First Interstate BancSystem Q3 2024 Earnings Call Transcript

There are 10 speakers on the call.

Operator

Good morning, everyone, and welcome to the First Interstate Baked Systems Third Quarter Earnings Conference Call. At this time, all participants are in a listen only mode. Later, you will have the opportunity to ask questions during the question and answer session. Also, today's call is being recorded. Now at this time, I'll turn things over to Nancy Vermeulen, Financial Communications and Analyst Manager.

Operator

Nancy, please go ahead.

Speaker 1

Thanks very much. Good morning. Thank you for joining us for our Q3 earnings conference call. As we begin, please note that the information provided during this call will contain forward looking statements. Actual results or outcomes may differ materially from those expressed by those statements.

Speaker 1

I'd like to direct all listeners to read the cautionary note regarding forward looking statements contained in our most recent annual report, on our Form 10 ks filed with the SEC and in our earnings release, as well as the risk factors identified in the annual report and in our more recent periodic reports filed with the SEC. Relevant factors that could cause actual results to differ materially from 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.

Speaker 1

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

Speaker 2

Thanks, Nancy. 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, which we believe would be helpful. The presentation can be accessed on our Investor Relations website. And if you haven't downloaded a copy yet, I would encourage you to do so.

Speaker 2

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 detail on our financials. Now let's get to our results. We recorded $55,500,000 in net income in the Q3 or $0.54 per share. Our net interest margin, excluding purchase accounting accretion, increased by 5 basis points to 2.97%. We believe our net interest margin, ex purchase accounting, will exceed 3% in the 4th quarter as it did in the month of September.

Speaker 2

Non interest expenses in the Q3 came in better than we expected and they included one time costs related to my transition. As we have announced, Jim Reuter, the former CEO of First Bank will step into the CEO role in a week on November 1. I will say a bit more about Jim in my closing remarks. In the Q3, we saw a modest growth in our fee business, which was enhanced by the sale of 1 of our branches, but excluding this sale, non interest income increased by approximately 3%. As for our credit quality, our criticized and classified loans both declined in the period.

Speaker 2

However, we did see some charge off noise in the 3rd quarter that was specifically related to our metro office portfolio. We have a large property that transitioned to non accrual for which we took a significant charge off to what we estimate as a realizable value. As we've said in the past, we believe we are addressing the challenges in our Metro office portfolio proactively and any significant challenges in that portfolio are now behind us. We have also included an additional slide in our investor presentation that provides further information on our Metro office exposure. Finally, we are pleased with our deposits in the Q3 as they ended essentially flat despite the change related to a large temporary deposit that was on the balance sheet at the end of last quarter.

Speaker 2

If we strip that effect out, our deposits increased approximately 1% during the quarter. As we look to 2025, the margin expansion that we expect to continue coupled with our expense discipline should lead to improved profitability. We believe the company is in the midst of an earnings inflection, which we have discussed previously, and we look forward to improving results going forward. And with that, I'll turn the call over to Marcia.

Speaker 3

Thank you, Kevin. As I walk through our financials, unless otherwise noted, all of the prior period comparisons will be with the Q2 of 2024 and I'll begin with our income statement. Our net interest income was $205,500,000 in the 3rd quarter, an increase of $3,800,000 Our yield on interest earning assets increased 3 basis points quarter over quarter driven again by an increase in loan yields. During the quarter, we also terminated $550,000,000 of swaps at approximately breakeven, which mitigated the impact to net interest income during the period. Our cost of interest bearing liabilities declined in the 3rd quarter, driven by a $205,300,000 reduction in average borrowings.

Speaker 3

Ending borrowings declined approximately $600,000,000 quarter over quarter. As the September rate cut by the Fed was widely anticipated by the market, we saw some of our customers more aggressively pursue higher rates ahead of the Fed action. While this resulted in the cost of our interest bearing deposits increasing more than we had anticipated at the beginning of the quarter, this activity has slowed significantly in the rate cut aftermath. Our fully tax equivalent net interest margin increased 4 basis points 3.04% in the 3rd quarter. And as Kevin stated, our net interest margin, excluding purchase accounting accretion, increased 5 basis points to 2.97%.

Speaker 3

This increase is net of a 1 basis point impact to our net interest margin from lower unrealized losses in our investment securities portfolio during the quarter, resulting in higher average balances. Overall, we continue to anticipate a sequential increase in the net interest margin in the Q4 and into 2025. Our balance sheet responded to the September rate cut as we expected with similar loan and interest bearing deposit betas. Our outlook now includes 2 more rate cuts by the Fed in the 4th quarter, each 25 basis points, neither of which should materially impact 4th quarter earnings results. As a result, we believe the net interest income will continue to increase sequentially in the 4th quarter and the increase in margin will more than offset the impact of modestly declining interest earning assets.

Speaker 3

In the Q4, our balance sheet is neutral as the amount of overnight borrowings repricing this quarter is de minimis. In the Q1 of 2025, we will see $1,700,000,000 of borrowings repriced early in the quarter, which includes both our BTFP and a portion of our term FHLB advances. Non interest income increased to $46,400,000 in the 3rd quarter. Excluding the $2,600,000 gain on the sale of 1 of our branches, as Kevin mentioned, we saw an increase of approximately 3% quarter over quarter. Non interest expense increased in the 3rd quarter by $2,500,000 However, a one time expense of $3,800,000 related to the CEO transition more than fully accounts for that increase.

