Fitch Affirms First Midwest's LT IDR at 'BBB-'; Outlook Stable
KEY RATING DRIVERS
IDR and VR
The affirmation of FMBI's ratings reflects its continued reduction of nonperforming assets, steady operating performance and solid execution of several acquisitions at the end of 2014. These strengths are offset by relatively high volatility in asset quality metrics through down credit cycles, stronger loan portfolio growth than peer institutions, and its geographic concentration within the Chicagoland region, an area that has a comparatively weaker fiscal and economic profile.
The Stable Outlook reflects Fitch's view that earnings performance will remain steady and further growth will be adequately managed in relation to capital and the bank's overall strategy.
FMBI's non-performing asset (NPA) ratio has improved to 1.22% over the last 12 months. The level of improvement has outpaced many within Fitch's rated universe and is now on the lower end of the community bank peer group. Nevertheless, NPAs remain somewhat elevated relative to higher rated banks, and asset quality metrics have benefited from limited portfolio seasoning given the level of organic growth in recent periods coupled with low debt servicing requirements in the current rate environment.
Similarly FMBI's net charge offs have declined in recent periods but also remain higher than its peers given the lumpiness of remaining legacy credits. Fitch expects the level of NPAs to remain relatively flat or slightly trend downward in the near term as management continues to address problem credits and ultimately begin to trend upward in the intermediate term as the commercial loan portfolios season. This expectation is reflected in today's rating affirmation as well as the Stable Outlook.
FMBI's loan portfolio has grown sizeably, albeit still within Fitch's expectations, over the last 24 months driven by a mix of acquisitions and organic growth. This level of growth outpaces the community bank peer group but is relatively consistent with regional institutions in the Chicagoland region.
Organic growth has predominantly been in the Commercial & Industrial (C&I) loan portfolio and has been driven by FMBI's entrance into several specialty lending segments including asset based lending (ABL), healthcare lending, agribusiness lending and equipment leasing. While generally viewing FMBI's balance sheet diversification as positive, Fitch continues to maintain a cautious view of strong C&I growth across the industry. Accordingly, Fitch will continue to monitor C&I loan growth relative to peers and assess any deterioration in asset-quality leading indicators.
Fitch anticipates that FMBI will cross the \\$10 billion asset threshold in 2016 resulting in FMBI being impacted by the Durbin Amendment as well as more strenuous and costly stress testing in following years.
Management has indicated that the after-tax cost of the Durbin Amendment to be around \\$5 million but that the earnings accretion generated by recent and future transactions will exceed Durbin's impact. Today's affirmation reflects Fitch's expectation that management will make measured decisions to cross over the \\$10 billion threshold in order to maintain reasonable capital levels and earnings performance.
FMBI has been able to generate better returns in recent periods due to lower credit-related costs and top line revenue growth from the acquisitions. Through 2Q15, the company generated an ROA of 0.94% while the company's net interest margin (NIM) has remained relatively flat. Fitch has observed some uptick in fee-revenue generation due to mortgage and wealth management strategies; however, non-interest income as a percentage of total revenue is expected to remain in line with that of other community banks at 25%-30%. Consistent with Fitch's expectations and general industry trends, reserve releases are coming to an end as the reserve level is now at 1.04% of loans (exclusive of credit marks on acquired loans).
Fitch anticipates revenue generation for FMBI, as well as other community banks, will be challenging in the current operating environment. Fitch expects FMBI to maintain an ROA of around 80 bps over the near to medium term given the current rate environment, which is slightly below industry and peer averages. The expectation is based on continued NIM compression and increasing credit costs in light of a normalized reserve level and portfolio seasoning. FMBI should be well positioned for a rising rate environment with just over half of earning assets carrying a floating rate.
FMBI has a good funding profile. Similar to most in its peer group and across the industry, FMBI has reduced its exposure to more volatile sources of funding through good core deposit growth enabled by interest rates that remain at historical low. The loan-to-deposit ratio of 83% at 2Q15 is down from more than 95% at YE08 but is expected to rise as loan growth continues and rates rise resulting in some deposit run-off. While Fitch expects FMBI and other banks to experience deposit run-off once rates rise and economic activity increases, the agency does not expect FMBI's overall funding profile to revert to an outsized reliance on wholesale funding.
Fitch views FMBI's capital as adequate relative to both its risk profile and current ratings. The company's core capital level (measured by TCE or Fitch Core Capital) and total capital levels remain lower than higher rated peers. Fitch expects the company will maintain its capital at levels commensurate with its risk profile, particularly as the balance sheet continues to grow.
