First Midwest Bancorp, Inc.

Welcome to the O'National Bank Corp first quarter 2023 earnings conference call. This call is being recorded and has been made accessible to the public in accordance with the SEC regulations FD. Correspondent presentation slides can be found on the investor relations page at O'National.com and will be archived there for 12 months. Management would like to remind everyone that certain statements on today's call may be forward looking in the nature and are subject to certain risks. uncertainties and other factors that could cause actual results or outcomes to differ from those discussed the company refers to you to its forward-looking statement legend in the earnings release presentation slides the company's risk factors are fully disclosed and discussed within this sec filing in addition certain slides contain non-gap measures which management believes provide more appropriate comparisons these non-gap measures are intended to insist investors understanding of performance trends. Reconciliations for these numbers are contained within the appendix of the presentation. I would now like to turn the call over to Old National CEO Jim Ryan for opening remarks. Mr. Ryan?

Good morning. On the morning of April 10th, our Old National family was blindsided by unthinkable tragedy. In the span of minutes, five of our team members were lost forever. while other team members and two Louisville Metro police officers suffered injuries. All Old National team members are out of the hospital and on the road to recovery. One Louisville officer remains in the hospital. In the aftermath of this tragedy, many heroes emerged, including members of law enforcement, city and state officials, the amazing Louisville medical community, and some of our own team members who were there on the scene. To all of you, thank you. from the bottom of our hearts. On behalf of everyone at Old National, I also want to thank the entire community of Louisville for your unconditional love, prayers, and support. I also want to acknowledge the overwhelming outreach from individuals and organizations throughout the country. Your outpouring of love and care has helped strengthen us, and we are so grateful. Turning to the quarter, we reported strong first quarter earnings despite a rapid shift in the operating environment for all banks. For Old National, it was business as usual, even throughout March, and the strength of our franchise remains evident in the results outlined on slide 4. Adjusted EPS was $0.54 per common share, with adjusted ROA and ROATCE of 1.4% and 23.4% respectively. Our adjusted efficiency ratio remained under 50%. Obviously, deposits, liquidity, and credit earned focus today. As you can see, deposit balances were stable during the quarter, despite the normal first quarter seasonal patterns in public fund balances. Our total cost of deposits at 72 basis points is well below peers, and we maintained our deposit pricing discipline with a low 15% total deposit beta cycle to date. Granularity is one of the keys to success here, and Brendan will share some additional details on the competitive advantage our funding base provides later in the deck. With respect to liquidity, as you'd expect, we took steps to increase our cash on hand and our available liquidity over the course of March and April. Our liquidity coverage in excess of our uninsured deposits is 150%, including unencumbered assets. Likewise, our credit remains strong with five basis points of non-PCD-related charge-offs and stable asset quality. We remain watchful, like other banks, and are focused on potential pockets of softness. Like our deposit portfolio, our loan portfolio is granular, which should continue to serve us well. We remain confident in our client selection and underwriting, and as you know, Old National has taken an active approach to credit management. This approach has served us well in various economic cycles. As evidenced this quarter, we worked aggressively to address some PCD credit from the merger. On the client side, engagement remained high in the quarter, and we continue to expect disciplined loan growth in 2023, albeit not at 2022's pace. In other areas, more of the same. Below peer deposit costs should drive a funding advantage, more organic growth of our wealth management client base, and a continued focus on disciplined expense management. Thank you. I will now turn the call over to Brendan to cover the quarter's results in more detail.

