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First Midwest Bancorp Inc (NASDAQ:FMBI)
Q4 2020 Earnings Call
Jan 27, 2021, 11:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning, ladies and gentlemen, and welcome to the First Midwest Bancorp 2020 Fourth Quarter and Full Year Earnings Conference Call. Following the close of the market yesterday, First Midwest released its earnings results for the fourth quarter and full year of 2020 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. [Operator Instructions]

Following the presentation 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 opened for question and answers for analysts only.

I will now turn the call over to Mr. Scudder. Please go ahead.

Michael L. Scudder -- Chairman and Chief Executive Officer

Great, thank you. Good morning, everyone. Thanks for joining us today. Great to be with you. I hope this finds everyone and your families doing well, staying healthy and certainly ready for a new year. Let me start, I want to offer some perspective as we close the quarter and certainly close on what has been, gosh a wild year. Just reflecting back on the year itself, it certainly has a best of times, worst of times bent to it.

When we set our plan for 2020, we were coming off a record 2019 moving into what was expected to be a lower, but relatively stable rate environment. And then, like all we had to pivot to address the immediacy of the pandemic, the economic shut down, a massive shift in fiscal and monetary policy, all of which seem to last longer than most had anticipated. But certainly as we stand here today is looking to be less damaging than what we all would have initially feared.

So from my perspective as I think about it, what we accomplished during 2020 as a company and frankly as an industry as a whole to me was truly amazing and a true testament to the character of our company and our teams. So as we kick off 2021, while the downside risk, I believe is still there, we are certainly feeling more positive still.

Our balance sheet remains very strong, that provides us with a lot of management flexibility as conditions unfold in 2021. Our Tier 1 capital now is at 11.6% that's over 100 basis points higher than when we started 2020. Our loan loss reserve stands at almost 1.7% that's double what it was when we started the year and that's about 40 to 50 basis points higher than what day one CECL would have been when we kicked off the year.

The quarter also offered several highlights as we move into 2021, certainly the quarter reflected improvement from an EPS standpoint that was came in at $0.33, that's up gosh some 57% or almost 60% versus last quarter and that's largely on the strength of greater PPP revenue and relatively lower loss provision expense. The forgiveness process for the 2020 program was faster than expected and accelerated the timing of receipts from what we all know and hope will eventually be a finite series of programs. The second draw of program is under way and frankly, it's going pretty well. Thanks to our teams' efforts, we're really pleased to be able to help our clients and the community as we roll out the second draw of program and that will help partly offset some of the acceleration from the earlier program into 2020. So Mark and Pat will get into that a little bit further.

We did take the opportunity in the quarter to move further to adjust our AL position given low rates trading some of the quarter's expense for the benefit of future performance. That trade essentially cost us about $0.12 to terminate the remainder of some hedge contracts and redeploy some of the security cash flows that were coming in. The combined benefit to 2021 and beyond, frankly will more than offset those costs.

So I would also highlight credit stood out as a positive for the quarter, provisioning was about $5 million lower than last quarter of probably greater import charge-offs were meaningfully lower for the quarter. They came in at 12 basis points and that's away from the acquired loan marks, and our NPAs were stable. So while our bias here is more positive, we certainly felt it prudent to hold our reserve levels pretty stable given all the noise that's still out there.

On the business side, we are also pleased on a number of fronts. Our branch consolidation and retail initiatives that we announced earlier continue to remain on track and performing well with -- in line with what we expected. So sometimes it gets lost amid the noise of the pandemic, our acquisition of Park Bank continues to go very well. Remember they added about $1.2 billion in assets and a really great team with a strong commercial platform that rounded out our wealth and our business presence in the Milwaukee and Southeast Wisconsin market. So I know they're very anxious to continue to look for opportunities to expand in the Milwaukee market.

We are very pleased to post record quarters this quarter as well for both mortgage and wealth. And then, last but certainly not least, the engagement of our teams is exceedingly strong. Our survey scores are up here and we're very pleased once again to be held out as to one of the best places to work in Chicago, and in fact, I think we are listed as the top commercial bank in Chicago. So all very positive for us as we kick-off 2021.

Let me turn it over to Mark and Pat, they can expand on some of the details and certainly as they walk through the remainder of the deck. Mark, you want to take it?

Mark G. Sander -- President and Chief Operating Officer

Thanks, Mike, and good morning, everyone. Starting on Slide 4 of our presentation, loans increased $100 million from the prior quarter due to strong organic mortgage production and a significant remix of our balance sheet into purchased 1-4 mortgages as Mike referenced largely offset by the decline in PPP balance as we saw.

Mortgage had another very strong quarter. Production was near record levels as the strategic repositioning of this team that we undertook a couple of years ago allowed us to take advantage of the favorable market dynamics. We saw nearly $150 million of net organic growth after selling approximately $275 million of that production at favorable prices, which boosted fee income as Pat will detail it shortly.

The short-term outlook for mortgage remains strong and while we certainly expect that the market may slow as the year progresses, I would again stress that our enhanced team here leaves us well-positioned to compete in any market environment.

