line with expectations, down 4 basis points compared to the prior quarter and down 9 basis points for the same period in 2017.
Excluding accretion, margin was flat to the prior quarter at 3.64% and expanded 13 basis points from the same period a year ago.
Current period margin would have been 3 basis points higher absent the reduction in tax equivalent adjustment, reflecting lower federal income tax rates.
Compared to the prior quarter, margin, excluding accretion, benefited from higher rates, largely offset by higher funding costs.
Compared to the same period in 2017, the increase was principally driven by the positive impact of higher rates.
Turning to earning assets, average earning assets were up more than $200 million linked quarter due to both loan and securities growth, partly offset by lower balances at the Fed.
Compared to the prior year, earning assets were up nearly $550 million, reflecting loan growth.
First quarter results were generally in line with our expectations for both net interest income and margin, and our outlook provided in the January call has not changed.
We continue to expect full year earning asset growth in the mid-single-digit range and GAAP net interest income growth in the mid- to high single-digit range when compared to the full year of 2017.
Net interest margin for 2018 on an FTE basis is expected to be relatively consistent compared to the 3.87% we reported for last year as the benefits of earning asset growth and higher rates are offset by lower annual accretion.
Excluding accretion, we expect modest expansion in NIM on an FTE basis.
And finally, I'd be remiss if I didn't remind you the projections are subject to volatility due to movements in interest rates, pace of loan growth and seasonal municipal deposit flows.
Prior to turning it back to <UNK> to discuss noninterest income, I'll remind you that our results are a bit noisy between noninterest income and expense due to the adoption of revenue recognition standard on January 1 of this year.
As a result, nearly $4 million of card and merchant expenses previously presented in noninterest expense were reclassified and netted against the related fees in noninterest income.
This is done on a prospective basis, prior periods were not adjusted in accordance with GAAP and the practical challenges of such a restatement.
We tried to bridge this change for you through additional disclosure in both the earnings release and on Slide 7 and 8 of the presentation.
Keep in mind this is a reclassification, there's no impact to net income.
I'll turn it back over to <UNK> to discuss noninterest income on Slide 7.
Thanks, Pat.
So again, on Slide 7, our noninterest income was in line with expectations and guidance.
We have a fair amount of noise this quarter, as Pat referenced, but stripping all that out, we were up 6% in Q1 versus the same period last year.
This was driven by our main areas of focus: wealth management, card and treasury management, all of which posted a solid start to the year.
Our outlook going forward is that noninterest income should increase $1 million to $2 million quarterly in 2018 off of our Q1 levels.
So Pat is going to cover noninterest expense.
So moving onto expenses on Slide 8.
As previously mentioned, total noninterest expense for the quarter was impacted by the $4 million reclass of card and merchant fees.
In addition, the prior quarter included $4 million in bonuses and charitable contributions related to the passage of tax reform, while the first quarter of 2017 included $18 million of acquisition and integration expenses.
Away from these items, quarterly expenses remain very tightly controlled at the sub-$100 million level, and our efficiency ratio is stable at 61%.
Our guidance on expense growth remains largely unchanged.
But with all the noise, we felt it'd be helpful to be more explicit.
So for the year, we expect low single-digit growth on reported expenses.
$96 million to $98 million per quarter on average is a good proxy, compared with the $95 million we reported in the first quarter.
Note that this guidance does not contemplate the effect of our Delivering Excellence initiative at this point.
More to come on that in a moment.
A quick word on taxes.
Our effective tax rate for the quarter was impacted by a $1 million benefit related to employee share-based payments.
In addition, the prior quarter was impacted by the deferred tax asset write-down associated with tax reform.
Excluding these items, our effective tax rate would have been 25% for the current quarter compared to 34% in the prior quarter.
For the year of 2018, we continue to expect our effective tax rate to be approximately 25%.
Wrapping up with capital on Slide 9.
Capital and capital generation continue to be strong.
In general, our capital ratios decreased slightly due to the impact of loan growth and the final phase-in of certain Basel III provisions largely offset by earnings.
Compared to a year ago, our tangible common equity, excluding AOCI, is up 22 basis points.
Certain tangible common equity ratios that do not include the impact of AOCI, or accumulated other comprehensive income, were impacted linked quarter by the increase in our unrealized loss on securities available for sale due to the higher interest rate environment.
Now I'll turn it back over to <UNK> for remarks on Delivering Excellence.