Thanks, Jim. Turning to the quarter's results on slide five, we reported gap net income applicable to common shares of $143 million, or 49 cents per share. Reported earnings include $15 million in pre-tax merger-related charges, $1 million in pre-tax property optimization charges, as well as $5 million in debt securities losses. Excluding these items, our adjusted earnings per share was 54 cents. Slide six provides our quarter end balance sheet. Total asset growth of $1.1 billion in the quarter was driven by disciplined loan growth and higher cash balances funded through stable deposits and higher borrowings. Moving to slide seven, total deposits were stable quarter over quarter, despite public fund outflows. Q1 is typically our seasonal low point for public funds, and we anticipate net inflows in Q2. Our trend in average deposits reflects mixed shifts away from non-interest-bearing accounts into money market and CDs, which is typical for this point in the rate cycle. Market conditions continue to put upward pressure on deposit rates, with total deposit costs up 38 basis points quarter-over-quarter to a still very low 72 basis points, which equates to a total deposit cost beta of 15%. Interest-bearing deposit costs increased 57 basis points to 1.09%, resulting in an interest-bearing deposit beta of 23%. Although the terminal beta is difficult to estimate, we have a strong track record of managing deposit costs and are confident we can maintain our funding advantage throughout the remainder of the rate cycle. We are actively defending deposit balances through competitive rack rates and limited pricing exceptions, in addition to playing offense through various deposit specials. We are pleased with the execution of this strategy to date as we have been able to generate new deposits sufficient to maintain stable overall balances. Slide 8 provides additional details and granularity of our deposit base. Our average core deposit account balances are meaningfully lower than peers. We have deep and long-standing relationships with our deposit customers, 75% of which have been with the bank for more than five years, and nearly a third have been with us for more than 25 years. The concentration of our largest customers is also exceptionally low, our top 20 deposit clients represent less than 5% of our total deposits. If you exclude collateralized deposits, our top 20 represents only 2% of our total deposits. Slide 9 provides details of our funding and liquidity. We have ample liquidity with approximately 150% coverage of our uninsured deposits, including $10.3 billion in immediately available funds from cash equivalents, federal home loan banks, Fed discount window, and the BTFP. We also have $5.4 billion in capacity from high quality unencumbered collateral available for pledging. Beyond the 150% coverage, we have significant other sources of liquidity through broker deposits and unsecured credit lines, as well as insured cash suite product capacity. Slide 10 shows trend in total loan growth and portfolio yields. Total loans grew 2%, consistent with our expectations and Q4 pipeline. Consumer loans were stable quarter over quarter, And loan portfolio yields increased 34 basis points to 5.42%. The invest portfolio was stable quarter over quarter as portfolio cash flows were offset by an improvement in fair values. Duration improved to 4.4, and we expect approximately $1.2 billion in total investment cash flows over the next 12 months. Nearly 80% of our portfolio consists of high-quality treasury and agency investments, with an additional 18% held in highly rated municipals. The remaining portfolio consists of highly rated corporate securities and other investments. Slide 11 details our Q1 commercial production. The $1.8 billion of production was well balanced across all product lines and major markets. We continue to maintain a disciplined approach to underwriting while taking advantage of market dislocation to grow attractive new relationships. That said, we have tightened our pricing standards, enhanced credit structure, and have reinforced with our relationship managers the importance of acquiring a full banking relationship for new loan requests. Turning briefly to pricing, new money yields of commercial loans increased 64 basis points to 6.72% for the quarter, with March production yields of 6.87%. Moving to slide 12, you will see further details of our loan portfolio. We have a well-diversified commercial loan portfolio that represents approximately 70% of total loans and carries an average loan balance of approximately $1 million. Our non-owner-occupied CRE is well diversified by asset class and geography. As it relates specifically to non-owner-occupied office, the bulk of the portfolio is made up of suburban or medical office with a meaningful amount of credit tenant leases. Less than 1% of total loans are located within central business districts, which are geographically diverse in 11 Midwestern cities, with only five deals totaling less than $50 million in Chicago and Minneapolis, St. Paul. Slide 13 shows our credit trends. Credit conditions are stable, and our commercial and consumer portfolios continue to perform exceptionally well. Delinquencies and MPLs are showing positive trends, and net charge-offs were stable at a modest five basis points, excluding the 16 basis point impact from PCD loans. Our special asset team is continuing to work through the F&B acquired PCD loan book and expect charge-offs from this portfolio to be elevated in the near term. The provision expense impact from the work-out effort should be minimal as we carry $54 million or approximately 5% reserve against this book. On slide 14, you will see details of our first quarter allowance, including