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Summary of Significant Accounting Policies (Policies)
3 Months Ended
Mar. 31, 2020
Accounting Policies [Abstract]  
Basis of Presentation Basis of Presentation – The accompanying unaudited condensed consolidated interim financial statements ("consolidated financial statements") of First Midwest Bancorp, Inc. (the "Company"), a Delaware corporation, were prepared in accordance with the rules and regulations of the Securities and Exchange Commission ("SEC") for quarterly reports on Form 10-Q and reflect all adjustments that management deems necessary for the fair presentation of the financial position and results of operations for the periods presented. The results of operations for the quarter ended March 31, 2020 are not necessarily indicative of the results that may be expected for the year ending December 31, 2020.The accounting and reporting policies of the Company and its subsidiaries conform to U.S. generally accepted accounting principles ("GAAP") and general practices within the banking industry. The accompanying consolidated financial statements do not include certain information and note disclosures required by GAAP for complete annual financial statements. Therefore, these financial statements should be read in conjunction with the Company's 2019 Annual Report on Form 10-K ("2019 10-K"). The Company uses the accrual basis of accounting for financial reporting purposes.
Reclassification Certain reclassifications were made to prior year amounts to conform to the current year presentation.
Use of Estimates Use of Estimates – The preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Although these estimates and assumptions are based on the best available information, actual results could differ from those estimates.
Principles of Consolidation Principles of Consolidation – The accompanying consolidated financial statements include the financial position and results of operations of the Company and its subsidiaries after elimination of all significant intercompany accounts and transactions. Assets held in a fiduciary or agency capacity are not assets of the Company or its subsidiaries and are not included in the consolidated financial statements.
Business Combinations Business Combinations – Business combinations are accounted for under the acquisition method of accounting. Assets acquired and liabilities assumed are recorded at their estimated fair values as of the date of acquisition, with any excess of the purchase price of the acquisition over the fair value of the identifiable net tangible and intangible assets acquired recorded as goodwill. Alternatively, a gain is recorded if the fair value of assets purchased exceeds the fair value of liabilities assumed and consideration paid. The results of operations of the acquired business are included in the Condensed Consolidated Statements of Income from the effective date of the acquisition.
Allowance for Securities Held-to-Maturity Allowance for Securities Held-to-Maturity The Company maintains an allowance for securities held-to-maturity for the risk of loss inherent in these financial assets, which reflects the difference between the carrying value and the discounted expected future cash flows of these assets and is included in securities held-to-maturity, at amortized cost, net in the Consolidated Statements of Financial Condition.
Loans Loans – Loans held-for-investment are loans that the Company intends to hold until they are paid in full and are carried at the principal amount outstanding, including certain net deferred loan origination fees. Loan origination fees, commitment fees, and certain direct loan origination costs are deferred, and the net amount is amortized as a yield adjustment over the contractual life of the related loans or commitments and included in interest income. Fees related to letters of credit are amortized into fee income over the contractual life of the commitment. Other credit-related fees are recognized as fee income when earned. The Company's net investment in direct financing leases is included in loans and consists of future minimum lease payments and estimated residual values, net of unearned income. Interest income on loans is accrued based on principal amounts outstanding. Loans held-for-sale are carried at the lower of aggregate cost or fair value and included in other assets in the Consolidated Statements of Financial Condition.
Acquired and Covered Loans
Acquired Loans – Acquired loans consist of all loans that were acquired in business combinations, including loans which are covered by Federal Deposit Insurance Corporation ("FDIC") Agreements. Acquired loans are included within loans held-for-investment.
Acquired loans are separated into (i) non-purchased credit deteriorated ("non-PCD") loans and (ii) purchased credit deteriorated ("PCD") loans. Non-PCD loans include loans that did not have evidence of more-than-insignificant credit deterioration since origination at the acquisition date. PCD loans include loans that had evidence of more-than-insignificant credit deterioration
since origination. Evidence of credit deterioration was evaluated using various indicators, such as past due and non-accrual status. Leases and revolving loans do not qualify to be accounted for as PCD loans and are accounted for as non-PCD loans.
The acquisition adjustment related to non-PCD loans is amortized into interest income over the contractual life of the related loans. If an acquired non-PCD loan is renewed subsequent to the acquisition date, any remaining acquisition adjustment is accreted into interest income and the loan is considered a new loan that is no longer classified as an acquired loan.
