First Interstate BancSystem Q2 2023 Earnings Call Transcript

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July 27, 2023

There are 7 speakers on the call.

Operator

To read the cautionary note regarding forward looking statements contained in our most recent annual report on Form 10 ks filed with the SEC and in our earnings release as well as the risk factors identified in the annual report and our more recent periodic reports filed with the SEC. Relevant factors that could cause actual results to differ materially from any forward looking statements are included in the earnings release and in our SEC filings. The company does not undertake to update any of the forward looking statements made today. A copy of our earnings release, which contains non GAAP financial measures, is available on our website at fibk.com. Information regarding our use of the non GAAP financial measures may be found in the body of the earnings release and a reconciliation to their most directly comparable GAAP financial measures is included at the end of the earnings release for your reference.

Operator

Joining us from management this morning are Kevin Reilly, our Chief Executive Officer and Marci Mutch, our Chief Financial Officer, along with other members of our management team. At this time, I'll turn the call over to Kevin.

Speaker 1

Thanks, Andrea. Good morning and thanks again to all of you for joining us on our call today. Again, this quarter, along with our earnings release, we have published an updated investor presentation that has some additional disclosures that we believe will be helpful. The presentation can be accessed on our Investor Relations website. And if you haven't downloaded a copy yet, I encourage you to do so.

Speaker 1

I'm going to start today by providing an overview of the major highlights of the quarter. And then I'll turn the call over to Marci to provide more details on our financials. We performed well in a difficult environment during the Q2, reflecting the strength of the franchise we've built, while we see pressure on deposit costs, balances performed as expected, benefiting from the strength of our markets and the diversity of our client base. We have not had to take any extraordinary measures around liquidity. Credit continues to perform well.

Speaker 1

Our capital is strong. And importantly, we are beginning to see some stabilization in our net interest margin, which has remained flat around 3% for May, June July. Though we expect the environment to remain challenging for the banking industry for the remainder of the year, we are well positioned to play offense. We generated $67,000,000 in net income or $0.65 per share in the 2nd quarter, which includes $0.01 of severance expense primarily related to the strategic repositioning of our home lending business, which we will discuss later in the call. As we indicated on our last earnings call, we did not see any meaningful disruption in customer behavior following the bank failures in March.

Speaker 1

During the Q2, it was very much business as usual in what we would characterize as a relatively normalized operating environment. We continue to see healthy economic conditions throughout many of our markets and most notably in tourism and the agricultural industries, where clients are performing well. In particular, Yellowstone is having a very strong tourist season with a number of visitors to the park up 19% compared to the 1st 6 months of last year. And we've seen sufficient moisture over most of our footprint, which bodes well for our ag clients. While deposits declined about 2% in the Q2, this result was very much in line with the expectations we spoke to in April.

Speaker 1

Importantly, throughout the quarter, balances expressed very normal seasonality. We saw expected outflows in the first half of the quarter with broad seasonal strength into the end of June. For the month of June, total balances grew $375,000,000 or 1.6 percent, which is partially a result of our success in new client acquisition. It is worth noting that we continue to have no brokered deposits on our balance sheet. Our non interest bearing deposits showed resiliency and while down for the quarter, balances ended June modestly higher than April.

Speaker 1

Given the strength of our balance sheet and our reputation we have developed for providing superior level service, we have been able to effectively capitalize on the current environment. Given our advantageous loan to deposit ratio, we have strategically raised our rates to provide a competitive value proposition to our current clients, which we believe is the right thing to do. At the same time, we are selectively raising rates and adding products to support new business development efforts, targeting new clients where we have the opportunity to develop deeper, more profitable relationships over the long term. As we indicated on prior calls, we continue to be thoughtful regards to new loan production, maintaining strong underwrite criteria and discipline in our pricing. As we expected, this resulted in a lower level of loan growth in the Q2, but with improved risk adjusted yield.

