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spk06: Good morning, ladies and gentlemen, and welcome to the First Midwest Bank Corp 2021 Second Quarter Earnings Conference Call. Following the close of the market yesterday, First Midwest released its earnings results for the second quarter of 2021 and issued presentation materials that will be referred to during the call today. During the course of the discussion, management's comments and the presentation materials may include forward-looking statements and non-GAAP financial information. The company refers you to the forward-looking statement, non-GAAP, and other legends included in its earnings release and presentation materials, which should be considered for the call today. This call is being recorded, and all participants are in a listen-only mode. Following the presentations by Mike Scudder, Chairman and Chief Executive Officer, Mark Sander, President and Chief Operating Officer, and Pat Barrett, Executive Vice President and Chief Financial Officer, The call will be open for questions and answers for analysts only. I will now turn the call over to Mr. Scudder.
spk05: Great. Thank you. Good morning. Thanks to all of you for joining us today. It's great to be with you and hope this finds everyone doing well, staying healthy and ready to go. These are exciting times here for us at First Midwest with our announced combination with Old National, now just a little over a month old. So what the plan here is to give you a quick update on the integration process. Mark will do that at the end, but obviously the near-term focus, or certainly the focus for this call, is on sharing perspectives on this quarter. Overall, we are very pleased with our performance for the quarter. Performance continues to improve as we see the benefits of a recovering economy. Obviously, comparisons a year ago are tough because of the pandemic, so my comments are going to largely center on quarterly momentum. Pat and Mark can certainly help walk through the nuances year over year as you find that necessary. Most importantly, as I think about the quarter, our operating performance benefited from strong loan production. We also continue to see strong performance from our fee-based businesses and obviously in the environment that we've been operating in for some time, continued focus on managing our costs. So I'll quickly walk through the highlights. EPS came in at 41 cents. That's up 14% for the first quarter. If you allow for adjustments, EPS was $0.46. That's up 24% from the prior period. And again, largely due to comparatively lower loan loss provisions and stronger revenue and lower expenses. Our loan growth was solid, up 7% annualized from year end. And Mark can speak to this in greater depth. Pretty much what we expected as pipelines continue to normalize. Net interest income was $144 million. That's up about 2% linked quarterly. Again, as we saw the benefit from stronger PPP fees and one more day in the quarter. Net margin was 2.96%, but once again is impacted by elevated liquidity, which obviously weighs on the percentages. Fee-based revenues remain strong. And as I said before, we saw again this quarter record wealth management revenue, which offset the fallout from last quarter. But we have to remember the fallout from last quarter was from record levels for mortgage revenue. And then obviously away from the transaction costs. attended to the old national combination. Non-interest expense was down about 3% from last quarter, which was inflated by seasonality and obviously from our perspective reflects our effort to remain tightly controlling our expenses. Credit and capital reserves are still robust as we see economic recovery continuing. Our allowance for credit losses stood at 1.56% of total loans. and that's after you exclude PPP, which is down from last quarter but still elevated relative to where we started 2020. During the quarter, we absorbed previously reserved charge-offs for two credits, while the improved credit climate and outlook simply just didn't warrant further provisioning given where we are in the economic recovery. Overall, our non-performing and potential problem levels continue to improve as did our past dues 30 to 89, so those trends continue to look positive. So with that as a recap, let me turn it over to Mark and Pat, and they can expand on some of the details and walk through the deck. Mark? Thanks, Mike, and good morning, everyone.