PCD loans are generally accounted for based on estimates of expected future cash flows. The Company uses a discounted cash flow analysis involving significant unobservable inputs and assumptions to measure the fair value of PCD loans. The significant assumptions utilized in the cash flow analysis include the probability of default ("PD"), loss given default ("LGD"), and discount rate. PCD loans are recorded at fair value, excluding credit-related adjustments, for which an allowance for loan losses is established at the acquisition date through purchase accounting adjustments. Expected future cash flows in excess of the fair value of loans at the purchase date ("accretable yield") are recorded as interest income over the life of the loans if the timing and amount of the expected future cash flows can be reasonably estimated. Subsequent to the acquisition date, the allowance for loan losses on PCD loans is estimated as are the allowances for all other loans in the portfolio.
Prior to the adoption of the current expected credit losses ("CECL") accounting guidance on January 1, 2020, acquired loans were separated into (i) non-purchased credit impaired ("non-PCI") loans and (ii) purchased credit impaired ("PCI") loans. The significant accounting policies related to non-PCI and PCI acquired loans are presented in Note 1, "Summary of Significant Accounting Policies" to the Consolidated Financial Statements in the Company's 2019 10-K.
90-Days Past Due Loans 90-Days Past Due Loans – The Company's accrual of interest on loans is generally discontinued at the time the loan is 90 days past due unless the credit is sufficiently collateralized and in the process of renewal or collection.
Non-accrual Loans
Non-accrual Loans Generally, corporate loans are placed on non-accrual status (i) when either principal or interest payments become 90 days or more past due unless the credit is sufficiently collateralized and in the process of renewal or collection, or (ii) when an individual analysis of a borrower's creditworthiness warrants a downgrade to non-accrual regardless of past due status. When a loan is placed on non-accrual status, unpaid interest credited to income in the current year is reversed, and unpaid interest accrued in prior years is charged against the allowance for loan losses. After the loan is placed on non-accrual status, all debt service payments are applied to the principal on the loan. Future interest income may only be recorded on a cash basis after recovery of principal is reasonably assured. Non-accrual loans are returned to accrual status when the financial position of the borrower and other relevant factors indicate that the Company will collect all principal and interest.
Non-accrual loans with balances under a specified threshold are not individually evaluated for impairment. For all other non-accrual loans, impairment is measured by comparing the estimated value of the loan to the recorded book value. The value of collateral-dependent loans is based on the fair value of the underlying collateral, less costs to sell. The value of other loans is measured using the present value of expected future cash flows discounted at the loan's effective interest rate.
Commercial loans and loans secured by real estate are charged-off when deemed uncollectible. A loss is recorded if the net realizable value of the underlying collateral is less than the outstanding principal and interest. Consumer loans that are not secured by real estate are subject to mandatory charge-off at a specified delinquency date and are usually not classified as non-accrual prior to being charged-off. Closed-end consumer loans, which include installment, automobile, and single payment loans, are usually charged-off no later than the end of the month in which the loan becomes 120 days past due.
Troubled Debt Restructurings (“TDRs”)
Troubled Debt Restructurings ("TDRs") – A restructuring is considered a TDR when (i) the borrower is experiencing financial difficulties, and (ii) the creditor grants a concession, such as forgiveness of principal, reduction of the interest rate, changes in payments, or extension of the maturity date. Loans are not classified as TDRs when the modification is short-term or results in an insignificant delay in payments. The Company's TDRs are determined on a case-by-case basis.
The Company does not accrue interest on a TDR unless it believes collection of all principal and interest under the modified terms is reasonably assured. For a TDR to begin accruing interest, the borrower must demonstrate some level of past performance and the future capacity to perform under the modified terms. Generally, six months of consecutive payment performance under the restructured terms is required before a TDR is returned to accrual status. However, the period could vary depending on the individual facts and circumstances of the loan. An evaluation of the borrower's current creditworthiness is used to assess the borrower's capacity to repay the loan under the modified terms. This evaluation includes an estimate of expected future cash flows, evidence of strong financial position, and estimates of the value of collateral, if applicable. For TDRs to be removed from TDR status in the calendar year after the restructuring, the loans must (i) have an interest rate and terms that reflect market conditions at the time of restructuring, and (ii) be in compliance with the modified terms. If the loan was restructured at below market rates and terms, it continues to be separately reported as restructured until it is paid in full or charged-off.