Speaker 1

We expect both trends to continue for the balance of the year. Excluding draws on construction lines, the average yield on new floats fundings in the 2nd quarter was up about 80 basis points from the prior quarter to 7.1%. Asset quality also remained strong. Although we saw modest increase in non performing and criticized loans this quarter, those balance make up just 51 basis points and 3.50 basis points of loans held for investments respectively. Looking forward, based on our current evaluation of the loan portfolio, we anticipate a reduction in criticized balances over the remainder of the year.

Speaker 1

Charge offs increased to $11,400,000 this quarter with about 85% coming from the restructuring of a single metro office construction property that we've discussed in the past. With the recent restructure, we expect this credit to perform going forward. Outside of this one credit, losses were negligible. With that, I'd like to turn the call over to Marci to provide some additional details around the 2nd quarter results. Go ahead, Marci.

Operator

Thanks, Kevin, and good morning, everyone. As I walk through our financial results, unless otherwise noted, all of the prior period comparisons will be with the Q1 of 2023. And I'll begin with our income statement. Our net interest income decreased by $20,500,000 which was primarily due to an increase in our interest expense resulting from higher rates on interest bearing deposits and a shift in our funding mix toward higher cost short term borrowings and interest bearing deposit accounts. Purchase accounting accretion was also $600,000 lower quarter over quarter.

Operator

Our reported net interest margin decreased 24 basis points from the prior quarter to 3.12%. Excluding purchase accounting accretion, our adjusted net interest margin also decreased by 24 basis points to 3.05 percent from the prior quarter as the 9 basis point increase in the average yield on earning assets was more than offset by the increase in our total cost of funds. Looking to the balance of the year, given the recent trend in our deposit costs, we are now expecting our interest bearing deposit beta to reach the low to mid-thirty percent range by the end of the year. This outlook assumes one additional 25 basis point rate hike the second half of twenty twenty three. As Kevin noted, in June July, our net interest margin was around 3%.

Operator

Under the repricing assumptions just noted and assuming deposits remain stable through the end of the year and average earning assets approximate $28,000,000,000 we would now expect this to approximate the net interest margin for the balance of the year. Our total noninterest income increased $27,700,000 quarter over quarter, primarily due to the $23,400,000 loss on investment securities and the $1,900,000 net write down to the fair value of loans held for sale recorded during the Q1. Excluding these items, noninterest income increased about 6% from the prior quarter. This was primarily due to higher levels of payment services revenue as we saw the impact of greater transaction volume driven by normal seasonality in our markets as well as modestly higher mortgage banking revenue and service charges on deposit accounts. Based on the first half of the year and the trends we're seeing, we expect quarterly fee income for the balance of the year to increase low to mid single digits from the reported second quarter.

Operator

This outlook is in line with the improvement in the second half of the year we have been expecting. Moving to total non interest expense, we saw a continued decline as we remain vigilant to control expenses with operating expenses down $1,900,000 from the prior quarter. Results in the 2nd quarter included $1,900,000 in severance expense, mostly related to the restructuring of the mortgage business. Excluding this item, expenses declined 2% from the prior quarter to $162,000,000 At this point, we would expect this to be a good approximation for the run rate over the rest of the year. This run rate does not include any impact from the FDIC special assessment.

Operator

Moving to the balance sheet. Our loans held for investment increased $18,000,000 from the end of the prior quarter with growth in the commercial real estate and ag portfolios offsetting slight declines in the commercial and consumer portfolios. The securities portfolio declined about $250,000,000 in the quarter, partly due to higher unrealized losses, but also from normal monthly cash flow that is not being reinvested. We would expect the portfolio to continue to decline and have provided a new disclosure related to the expected quarterly cash flows on Slide 18 of the investor deck. On the liability side, our total deposits decreased $528,000,000 we saw declines in most categories, which were partially offset by increases in our balances of time deposits as we see more customers taking advantage of attractive CD rates.

