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FMBI > SEC Filings for FMBI > Form 10-K on 3-Mar-2014All Recent SEC Filings

Show all filings for FIRST MIDWEST BANCORP INC

Form 10-K for FIRST MIDWEST BANCORP INC


3-Mar-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

INTRODUCTION

First Midwest Bancorp, Inc. is a bank holding company headquartered in the Chicago suburb of Itasca, Illinois with operations throughout the greater Chicago metropolitan area as well as northwest Indiana, central and western Illinois, and eastern Iowa. Our principal subsidiary is First Midwest Bank (the "Bank"), which provides a broad range of commercial and retail banking and wealth management services to consumer, commercial and industrial, commercial real estate, and municipal customers through approximately 90 banking offices. We are committed to meeting the financial needs of the people and businesses in the communities where we live and work by providing customized banking solutions, quality products, and innovative services that fulfill those financial needs.

The following discussion and analysis is intended to address the significant factors affecting our Consolidated Statements of Income for the years 2011 through 2013 and Consolidated Statements of Financial Condition as of December 31, 2012 and 2013. When we use the terms "First Midwest," the "Company," "we," "us," and "our," we mean First Midwest Bancorp, Inc., a Delaware Corporation, and its consolidated subsidiaries. When we use the term "Bank," we are referring to our wholly owned banking subsidiary, First Midwest Bank. Management's discussion and analysis should be read in conjunction with the consolidated financial statements, accompanying notes thereto, and other financial information presented in this Form 10-K.

Our results of operations are affected by various factors, many of which are beyond our control, including interest rates, local and national economic conditions, business spending, consumer confidence, legislative and regulatory changes, and changes in real estate and securities markets. Our management evaluates performance using a variety of qualitative and quantitative metrics. The primary quantitative metrics used by management include:


Pre-Tax, Pre-Provision Operating Earnings - Pre-tax, pre-provision operating earnings, a non-GAAP financial measure, reflects our operating performance before the effects of credit-related charges, securities gains, losses, and impairments, and certain unusual, infrequent, or non-recurring revenues and expenses. We believe this metric is useful because it helps investors to assess the Company's operating performance. A reconciliation of pre-tax, pre-provision operating earnings to GAAP can be found in Table 1.
Net Interest Income - Net interest income, our primary source of revenue, equals the difference between interest income and fees earned on interest-earning assets and interest expense incurred on interest-bearing liabilities.
Net Interest Margin - Net interest margin equals net interest income divided by total average interest-earning assets.
Noninterest Income - Noninterest income is the income we earn from fee-based revenues, investment in bank-owned life insurance ("BOLI") and other income, and non-operating revenues.
Asset Quality - Asset quality represents an estimation of the quality of our loan portfolio, including an assessment of the credit risk related to existing and potential loss exposure, and can be evaluated using a number of quantitative measures, such as non-performing loans to total loans.
Regulatory Capital - Our regulatory capital is currently classified in one of the following two tiers: (i) Tier 1 capital consists of common equity, retained earnings, qualifying non-cumulative perpetual preferred stock, and qualifying trust-preferred securities, less goodwill and most intangible assets, and (ii) Tier 2 capital includes qualifying subordinated debt and the allowance for credit losses, subject to limitations.

A condensed review of operations for the fourth quarter of 2013 is included in the section titled "Fourth Quarter 2013 vs. Fourth Quarter 2012" of this Item 7. The summary provides an analysis of the quarterly earnings performance for the fourth quarter of 2013 compared to the same period in 2012.

Unless otherwise stated, all earnings per common share data included in this section and throughout the remainder of this discussion are presented on a fully diluted basis.


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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

This report, as well as our other filings with the SEC or our communications with stockholders, may contain forward-looking statements within the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 ("PSLRA"). These statements involve known and unknown risks, uncertainties, and other factors that may cause actual results to be materially different from any results, levels of activity, performance, or achievements expressed or implied by any forward-looking statement. These factors include, among other things, the factors listed below.