So you see, our update on delivering excellence is on Page 10.
You'll recall that at the end of last year, we began a diagnostic review to improve our customer service delivery, processes and efficiency.
We are nearing completion of this broad initiative and are encouraged that it will not only meet these objectives but also provide the scalability for future growth that Mike referenced.
We anticipate more detailed information will be available by the end of the second quarter, but we remain comfortable with our early expectations, namely that while cost of implementation will likely exceed any benefit in 2018, we anticipate at least a 5% reduction in noninterest expense in 2019 as we hit our full run rate early in the year.
So we've provided a brief summary of all that we've just discussed on Page 11, and I'll turn it back to Mike to conclude our prepared remarks.
Okay.
Thanks, <UNK>.
So some final remarks before we open it up for questions.
As we look ahead, our balance sheet remains strong.
Our core deposit base is outstanding.
Credit costs will average out and return to more normalized run rates.
Combined with higher-earning assets, rates ---+ and higher rates as well as lower corporate taxes, we expect to earnings momentum to continue to build and, obviously, strengthen capital as an extension to that.
As <UNK> just shared, Delivering Excellence is progressing nicely.
We expect to communicate more specifics soon and certainly progress toward implementation soon thereafter.
This continues to be a strategic priority for us and obviously has gathered a lot of management effort over the course of the preceding quarters.
But at the same time, we don't view its implementation as either a distraction or an inhibitor to business as usual.
This is just part of being a healthy, growing organization and the steps you need to take to continue to do that.
So with that, let's open it up to questions.
Well, it's good you're not going to hold us to a number.
But I think the best way right now, because we don't have all the details prepared, we'll give more explicit guidance on that, is to think about it as sort of a $20 million reduction in run rate of expenses spread across the year.
So if you take our guidance for the remainder of the year, you would come up with a full year of somewhere in the mid- to upper $380 million range.
And I'll remind everybody, we do have about $6 million of higher occupancy expense in 2019 as our sale-leaseback lease accounting goes into effect, with an offset of having about $50 million of additional Tier 1 capital.
So that's just a onetime thing.
But at this point, just keep it at the 5% of expense rate.
I'd really rather have all the details firmed up, what our costs and ongoing benefits are before I answer that.
We typically do have a 1% to 2% sort of inflationary upward bias, certainly in staffing costs.
But we've been doing a really good job of keeping staffing levels at or even below expectations, which is serving to offset that.
So I'd rather not commit to flat versus inflation for '19 at this point.
We think there's ---+ <UNK> ---+ Chris, it's <UNK>.
We think there will be revenue impact.
We're not building any in yet.
We're not ready to talk at length about that.
But we certainly believe that there are opportunities to generate revenues, both in terms of greater cross-sell and greater penetration in retail client base as well as in treasury management.
Well, I'll just build off of kind of my remarks before I opened it up for questions, Chris.
We put a lot of energy into creating a process and building a road map for what we want to accomplish, certainly off of Delivering Excellence, and that is a strategic priority for us.
But at the same time, we don't view its implementation or execution as being something that would inhibit us from business as usual.
And a part of our business as usual is, as opportunities present themselves for consolidation, if they fit strategically with what we're trying to do, then we'll certainly consider those and don't view ourselves as prevented from executing anything that we think is in the best interest of the company.
I'd say ---+ the first part of your question, Brad, I'll take, which is we got there through, frankly, a bottoms-up look at how we can improve our processes and deliver it to our clients.
And it was not solving to a number.
Certainly, we had goals, but it was around the right answer.
And we felt that the right answer would generate efficiencies, and that's how we got to our 5% number, because we ---+ it does based on our analysis.
The second part of your question again, I'm sorry, Brad.
Oh, ROA and ROE.
.
Yes, Brad, this is Pat.
We historically and continue to really target performing in the top third of our peer group, broader national peer group as a measure of what it takes to be high-performing.
Because things will move around, and to be a higher performer relative to other alternatives we think is the right recipe.
So for us, that historically has been thinking of it in a ROTCE level, something in the 13% to 15% range.
And we have ---+ so we're sort of knocking on that door right now.
And so the ---+ part of the objective of delivering excellence away from is improving the client experience, is to ensure that we continue to make progress in improving our overall performance and profitability relative to others because we know the world is not going to stand still on us.
Yes.
I think that's very well said, Pat.