Operator

Again, as Kevin noted, we have no broker deposits on the balance sheet. Short term borrowings also declined from the prior quarter end. Moving to asset quality, non performing assets increased $8,500,000 and criticized loans increased $20,000,000 from the prior quarter, which was partially attributable to problem loans moving through the credit administration process. Outside of these loans, the remainder of the portfolio continues to perform well. Based on current projections, we expect to see asset quality improvement for the balance of the year.

Operator

Our net charge offs were $11,400,000 or 25 basis points of average loans in the quarter, driven primarily by the one charge off on a metro office property that Kevin discussed earlier. Our provision covered our net charge offs this quarter. And with total loans being relatively flat, our allowance for credit losses percentage remain relatively unchanged at 1.23 percent of total loans held for investment. Lastly, while AOCI offset the growth in retained earnings this quarter, which resulted in modest reductions to book value and tangible book value, our regulatory capital ratios all strengthened as we are proactively managing our risk weighted asset exposure while continuing to support the strategic growth of the company. With that, I'll turn it back over to Kevin.

Speaker 1

Kevin? Thanks, Marcy. Now I'll wrap up with a few comments. Dealing with the relative stability in our outlook from here, the strength of our balance sheet and the strength of our footprint, We continue to believe First Interstate is well positioned to play offense. As such, we are moving forward with several initiatives to further strengthen the franchise and improve our ability to generate long term profitable growth.

Speaker 1

One of these initiatives is a shift in our mortgage business away from a mortgage loan originator model. We have implemented a new digital loan origination system enabled us to push the sourcing of loans across our branch network, while the underwriting is and the fulfillment is now fully centralized. Not only will this improve our operational efficiencies for the benefit of our people and our clients, but it's much more cost effective delivery mechanism for the company, allowing this product to be more profitable and more scalable in the future. As part of this restructure, we have eliminated most of our MLO positions, which contributed to the severance expense this quarter that Marci mentioned earlier. Going forward, we will look to leverage our network of more than 300 retail branches to generate referrals for our digital mortgage loan origination platform.

Speaker 1

And we will incent our retail staff for leads they generate. We have just launched this program, but the initial results are encouraging and we are excited about the possibilities. In August, we will be introducing our new suite of consumer credit cards, which will offer a more robust set of benefits and a more competitive and user friendly rewards program. We believe this new suite of cards along with our marketing initiatives will help us achieve our goals of growing our customer base and expanding existing customer relationships, particularly in our new markets. We are also strengthening our commitment to being a good corporate steward and reducing our carbon footprint to the investment in 2 solar projects, 1 in Iowa and 1 in Oregon.

Speaker 1

The electricity generated by these two projects will offset a good portion of the from our operations in these two states. Heading into the second half of the year, we will continue to prioritize prudent risk management and expect to deliver solid financial performance. Expect us to remain thoughtful regarding new loan production, which will likely result in a full year loan growth being in the low single digit range. Finally, we are pleased to announce that the Board has approved a $0.47 dividend for the Q3. Given the strength of our balance sheet, the prospective earnings power of the company and our high and growing capital ratios, we are well positioned to maintain our dividend at the current level, which is an important component of the total return that we deliver to our shareholders.

Speaker 1

So with that, we'll open the call up for questions.

Speaker 2

Thank one moment please for your first question. Your first question comes from Jared Shaw from Wells Fargo. Please go ahead.

Speaker 3

Hey, good morning, everybody.

Speaker 1

Can you hear me? Hello? Hello? Hello?

Operator

Can you hear us?

Speaker 1

Hello?

Operator

Can you hear

Speaker 3

us? I can hear you.

Speaker 1

Okay.

Speaker 3

Okay. So maybe sticking with the starting with deposits, Do you think that we're at a floor for dollars of DDA here? Or is there Yes, still more pressure on sort of the dollars of DDA.

Speaker 1

That interest bearing you're talking about, Jerry? Yes. Well, we've seen some stabilization in that, but We're still projecting that there'll be some deterioration as we move through the remainder of the year, but we are seeing some stabilization in that.