In some cases, we identified forward-looking statements by such words or phrases as "will likely result," "is confident that," "remains optimistic about," "expects," "should," "could," "seeks," "may," "will continue to," "believes," "anticipates," "predicts," "forecasts," "estimates," "projects," "potential," "intends," or similar expressions identifying forward-looking statements within the meaning of the PSLRA, including the negative of those words and phrases. These forward-looking statements are not historical facts, but instead are based on management's current views and assumptions regarding future events, future business conditions, outcomes, and our outlook for the Company based on currently available information. We wish to caution readers not to place undue reliance on any such forward-looking statements as we do not undertake any obligation to update them to reflect circumstances or events that occur after the date on which the forward-looking statement is made.

In connection with the safe harbor provisions of the PSLRA, we are hereby identifying important factors that could affect our financial performance and could cause our actual results for future periods to differ materially from any opinions or statements expressed with respect to future periods in any forward-looking statements.

Among the factors that could have an impact on our ability to achieve operating results, growth plan goals, and the beliefs expressed or implied in forward-looking statements are:


Management's ability to reduce and effectively manage interest rate risk and the impact of interest rates in general on the volatility of our net interest income.
Asset and liability matching risks and liquidity risks.
Fluctuations in the value of our investment securities.
The ability to attract and retain senior management experienced in banking and financial services.
The sufficiency of the allowance for credit losses to absorb the amount of actual losses inherent in the existing loan portfolio.
The models and assumptions underlying the establishment of the allowance for credit losses and estimation of values of collateral and various financial assets and liabilities may be inadequate.
Credit risks and risks from concentrations (by geographic area and by industry) within our loan portfolio.
The effects of competition from other commercial banks, thrifts, mortgage banking firms, consumer finance companies, credit unions, securities brokerage firms, insurance companies, money market and other mutual funds, and other financial institutions operating in our markets or elsewhere providing similar services.
Changes in the economic environment, competition, or other factors that may influence the anticipated growth rate of loans and deposits, the quality of the loan portfolio, and loan and deposit pricing.
Changes in general economic or industry conditions, nationally or in the communities in which we conduct business.
Volatility of rate sensitive deposits.
Our ability to adapt successfully to technological changes to compete effectively in the marketplace.
Operational risks, including data processing system failures, fraud, or breaches.
Our ability to successfully pursue acquisition and expansion strategies and integrate any acquired companies.
The impact of liabilities arising from legal or administrative proceedings, enforcement of bank regulations, and enactment or application of laws or regulations.
Governmental monetary and fiscal policies and legislative and regulatory changes (including those implementing provisions of the Dodd Frank Act) that may result in the imposition of costs and constraints through higher FDIC insurance premiums, significant fluctuations in market interest rates, increases in capital or liquidity requirements, operational limitations, or compliance costs.
Changes in federal and state tax laws or interpretations, including changes affecting tax rates, income not subject to tax under existing law and interpretations, income sourcing, or consolidation/combination rules.


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Changes in accounting principles, policies, or guidelines affecting the businesses we conduct.
Acts of war or terrorism.
Other economic, competitive, governmental, regulatory, and technological factors affecting our operations, products, services, and prices.

The foregoing list of important factors may not be all-inclusive, and we specifically decline to undertake any obligation to publicly revise any forward-looking statements that were made to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.

With respect to forward-looking statements set forth in the notes to the consolidated financial statements, including those relating to contingent liabilities and legal proceedings, some of the factors that could affect the ultimate disposition of those contingencies are changes in applicable laws, the development of facts in individual cases, settlement opportunities, and the actions of plaintiffs, defendants, judges, and juries.


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PERFORMANCE OVERVIEW

                                    Table 1
                            Selected Financial Data
              (Dollar amounts in thousands, except per share data)

                                                          Years ended December 31,
                                                       2013         2012         2011
Operating Results
Interest income                                     $  287,247   $  300,569   $  321,511
Interest expense                                       (27,115 )    (34,901 )    (39,891 )

Net interest income                                    260,132      265,668      281,620
Fee-based revenues                                     106,282       97,323       94,182
Other noninterest income (1)                             6,954        5,662        4,269
Noninterest expense (1)                               (249,122 )   (248,349 )   (248,838 )