SUPPORT RATING AND SUPPORT RATING FLOOR
FMBI has a Support Rating of '5' and Support Rating Floor of 'NF'. In Fitch's view, FMBI is not systemically important and therefore, the probability of support is unlikely. The IDRs and VRs do not incorporate any support.
SUBORDINATED DEBT AND OTHER HYBRID SECURITIES
FMBI's trust preferred stock is notched four levels below its VR. These ratings are in accordance with Fitch's criteria and assessment of the instruments' non-performance and loss severity risk profiles. Thus, Fitch has affirmed these ratings due to the affirmation of the VR. FMBI's trust preferred stock is notched two times from the VR for loss severity, and two times for non-performance.
FMBI's subordinated debt is notched one level below its VR. These ratings are in accordance with Fitch's criteria and assessment of the instruments' non-performance and loss severity risk profiles. Thus, Fitch has affirmed these ratings due to the affirmation of the VR.
HOLDING COMPANY
The IDR and VR of FMBI is equalized with its operating company First Midwest Bank, reflecting its role as the bank holding company, which is mandated in the U.S. to act as a source of strength for its bank subsidiaries.
LONG- AND SHORT-TERM DEPOSIT RATINGS
FMBI's uninsured deposit ratings at the subsidiary banks are rated one notch higher than the company's Issuer Default Rating (IDR) and senior unsecured debt because U.S. uninsured deposits benefit from depositor preference. U.S. depositor preference gives deposit liabilities superior recovery prospects in the event of default.
RATING SENSITIVITIES
IDRS and VR
Fitch believes there is limited upside to FMBI's ratings over the intermediate term given the bank's geographic concentrations, its expected earnings performance, and balance sheet growth.
Over a longer period of time, Fitch believes there could be positive rating or Outlook movement for FMBI. Catalysts for such rating actions would include evidence of underwriting standards in-line with higher rated peers as loan portfolios season. Further catalysts include the ability to generate stronger core profitability measures while maintaining good capital ratios
FMBI has experienced greater than average year-over-year loan growth in multiple product lines, some due to acquisitions and some through organic growth. To the extent that the bank begins exhibiting adverse credit trends in these new product lines which are outside of Fitch's expectations, negative rating actions could ensue. Moreover, should wholesale funding revert back to the level it was leading up to the crisis, negative pressure could be placed on FMBI's rating or Outlook.
Fitch's current rating and Outlook for FMBI incorporate the expectation that the bank will continue to maintain adequate levels of capital through organic balance sheet growth or in the event of an M&A transaction of significance. Fitch would potentially review FMBI's ratings or Outlook should capital levels be managed over-aggressively either though future growth or increased shareholder distributions.
SUPPORT RATING AND SUPPORT RATING FLOOR
The Support Rating and Support Rating Floor are sensitive to Fitch's assumptions regarding FMBI's capacity to procure extraordinary support in case of need.
SUBORDINATED DEBT AND OTHER HYBRID SECURITIES
Hybrid capital issued by FMBI and its subsidiaries are all notched down from the VRs of FMBI in accordance with Fitch's assessment of each instrument's respective non-performance and relative loss severity risk profiles, which vary considerably. Their ratings are primarily sensitive to any change in FMBI's VRs.
HOLDING COMPANY
If FMBI became undercapitalized or increased double leverage significantly there is the potential that Fitch could notch the holding company IDR and VR from the ratings of the operating companies.
LONG AND SHORT-TERM DEPOSITS
The ratings of long- and short-term deposits issued by FMBI and its subsidiaries are primarily sensitive to any change in the company's IDR. This means that should a long-term IDR be downgraded, deposit ratings could be similarly impacted.
Fitch has affirmed the following ratings with a Stable Outlook:
First Midwest Bancorp, Inc.
--Long-term IDR at 'BBB-';
--Short-term IDR at 'F3';
--Viability Rating at 'bbb-';
--Senior unsecured debt at 'BBB-';
--Subordinated debt at 'BB+';
--Support '5';
--Support Floor 'NF'.
First Midwest Bank
--Long-term IDR at 'BBB-';
--Short-term IDR at 'F3';
--Long-term deposits at 'BBB';
--Short-term deposits at 'F3'.
--Viability Rating at 'bbb-';
--Support '5';
--Support Floor 'NF'.
First Midwest Capital Trust I
--Preferred stock at 'B+'.
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