Operator

This is Jerry, by the end of the year, we're thinking non interest bearing should be about 25% of total deposit.

Speaker 3

Okay. 25 percent with the overall balance of deposits still following those trends in June still seeing an upward bias as we go through the year?

Operator

Yes, we flat deposits through the balance of the year.

Speaker 4

Okay.

Speaker 3

And then on the loan yields, thanks for the color on loan yields ex construction. What's the balance of remaining Construction loans that could be funded and should we be what's the timing of the funding of those loans?

Operator

There's still about $1,100,000,000 to be funded based around $75,000,000

Speaker 1

a month? Jared, it's John. So the yield by commitment is just over 5.3%. So as we roll forward that yield drag that we were referencing that will lessen as the year goes on. It's about $75,000,000 a month as Marcio mentioned, but the funding kind of picks up as the year progresses.

Speaker 1

Okay. Okay,

Speaker 3

that's good. Thanks. And then, when we look at the securities cash flow slide, Should we just assume that you use that to pay down FHLB? And as we move forward, we assume that securities are smaller as a percentage of assets and that wholesale funding goes lower?

Speaker 1

Yes. Because I use it for loan growth, we'll be paying down our funding.

Operator

Yes. And we expect loan growth to be pretty modest into the back half of the year.

Speaker 3

Okay.

Speaker 1

Thanks. And I guess

Speaker 3

just finally for me, when you look at the rollout of cards that you're talking about, How is the proposed legislation, the proposed urban legislation on interchange, does that impact your timing Or your enthusiasm for that product?

Speaker 1

No.

Speaker 3

So if for some reason that went through, that wouldn't change the economics of rolling that out?

Speaker 1

Well, the thing is that, first of all, I'll be honest with you, I am not fully aware of the new amendment or law that you're talking Because Durbin usually is on debit cards, it wasn't on credit cards. But if they're going toward credit card, It is going to hurt the economics of the product.

Speaker 3

Okay. Yes, he's there's a proposed legislation to have the interchange Impact credit cards as well. So it feels like it's a long shot, but it seems like They're trying to sneak it in on must pass legislation. So that will have

Speaker 1

an impact on us and every other bank. Yes.

Speaker 3

Okay. All right. Thanks, guys.

Speaker 2

Your next question comes from Brody Preston from UBS. Please go ahead.

Speaker 5

Hi. My question is on the NII guidance. So I'm looking at that kind of implies flattish NII in the back half of the year. I was just curious if there are any factors or any levers you could pull that Would cause it to be either above or below that.

Speaker 1

The only factor would be is Really, as we've said in the past, it's really based on our assumption on deposits right now. Deposits Balances have been stable since the end of April to date. So if deposits

Speaker 5

Got you. And then just on the, on that metro office construction project, I was just Hoping for a little more color on that, like what metro was it in and any details you can give on that one. Plus, Are there any updates on the 2 CRE NPLs from last quarter?

Speaker 1

So the metro offers that we talked about today was The one that was in Seattle that we talked about and we have a qualified new tenant going into that. We took a charge off, We're down to the level and it should and we get some more equity coming from the investors. So From this point forward, we're looking at that we should perform going well going forward, but it did cost us a little bit to get it into that position.

Operator

So that was the one that we talked about last quarter.

Speaker 1

And so that should be resolved,

Operator

the one in Seattle.

Speaker 5

Understood. Thank you. And then just last one for me. On the expense base, is there any other opportunities to rationalize that outside of the mortgage that guys announced this quarter.

Speaker 1

We continue to look at that as our staff turnover. We continue to look at the fact are they needed. And part of the goal we had this year at First Interstate we're working on, and we don't have any kind of estimates on that is that We're looking at process to automate some manual processes in the back room where there's a number of processes that are done and then re entered into the operational group. So we're looking to automate that. So it goes flows straight through.

Speaker 1

So there are some possibilities to eliminate some staff and operations as we modernize some of the processes.