Pre-tax, pre-provision operating earnings (2)          124,246      120,304      131,233
Provision for loan and covered loan losses             (16,257 )   (158,052 )    (80,582 )
Net securities gains (losses)                           34,164         (921 )      2,410
Net losses on sales and valuation adjustments of
OREO, excess properties, and assets held-for-sale       (3,908 )     (7,974 )    (10,797 )
Severance-related costs                                 (2,207 )     (1,155 )     (2,269 )
Adjusted amortization of FDIC indemnification
asset                                                   (1,500 )     (6,705 )          -
Net losses on early extinguishment of debt              (1,034 )       (558 )          -
BOLI modification loss                                 (13,312 )          -            -
Gain on termination of FHLB forward commitments          7,829            -            -
Gains on acquisitions, net of integration costs              -        2,486        1,076
Net gain on bulk loan sales                                  -        2,639            -

Income (loss) before income tax                        128,021      (49,936 )     41,071
Income tax expense (benefit)                            48,715      (28,882 )      4,508

Net income (loss)                                       79,306      (21,054 )     36,563
Preferred dividends and accretion on preferred
stock                                                        -            -      (10,776 )
Net (income) loss applicable to non-vested
restricted shares                                       (1,107 )        306         (350 )

Net income (loss) applicable to common shares       $   78,199   $  (20,748 ) $   25,437

Diluted earnings (loss) per common share            $     1.06   $    (0.28 ) $     0.35
Performance Ratios
Return on average common equity                          8.04%       (2.14% )      2.69%
Return on average assets                                 0.96%       (0.26% )      0.45%
Net interest margin - tax equivalent                     3.68%        3.86%        4.04%
Efficiency ratio (3)                                    64.19%       67.14%       62.12%

(1)
Excludes certain non-operating noninterest items. (2)
Our accounting and reporting policies conform to GAAP and general practices within the banking industry. As a supplement to GAAP, we provided this non-GAAP performance result, which we believe is useful because it assists investors in evaluating our operating performance. This non-GAAP financial measure should not be considered an alternative to GAAP and may not be comparable to similar non-GAAP measures used by other companies. (3)
The efficiency ratio expresses noninterest expense, excluding OREO expense, as a percentage of tax-equivalent net interest income plus total fee-based revenues, other income, net trading gains (losses), and the tax-equivalent adjustment on BOLI income. The $7.8 million gain on the termination of FHLB forward commitments and the $13.3 million BOLI modification loss are non-recurring items excluded from the efficiency ratio for the year ended December 31, 2013.


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                                   December 31,     December 31,
                                       2013             2012        $ Change     % Change
Balance Sheet Highlights
Total assets                      $    8,253,407   $    8,099,839   $ 153,568          1.9
Total loans, excluding covered
loans                                  5,580,005        5,189,676     390,329          7.5
Total loans, including covered
loans                                  5,714,360        5,387,570     326,790          6.1
Total deposits                         6,766,101        6,672,255      93,846          1.4
Transactional deposits                 5,558,318        5,272,307     286,011          5.4
Loans-to-deposits ratio                    84.5%            80.7%
Transactional deposits to total
deposits                                   82.1%            79.0%
Asset Quality Highlights
Non-accrual loans (1)             $       59,798   $       84,534   $ (24,736 )      (29.3 )
90 days or more past due loans
(still accruing interest) (1)              3,708            8,689      (4,981 )      (57.3 )

Total non-performing loans (1)            63,506           93,223     (29,717 )      (31.9 )
Accruing troubled debt
restructurings ("TDRs") (1)               23,770            6,867      16,903          N/M
OREO (1)                                  32,473           39,953      (7,480 )      (18.7 )

Total non-performing assets (1)   $      119,749   $      140,043   $ (20,294 )      (14.5 )

30-89 days past due loans
(still accruing interest) (1)     $       20,742   $       22,666   $  (1,924 )       (8.5 )
Performing potential problem
loans (1)(2)                             155,954          218,599     (62,645 )      (28.7 )
Allowance for credit losses               87,121          102,812     (15,691 )      (15.3 )
Allowance for credit losses as
a percent of loans                         1.52%            1.91%
Allowance for credit losses to
non-accrual loans                        107.90%          104.15%


N/M - Not meaningful.

(1)
Excludes covered loans and covered OREO. For a discussion of covered loans and covered OREO, refer to Note 5 of "Notes to the Consolidated Financial Statements" in Item 8 of this Form 10-K. Asset quality, including covered loans and covered OREO, is included in the section titled "Loan Portfolio and Credit Quality" of this Item 7. (2)
Total performing potential problem loans excludes $2.8 million of accruing TDRs as of December 31, 2013 and $448,000 of accruing TDRs as of December 31, 2012.