Brad, just to add to it, going back to the Delivering Excellence initiative.
I ---+ <UNK> hit it on the head.
Our first priority is to create the best experience that we can for our clients.
We have an opportunity to do that.
It creates an ability to make that happen and deliver that service the way the clients want it, which certainly recognizes the expectations that come from a digital world and the investments in technology that go along with it.
Those create the opportunity to do that better.
They also create efficiency that play back out of it.
But most importantly, they also create a skill set and a platform from which we can grow and build off of.
So that's ---+ those are the real positives that come back out of it.
And as we said, you certainly can look where ---+ as we guided to that 13% to 15% ROTCE and say that's probably on the upper end of that now given tax reform and all the earnings momentum that's out there within the industry.
But ultimately, we're looking to consistently perform in that top level among peers.
And to do that, in our judgment, you need to both generate that return and likely continue to drive and leverage greater operational efficiency that ---+ when you deliver that service to the clients.
Our appetite for buying more on C&I is fairly low.
We did a little bit just to supplement and make sure that we hit our earning asset targets early in the quarter, then we ended up with a solid organic growth and perhaps didn't need to.
But ---+ so our appetite going forward on the C&I side, I would say, is fairly low.
To answer the other part of your question, yes, those are larger syndicated deal that are, I would say, of a high quality.
Those are slightly lower margin, we think that's okay given the high quality of the credit we're underwriting there.
No common theme.
And again, the increase was pretty modest, Terry.
I mean, our NPAs had been running in the same 90-ish basis points kind of levels for quite some time now.
So we had a minor tick-up in NPAs this quarter.
I'd say there's probably more to come in the future on that, Terry, than we're ready to delve into now.
I don't think there's major technology investments.
There's a little bit but not a lot, but there are certainly some onetime costs as you try to implement the programs like this.
And again, more will be forthcoming before the second quarter is out.
So C&I demand is solid.
It's not like people are rushing out there to make capital investments based on the tax reform.
But I would say, overall, businesses are optimistic.
And again, positive overall mood.
Our pipeline is strong.
It's actually ---+ it's up a little bit this quarter versus last.
So given the growth we had last quarter, that's what leads us to think that we could continue to hit those guidance that we've given.
Pricing is the rub, if you will.
There's just pressure.
It's been a competitive market for some time.
Nothing unusual in Q1, I would say, but it is very competitive.
And again, as we underwrite, depending on where we are in the risk spectrum, the margins can get a little compressed.
They were a little bit lower new and renewed spreads in Q1.
Again, we don't think it's symptomatic of any great long-term trend, but something we have to fight every day, I guess, I would say.
Wanted to touch on, kind of following up on Brad's question, the consumer loans that were purchased this quarter along with the C&I.
I mean, you kind of increased borrowings in order to fund that this quarter.
So can you just talk about kind of the thought process there and then what the impact will be on margin as kind of those borrowings come down and deposits come back in, if there are some attractive characteristics about loan book you specifically purchased this quarter.
Two pieces to that, <UNK>, it's Pat.
I'll maybe start off a little bit on the funding of that and <UNK> can wrap up with the thinking on the consumer purchases.
So our borrowings are generally a subject of, obviously, where our cash flows are.
And we're at a low cyclical point in the first quarter, as we always are, on cash flows with the municipal and commercial, frankly, deposits hitting their low points of the year as they typically do.
We also, on the borrowing side, you guys have heard us talking about our balance sheet and funding swap strategy, where we'll periodically swap down some of our floating-rate loan production into longer-term fixed rate swaps just to keep our asset sensitivity closer to midpoint.
And as part of that, we entered into forward-borrowing swaps, usually 2 or 3 years out, and so those periodically will come on.
So probably 70% of the FHLB balances that we have are longer-termed out swap balances, where we entered into forward swap agreements 1, 2 or 3 years ago, and there will be more to come on that.
That balance will probably grow to be close to $1 billion by year-end just to take advantage of those rates.
And those rates, the stuff we have coming on this quarter, is at 1 17 for 2-year FHLB money, which is significantly lower than we could get funding otherwise.
And it also keeps us from having to aggressively compete for deposits, which keeps our betas low.
As far as the assets that we purchase, we plan for a modest amount of transactional activity in consumer, I will say, on an annual basis.
Certainly for 2018, this was in our plan.