Turning to commercial. We're encouraged by the trends here. Production increased nicely from Q3, up over 50% as we began to see some return to normalcy. While demand increased, it was not enough to offset payoffs, which were up slightly away from normal amortization. Commercial, real estate finance, refinance activity in particular ticked up mostly from CMBS lenders that are willing to go out longer and at higher levels of non-recourse than we are.

Line utilization and C&I was flat during the quarter. That's an improvement from the prior two quarters, but still reflective of clients' strong liquidity and overall somewhat cautious outlook. That all said, our pipelines are building nicely. They're not back to pre-pandemic levels, but we've recovered more than half of the decrease we saw in the spring. As a result, we are optimistic for a return to core organic commercial loan growth in 2021 starting this quarter given the strong near-term pipeline in our specialty and middle-market businesses.

Turning to PPP, we saw a decrease here of about $400 million in the quarter as forgiveness occurred a little sooner than we expected, which of course is great for our clients. The client experience -- and I would say ultimate outcome of the forgiveness stage has gone very well in every regard thus far. And we expect nearly all of the remaining balances from the first program to run out over the first six months of this year. Similarly, the 2021 program that launched just last week is off to a great start. We were really well prepared for this round and submitted about 2,000 applications on the day the window opened. We expect to fund about half as much of this round as we did in the initial two phases last year.

So Page 21 gives a good amount of detail and summarizes all what I just said, but at a high level, we've already received confirmation on about $300 million of new loans thus far.

As to our outlook going forward, we expect loans to grow mid-single digits in 2021 organically and away from PPP. As to PPP, we expect those loans to be largely repaid by year-end. Of course, we will see a net income benefit as we again assist with what we assume will be near 100% forgiveness in this round also.

Looking deeper at the portfolio, beginning on Slide 5. We continue to have a well-diversified loan book with very modest exposures to the industries most impacted by the pandemic. We highlighted here the segments we are watching most closely. I'd be happy to delve into any one of these or any other industry segment for that matter in the Q&A portion of this call.

For now, suffice it to say, we continue to feel a relatively conservative underwriting, exposure granularity and portfolio management practices will serve us well as we navigate the still somewhat uncertain landscape.

On Slide 6, we provide detailed information by industry on our loan deferrals. At this point, our payment deferrals across the entire book are very modest. As the programs we ran earlier in the year to help clients accomplished their objectives and expired. Of course, we will continue to engage and work with clients on the ones if they need help, but demand to do so has been very limited.

Slide 7 displays our consumer loan portfolio, a prime borrower book dominated by 1-4 residential. We highlight here our unsecured installment segment, a specialty product also targeted to prime borrowers. The enhanced yield here more than offset the higher charge-off rate, which theoretically should benefit from the higher level of federal stimulus. Away from any external factors, we deliberately pulled back on this segment at the end of 2019 by tightening underwriting parameters, which when combined with normal amortization has driven this category down over 20% as of year-end.

As Mike alluded to, we again feel better this quarter versus last with regard to the credit outlook. As shown on Slide 8, our current level of risk is of course reflective of the uncertain environment, but performing well, including the elevated risk segments. Our clients have adapted well by generating and managing liquidity and controlling expenses.

Certainly, the stimulus programs are also helping. As a result of all that NPAs were stable. We will continue our proactive portfolio reviews and constant client dialogs in order to identify risk across all sectors, but again, we felt better each successive quarter over the course of 2020.

Turning to Slide 9, charge-offs were very benign, at the lowest level, we have seen in years. Commercial charge-offs were minimal and consumer charge-offs this quarter remain lower than in previous years as expected, given the underwriting changes I mentioned a minute ago. We forecast total charge-offs to remain relatively modest for the short forward period, but ultimately increase further out. Yet still remain manageable in the 25 to 40 basis points range for the full year 2021. We are very well reserved for losses with an allowance to loans excluding PPP of nearly 1.8%.

While we feel better about the outlook as I stated, our elevated reserves continue to reflect the uncertainty relative to the virus, vaccinations and reopenings and the fact that the economy has been propped up by the massive federal stimulus.

Deposits remain a core strength of our franchise as seen on Slide 10. With the industry flush with liquidity, our historical-comparative strength in funding costs is a little more muted now, but still there. Our cost of deposits came down another 6 basis points in the quarter to 11 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 pick it up from here. Pat?

Patrick S. Barrett -- Executive Vice President and Chief Financial Officer

Thanks, Mark. Good morning, everybody. Turning to net interest income and margin on Slide 11. Net interest income increased 4% compared to the prior quarter and was consistent with the same period in 2019. Compared to both prior periods NII reflected the positive impact of the more than $400 million of PPP loan forgiveness during the fourth quarter as well as lower funding costs offset by the negative impact of lower rates. Compared to the prior year, growth in both loans and securities, as well as the Park Bank acquisition helped partially offset the impact of lower rates.

Acquired loan accretion contributed nearly $8 million for the quarter, consistent with the prior quarter and down $2 million compared to the same period a year ago. Accretion was higher than scheduled 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 3.14% was up by 19 basis points linked quarter, primarily as a result of the PPP loan forgiveness and down 58 basis points from the same period a year ago.