Allowance for Credit/Loan Losses and Reserve for Unfunded Commitments
Allowance for Credit Losses – The allowance for credit losses is comprised of the allowance for loan losses and the allowance for unfunded commitments and is maintained by management at a level believed adequate to absorb current expected credit losses in the existing loan portfolio. Determination of the allowance for credit losses is subjective since it requires significant estimates and management judgment, including the amounts and timing of expected future cash flows, actual loss experience, consideration of current national, regional, and local economic trends and conditions, reasonable and supportable forecasts about the future, changes in interest rates and property values, various internal and external qualitative factors, and other factors.
Loans deemed to be uncollectible are charged-off against the allowance for loan losses, while recoveries of amounts previously charged-off are credited to the allowance for loan losses. Additions to the allowance for loan losses are charged to expense through the provision for loan losses. The amount of provision depends on a number of factors, including net charge-off levels, loan growth, changes in the composition of the loan portfolio, and the Company's assessment of the allowance for loan losses based on the methodology discussed below.
Allowance for Loan Losses The allowance for loan losses consists of (i) specific allowance for individual loans where the recorded investment exceeds the value, (ii) an allowance based on historical credit loss experience with consideration of reasonable and supportable forecasts of economic conditions for each loan category, and (iii) an allowance based on other internal and external qualitative factors.
The allowance for individual loans is based on a periodic analysis of non-accrual loans individually exceeding a specific dollar amount. If the estimated value of a non-accrual loan is less than its recorded book value, the Company either (i) provides an allowance in the amount of the excess of the book value over the estimated value of the related loan or, (ii) if the loss is confirmed, charges off the loss.
The allowance by loan category is based on a discounted cash flows analysis as future cash flows are discounted at an effective rate of return. In addition, estimates of losses on future cash flows is forecasted by applying probability of default and loss given default factors as well as prepayment and curtailment assumptions to cash flows that are adjusted to a present value. This discounted cash flow analysis is updated quarterly, primarily using actual loss experience adjusted for current reasonable and supportable forecasts of economic conditions over a one-year forecast period. After the one-year forecast period, a one-year reversion period adjusts loss experience to the historical average on a straight-line basis. These forecasts consider multiple scenarios of key assumptions including national unemployment rates, housing price indices, and gross domestic product.
This general allowance component is then adjusted based on management's consideration of many internal and external qualitative factors, including:
Changes in the composition of the loan portfolio, trends in the volume of loans, and trends in delinquent and non-accrual loans that could indicate that historical trends do not reflect current conditions.
Changes in credit policies and procedures, such as underwriting standards and collection, charge-off, and recovery practices.
Changes in the experience, ability, and depth of credit management and other relevant staff.
Changes in the quality of the Company's loan review system and Board of Directors oversight.
The effect of any concentration of credit and changes in the level of concentrations, such as loan type or risk rating.
Changes in the value of the underlying collateral for collateral-dependent loans.
Changes in the national, regional, and local economy that affect the collectability of various segments of the portfolio.
The effect of other external factors, such as competition and legal and regulatory requirements, on the Company's loan portfolio.
The allowance for loan losses also includes an allowance on acquired non-PCD and PCD loans. An allowance for loan losses is recorded on acquired PCD loans at the acquisition date through purchase accounting adjustments. Subsequent to the acquisition date, the allowance for loan losses on PCD loans is estimated as are the allowances for all other loans in the portfolio. No allowance for loan losses is recorded on acquired non-PCD loans at the acquisition date through purchase accounting. Instead, an allowance is established on acquired non-PCD loans at the acquisition date in-line with all other loans in the portfolio as if the loans were originated at the acquisition date. On a periodic basis, the adequacy of this allowance is determined using either a PD/LGD methodology or a specific review methodology.
Allowance for Unfunded Commitments The Company also maintains an allowance for unfunded commitments, including letters of credit, for the risk of loss inherent in these arrangements. The allowance for unfunded commitments is estimated using the historical credit loss experience with consideration of reasonable and supportable forecasts of economic conditions for each loan category. The allowance for unfunded commitments is included in other liabilities in the Consolidated Statements of Financial Condition.
The establishment of the allowance for credit losses involves a high degree of judgment and estimation given the difficulty of assessing the factors impacting loan repayment and estimating the timing and amount of losses. While management utilizes its best judgment and information available, the adequacy of the allowance for credit losses depends on a variety of factors beyond the Company's control, including the performance of its loan portfolio, current national, regional, and local economic trends, reasonable and supportable forecasts about the future, changes in interest rates and property values, the amounts and timing of expected future cash flows on non-accrual loans, estimated losses on pools of homogenous loans, the interpretation of loan risk classifications by regulatory authorities, various internal and external qualitative factors, and other factors.