spk04: Starting on slide three of our presentation, loan growth was strong and widely distributed in Q2. Away from PPP, loans were up $250 million, or 7% annualized from last quarter, as our mortgage, middle market, and specialty teams all generated results in line with our clients' improved expectations. We also added some nice multifamily clients in Milwaukee and Chicago. We discussed in our last earnings call our view that the outlook for commercial loan growth was favorable given our rising pipelines. That came to fruition this quarter as production was up about 6% from the prior quarter, and we saw some net line draws for the first time in over a year. The results we posted in commercial in Q2 we believe are likely to continue for the near term as pipelines remain steady at pre-pandemic levels. Mortgage had another robust quarter with production in excess of $400 million, which allowed us to add about $100 million net to our balance sheet while still generating nearly $7 million of fee income through asset sales. Lastly, we did buy some high-quality installment paper, really to offset the continuing declines we see in home equity loans from refinance activity. In total, then, our outlook for full-year loan growth of mid-single digits away from PPP remains unchanged. As to PPP, and there's a page in the appendix which summarizes this, we ended the quarter with $700 million in outstanding loans. As we further supported our clients with some incremental new loans early in the quarter, but then we saw over $450 million forgiven by June 30th. Again, we believe most of our balances here will be forgiven and repaid before year end, as Pat will detail in his margin discussion shortly. Asset quality, beginning on slide four. continued to improve as expected, like Mike highlighted. All adverse categories, NPAs, substandard, special mention, and 30 to 80, 90 days past due, they all declined in Q2. We believe this favorable risk rating migration will continue over the back half of this year. Charge-offs, as shown on slide five, did increase as expected solely due to two large credits that we had previously fully reserved for. While these isolated issues came a little earlier than we thought, they were in our 2021 forecast, and thus our outlook for the full year has really not changed. If anything, it's improved slightly, as elsewhere across both commercial and consumer charge-offs were benign. Given our continuing improved outlook, our $220 million allowance leaves us very well reserved for the lower charge-offs we foresee the rest of the year. Turning to deposits on slide six, Funding remains a core strength of our franchise. With the industry flush with liquidity, our historical comparative cost advantage is more muted now, but it's still there. Our cost of deposits came down a little further in the quarter to eight basis points, levels last seen following the financial crisis. Importantly, we have plenty of dry powder and funding sources to take advantage of market opportunities. So Pat will now pick it up from here on net interest income.
spk03: Thanks, Mark. Good morning to everyone on the call. Turning to net interest income and margin on slide seven, net interest income was up 2% compared to the prior quarter, down 1% from the same period in 2020. The increased linked quarter was driven by $2 million in higher PPP loan forgiveness and an additional day in the quarter, as Mike mentioned, partly offset by lower acquired loan accretion. PPP loans forgiven in the quarter increased from approximately $200 million in the first quarter to approximately $450 million in the second quarter. Compared to the prior year, the decrease in NII was due to lower rates, partly offset by interest income and fees on PPP loans, lower cost of funds, and loan growth. Acquired loan accretion of approximately $6 million was down $1 million compared to both prior periods. Accretion in the second quarter was higher than anticipated due to favorable resolution of certain acquired loans. Continuing on the same slide with net interest margin, Tax equivalent NIM for the current quarter of 2.96 percent was down seven basis points, linked quarter, and down 17 basis points from the same period a year ago. Excluding accretion, adjusted margin was 2.84 percent for the quarter, down four basis points, linked quarter, and 14 basis points from the prior year. Note that adjusted net interest margin, excluding the impact of PPP, continued to increase modestly, a trend that we've been experiencing since late 2020. Link quarter net interest margin compression was due to higher customer liquidity and the normal seasonal increase in municipal deposits that occurs in the second and third quarters, partly offset by higher accelerated income on the forgiveness of PPP loans. Compared to a year ago, net interest margin compression was primarily driven by the impact of lower interest rates on loan and securities yields, as well as the impact of higher customer liquidity, partly offset by lower cost of funds and PPP income. Our outlook for 2021 net interest income is unchanged and is expected to remain relatively stable, while net interest margin, excluding accretion and PPP, is expected to grow modestly the remainder of the year from the second quarter of 2021 levels. Accretion is expected to be approximately $22 million for the full year, with $9 million expected over the remaining two quarters of 2021. Aggregate PPP, net interest income, is expected to approximate $35 million for the full year, with $14 million coming in the remainder of the year, roughly evenly by quarter, though the exact timing and the amounts are completely dependent on the SBA's process for forgiveness. Returning to non-interest income on slide 8, we continue to see solid recovery, most fee-based revenue streams returning to pre-pandemic levels, except for capital markets income. Non-interest income was up 1% linked quarter and 40% versus a year ago. Mortgage income of $7 million was down 3 million from our record first quarter 2021 levels, but was up 3 million or 94% from a year ago. We posted another record quarter in wealth management, up 3% linked quarter and 22% from a year ago, reflecting robust markets as well as strong sales production and client retention. Service