Performance Overview for 2013 Compared with 2012

Net income applicable to common shares for 2013 was $78.2 million, or $1.06 per share, compared to a net loss applicable to common shares of $20.7 million, or $0.28 per share, for 2012.

Pre-tax, pre-provision operating earnings of $124.2 million for 2013 increased $3.9 million compared to 2012, resulting primarily from growth in wealth management fees, gains on mortgage loan sales, and fees from sales of capital market products to commercial clients, which more than offset a decrease in net interest income.

Tax-equivalent net interest margin declined 18 basis points to 3.68% for 2013 from 3.86% for 2012. The reduction in margin reflected a 30 basis point decrease in the average yield on interest-earning assets due primarily to a lower yield earned on new and renewing loans as a result of greater customer preference for floating rate loans, as well as the reinvestment of cash flows from the investment portfolio into lower yielding securities. These lower yields were partially offset by a decline in the rates paid for interest-bearing liabilities, including a 2 basis point decline on


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interest-bearing transactional deposits, a 28 basis point decline on time deposits, and a 3 basis point decline on senior and subordinated debt.

The provision for loan and covered loan losses was $16.3 million for 2013 compared to $158.1 million for 2012. The higher provision for loan and covered loan losses for the year ended December 31, 2012 resulted from the additional provision of $62.3 million recorded as a result of moving $172.5 million of loans to held-for-sale status in anticipation of the bulk loan sales and the related charge-offs of $80.3 million. Refer to the section titled "Loan Portfolio and Credit Quality" of this Item 7 for additional discussion of the provision for loan and covered loan losses.

Total noninterest income for 2013 rose 28.1% compared to 2012, driven primarily by certain balance sheet repositioning activities, which mainly impacted the securities and BOLI portfolios. These activities were executed to take advantage of changing market conditions, strengthen capital, and better position the Company to benefit from a rising interest rate environment. These activities included:


The sale of our $4.2 million investment in Textura Corporation ("Textura") for $38.2 million, resulting in a gain of $34.0 million. Textura completed an initial public offering ("IPO") of common stock during the second quarter of 2013. At June 30, 2013, we reclassified our investment in Textura's common stock from an equity investment to available-for-sale and valued it using the closing stock price reported by the New York Stock Exchange. Initially, we were restricted from selling any of our shares for six months following the completion of the IPO. During the third quarter of 2013, Textura completed a secondary offering and certain stockholders, including the Company, were permitted to sell their shares. Therefore, we sold all of our common shares in Textura. The Company has no other similar investments. We hold a warrant to purchase 20,000 shares of Textura common stock.
The termination of two forward commitments with the FHLB to borrow a total of $250 million for a 5-year period beginning in 2014 at a weighted average interest rate of approximately 2.0% resulting in a gain of $7.8 million. This termination was executed to take advantage of a temporary rise in interest rates and an expectation that future liquidity needs could be better managed through maturities of securities, continued growth in our deposit base, and other similar low rate borrowings.
The voluntary modification of crediting rate terms and the underlying cash surrender value ("CSV") of approximately $100 million of lower yielding BOLI policies, resulting in a $13.3 million write-down. This write-down represents the difference between the book value and the fair value of the underlying investments and was previously being amortized in other noninterest income, offsetting BOLI income and any insurance proceeds received. This action gives the Company the flexibility to reinvest these assets in longer duration securities at higher yields to enhance BOLI income.

A discussion of net interest income and noninterest income and expense is presented in the following section titled "Earnings Performance" of this Item 7.

As of December 31, 2013, our securities portfolio totaled $1.2 billion, rising 3.4% from December 31, 2012. The current year growth resulted primarily from the redeployment of cash and cash equivalents into purchases of collateralized mortgage obligations ("CMOs") and other mortgage-backed securities ("MBSs"). These increases were partially offset by maturities and calls of municipal securities. For a detailed discussion of our securities portfolio, refer to the section titled "Investment Portfolio Management" of this Item 7.

Total loans, excluding covered loans, of $5.6 billion as of December 31, 2013 reflected growth of $390.3 million, or 7.5%, from December 31, 2012. The loan portfolio benefited from well-balanced corporate loan growth reflecting credits of varying size and diverse geographic locations within our markets. For a discussion of our loan portfolio, see the section titled "Loan Portfolio and Credit Quality" of this Item 7.

