First Midwest Bancorp, inc (FMBI) Q2 2021 Earnings Call Transcript

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First Midwest Bancorp, inc (FMBI)
Q2 2021 Earnings Call
Jul 20, 2021, 10:00 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 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. [Operator Instructions]

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 opened for questions and answers for analysts only.

I will now turn the call over to Mr. Scudder.

Michael L. Scudder -- Chairman of the Board and Chief Executive Officer

Great. Thank you. Good morning. Thanks to all of you for joining us today. It's great to be with you. I 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's 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 were certainly the focus for this call and 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 to year-to-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 continued 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 $0.41, that's up 14% from 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 quarter, 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 was impacted by elevated liquidity, which obviously weighs on the percentages.

Fee-based revenues remained strong. And as I said before, we saw again this quarter record wealth management revenue, which offset the fall-off from last quarter, but we have to remember the fall-off from last quarter was record levels for mortgage revenue. So -- and then obviously away from the transaction costs attended to the Old National combination, noninterest 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 they have -- 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. They can expand on some of the details and walk through the deck. Mark?

Mark G. Sander -- President and Chief Operating Officer

Thanks, Mike, and good morning, everyone.

Starting on Slide 3 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 multi-family 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 merely 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 4, continue to improve as expected, like Mike highlighted. All adverse categories, NPAs, substandard, special mention and 30 to 89 days past due, they all declined in Q2. We believe this favorable risk credit migration will continue over the back half of this year.

Charge-offs, as shown on Slide 5, did increase as expected solely due to two large credits that we have 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 6. Funding remains a core strength to 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 8 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.

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

Thanks, Mark. Good morning to everyone on the call.

Turning to net interest income and margin on Slide 7. Net interest income was up 2% compared to the prior quarter and down 1% from the same period in 2020. The increased linked quarter was driven by $2 million in higher PPP loan forgiveness and 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 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% was down 7 basis points linked quarter and down 17 basis points from the same period a year ago. Excluding accretion, adjusted margin was 2.84% for the quarter, down 4 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.

Linked 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 for 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 [Phonetic] the exact timing and the amounts are completely dependent upon the SBA's process for forgiveness.

Turning to noninterest 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. Noninterest 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 noninterest income for the full year remains unchanged, with quarterly total noninterest income expected to be stable to Q2 levels over the second half of the year, despite the expected continued normalization of mortgage income performance [Phonetic] record levels at the beginning of the year.

Moving on to expenses on Slide 9. Note the current quarter includes $8 million of acquisition and 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 from the second quarter. In addition, lower equity compensation valuations and the ongoing benefits 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 payout 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% in the same period a year ago. Away from the ongoing acquisition and integration costs, our outlook for noninterest expenses is 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 income. 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 $0.14 per share, consistent with prior quarter and prior year, and provide strong capabilities to support borrowing needs of our customers.

Now I'll turn it back over to Mark.

Mark G. Sander -- President and Chief Operating Officer

So, on Slide 11, we tried to briefly summarize a 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 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 I'll hand it back to you, Mike.

Michael L. Scudder -- Chairman of the Board and Chief Executive Officer

Thanks, Mark.

Yeah, let me just echo a couple of things on Mark's comments before we open it up for questions. A, 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 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.

Questions and Answers:

Operator

Thank you. [Operator Instructions] Please standby for your first question. It is from Michael Young of Truist. Please go ahead.

Michael Young -- Truist Securities -- Analyst

Hey, thanks for taking the question. Yeah, I was just curious maybe sort of qualitatively what we should expect in the interim before the Old National deal closes in terms of 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 just any other qualitative things you'd like to put out there?

Michael L. Scudder -- Chairman of the Board and Chief Executive Officer

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 costs -- or excuse me, the transaction as we've described, and strategically it's a great opportunity. So, we spent 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 to today.

Mark G. Sander -- President and Chief Operating Officer

Yeah, I guess, can I add? I would just say -- it's Mark. Michael, thanks for the question. To start with [Phonetic], it's business as usual here. We continue to expect to grow. We continue to call on clients proactively and tell our story. And I think the market reaction has been very favorable. So, it's -- and any expenses that we have were certainly built into -- I think, retention efforts were built into our modeling as we outlined the transaction.

Michael Young -- Truist Securities -- Analyst

Okay. Great. And maybe just kind of bigger picture on loan growth, loan demand, heard a few comments, obviously, about that in the prepared remarks. But are there areas that you're seeing maybe higher demand or more strength? And then, are there any sort of limitations or anything we should think about in terms of growth going into the back half before the merger closes?

Mark G. Sander -- President and Chief Operating Officer

I think we're seeing a nice recovery -- it's Mark again, Michael, across, really, all sectors. We've seen the most strength in C&I thus far. The headwinds would be those pesky competitors that are out there. But we faced the competitors and we've competed and win -- and won before and we continue to do so. So, I don't mean to be so tongue and cheek about it. I think that there is no market headwinds that we see. 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.

Michael Young -- Truist Securities -- Analyst

Okay. And maybe last one from me. Just as you look at sort of the fee business lines, as you move into closing with Old National, are there certain areas that you're starting to or going to try to 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?