Excluding accretion, margin was 2.98% for the quarter, up 19 basis points linked and down 50 basis points from the prior year. Compared to a year ago 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 balances.

Our outlook for 2021 NII is relative stability with core NIM, excluding the impact of accretion approximating 3% throughout the year. Scheduled accretion is expected to be approximately $16 million for the full year, down $15 million or 40% from 2020 actuals. More specifically speaking to the impact of PPP loans, the remaining effect of the 2020 PPP program to last year's program is expected to be around $15 million compared to the $28 million in 2020 and concentrated in the first half of this year.

The impact of the 2021 PPP program, which is really just getting stood up at this point is likely to be around half of the prior year's program and the impact is estimated at this point to be in the $10 million to $15 million pre-tax range of NII, but the magnitude and timing would be much more estimable by the end of the first quarter of this year.

Turning to noninterest income on Slide 12. We continue to see solid recovery and growth overall in our fee income streams. Fees in total were up 10% linked quarter. Mortgage income of $9.2 million was a record of 38% from the third quarter, driven by the factors Mark already referenced. As Mike mentioned, we also posted a record quarter in wealth management, while the robust market helped a continuation of great sales, production and client retention grow these strong results. Teams didn't miss a beat in 2020.

Additionally, our treasury management group posted solid fee gains, up 5% year-over-year away from the Park acquisition. As we've said previously, we see continued growth opportunities in the treasury management business unit as we have delivered over the past few years. Card income was relatively flat linked quarter and versus the prior year demonstrating a near return to normalcy.

We forecast modest upside here as spending normalizes. These various product strength substantially offset the pressure we saw in service charges, specifically in NSF fees from both long-term trends and of course the short-term boost in customer liquidity as well as capital markets, which has been softer reflecting lower commercial real estate loan production. We expect both areas to continue improving in 2021 as the economy recovers more fully.

In total, we expect high single-digit fee growth in 2021 after all the puts and takes of the gradual return to normalcy across several categories and the underlying solid continuing opportunities we see in wealth management, treasury management and card.

I'd also highlight that during the quarter in light of current market conditions, we continued executing on our balance sheet optimization strategy to deploy excess liquidity. This involved terminating our remaining $510 million in longer-term interest rate swaps, resulting in reductions in future borrowings that were hedged to the terminated swaps. This action results -- resulted in $18 million of pre-tax termination costs during the fourth quarter. The offset is future NII will benefit by approximately $8 million annually. This optimization provides further flexibility to take advantage of lower cost on future borrowings.

Moving to expenses on Slide 13. Note that the current quarter includes $2 million of anticipated acquisition and integration-related expenses, largely driven by costs associated with the Park Bank acquisition as well as $1 million in optimization costs associated with executing on the retail optimization strategy that we announced in the third quarter. Away from these items, total expenses were up 3% both linked quarter and versus the same period a year ago.

Compared to both prior periods higher commissions primarily on mortgages were partly offset by higher deferred loan origination costs and lower advertising and OREO workout expenses. In addition, higher compensation accruals and equity compensation valuations and true ups at year end contributed to the increase linked quarter.

Compared to the same quarter a year ago, our larger operating base due to the Park acquisition combined with elevated pandemic related expenses and higher technology costs contributed to the increase. We continue to be focused on our expense run rate and while our efficiency ratio has ticked up due to revenue declines during the year. Overall annualized expenses as a percentage of average assets excluding PPP loans was approximately 2.3%, down 7% from a year ago.

Our outlook for 2021 is for a very modest uptick in expenses for the full year compared to 2020, primarily driven by an additional $6 million in mortgage loan servicing costs associated with our larger mortgage portfolio. As to timing, you should expect an uptick in the first half of the year, reflecting the elevated servicing expenses and then gradual overall declines in expenses in the second half of '21, reflecting the benefits of ongoing process efficiency efforts.

Last note on taxes before I leave this slide. Our effective tax rate for the quarter was around 12% half of the 24% for both prior periods reflective of approximately $4 million in non-recurring benefits resulting from deferred tax asset adjustments and other prior-year tax return finalizations. We expect our effective tax rate going forward to revert to a more normal 25% for 2021.

We've included a summary on Slide 14 that reflects the optimization strategies both retail and balance sheet, including the remix of current and expected securities cash flows into around $600 million of net growth in high quality one-to-four family mortgages. The upfront pre-tax cost of $18 million due to the balance sheet optimization and the ongoing $8 million pre-tax benefit to NII annually starting in the first quarter of 2021.

In addition, as we continue to execute on our retail optimization strategy, we recognized $1.5 million during the fourth quarter associated with severance and other costs associated with closing the 17 branch locations previously announced. We continue to expect the full run rate impact of this optimization to be around $8 million as I've said pre-tax expense reduction in 2021. As we've said previously, we continue to see a steady shift to more digital transaction volumes comprising both online and mobile banking.

This is not a new trend for us clearly has accelerated during the pandemic, you should expect to see us continue to make technology investments to further enhance our digital platform capabilities. I should note that all of our outlook and guidance contemplates all of these changes as a result of these optimization strategies and investment -- anticipated investments.