charges on deposits were up 8% linked quarter and 18% from a year ago, while card income was up 5% linked quarter and 50% from a year ago, both areas reflecting a much more normalized transaction volume environment. Capital markets income was relatively flat linked quarter and up $1 million from a year ago, with pipelines continuing to strengthen during the second quarter. Our guidance for high single-digit to low double-digit growth in non-interest income for the full year remains unchanged, The quarterly total non-interest income expected to be stable to Q2 levels over the second half of the year, despite the expected continued normalization of mortgage income from its record levels at the beginning of the year. Moving on to expenses on slide nine. Note the current quarter includes $8 million of acquisition integration costs associated with the pending old national merger. Away from these items, total expenses were down 3% linked quarter and down 1% from the same period a year ago. Q1 expenses were impacted by the seasonal impact of payroll tax timing and weather-related costs, which were both absent in the second quarter. In addition, lower equity compensation valuations and the ongoing benefits of expense optimization strategies contributed to the linked quarter decrease, partly offset by higher pension plan payouts and higher advertising costs. Compared to a year ago, lower pandemic-related expenses, and the ongoing benefits of optimization strategies more than offset higher compensation accruals, pension plan payouts, and merit increases. We continue to be focused on our expense run rate, lowering our efficiency ratio to 59% in the second quarter compared to 62% in the first quarter and 64% the same period a year ago. Away from the ongoing acquisition and integration costs, our outlook for non-interest expenses relative stability compared to Q2 run rates. Last note on taxes before I leave this slide. Our effective tax rate for the quarter was approximately 26%, down from 28% in the prior quarter, which was impacted by approximately $1 million in equity compensation investing expense. Compared to the same period a year ago, the effective tax rate increased from 24% to 26% due to a lower concentration of tax-exempt incomes. Our guidance for an effective tax rate of 26% for 2021 remains unchanged. Moving to capital on slide 10. Capital levels continue to be strong with retained earnings and the volume and mix of risk-weighted assets contributing to growth in the second quarter. These levels support our quarterly dividend of 14 cents per share, consistent with prior quarter and prior year, and provide strong capabilities to support the borrowing needs of our customers. I'll turn it back over to Mark.
spk04: So on slide 11, we tried to briefly summarize the great opportunity ahead in combining with Old National. As Mike mentioned, and as we discussed when we announced on June 1st, we're tremendously excited about our anticipated merger. The strategic fit and the financial benefits remain clear. But as importantly, I would say, we continue to feel great about the cultural alignment as we work through the process. Recognizing it has only been a month and a half since the announcement, We are extremely pleased with the progress we are making and how the teams are working together. Slide 12 highlights some of these processes. We have made all the appropriate filings, and we have an experienced team leading our efforts, encompassing over 350 of our colleagues. I would simply emphasize that while much work remains, we are on track on all fronts and still hoping to close prior to year end. So now handing it back to you, Mike.
spk05: Thanks, Mark. Yeah, let me just echo a couple of things in Mark's comments before we open it up for questions. Obviously, we are very excited about what lies ahead for our partnership with Old National, certainly what it means for our clients, our markets, our communities, our colleagues just across the board. And as we have shared, and for those of you who had the opportunity to listen to Old National and Jim speak this morning, certainly that was echoed in their comments, this is really at its core a growth strategy for two strong companies, that share a vision and a culture that we firmly believe leaves us very well positioned for the future. So with that, let's open it up for any questions you might have.
spk06: Thank you. The question and answer session will begin at this time. If you are using a speakerphone, please pick up the handset before pressing the keys. If you have a question, please press star, then one, on your touchtone song. If you wish to withdraw from the queue, please press star, then two. Your questions will be taken in the order received. Please stand by for your first question, sir. It is from Michael Young of Truist. Please go ahead.
spk02: Hey, thanks for taking the question. Yeah, I was just curious maybe sort of qualitatively, you know, what we should expect in the interim before the old national deal closes in terms of, you know, any efforts you may undertake in terms of retention or proactive marketing to clients. Should we expect Any higher expenses related to any of those things? And any other qualitative things you'd like to put out there?
spk05: Well, this is Mike. I certainly can speak to some of that. Certainly you can expect us to continue to make active outreach to clients and the markets and to build on what we've established here across the marketplace and continue to reinforce all the positives that come along the transaction as As we've described, strategically, it's a great opportunity. So we spend a lot of time and energy, but that's really largely embedded in our run rate as we go forward. So I wouldn't think that you would see anything different than what Pat had guided you today.
spk04: Yeah, I guess, can I add, I would just say as Mark, Michael, thanks for the question. It starts with it's business as usual here. You know, we continue to expect to grow. We continue to call on clients proactively and tell our stories. And I think the market reaction has been very favorable. So, you know, in any expenses that we have, we're certainly built into any retention efforts or we're built into our modeling as we outline the transaction.
