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Jackie Lam/MEDILL

During the financial recession, First Midwest's stock price fell, but it has been rising recently.

For First Midwest, better days ahead

by Jackie Lam
Dec 04, 2012


Jackie Lam/MEDILL

Charged-off loans and leases at commercial banks reached their highest point in 2009 after the housing market imploded.

Ever since the economy went into a tailspin, bad loans –- particularly a substantial portfolio of troubled commercial real estate assets -- have taken a toll on profits at First Midwest Bancorp Inc. And it didn’t help matters that the Chicago-area lender was a bit late in facing up to the true scale of the problem. 

But in this year's third quarter, First Midwest finally addressed the issue, ringing up a painful charge as it took what officials called “aggressive action” to write down lingering problem loans. In the wake of that move, a number of Wall Street analysts think better days are not far away for First Midwest.

With $8.2 billion in assets, the Itasca-based bank holding company for First Midwest Bank is the fifth largest bank in Chicago, after BMO Harris Bank, Northern Trust Corp., Private Bank & Trust Co. and MB Financial Inc. It serves communities in Chicago, Illinois, Indiana and Iowa, but it primarily focuses on suburban areas in its home state.

During the real estate boom, First Midwest generated strong profits, and its share price surged above $35. When the crash came, the bank –- like lenders across the U.S. -– found that many of the loans it had made during the bubble years were in trouble. And like other banks, it had to write down the bad loans. 

In 2008, First Midwest’s provision for bad loans was a modest $70.3 million. But in 2009, its loan-loss provision was three times as large, at $215.7 million. 
In 2010, the loan-loss charges were a still-painful $147.3 million. But by 2011, First Midwest’s set-aside for bad loans had declined to $80.6 million. 

As it turned out, however, the Itasca bank wasn’t quite out of the woods. In early July, Moody’s Investor Services marked First Midwest’s debt down to Baa2, citing the bank’s “weaker asset quality and profitability performance” compared to other banks with similar debt ratings. The problem, Moody’s said, was the bank’s relatively large exposure to the suburban Chicago commercial real estate market. 

First Midwest makes the highest percentage of commercial real estate loans among the top five banks in Chicago. Of all the loans it made in the third quarter, commercial real estate represented up 48 percent, compared with 31 percent at MB Financial and 22 percent at Northern Trust.

When the commercial market tumbled -- the office vacancy rate in Chicago hit 17 percent in 2010, compared with 11 percent in 2008 -- First Midwest’s prominent position as a lender to the sector turned into a liability. 

Midwest responded to the Moody’s markdown by targeting $223 million of problem loans for resolution, resulting in $99 million of charge-offs. The company packaged $171 million of bad loans for sale in future quarters; its bottom line was hurt by a $111.8 million quarterly loan-loss provision linked to what it called the “significant initiatives designed to improve the Company’s credit risk profile.” 

“As always, we remain focused on tight and balanced control of our operating overhead.” Michael Scudder, president and chief executive officer, said in a press release. “This momentum, when combined with our strong capital foundation, positions us well to grow and continue to take advantage of market opportunities,” he added.
John Rodis, analyst at Fig Partners, LLC, said that after the second quarter, it became clear that First Midwest would take care of its bad loans in the coming quarters. 

In terms of bringing its credit risk profile back to a healthy level, First Midwest is slowly catching up with other banks in its rank.  Some critics think it's taken too long.

“They have had less improvement in non-performing assets than any other regional banks we follow,” Tom Mitchell, analyst at Miller Tabak + Co. who has been holding a sell position on First Midwest since 2010, said in an interview. “They have lagged badly in addressing the need to have strong reserves to non-performing assets.” 

MB Financial, the fourth largest Chicago-based bank, was facing similar challenges two years ago. In April 2010, the company reported that problem loans made up 5 percent of its total loans. 

Unlike First Midwest, MB Financial took action right away. In mid-2011, it sold $384 million of bad loans to Colony Capital LLC, a private real estate investment firm, in July 2011. has 1.87 percent of bad loans in its overall credit profile.

While First Midwest took care of the bad loans left over from the recession, it continues to have an inflow of non-performing assets. Mitchell said this is more of a reflection of a weak Chicago suburban economy than a reflection on the company’s lending performance. 

“Whatever is in store for the economy is what is in store for First Midwest,” Mitchell said.
Despite First Midwest's lag in addressing its non-performing asset problems, its ability to maintain a steady stream on interest income in the low interest rates environment and the company's recent structural improvements give Wall Street hope that it will pick up its pace again in the coming quarters.
Wall Street analysts surveyed by Bloomberg expect the net loss of First Midwest to drop to $10 million, or 15 cents per adjusted share, in the fourth quarter. But they anticipate that First Midwest will swing to a profit by the end of 2013, with annual earnings of $70 million, or 95 cents per adjusted share.

New regulations and low interest rates continue to bear down on banks’ interest income across the nation. Interest rates remain at near-zero levels and banks are anticipating new capital rules from the Federal Reserve and other agencies. 

While its net interest income margins -- a measure of lending profitability that represents the difference between what a bank pays for money and what it receives from loaning funds out -- were dampened by these economic challenges, First Midwest managed to maintain a consistent performance on that front.

Compared with the national net interest margin of 3.39 percent, First Midwest’s 3.83 percent in the third quarter is outperforming. 

First Midwest’s net interest margin has been hovering around that level for the past few quarters. In the second quarter, First Midwest’s net interest margin stood at 3.88 percent, unchanged from the previous quarter.

“When you take the bad loans out of the picture, a flat trajectory is pretty good performance,” Mitchell at Miller Tabak + Co. said. “It requires some skills in keeping operating expenses as low as possible when there is no revenue growth in general nationally.” 

Besides maintaining a steady stream of interest income, First Midwest has undertaken several structural reforms in the past year to expand its operations and boost its efficiency. 

“The major change in management has been the addition of (Chief Operating Officer) Mark Sander,"  Rodis at Fig Partners said. “I think this was a good move as it gives the CEO, Mike Scudder, more time to deal with big pictures issues and the like. Mark has made some new hires to fill out his team and it will take time to know how successful those are but I would say so far so good.”

In August, First Midwest joined Allpoint, a surcharge-free ATM network, to extend its banking customers’ access to 43,000 free ATMS under its network. The company has also created a four-person team to expand its asset based lending division and scout out new opportunities in Kansas, Kentucky, Minnesota, Ohio and Wisconsin.

Investors will likely see the results of these organizational changes and enhancements in the next few quarters.

The credit actions that First Midwest took in the third quarter will set the tone for a brighter 2013 for the bank. While bad loans might have represented a slight setback for the company, with its consistent performance reflected in its net interest margin and its plan for growth, First Midwest a solid regional player in the Midwest.