Moving to capital on Slide 15. Capital levels continue to be strong with earnings and the volume and mix of risk-weighted assets contributing to fourth quarter growth, these levels support our quarterly dividend of $0.14 per share, consistent with the prior quarter and a year ago.

Consistent with our usual practice, we've summarized, our outlook for 2021 on Slide 16. And I have to emphasize that our commentary and outlook for the quarter and for the year is dependent on the persistence and impact of the pandemic, customer behaviors and the impact of significant federal stimulus activities. We've also included for your convenience, a summary of our financial results for the quarter on Slide 17.

Now, I'll turn it back over to Mike for final remarks.

Michael L. Scudder -- Chairman and Chief Executive Officer

Thanks, Pat. So before we open it up, just a couple of things to reemphasize. Clearly as we stand here today, I think most of us would not be a stretch to say there is downside risk still out there. At the same time like many of us, we are hopeful and feel better about recovery in 2021. I've been doing this -- gosh for this year

I'll be 35 years at First Midwest and I've noticed over that period of time as many of you had, the world rarely operates in a linear fashion.

As we think about 2021, I really think about it in the context of building momentum over the course of the year and we would expect the second half of the year to see the greater benefit on production from the vaccination, efforts in fiscal and monetary stimulus and the effectiveness of the same. So efforts in fiscal and monetary stimulus and the effectiveness of the same. So as we work through all of this, just again to reemphasize what I started with, our balance sheet is really strong, liquidity is there, credit is stable and our reserves are robust, all of which is going to create opportunity as conditions stabilize and outlooks improve.

Volumes are recovering, our core deposit base remains an undervalued strength that will differentiate as rates ultimately move higher at some point. In the interim, the efforts that we undertook this quarter also will help navigate that. Our teams are working hard as Mark suggested, pipelines are building, and again, we have the flexibility that our capital offers us there.

I would emphasize what pads that efficiency and optimization activities are clearly a focus as one operates in the extended low rate period. And while it's important, and those are there and the focus of that is on those, it is also equally important that they remain aligned with our broader priorities around building a superior client experience, which is ultimately what we're trying to accomplish. Our digital and online skill sets and the investments we've made and are making will also mature and all of those will help us with our efforts to become more efficient in our processes and deliver on that experience.

So as we navigate the near term, our franchise priorities remain pretty much at the same, drive our return sustainably higher that requires a focus on building and retaining a talented team of colleagues, building revenue growth and breadth and continuing to focus on driving a superior and efficient experience.

And as I said, we will continue to take advantage of those opportunities that present themselves that align with those goals. So we talk about this all the time with our teams, times such as these present challenges, but they also present tremendous opportunities, opportunities to leverage the engagement of our people, our financial strength and continue to build on our strong relationships with the clients, better serve their needs and ultimately, the long-term goal of enhancing the value of our franchise.

So with that, let's turn to it and open it up for questions, as is our practice it just to help us from talking over each other up, I'll take the question and then just direct it among the three of us as to where the answer will come from. Tim?

Questions and Answers:

Operator

[Operator Instructions] The first question is from Chris McGratty with KBW. Please go ahead.

Christopher McGratty -- Keefe Bruyette & Woods Inc. -- Analyst

Hey, good morning.

Michael L. Scudder -- Chairman and Chief Executive Officer

Hi, Chris.

Patrick S. Barrett -- Executive Vice President and Chief Financial Officer

Good morning, Chris.

Christopher McGratty -- Keefe Bruyette & Woods Inc. -- Analyst

Hey, Mike. The mid-single digit loan growth I'm interested in kind of the source you talked about building pipeline, but also you bought the mortgages in the quarter. I am interested, how you see the allocation of that for '21? And do you expect to be buying more mortgages like some of your peers will do and given the better alternative to an MBS? Thanks.

Michael L. Scudder -- Chairman and Chief Executive Officer

Go ahead, Mark. Sure. So, Chris, good morning. The -- we expect that growth to come organically from both commercial and consumer. So we would expect both of those businesses, again organically away from purchases to grow mid-single digits. At this point, we're not per se planning on transactional purchases, so much of that of course depends on what happens with our liquidity, and then if it stays higher than we expect like it did all through 2020 we may, but that's not contemplated in the mid-single digit guidance we gave.

Christopher McGratty -- Keefe Bruyette & Woods Inc. -- Analyst

Okay. And just a point of clarification on Slide 16, the relatively stable NII, is that -- maybe Pat, is that a reported number, including the accretion in the PPP or is that stripping out that like your NIM guidance?

Patrick S. Barrett -- Executive Vice President and Chief Financial Officer

That would be our core NIM, so stripping out the impact. I will say that we wouldn't be surprised to see a plus-minus 10 basis points of volatility on a quarterly basis depending on how liquidity flows, particularly with the new PPP program and the timing of the forgiveness of the remaining already booked PPP, which we're finding is pretty challenging to predict on a quarterly basis. But over the course of the year away from accretion, we would expect to hit or modestly exceed a 3 handle each quarter.