spk02: Okay, great. And maybe just, you know, kind of bigger picture on loan growth, loan demand. You know, I heard a few comments, obviously, about that in the prepared remarks. But, you know, are there areas that you're seeing, you know, maybe higher demand or more strength? And then are there any sort of limitations or any things we should think about in terms of growth going into the back half before the merger closes?
spk04: I think you're seeing a nice recovery. It's Mark again, Michael. Across really all sectors, we've seen the most strength in CNI thus far. You know, the headwinds would be those pesky competitors that are out there. But we face the competitors, and we've competed and won before, and we continue to do so. So I don't mean to be so tongue-in-cheek about it. I think that there's no market headwinds that we see. You know, I think businesses overall are recovering. There's still some pockets in the economy that are a little slower to recover. But by and large, we see good strength across all of our sectors.
spk02: Okay. And maybe last one for me, just, you know, as you look at sort of the fee business lines, you know, as you move into closing with Old National, are there certain areas that you're starting to or going to try to, you know, expand maybe proactively ahead of the merger close geographically or otherwise, or will it kind of be status quo until the actual day one closing?
spk04: I'll answer it this way. It really is business as usual. So we had nice growth plans, particularly around our core businesses of wealth management, treasury management, and card, all of which saw nice, solid growth this quarter, and we expect that to continue. We'll continue to selectively look to add talent. So I don't think you'll see – it won't change the dynamic dramatically, Michael, but we certainly would look to add talent in all these areas. But we think we're on a nice path to hit the numbers that we forecasted the staff that we have.
spk02: Okay, great. Thanks. That's all for me.
spk06: Ladies and gentlemen, as a reminder, please press star one if you have a question. The next question is from Nathan Race of Piper Sandler. Please go ahead.
spk01: Yep. Hi, everyone. Good morning. Going back to the loan growth discussion in terms of the outlook, It looks like one of the drivers in the quarter was the consumer installment growth, and I think in the past you guys have had some purchases within that segment that's augmented growth in that portfolio. So just curious, one, if that was the driver again this quarter, and two, as you guys kind of look at the pipeline, kind of where do you expect to see growth in that mid-single-digit range over the balance of 2021?
spk04: Yeah, Nate, it's Mark. I'd answer it this way. The growth you saw in installment was as much – Our effort to forestall the decline we saw in home equity. So some of the other consumer categories declined. And so our growth and installment was really to keep that relatively flat. The net overall growth that we saw was in C&I, multifamily, and mortgage. That's really where our growth came from this quarter. And we expect that to continue. I'd like to see CRE more broadly grow. CRE has done nice production levels. But we continue to see a fair amount of payoffs in that area, so it's been relatively flat away from multifamily. But, again, our growth this quarter was CNI, multifamily, and mortgage-driven, not installments in our view. Please.
spk03: Nate, it's Pat, though. Just to kind of close the loop on our transactional purchase book, so we do from time to time augment more from a mixed perspective and a yield perspective on with purchases primarily of residential one to fours, those run off at a pace that has continued to be higher than what I'd call normal because people first were refinancing like crazy and now they're continuing to sell their houses and buy new ones. So still higher activity. So we do periodically top up that portfolio just to maintain kind of status quo in balances, but we're not anticipating, contemplating, or guiding to any of our growth for the year. coming from purchase labs, just to be clear.
spk01: Got it. I appreciate that. And then kind of along these lines, just thinking about the overall earning asset base and balance sheet growth over the next couple of quarters up until the deal closes. As the PPP forgiveness process continues to unfold, I'm curious to get your guys' thoughts on kind of how liquidity balances trend with that process ensuing. Should we expect some continued earning asset growth and liquidity inflows, or do you guys maybe anticipate some shrinkage as some of those dynamics play out going forward?
spk03: Hey, it's Pat again. I'd say yes to both of those things. We keep forecasting we're going to see a pretty market runoff in liquidity balances, and we've been believing that for almost a year. So at some point, particularly as we start to see things like commercial line utilization, which ticked up for the first time in a number of quarters. This quarter, we do expect that customers will naturally draw on their balances. That does get offset by just continued consumer stimulus and whatever the offset is with consumer spending patterns. So we would anticipate probably somewhere between $500 and $750 million of runoff of cash that's just sitting there, which is difficult to deploy for longer-term, reasonably yielding earning assets simply because we continue to have the belief that that is going to run off at some point later this year or early into the following.
spk01: Understood. If I could just ask one follow-up along those lines. If that liquidity does sit around, what's the appetite to redeploy some of that in the securities book absent the opportunities that you guys are going to see from a lending perspective over the next couple of quarters?