Speaker 5

Great. That's it for me. Thanks for taking my questions.

Speaker 1

Thanks.

Speaker 2

Your next question comes from Chris McGratty from KBW. Please go ahead.

Speaker 4

Hi, this is Nick Matopakis on for Chris McGrady. Good morning, guys.

Speaker 1

Good morning, Nick.

Speaker 4

Maybe just on the deposits, just going back to the NIBs, are you seeing primarily outflows From the commercial side on the NIB mix? And is there any catch up in the retail You think on a go forward basis?

Speaker 1

Actually, seasonally, we're seeing commercial grow and The downward trend is a little bit more on the retail side. So seasonally, that's what we're expecting, and we are seeing that our commercial balances are growing.

Speaker 4

Okay. And then maybe just on the CDs, what's the duration on that Portfolio now is relatively short or?

Speaker 1

Well, most of the CDs that we're putting out is like 12 months or less. So the duration is pretty short.

Speaker 4

Okay. Just trying to get a sense If the forward curve plays out and we start to get cuts in 2024, it sounded like a comment on how You think the margin reacts to rate cuts on the way down?

Speaker 1

Well, right now, we would characterize ourselves as slightly liability sensitive and that we would benefit on a downward rate cuts.

Speaker 4

Okay. Thanks guys.

Speaker 1

Thank you,

Speaker 2

Your next question should come from Jeff Rulis from D. A. Davidson. Please go ahead.

Speaker 6

Thanks. Good morning. Question on the criticized loan balance increase, that $20,000,000 What Segments was that in and was that acquired or legacy credits? Just Looking for a little color.

Speaker 1

It was acquired loan. It's in Arizona. It's a commercial.

Operator

Criticized loans.

Speaker 1

Oh, criticized? Oh, I thought I was talking about performing. Okay,

Operator

go ahead. The criticized loans that was those were acquired and largely in the senior housing sector. And so again, we expect those to improve over the long term just because we're as the states kind of resolve the reimbursement rate issues, we could see some improvement in those credits.

Speaker 1

Yes. And we're forecasting Just so you know, we're forecasting that our criticized loans should go down from here throughout the remainder of the year.

Speaker 6

And that Kevin, is that resolution of some of these credits or is that broad based other improvement that you see?

Speaker 1

It's a resolution of these credits as well as other credits that are in that portfolio.

Speaker 6

Okay. I appreciate it. And you mentioned the elevated charge offs this quarter were related to The office credit, is that right?

Speaker 1

Yes, 85 percent of the charge off pretty much was the office credit in Seattle.

Speaker 6

Great. Thank you. And then Kevin and Marci, you touched on it as well, but Kevin mentioned margin in June July was near 3%, I believe. And just wanted to clarify, Marcy, you're kind of in the guide as well. Is that the expectation that you've moderated and So for the balance of the full quarter average could be down, but kind of hugging the 3% at this point?

Speaker 1

That is correct.

Speaker 6

Okay, great. And last one for me, would just be Interested in the competitive on the deposit side, not just your own customers sort of asking rate, but just Seeing the peer landscape, how aggressive do you see pricing amongst peers in your footprint?

Speaker 1

Well, it varies geographically, but I would tell you that everybody is pretty much at the Same place and that's really where the short term rates are. So it's I would say pretty much everybody's moved to the same position. So It's pretty competitive.

Operator

Yes, it is very competitive. And it's really to credit unions as much as anything that in a kind of price enterprise up some deposits.

Speaker 6

Okay. I appreciate it. Thanks.

Speaker 2

Presenters, there are no further questions at this time. Please proceed with your closing remarks.

Speaker 1

Again, thank you for your questions. And as always, we welcome calls from our investors and analysts. Please reach out to us if you have any follow-up questions. And thank you for tuning in today. Goodbye.

Speaker 2

Ladies and gentlemen, this concludes your conference call for today. We thank you for joining and you may now disconnect your line.

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First Interstate BancSystem Q2 2023
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