Lease Obligations Lease Obligations – The Company leases certain premises under non-cancelable operating leases in the normal course of business operations. These lease obligations result in the recognition of right-of-use assets and associated lease liabilities. The amount of right-of-use assets and associated lease liabilities recorded is based on the present value of future minimum lease payments. Right-of-use assets are amortized on a straight-line basis over the estimated useful lives of the related premises, and interest associated with the net present value of future minimum lease payments is included in net occupancy and equipment expense in the consolidated financial statements.
Derivative Financial Instruments
Derivative Financial Instruments – To provide derivative products to customers and in the ordinary course of business, the Company enters into derivative transactions as part of its overall interest rate risk management strategy to minimize significant unplanned fluctuations in earnings and expected future cash flows caused by interest rate volatility. All derivative instruments are recorded at fair value as either other assets or other liabilities in the Consolidated Statements of Financial Condition. Subsequent changes in a derivative's fair value are recognized in earnings unless specific hedge accounting criteria are met.
On the date the Company enters into a derivative contract, the derivative is designated as a fair value hedge, a cash flow hedge, or a non-hedge derivative instrument. Fair value hedges are designed to mitigate exposure to changes in the fair value of an asset or liability attributable to a particular risk, such as interest rate risk. Cash flow hedges are designed to mitigate exposure to variability in expected future cash flows to be received or paid related to an asset, liability, or other type of forecasted transaction. The Company formally documents all relationships between hedging instruments and hedged items, including its risk management objective and strategy at inception.
At the hedge's inception, a formal assessment is performed to determine the effectiveness of the derivative in offsetting changes in the fair values or expected future cash flows of the hedged items in the current period and prospectively. If a derivative instrument designated as a hedge is terminated or ceases to be highly effective, hedge accounting is discontinued prospectively, and the gain or loss is amortized into earnings. For fair value hedges, the gain or loss is amortized over the remaining life of the hedged asset or liability. For cash flow hedges, the gain or loss is amortized over the same period that the forecasted hedged transactions impact earnings. If the hedged item is disposed of, any fair value adjustments are included in the gain or loss from the disposition of the hedged item. If the forecasted transaction is no longer probable, the gain or loss is included in earnings immediately.
For fair value hedges, changes in the fair value of the derivative instruments, as well as changes in the fair value of the hedged item, are recognized in earnings in the same income statement line item as the earnings effect of the hedged item. For cash flow hedges, the effective portion of the change in fair value of the derivative instrument is reported as a component of accumulated other comprehensive loss and is reclassified to earnings when the hedged transaction is reflected in earnings.
Recent Accounting Pronouncements
Adopted Accounting Pronouncements
Measurement of Credit Losses on Financial Instruments: In June of 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standard Update ("ASU") 2016-13 that requires entities to present financial assets measured at amortized cost at the net amount expected to be collected, considering an entity's current estimate of all expected credit losses. In addition, credit losses relating to available-for-sale debt securities are required to be recorded through an allowance for credit losses, with changes in credit loss estimates recognized through current earnings. This guidance is effective for annual and interim periods beginning after December 15, 2019.
The Company adopted this guidance on January 1, 2020, which resulted in the recognition of $76.0 million of allowance for credit losses which includes $26.0 million attributable to loans, $5.6 million attributable to unfunded commitments, $35.7 million attributable to PCD loans, $8.5 million attributable to non-PCD acquired loans, and $220,000 attributable to securities held-to-maturity. The portion of the allowance for credit losses attributable to PCD loans did not have an impact on equity as the credit-related portion of acquisition adjustments on loans previously classified as PCI transitioned to PCD accounting treatment upon adoption. The amount of allowance for credit losses recognized upon adoption was based on the composition of the loan portfolio, as well as the economic conditions and forecasts as of the adoption date. The Company adopted this guidance using the modified retrospective approach which resulted in the recognition of a $26.8 million after-tax
reduction to retained earnings as a cumulative-effect adjustment on January 1, 2020. Prior period amounts continue to be reported in accordance with previously applicable standards and the accounting policies described in the Company's 2019 10-K.
The Company has made the following elections upon adoption of ASU 2016-13:
When determining the allowance and net carrying value amount for financial assets in which the repayment is expected to be provided substantially through the operation or sale of the collateral when the borrower is experiencing financial difficulty, the Company will use the fair value of collateral at the reporting date.
The Company writes off uncollectible accrued interest in a timely manner and, therefore, will not measure an allowance for credit losses for accrued interest receivable.