spk03: Well, we're always looking for opportunities to top up the securities book. So you've seen yields and rates experience pretty significant volatility on a day-to-day, week-to-week, month-to-month basis throughout this year. And as we see opportunities to jump in and buy heavier and more, we absolutely will do that. Those have been kind of few and far between this quarter. We were kind of struggling to get yields on new purchases much higher than 170, 175, which was roughly the same as Q1. So our securities purchases were net, net lower than the volumes that we had during last year when we certainly saw higher and more attractive yields. And we'll look for opportunities to do that again for sure. But that's one of the few places we would park excess liquidity. would be something that is very high liquidity, low premium that we could get in and out of if we do start to see the kind of cash outflows that we're expecting at some point.
spk01: Okay. Understood. I appreciate all the color. Thanks, guys. Nice quarter. Thanks.
spk06: The next question is from Chris McGrady of KBW. Please go ahead.
spk00: Good morning, gentlemen. This is Chris O'Connell filling in for Nagrati. I just wanted to, you know, kind of follow up on the same trend there, or line of questioning with regards to liquidity management. You know, I appreciate the guidance that you guys have given, you know, around the unchanged, unstable, and high, and with the NIM growing. um but but just curious is you know so far into uh in 3q21 um have you seen any of those deposit movements from customers um or any of kind of the you know the strong inflows that you've seen over the past year start to you know moderate or come down yet or do you think that's still a little bit uh you know more of a late half uh 2021 event
spk03: Yeah, I think the pace of inflows from consumer and commercial balances slowed a bit. Those balances were relatively stable linked quarter, which isn't always typical. We would typically see balances declining early in the year as people paid off things that they accumulated late the previous year. Municipal inflows remain very consistent, and so we're in the middle of kind of the normal seasonal inflow for municipal deposits. But I'll say that the growth has moderated a little bit absent the late Q1 stimulus outflow, the stimulus checks that went out as part of the most recent CARES package. And we can see that every time there's a stimulus package, we can see multiple hundreds of millions hit it almost immediately. So it just seems to be persisting as far as balance growth. Mark, was there anything you'd add on to that? I think you summarized it well, Pat.
spk00: Scott, I understood. And as far as the deployment into, you know, securities, and I hear you on rates where it hasn't been a great environment recently, you know, to go all in, is there a certain point where, or is there a certain yield threshold where, you know, you guys are going to, you know, be more aggressive or take opportunities, you know, that you'd, you know, kind of be allowed to disclose?
spk03: Well, I mean, we've got cash that needs to be deployed that's always coming through just from the normal cash flows out of our book. That's $150 million a quarter, roughly. And so we're generally going to work pretty hard to make sure we're investing that. Away from that, we look for opportunities to see where yields tick up to potentially pre-invest future cash flows or to grow the book modestly. We just haven't seen as many of those opportunities this past quarter where rates were generally falling or yields. So we'll continue to watch for those. Volatility seems to be the rule of the day, even in a low rate environment. So we'll expect and take advantage of opportunistic investing.
spk00: Got it. Thanks. And then one last one, if I could. You know, the loan growth and guidance, you know, stable seems to be on track. And is there anything on the commercial side, I guess, or you see opportunities to kind of beat guidance there on the mid-single digit as in a particular industry or area where, you know, if line utilization could come back a little bit stronger than expected or something along those lines?
spk04: I would say nothing in particular, but I'd answer it this way maybe better, which is we expect modest to medium growth in all of our business lines. And so those growth rates might be different in some of our core business banking and CRE markets might be a little lower there and a little higher in some of our specialty units where we've had some outsized growth these last few years. But again, we expect every one of our business units to have some growth all netting to a mid-single digit.
spk00: Understood. Thanks. Thank you.
spk06: Again, if you have a question, please press star then 1. There are no further questions. I would now like to turn the call back over to Mr. Scudder for closing comments.
spk05: Great, thank you. Thank you all. Before closing, once again, I think it's always nice to take the opportunity to thank all of our colleagues, both here and frankly with our newest partners at Old National, who all have the opportunity to listen to our collective calls for their enthusiasm and hard work. It's really an exciting time for us, and I want to thank all of them for their continued commitment to living our values, which is what makes our two companies so special. I'm very proud to be surrounded by so many good people who strive to do the right things every day for our clients, our communities, and for each other. So thank you all for your attention and interest in our story and our ongoing belief that we're a great investment. So have a great day, everybody.
spk06: 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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