As of December 31, 2013, non-performing assets, excluding covered loans and covered OREO, declined by 14.5% compared to December 31, 2012. Improvement in non-performing assets and related credit metrics resulted primarily from management's continued focus on credit remediation. Refer to the section titled "Loan Portfolio and Credit Quality" of this Item 7 for additional discussion of non-performing assets.

Average funding sources for 2013 increased $156.7 million compared to the year ended December 31, 2012, primarily from growth in transactional deposits, which more than offset a reduction in higher-costing time deposits.


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Average senior and subordinated debt decreased $18.4 million from 2012 driven by the repurchase and retirement of $24.0 million of junior subordinated debentures during the fourth quarter of 2013. For a discussion of our funding sources, see the section titled "Funding and Liquidity Management" of this Item 7.

Performance Overview for 2012 Compared with 2011

The net loss applicable to common shareholders for 2012 was $20.7 million, or $0.28 per share. This compared to net income applicable to common shareholders of $25.4 million, or $0.35 per share, for 2011. The net loss for 2012 was driven primarily by accelerated credit remediation actions during the third quarter of 2012.

Pre-tax, pre-provision operating earnings of $120.3 million for 2012 were down $10.9 million, or 8.3%, compared to 2011, resulting primarily from a reduction in net interest income, which was partly mitigated by an increase in fee-based revenues and gains on mortgage loan sales.

Tax-equivalent net interest margin declined 18 basis points to 3.86% for 2012 from 4.04% for 2011. The reduction in margin reflected a 25 basis point decrease in the average yield on interest-earning assets due primarily to a lower yield earned on new and renewing loans in the low interest rate environment as well as the reinvestment of cash flows from the investment portfolio into lower yielding securities. These lower yields were partially offset by a decline in the rates paid for interest-bearing liabilities, including a 6 basis point decline on interest-bearing transactional deposits, a 27 basis point decline on time deposits, and a 16 basis point decline on senior and subordinated debt.

Total noninterest income increased from 2011 as a result of higher fee-based revenues, which were partially offset by securities losses compared to securities gains in the prior year. The gain on the bulk loan sales and a gain on an FDIC-assisted acquisition also contributed to the increase from 2011.

The rise in noninterest expense resulted primarily from higher compensation expense, increased professional services, $6.7 million of adjusted amortization of the FDIC indemnification asset, and valuation adjustments of assets held-for-sale.

As of December 31, 2012, our securities portfolio totaled $1.1 billion, increasing 4.1% from December 31, 2011. This growth was driven by an increase in CMOs and MBSs. In the first quarter of 2012, deposits acquired in the fourth quarter of 2011 that had previously been held in short-term investments were redeployed into these types of securities.

During the third quarter of 2012, we identified certain non-performing and performing potential problem loans totaling $172.5 million in original carrying value for accelerated disposition through multiple bulk loan sales and recorded charge-offs of $80.3 million. The bulk loan sales were completed in the fourth quarter of 2012, resulting in proceeds of $94.5 million and a gain, less commissions and other selling expenses, of $2.6 million.

Total loans of $5.4 billion as of December 31, 2012 grew $39.0 million from December 31, 2011. Excluding covered loans, net charge-offs, loans disposed of through bulk loan sales, and loans acquired in an FDIC-assisted transaction, our loan portfolio increased by approximately 6.5% from December 31, 2011. The loan portfolio benefitted from growth in commercial and industrial loans, agricultural loans, office and retail loans, and 1-4 family mortgages.

The improvement in non-performing assets, excluding covered loans and covered OREO, from December 31, 2011 to December 31, 2012 reflected aggressive remediation actions taken by management during the year and, in particular, the bulk loan sales discussed above.

For 2012, total average funding sources increased $98.8 million, or 1.4%, from 2011 driven primarily by growth of $352.9 million, or 7.4%, in average transactional deposits, partially offset by reductions in higher-costing time deposits of $263.0 million and borrowed funds of $72.1 million, resulting in a more favorable funding mix. The rise in average senior and subordinated debt reflected the issuance of $115.0 million of senior debt in the fourth quarter of 2011, less the repurchase and retirement of $37.4 million of junior subordinated debentures and subordinated notes during 2012.

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