reserve for unfunded commitments, which stands at $333 million, consistent with Q4. Reserves reflect loan growth with relatively small increases due to portfolio mix, more than offset by improvement in economic forecasts and charge-offs of PCD loans that don't require reserve replenishment. The financial health of our clients remains strong, and while credit metrics are stable, we believe it is prudent to maintain elevated reserves given the uncertainty in our economic outlook. Our current reserves reflect a 100% weighted Moody's S3 scenario, with negative GDP of 3.1% and unemployment of 7.1%. Unless the economic outlook deteriorates materially, 2023 provision expense should continue to be limited to portfolio performance and loan growth. In addition to the $333 million in reserves, we also carry $96 million in acquired loan discount marks. Next, on slide 15, you will see details of our net interest income and margin. Both metrics were generally in line with our expectations. Manager's margin contracted 16 basis points quarter-over-quarter to 3.69%, while core margin, excluding accretion, decreased 13 basis points to 3.62%. Core margin was just shy of the low end of our margin guidance due to holding more cash on hand following market disruption in March. We continued to proactively manage the balance sheet towards a neutral rate risk position while layering in protection for a sudden reversal in Fed rate policy. Slide 16 shows trends in adjusted non-interest income, which was $76 million for the quarter. Again, this was generally aligned with our expectations with improvements in capital markets and wealth revenues, offsetting macro-driven weakness in mortgage and a full quarter impact of our service charge enhancement put in place in December. The linked quarter increase in our other category was driven by fair market value adjustments on equity securities and higher bully income. Next, slide 17 shows a trend in adjusted non-interest expenses. Adjusted non-interest expense was $235 million, and our adjusted efficiency ratio was a low 48.8%. Expenses were well controlled and consistent with the prior quarter. The increase in the other expense category was largely due to higher FDIC assessment and marketing expenses. Slide 18 provides details on our capital position at quarter end. Capital ratios were stable and reflect strong earnings offset by loan growth and share repurchases in the quarter. Our TCE ratio increased 19 basis points to 6.37%, largely due to a reduction in unrealized losses and other comprehensive income. Total available for sale unrealized losses is impacting our TCE ratio by 145 basis points. Our after-tax HDM unrealized losses stood at approximately $300 million a quarter end. We continue to monitor our balance sheet for economic stress and feel very comfortable with our capital levels. While we did repurchase 1.8 million shares of ComiStock earlier in the quarter, we do not anticipate repurchasing additional shares in the near term. As I wrap up my comments, here are some key takeaways. We had a strong start to 2023 with results in line with our expectations. We posted strong return metrics with adjusted return on average assets of 1.39% and adjusted return on tangible common equity of 23%. Our deposit franchise continues to perform exceptionally well in this environment, as we have maintained stability in our deposit balances while delivering a top quartile total deposit beta of 15%. We have ample liquidity with uninsured deposit coverage ratio of approximately 150%, including unencumbered eligible collateral. Credit remains strong, and we continue to manage expenses in a disciplined manner. as evidenced by our efficiency ratio of 48.8% for the quarter. Slide 19 includes thoughts on our outlook for the remainder of 2023. We believe our current pipeline should continue to support near-term loan growth in the mid-single-digit range. While we expect to have meaningful year-over-year NII growth in 2023 in the range of 9% to 12%, margin will continue to be under pressure from higher deposit costs. More detailed NII and margin guidance is difficult to provide given the uncertainty of future Fed rate actions and the uncertainty of market dynamics that will ultimately determine terminal deposit betas. That said, we remain confident in our ability to manage deposit costs better than most. Contractual accretion is expected to be approximately $16 million for the remainder of full year 2023. We expect our seed businesses to continue to perform well despite headwinds, with mortgage following industry patterns. We should continue to see revenue momentum and wealth from the strategic hires we've made over the last two years. Capital markets revenues will largely follow loan demand and should perform consistent with Q1 levels. This quarter's bank fees fully reflect the HSA sale and service charge enhancements implemented in December and should represent a good baseline. Our expense outlook is consistent with our prior guidance with full year 2023 total expense of approximately $939 million excluding merger-related charges and property optimization-related expenses. Provision expense should continue to be limited to loan growth, portfolio changes, and non-PCD charge-offs, as we believe we have adequate reserve against the PCD book, and we are already 100% weighted towards the Moody's S3 scenario. Turning to taxes, we expect approximately $11 million in tax credit amortization for the remainder of 2023, with a corresponding full-year effective tax rate of 24% on a core FTE basis and 22% on a GAAP basis. With those comments, I'd like to open the call for your questions. And we do have the full team available, including Mark Sander, Jim Sangren, and John Moran.