Christopher McGratty -- Keefe Bruyette & Woods Inc. -- Analyst

Okay, that's great. On the NII, the net interest income, is that the stable comment, is that reported or is that core?

Patrick S. Barrett -- Executive Vice President and Chief Financial Officer

It actually turns out to be both. If you look at it purely on a core basis, we will see flat to modest like very modest increases each quarter. And of course that's dependent on the timing of loan growth. So away from the impact of accretion of PPP.

Christopher McGratty -- Keefe Bruyette & Woods Inc. -- Analyst

Okay, got it. And then just a couple of housekeeping, the tax guide that you gave, that's a GAAP, that's not a tax-equivalent right?

Patrick S. Barrett -- Executive Vice President and Chief Financial Officer

Well, that would be our stated and reported effective tax rate.

Christopher McGratty -- Keefe Bruyette & Woods Inc. -- Analyst

Okay. So for…

Patrick S. Barrett -- Executive Vice President and Chief Financial Officer

And then, the fully tax-equivalent differential is pretty modest, we don't have a lot of tax exempt streams.

Christopher McGratty -- Keefe Bruyette & Woods Inc. -- Analyst

Okay. And any one-timers left from the charge -- from the plans, you guys have been doing with warranty in the first quarter?

Patrick S. Barrett -- Executive Vice President and Chief Financial Officer

I would say de minimis. So I think -- if there is any it's likely to be kind of in the $1 million range.

Christopher McGratty -- Keefe Bruyette & Woods Inc. -- Analyst

Got it. Okay. Thanks a lot.

Operator

The next question is from Daniel Tamayo with Raymond James. Please go ahead.

Daniel Tamayo -- Raymond James -- Analyst

Good morning, guys. How are you?

Michael L. Scudder -- Chairman and Chief Executive Officer

Good morning, Dan.

Patrick S. Barrett -- Executive Vice President and Chief Financial Officer

Hey, Danny.

Daniel Tamayo -- Raymond James -- Analyst

Yeah. Maybe first on the balance sheet optimization, how that impacts your asset sensitivity, how does that compare now if we do -- were to see an increase in the short rates to what it was prior to the optimization efforts?

Michael L. Scudder -- Chairman and Chief Executive Officer

Go ahead, Pat.

Patrick S. Barrett -- Executive Vice President and Chief Financial Officer

It's -- Danny, it's a modest improvement. So it would take us from an earnings at risk of say 6% to 5%, not significant and puts us from an interest rate shock perspective, it doesn't modest -- it modestly changes that, but not meaningfully.

Daniel Tamayo -- Raymond James -- Analyst

Okay, got it. And then maybe on -- now that the environment is improving and you do have excess capital here. If you're having to the extent, I should say you're having conversations with potential targets, how those may be changing over the last few months and kind of what expectations are out there by others?

Michael L. Scudder -- Chairman and Chief Executive Officer

Well, I can take that one. Fundamentally, any conversation through not just in this current environment, but any time for us always starts with, how does it align strategically with what we're trying to do and how do things match up culturally. In terms of bid-ask spreads on those fronts, again, these are broader perspective, they are always wide. For some reason, people who are looking to sell always think their value is higher than people looking to buy, and that's just a natural state of affairs.

So -- but other than that, I think most people are just trying to get their feet under them relative to the environment and look out forward as to how that's going to play out.

Daniel Tamayo -- Raymond James -- Analyst

Okay, that's helpful. And can you just remind us of your area geographically and size, how you're thinking about priorities there?

Michael L. Scudder -- Chairman and Chief Executive Officer

So again, as we focused on our platform in our business, we look up and say, we're operating in the metropolitan Chicago marketplace with a really strong operating presence in a very diverse and broad market. So we -- the anchoring of that here is a real value to the franchise. And then from there, we just look at adjacent Urban Midwestern markets as to opportunities that continue to expand much like what we did in Milwaukee.

Daniel Tamayo -- Raymond James -- Analyst

And is there a particular size that shifted at all recently, or how are you thinking about that?

Michael L. Scudder -- Chairman and Chief Executive Officer

Well, obviously, we're a larger company, so you have to think about how does that change relative to the size of the opportunity. So it really does start, as I said smaller, and I mean on the small scale, probably a more difficult for us to integrate culturally. At the same time, it really does start with the platform and how it aligns with what we're trying to do. Again, it's easier to do it in the context of look at the Park Bank, where you look up and you've got $1.2 billion financial institution that brings a really strong commercial platform into a market that we think is important to be able to grow and build on what we do from a relationship-based lending standpoint, so.

Daniel Tamayo -- Raymond James -- Analyst

Understood. I appreciate all the color, guys.

Michael L. Scudder -- Chairman and Chief Executive Officer

Great.

Operator

The next question is from Terry McEvoy with Stephens. Please go ahead.

Terry McEvoy -- Stephens Inc. -- Analyst

Morning, everyone.

Mark G. Sander -- President and Chief Operating Officer

Hi, Terry.