We did it early in the year because the opportunity was there to purchase high-quality assets at the right price, we thought.
So it was, in Q1, all home equity loans.
You can see that category increase about $50 million this quarter.
So all of our purchase activity was there, prime floating, home equity loans at a really nice credit score.
I mean, I think our average FICO there was in the 730 range.
So really, again, high-quality assets for a good price, we thought.
Okay.
And without putting too fine a point on the Delivering Excellence program and the timing, but the comment that the 5% improvement will be in 2019.
Are you saying for the full year, like it will be fully implemented by the beginning of 2019.
Or is this more kind of a run rate improvement by 4Q '19.
I would say it this way, that while I can't say it'll all be there on January 1, we believe that we will get that 5% fully loaded, if you will, in 2019.
Okay.
And if I can sneak one last one in, just on the credit guide for the remainder of the year.
I understand you said it's unchanged, right.
I had it before at a mid-20s net charge-off range.
And now, we're 25 to 30, so maybe a little extra caution there.
Anything to read into that.
Or is that just falling on kind of the worst credit performance this quarter.
<UNK>, I hate to ask you to do this, but you cut out a little bit there from our end.
Your question was around charge-off guidance, was it.
Yes.
So I think previously, it was a mid-20s range for the full year, and now you're saying 25 to 30 basis points for the full year, so a little uptick.
Is there anything else we should read into that.
No, I don't believe so.
We don't consider a couple of basis points a material change.
So going from mid-20s to 25 to 30, we consider kind of the nuanced ebb and flow of normal credit activity.
And again, outsized in Q1, but normalized the rest of the year, we believe.
I apologize I got on late as well.
But I was just curious if you could provide any additional color on the 2 C&I relationships that were charged-off this quarter.
Any additional color in terms of the industry they're in, if they're long-term clients of the bank, if these are club deals or syndicated.
Just any additional color would be appreciated.
Sure.
And again, I want to point out, we ---+ when we established reserves for both at the end of last year, we didn't anticipate the pace and the magnitude of the deterioration we saw in Q1.
So specifically, the larger of the 2 was in the heavy equipment business.
This was not an ---+ this issue was not reflective of any weakness in the industry.
Rather, I'll just say it's a unique circumstance that we have referred to state and federal authorities.
So while that's incredibly disturbing, I have to say that if you've been in this business long enough, you occasionally see this.
And people misbehave, even people that you've known for a few years.
The other was a syndicated credit with ---+ we're in a club deal with 2 other larger, very experienced banks, where we lent on some assets that are proving challenging in liquidation.
So we'll continue to pursue remedies there, but we felt recognizing the loss now was the right thing to do.
Yes, I appreciate that color, <UNK>.
And Pat, just to clarify on the expense guide for the remainder of this year, does that ---+ that does not ---+ or that does include any onetime costs that you would have along with Delivering Excellence.
Or are some of those onetime costs going to be recognized in 2019.
Well, I apologize.
The connection has gotten very choppy here so you broke up.
I think you were asking about our expense guide for the rest of the year whether it includes any onetime costs.
Right.
Or some of those onetime costs are going to be reflected in 2019.
Our guidance does not include any onetime costs.
In the same fashion, it doesn't include any of the ongoing run rate benefit associated with that.
So those will be incremental.
We are likely and working towards being able to recognize all of our onetime costs upfront in '18.
And as <UNK> said, expect to start giving a full ---+ at least a full run rate to our guidance, if not a full longer-term run rate, in 2019.
Got you.
And can you give us a sense of the magnitude of those onetime costs that we should expect to see this year.
No, that's a more to come.
Hopefully, like this quarter, we'll have that ---+ have all that completed.
We're still probably 10% from being finished with just the design phase of implementation, and part of that is making sure that we've accumulated and validated all of the costs and benefits.
So thanks for your patience.
Well, we're having all sorts of connection problems at this time.
We hope that you can all hear us, but you're talking about noninterest income in our guidance, Chris, I think, right.
Yes.
It's off of the $35 million.
So $1 million to $2 million a quarter off of the $35 million.
Great.
Thank you.
Before closing, I want to take the opportunity to thank all of our colleagues who listened to our call for their contributions to and investment in our performance.
They continue to be the face of our company and our greatest asset.
I would then go on to thank all of you for your interest in and attention to our story as we share our ongoing belief that First Midwest is a great investment.
So have a great day, everyone.