Mark G. Sander -- President and Chief Operating Officer

I'll try my best -- 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 a 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 it'll change -- 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 with the staff that we have.

Michael Young -- Truist Securities -- Analyst

Okay. Great. Thanks. That's all from me.

Operator

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

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

Yeah. Hi, everyone. Good morning.

Mark G. Sander -- President and Chief Operating Officer

Hey, Nathan.

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

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 instalment growth. And I think in the past, you guys have had some purchases within that segment that's augmented growth in that portfolio. So, I'm just curious, one, if that was a 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?

Mark G. Sander -- President and Chief Operating Officer

Yeah. Nate, it's Mark. I'd answer this way. The growth you saw in instalment 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 in instalment was really to keep that relatively flat. The net overall growth that we saw was in C&I, multi-family 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. They've -- CRE has the nice production levels, but we continue to see a fair amount of payoffs in that area. So, it's been relatively flat away for multi-family, but again, our growth this quarter was C&I, multi-family and mortgage driven, not instalments, in our view.

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

[Speech Overlap] Nate, it's Pat. Just to kind of close the loop on our transactional purchased book, so we do from time to time, augment more from a mix perspective than a yield perspective with purchases, primarily residential one to force [Phonetic]. Those run-off at a pace that has continued to be higher than, what I call, normal, because people first were refinancing like crazy, and now they're continuing to sell their houses and by 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 purchased loans, just to be clear.

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

Got it. Appreciate that. And then kind of along those lines, just thinking [Phonetic] 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? And assuming [Phonetic], should we expect some continued earning asset growth and liquidity inflows, or do you guys maybe anticipate some shrinkages, some of those dynamics play out going forward?

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

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 run off 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 pattern. So, we would anticipate probably somewhere between $500 million and $750 million of run-off 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 to believe that that is going to run-off at some point later this year or early into the following.

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

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 them in securities book, absent the opportunities that you guys are going to see from a lending perspective over the next couple of quarters?

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

Well, we're always looking for opportunities to top up the securities book. So, you've seen yields and rates experienced 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 are kind of struggling to get yields on new purchases, much higher than 1.70%, 1.75%, 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 hired more attractive yields, and we'll look for opportunities to do that again for sure. So, 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.

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

Okay. Understood. I appreciate all the color. Thanks, guys. Nice quarter.

Michael L. Scudder -- Chairman of the Board and Chief Executive Officer

Thanks.

Operator

The next question is from Chris McGratty of KBW. Please go ahead.

Chris O'Connell -- Keefe Bruyette & Woods Inc. -- Analyst

Good morning, gentlemen. This is Chris O'Connell filling in for McGratty. I just wanted to kind of follow up on the same trend there or line of questioning with regards to liquidity management. I appreciate the guidance that you guys have given around the unchanged on a stable NII and with the NIM growing. But just curious, so far into -- in 3Q '21 [Phonetic], have you seen any of those deposit movements from your customers? Or any kind of the strong inflows that you've seen over the past year start to moderate or come down yet? Or do you think that's still a little bit more of a late off 2021?

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

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 up things that they accumulated late previous year. Municipal inflows remain very consistent, and so we're in the middle of kind of the normal seasonable -- 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 is a stimulus package, we can see multiple hundreds of millions [Technical Issues] immediately. So, it just seems to be persisting as far as balanced growth.

Mark, is there anything you'd add on to that?

Mark G. Sander -- President and Chief Operating Officer

I think you summarized it well, Pat.

Chris O'Connell -- Keefe Bruyette & Woods Inc. -- Analyst

Got it. Understood. And as far as the deployment into securities, and I hear you on rates, it hasn't been a great environment recently to go all in. Is there a certain point where there is a certain yield threshold where you guys are going to be more aggressive or take opportunities that you can of be allowed to disclose?

Mark G. Sander -- President and Chief Operating Officer

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, our 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 will expect and take advantage of opportunistic investing.

Chris O'Connell -- Keefe Bruyette & Woods Inc. -- Analyst

Got it. Thanks. And then one last one if I could. Loan growth in guidance stable, seems to be on track. And is there anything on the commercial side, I guess, where you see opportunities to kind of beat guidance there in the mid single-digit as in any particular industry or area where if line utilization could come back a little bit stronger than expected or something along those lines?

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

I would say nothing in particular, but I'd answer it this was 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, so might be a little lower there, but -- 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 on that into a mid single-digit.

Chris O'Connell -- Keefe Bruyette & Woods Inc. -- Analyst

Understood. Thanks.

Operator

[Operator Instructions] There are no further questions. I would now like to turn the call back over to Mr. Scudder for closing comments.

Michael L. Scudder -- Chairman of the Board and Chief Executive Officer

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 collected 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 company so special. I'm very proud to be surrounded by so many good people who strive to do great things every day for our clients, our communities and for each other. So, thank you all for your attention and interest in our story, our ongoing belief that we're a great investment. So, have a great day everybody.

Operator

[Operator Closing Remarks]

Duration: 31 minutes

Call participants:

Michael L. Scudder -- Chairman of the Board and Chief Executive Officer

Mark G. Sander -- President and Chief Operating Officer

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

Michael Young -- Truist Securities -- Analyst

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

Chris O'Connell -- Keefe Bruyette & Woods Inc. -- Analyst

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