Terry McEvoy -- Stephens Inc. -- Analyst

Just a question on the expense outlook. When I read the presentation, it seem like maybe there was a downward bias to expenses, you talked about identifying further process efficiency benefits, but then listening to Pat, it sounded like technology and investing in technology would also be something that you would focus on this year. So I guess my question is, if there is $1 of cost saves that's identified, does that -- is that really offset by just call it technology spending or do you think there are opportunities to maybe improve the expense outlook over the course of this year?

Michael L. Scudder -- Chairman and Chief Executive Officer

Go ahead, Pat.

Patrick S. Barrett -- Executive Vice President and Chief Financial Officer

Yeah. Terry, it's a great question. I think that this -- because we're continuing to invest in platform, which includes people but is also from a product platform perspective pretty significantly this year. I think that our kind of reasonably flat guidance is likely to be the 2021 outlook. I think the better opportunity is once we start completing the investments is -- how does that drive further transaction volume to digital away from physical, which obviously has a potential expense impact and how do customer self service trends impact that.

So we're hopeful that with the investments we're making this year we're setting ourselves up for further efficiency improvements and operating leverage improvements away from growth as we go into 2022. Round about way to sort of answer your question, so if I didn't ask it again.

Terry McEvoy -- Stephens Inc. -- Analyst

No, that's great. Thanks, Pat.

Patrick S. Barrett -- Executive Vice President and Chief Financial Officer

Okay, sure.

Terry McEvoy -- Stephens Inc. -- Analyst

And then as a follow-up on Slide 5 as I think about 2021 those other areas of focus kind of retail CRE, office CRE may kind of grow in importance among kind of the investment community and maybe some of those elevated risk may fall off. So I don't know Mark, could you maybe comment on retail and office whether those trends have improved and where do you think maybe there is some kind of additional risk over the course of 2021 that we'll keep it on this slide? Thanks.

Mark G. Sander -- President and Chief Operating Officer

Yeah, I would say this way Terry, I think the -- what we've seen over these last quarters has been stability in terms of occupancy and rent collections. But in our view, the jury is still out here a little bit. And so as we've talked about our last few years, we've been cautious on retail CRE for quite some time. We view leverage finance as an important business, but a higher risk business inherently.

So I think these will -- those two will stay on here for some time because as i say I think there is still the story remains to be seen and that's probably most notable in office CRE where that's about as murky as anything. Again, rent collections have been very strong, and we feel good about our original underwriting such that the loan to values are strong, but what does that look like over the success of a few years, there is mix views there. And so as I say, I think you'll see these -- those three stay there for some time.

Terry McEvoy -- Stephens Inc. -- Analyst

Great. Thanks, everyone.

Operator

[Operator Instructions] The next question is from Nathan Race with Piper Sandler. Please go ahead.

Nathan Race -- Piper Sandler & Co. -- Analyst

Yes, hi guys. Good morning.

Michael L. Scudder -- Chairman and Chief Executive Officer

Hey, Nat.

Patrick S. Barrett -- Executive Vice President and Chief Financial Officer

Hey, Nat.

Nathan Race -- Piper Sandler & Co. -- Analyst

Maybe just continuing the credit discussion just curious to kind of get some thoughts on just the charge-off guidance perhaps or particularly with increase expected in the back half of 2021 here, is that more so a function of just a stimulus kind of abating as we get further out this year or is it somewhat of a function of just the increase in criticized loans that we saw during last couple of quarters that may drive some of that as you guys put through?

Michael L. Scudder -- Chairman and Chief Executive Officer

Go ahead, Mark.

Mark G. Sander -- President and Chief Operating Officer

Yeah, I think you answered your own question well there, because I think that is it really, it's not like we see anything obviously if we saw charge-offs with clarity we would take them now. The -- as we look out the next quarter or two, they seem pretty muted. But we still just think there is enough uncertainty out there to make us believe that again when you -- with the amount of criticized and classified that we have, you have to believe that there is some level that may manifest itself over time. So that's really how it reflects is our best guess on that migration.

Nathan Race -- Piper Sandler & Co. -- Analyst

Understood. And then just kind of changing gears a little bit and just think about the growth guidance for this year of 4% to 5% in loans. Curious if that's just a function of continuing to take market share in around Chicago with some of the M&A transactions that we've seen recently, or are you guys kind of seeing it first shift in client demand or just some kind of moderation in payoffs at this point?

Michael L. Scudder -- Chairman and Chief Executive Officer

Go ahead.

Mark G. Sander -- President and Chief Operating Officer

A little bit -- sorry Mike, yeah. A little bit of all of the above, and Nathan, I would say it this way, it starts would having the right team that you feel can compete and win which I strongly feel that we do. So I think it's a little bit of -- I think we can pick up market share, I think we expect to pick up market share in all of our core businesses.

There is a certain amount of just return to normalcy, of course, built in there. We've added a few people over the last few years, but not a lot, because again as I said, we have the team, I think that can go compete and win.

Terry McEvoy -- Stephens Inc. -- Analyst

Okay, got it. If I could just ask one more on capital and share buybacks. Obviously, capital ratios increased across the board I believe in the fourth quarter here. So I guess just any thoughts or appetite on the buybacks really this year. I know M&As are not going into considerations as well, but just any thoughts on buyback particularly just given where the stock is trading today?