The Company uses a discounted cash flow approach for the majority of its applicable instruments. The change in the present value from one reporting period to the next may result from the passage of time, in addition to changes in estimates of the timing of the cash flows. The Company will report the entire change in the present value as provision for loan losses (or reversal of provision for loan losses) versus reporting the change related to the passage of time as interest income.
For additional discussion of the allowance for credit losses, see Note 7 "Past Due Loans, Allowance for Credit Losses, Non-Accrual Loans, and TDRs."
Accounting for Goodwill Impairment: In January of 2017, the FASB issued ASU 2017-04 that simplifies the accounting for goodwill impairment for all entities. The new guidance eliminates the requirement to calculate the implied fair value of goodwill using the second step of the quantitative two-step goodwill impairment model prescribed under current accounting guidance. Under the new guidance, if a reporting unit's carrying amount exceeds its fair value, an entity will record an impairment charge based on that difference. This guidance is effective for annual and interim goodwill impairment testing dates beginning after December 15, 2019. The adoption of this guidance on January 1, 2020 did not materially impact the Company's financial condition, results of operations, or liquidity.
Changes to the Disclosure Requirements for Fair Value Measurement: In August of 2018, the FASB issued ASU 2018-13 that eliminates, modifies, and adds to certain fair value measurement disclosure requirements associated with the three-tiered fair value hierarchy. This guidance is effective for annual and interim periods beginning after December 15, 2019. The adoption of this guidance on January 1, 2020 did not materially impact the Company's financial condition, results of operations, or liquidity.
Loan Modifications Due to COVID-19: In March of 2020, the CARES Act was enacted by the U.S. government in response to the economic disruption caused by the COVID-19 pandemic. The Company's banking regulators issued a statement titled the "Interagency Statement on Loan Modifications by Financial Institutions Working with Customers Affected by the Coronavirus" that encourages financial institutions to work prudently with borrowers who are or may be unable to meet their contractual payment obligations due to the effects of COVID-19. Additionally, the CARES Act provides that a qualified loan modification is exempt by law from classification as a TDR as defined by GAAP, from the period beginning March 1, 2020 until the earlier of December 31, 2020 or the date that is 60 days after the date on which the national emergency concerning the COVID-19 pandemic declared by the President of the United States terminates. Accordingly, the Company is offering short-term modifications made in response to COVID-19 to borrowers who are current and otherwise not past due. These include short-term modifications in the form of payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. The modifications completed in the three months ended March 31, 2020 were immaterial.
Regulatory Capital Delay of CECL Impact: In February of 2019, the federal bank regulatory agencies issued a final rule, the 2019 CECL Rule, that revised certain capital regulations to account for changes to credit loss accounting under U.S. GAAP. The 2019 CECL Rule included a transition option that allows banking organizations to phase in, over a three-year period, the day-one adverse effects of CECL on their regulatory capital ratios (three-year transition option). In March of 2020, the federal bank regulatory agencies issued an interim final rule that maintains the three year transition option of the 2019 CECL Rule and also provides banking organizations that were required under GAAP (as of January 2020) to implement CECL before the end of 2020 the option to delay for two years an estimate of the effect of CECL on regulatory capital, relative to the incurred loss methodology's effect on regulatory capital, followed by a three-year transition period (five-year transition option). The Company elected to adopt the five-year transition option. This election of the transition option is applicable only to regulatory capital computations under federal banking regulations and does not otherwise impact the financial statements prepared in accordance with GAAP.
Accounting Pronouncements Pending Adoption
Changes to the Disclosure Requirements for Defined Benefit Plans: In August of 2018, the FASB issued ASU 2018-14 that makes minor changes and clarifications to the disclosure requirements for entities that sponsor defined benefit plans. This guidance is effective for annual and interim periods beginning after December 15, 2020. Early adoption is permitted.
Management does not expect the adoption of this guidance will materially impact the Company's financial condition, results of operations, or liquidity.
Income Taxes: In December of 2019, the FASB issued ASU 2019-12 that removes certain exceptions to the general principles of accounting for income taxes. This guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020. Early adoption is permitted. Management does not expect the adoption of this guidance will materially impact the Company's financial condition, results of operations, or liquidity.
Reference Rate Reform: In March of 2020, the FASB issued ASU 2020-04 that provides optional expedients and exceptions for applying GAAP to contracts and other transactions affected by reference rate reform, if certain criteria are met. This guidance is effective as of March 12, 2020 through December 31, 2022. Management is in the process of determining the impact on the Company's financial condition, results of operations, and liquidity.