First Midwest Finally Cleans House

NEW YORK ( TheStreet) -- First Midwest Bancorp ( FMBI) has moved aggressively to trim it stubbornly high level of problem loans and move on.

As expected by FIG Partners analyst John Rodis, who said in August that there was a "pretty good chance of a bulk loan sale between now and year-end," First Midwest of Itasca, Ill., in the third quarter reduced its nonperforming loans by 46% by targeting "$223 million of select non-performing and performing potential problem loans for accelerated resolution, resulting in charge-offs of $99 million."

First Midwest had $8.2 billion in total assets as of Sept. 30. The Chicago-area lender last Wednesday reported a third-quarter net loss applicable to common shares of $47.8 million, or 65 cents a share, compared to second-quarter earnings of $6.3 million, or nine cents a share, both in the second quarter and during the third quarter of 2011.

During the most recent quarter, the company transferred $171.1 million in nonperforming or potential problem loans to held-for-sale, and modified its disposition strategy for $52.4 million in nonperforming or potential problem loans, while charging-off 44.4% of the total.

This left the company with $112.2 million in nonperforming loans as of Sept. 30, declining from $206.7 million the previous quarter. First Midwest had $155.0 million in total assets as of Sept. 30, or 1.88% of total assets, improving from 2.99% the previous quarter, and 2.53% a year earlier.

First Midwest on Oct. 26 agreed "to sell $64.0 million of loans held-for-sale, which represents 71% of the total loans held-for-sale at September 30, 2012." The loan sale is expected to close during the fourth quarter, with the loans being sold close to their carrying value.

The company's total third-quarter provision for loan losses -- the addition to loan loss reserves -- totaled $111.8 million. Following the third-quarter credit actions, First Midwest was left with loan loss reserves totaling $105.0 million, covering 2.01% of total loans, and 105% of nonaccrual loans -- excluding balances covered by Federal Deposit Insurance Corp. loss-sharing agreements -- making it appear that reserve provisioning over the next few quarters could remain somewhat elevated.

First Midwest Bancorp's capital ratios declined as a result of the credit actions, but remained strong relative to regulatory requirements. The regulatory ratio of total capital to risk-weighted assets declined to 11.65% as of Sept. 30 from 13.68% the previous quarter, but was well above the 10% required for most banks to be considered well-capitalized. The company's ratio of tangible common equity to tangible assets was 8.26% as of Sept. 30, declining from 8.83% the previous quarter.

First Midwest CEO Michael Scudder said during the company's earnings conference call that "the remaining pool of non-performing and potential performing problem assets are better situated to improve or, as necessary, be liquidated," which "positions us for significantly lower future credit costs and we expect the resulting capital pressure to be relatively short-lived when these benefits are added to our current business momentum."

The company's total portfolio loans declined by 2% during the third quarter, to $5.4 billion, as a result of the loan transfer. Commercial and industrial loan balances grew 1% sequentially and 9% year-over-year, to $1.6 billion as of Sept. 30.

Third-quarter net interest income totaled $70.6 million, increasing from $70 million in the second quarter, but declining from $73.9 million a year earlier, as yields on interest-earning assets declined, following the industry trend. The company's third-quarter net interest margin -- the difference between the average yield on loans and investments and the average cost for deposits and borrowings -- was 3.83%, narrowing from 3.88% the previous quarter, and 3.97% a year earlier.

First Midwest CFO Paul Clemens said during the conference call that "even with $250 million of average earning asset growth over the past two quarters, we continue to maintain over $400 million in short-term overnight instruments." This liquidity, along with our significant decline in non-accrual loans should enable us to further mitigate market pressures" on asset yields.

Clemens also provided some forward guidance on the margin, saying "we think the margin is going to hover around where it is right now," and "maybe actually improve a little bit because we're going to be redeploying first of all about $70 million worth of non-performing, non-accruing loans."

Rodis has a neutral rating on First Midwest, with a price target of $13, and said on Thursday that the level of write-downs on the transferred loans "was somewhat higher than expected," and that tangible common equity "remained solid at 8.26% vs. 8.91% at June 30th while total risk-based capital (TRBC) fell to 11.65%. We expect TRBC to be back above 12% in the next few quarters."

The analyst said that "overall, we were pleased to see the Company get more aggressive with its problem assets this quarter," but expressed some caution, saying that "we believe investors will be happy with these actions but may be surprised by the additional 'hair-cuts' taken to get these loans ready for accelerated resolution/sale," and that "the fact that these loans have not been sold yet also poses some added pricing risk when the loans are ultimately sold or returned to performing status."

Rodis raised his 2013 earnings estimate for First Midwest by a dime to 95 cents, "driven by lower provisioning as the actions taken this quarter should lower credit cost going forward," and also a decline in his 2013 operating expense estimate by $5 million, to $240 million. The revised estimates assume "the margin is in the 3.80-3.85% range for 2013 with core loan growth of 6-8%," and an increase in loan loss reserves to a level covering 1.80% of noncovered loans by the end of next year."

Jefferies analyst Emlen Harmon rates First Midwest a "Buy," and on Monday raised his price target for the shares by a dollar to $15, "as the announcement of the bulk sale of assets reduces tail risk."

Harmon lowered his 2013 EPS estimate by five cents to $1.00, "on a higher than expected expense" into the first half of next year, but maintained his 2014 EPS estimate of $1.20, "as we continue to expect normalized charge-offs around 45bp and credit-related expenses roll off."

Harmon's price target "is based on a 12.5x multiple on '14 EPS of $1.20. This multiple is a shade above our regional bank universe given improving growth prospects."

First Midwest's shares closed at $12.66 Friday, returning 25% year-to-date, following a 12% decline during 2011.

The shares trade for 1.5 times tangible book value, according to Thomson Reuters Bank Insight, and for 11 times the consensus 2014 EPS estimate of $1.16, among analysts polled by Thomson Reuters. The consensus 2013 EPS estimate is 95 cents.

FMBI Chart FMBI data by YCharts

Interested in more on First Midwest Bancorp? See TheStreet Ratings' report card for this stock.

-- Written by Philip van Doorn in Jupiter, Fla.

>Contact by Email.

Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.

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