Michael L. Scudder -- Chairman and Chief Executive Officer

Go ahead, Pat.

Patrick S. Barrett -- Executive Vice President and Chief Financial Officer

Yeah, well, look, our capital priorities remain pretty steady, which is first and foremost to fund growth. The outlook for that is as we've laid out probably kind of normal or returning to a more normal organic growth rate sustaining a dividend level, which we feel good about where we are and expect to be from a payout ratio in the near term, to have dry powder for M&A which Mike has already talked about.

And then kind of a last utilization would be capital optimization through buybacks or other means. I think where we are right now from a criticized and classified loan perspective even though our credit is at near-record positive levels for the fourth quarter, there is still this expectation that we will see a tick up in credit. We feel very good about the reserve levels we have, but until we actually do start to see that is washed through and get a higher level of confidence around that, I think it's still a little bit premature for us to be talking about planning for or guiding to share repurchases.

But you should expect that this is going to be a recurring quarterly discussion that we'll have. So I'd say, more to come as we gain more certainty around both growth and ultimate credit outcomes.

Michael L. Scudder -- Chairman and Chief Executive Officer

Yeah, I would add to that and emphasize what Pat said there at the tail end. This is a ongoing and will be an ongoing and active dialog that we have with the Board and frankly with investors as well, so.

Nathan Race -- Piper Sandler & Co. -- Analyst

Okay, great. I appreciate you guys taking the questions. Thank you.

Michael L. Scudder -- Chairman and Chief Executive Officer

Great, thanks.

Patrick S. Barrett -- Executive Vice President and Chief Financial Officer

Thanks, Nat.

Operator

The next question is from Michael Young with Truist Securities. Please go ahead.

Michael Young -- Truist Securities -- Analyst

Hey, thanks for taking the question. Wanted to ask a follow-up on the capital return commentary you just mentioned. So stocks at 1.1 times tangible, I understand criticized classified are a little elevated, but I would assume the priority would be share buyback over M&A despite increases in M&A activity at these valuation levels, is that fair?

Michael L. Scudder -- Chairman and Chief Executive Officer

Yeah, let me kind of state it differently and the answer to that is the goal is always the same what is the best return to our shareholders for the deployment of capital choice that we have available to us. So if -- yeah, you're right, if in a world where opportunities come from an acquisition standpoint, those have to be weighed against the risk and the relative returns that those loss project. So that's kind of the screen we look through it every time.

So in a world where you're operating with valuations where they are today, you have to think about that relative to how you deploy it, so.

Michael Young -- Truist Securities -- Analyst

And I guess Mike maybe as a follow-up just on kind of geographic interest and strategy around M&A once we get -- once you get back to a valuation level where you can be more active there, is there still kind of the focus on just bolt-on cost out acquisitions or do you feel like this is kind of early cycle and you need to expand geographically from here?

Michael L. Scudder -- Chairman and Chief Executive Officer

We really haven't changed strategically in terms of where our thoughts go relative to who we are and what we do, we're commercial a relationship-based franchise. We think that operates well in not just the markets in terms of which where we operate here in Chicago, but for those urban markets of reasonable size and Midwestern adjacencies those make sense for us to be able to continue to build on that.

So our strategy there really hasn't changed other than our size is larger, so the impact in the relative opportunities that are available to us certainly can be -- have to be larger to be more impactful, but the strategic goal of what we're trying to do really hasn't changed.

Michael Young -- Truist Securities -- Analyst

And then last one for me, just on the kind of organic growth and hiring opportunities, there's been a lot of M&A, in your market. So I would assume there's potentially some opportunity sets out there, should we think of it as kind of an up tiering of talent with a focus on cost rationalization from here or do you want to be net adders of loan producers at this point in the cycle?

Mark G. Sander -- President and Chief Operating Officer

Let me take that, Mike.

Michael L. Scudder -- Chairman and Chief Executive Officer

Go ahead, Mark.

Mark G. Sander -- President and Chief Operating Officer

Yeah, I would say, Michael net -- good loan producers, good relationship managers, I want to be clear, it's not just loans, it's full relationship. Good relationship managers always pay for themselves very quickly and so we will always be in the market for strong producers. And so even in good times and bad times that's our philosophy. I don't think that we need to add a lot of people to hit the growth targets that we have, but we will expect to add a few people, but it's more topping up of the talent as opposed to changing out anything that we have.

Michael Young -- Truist Securities -- Analyst

Okay, thanks.

Operator

The next question is a follow-up from Daniel Tamayo with Raymond James. Please go ahead.

Daniel Tamayo -- Raymond James -- Analyst

Hey, thanks. Just quickly here, just want to make sure I understand the net interest income guidance, does that include your expectation for the $10 million to $15 million from the second round, kind of the 2021 PPP program.

Michael L. Scudder -- Chairman and Chief Executive Officer

Go ahead. Pat.

Operator

Mr. Barrett, did you mute your line on your end? You're so open on ours.

Patrick S. Barrett -- Executive Vice President and Chief Financial Officer

Apologies, Danny, It does but whether you include PPP and the offset -- that offsets the decline in accretion or not, you still end up with essentially the same guidance. Does that makes sense?

Daniel Tamayo -- Raymond James -- Analyst

Right. Yeah. No, I understand. I just wanted to make sure that I understood that correctly in terms of the reported side.

Patrick S. Barrett -- Executive Vice President and Chief Financial Officer

Yeah, I mean away -- just our core NII away from the impact of accretion or PPP at all, I would expect steady, but quite modest improvement quarterly just reflecting ongoing growth. So like 1%-ish for this year. So not significant, if you include PPP and accretion the kind of improved or increased PPP that we would expect will offset the decline in accretion that we have scheduled versus actual in 2020. The delta between those two tends to be a wash year-on-year.

Daniel Tamayo -- Raymond James -- Analyst

Okay. All right, that's helpful. And then within the mortgage banking, a big spike in the fourth quarter, you talked about that was really on the margin side is that what's driving the decline? I'm assuming that mortgage banking is kind of -- as I work through the numbers going to fall off from that elevated number in the fourth quarter going forward, is that really a margin issue or how are you thinking about the origination side in 2021 to kind of similar to the industry forecast of 20% to 30% down?

Mark G. Sander -- President and Chief Operating Officer

Yeah.

Michael L. Scudder -- Chairman and Chief Executive Officer

Go ahead, Mark.

Mark G. Sander -- President and Chief Operating Officer

Yes, is the short answer Danny. We're expecting it to come down a little bit the -- now that said, the first quarter was not that robust we'll have a -- presumably a favorable comparison in Q1 versus Q1 of '20 but overall, we're expecting a bit of a decline this year.

Daniel Tamayo -- Raymond James -- Analyst

Okay. And it was a big spike in the margin in the fourth quarter that really drove that increase.

Mark G. Sander -- President and Chief Operating Officer

Yeah, the sale prices in mortgage were nice, were really strong in the fourth quarter. And so we just took advantage of the trade between put it on our balance sheet or the sale, we just thought the sale price was attractive enough to take advantage of.

Daniel Tamayo -- Raymond James -- Analyst

Understood. Okay, thanks. All for me -- that's all from me. Thanks.

Operator

[Operator Instructions] Our next question is from Chris McGratty, a follow-up from him from KBW. Please go ahead.

Christopher McGratty -- Keefe Bruyette & Woods Inc. -- Analyst

Yeah, thanks. I might have missed it, but did you provide any color about the increase in the special mentions which went up about what $60 million, what portfolio maybe?

Michael L. Scudder -- Chairman and Chief Executive Officer

Go ahead, Mark.

Mark G. Sander -- President and Chief Operating Officer

We did not that almost entirely came from fitness and recreation in the quarter, Chris.

Christopher McGratty -- Keefe Bruyette & Woods Inc. -- Analyst

Okay. And would those be -- are those loans coming off deferral. Is it just -- are you seeing notable changes just given the pace of improvement in COVID reopening, what the story there, Mark?

Mark G. Sander -- President and Chief Operating Officer

Yeah, the latter, Chris. It's really just the pace of improvement and the clarity with which -- how long it might go on that caused us to downgrade a few credits there.

Christopher McGratty -- Keefe Bruyette & Woods Inc. -- Analyst

Okay, thanks.

Patrick S. Barrett -- Executive Vice President and Chief Financial Officer

And Chris, while you're on, this is Pat. I just wanted to correct myself, you were asking about kind of one-time ongoing optimization costs in Q1 and I said $1 million, I should have said around $2 million, but that should wrap it up.

Christopher McGratty -- Keefe Bruyette & Woods Inc. -- Analyst

Got it, thanks.

Operator

If there are no further questions, I will now turn the call back over to Mr. Scuddy for any closing remarks.

Michael L. Scudder -- Chairman and Chief Executive Officer

Great, thanks. So before we close, just once again want to take the opportunity and recognize and thank all of our colleagues. I know they listen to these calls and I want to thank them on behalf of all of us for their response, particularly during these times. It's their continued commitment to who we are and what we're all about and the values we represent as a company that I believe makes First Midwest special.

So we're very proud to be surrounded by so many good people who try to do the right thing every day for our clients, our communities and for each other. So with that, I would like to thank all of you for your interest in and attention to our story, and as we share our ongoing belief that First Midwest is a great investment opportunity, I would encourage you to take advantage of it. So have a great day.

Operator

[Operator Closing Remarks]

Duration: 51 minutes

Call participants:

Michael L. Scudder -- Chairman and Chief Executive Officer

Mark G. Sander -- President and Chief Operating Officer

Patrick S. Barrett -- Executive Vice President and Chief Financial Officer

Christopher McGratty -- Keefe Bruyette & Woods Inc. -- Analyst

Daniel Tamayo -- Raymond James -- Analyst

Terry McEvoy -- Stephens Inc. -- Analyst

Nathan Race -- Piper Sandler & Co. -- Analyst

Michael Young -- Truist Securities -- Analyst

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