Speaker 3

Excluding that cost, our non interest expenses again declined compared to the prior period. As we anticipated, our medical insurance expenses normalized somewhat in the 3rd quarter after running consistently below our expectations for the first half of the year. That moderate increase was more than offset by savings in other expense lines. As we've done all year, we remain focused internally on expense control and more effective management of our resources and branch network. Moving to our balance sheet.

Speaker 3

Loan balances decreased by $207,900,000 in the 3rd quarter. The conversion of construction loans to permanent real estate financing with typically lower risk profiles continued this quarter, which is reflected in the increase of $164,800,000 in our commercial real estate loans. Construction loans declined $212,000,000 We did experience some seasonality in our commercial and industrial balances with utilization declining about 2%. We also saw a decline in our lower yielding mortgage balances as a result of normal amortizations and subdued production demand. Our unfunded commercial construction commitment balance stood at approximately $300,000,000 at the end of the quarter at a weighted average rate of approximately 6%.

Speaker 3

This should now be reflective of somewhat normal levels of unfunded construction commitments and we no longer believe that funding for this portfolio will have a material drag on our loan yields going forward. With that in mind, we don't intend to continue to call out these commitments in the future. We continue to see stability in our non interest bearing deposits, which again averaged 26% of our total deposits in the period, roughly unchanged from the end of 2023. In the Q3, we recorded a modest decrease of $6,600,000 in deposits compared to the prior period. However, excluding the effect of the temporary outflow we've identified, our deposits increased approximately 1% as we expected.

Speaker 3

With respect to credit, as Kevin pointed out, criticized and classified loans both decreased in the Q3. Our total provision expense was $19,800,000 with our funded ACL coverage at 1.25 percent of total loans. As we indicated last quarter, we've been keeping our eye on the Metro office portfolio, which included higher than expected net charge offs this quarter. Approximately 80% of our charge offs were comprised of 2 loans in that portfolio. The smaller of the 2, a construction real estate loan, is fully charged off with no remaining exposure.

Speaker 3

The larger Metro office loan was written down 70% this quarter, which reflects our estimated realizable value. For additional transparency, we have added a slide in our investor presentation that describes this portfolio in more granular detail. Overall, our exposure in the metro office sector is now less than $90,000,000 and we believe there are no more material losses in the portfolio at this time. Our total charge offs for the quarter were $27,400,000 Excluding the 2 metro office loans we just discussed, our charge offs were $5,300,000 or 12 basis points of average loans. We also wanted to give you an update regarding the 2 other significant non performing loans we've been reporting on in previous quarters.

Speaker 3

Regarding the agricultural credit, we anticipate a resolution in the 4th quarter. With respect to the commercial loan for which we have a specific reserve, we remain in weekly communication with the borrower who is performing as expected under our agreement. At this time, little has changed, but we anticipate additional clarity in the 4th quarter and believe this specific reserve is adequate based on what we know today. And finally, our capital continued to accrete in the 3rd quarter. Our common equity Tier 1 capital ratio increased 30 basis points to 11.83% as we continue to prudently manage risk weighted assets.

Speaker 3

We also declared a dividend of $0.47 per share or a yield of 6.3% for the Q3 of 2024. And with that, I'll turn it back to Kevin.

Speaker 2

Thank you, Marcy. I would like to congratulate our Board on finding an excellent successor to me in Jim Reuter. As I have mentioned, Jim joins us from First Bank Holding Company, one of the largest privately held banks in the nation, where he served as President and CEO for the past 7 years before retiring in March. After spending a little time with Jim, I believe his leadership style is a great fit for our culture and I'm leaving the company in good hands. When he arrives here at the beginning of next month, he will find unwavering support from a team that has the talent, the energy and a commitment to excellence that will continue to drive this company forward.

Speaker 2

Now comes the bittersweet moment for myself. As I give my concluding remarks in my last earnings call as a CEO of First Interstate, after 17 consecutive years of performing quarterly earnings calls, First at Berkshire Hills and now the last 11 at First Interstate, I'm not sure what I'm going to do with myself come January. I want to wrap up by thanking my First Interstate family, our shareholders and all of our stakeholders for their hard work and support over the last 11 years I have served this great company. I'm very proud of all that we have achieved and how much we have grown and matured as a company during my time here. So this is goodbye, at least for now.

Speaker 2

We shall see if our paths cross again in the future. And now I'd like to open the call up for questions.

Operator

Thank you, Mr. Riley. We'll go first this morning to Matthew Clark with Piper Sandler.

Speaker 4

Hey, good morning. Good morning, Matt. I just want to, can you just remind us the specific reserves you have set aside for that C and I relationship that's expected to get resolved by year end? Just want to make sure we're capturing that in terms of charge offs.

Speaker 2

Matt, you've asked that question a number of times. We don't specifically highlight with a specific reserve on our credit. But I would say at this point, it's very adequate to what we think could be the realizable value.

Speaker 4

Okay. And then did you have reserves previously set aside on the charge offs on those 2 metro office credits? And if so, how much?

Speaker 5

Go ahead, Maris.

Speaker 3

Yes. So, Matt, while there was no specific reserves set aside on that, the characteristics of those loans were considered in our overall allowance. Again, in the larger of those two loans, it was paying into the Q4, but we anticipated there may be a problem. And so we ordered an appraisal and then wrote it down based on that appraisal.

Speaker 4

Okay. And then, I don't think it was in the slide deck, but the spot rate on deposits at the end of September and the average margin in the month of September?

Speaker 3

The spot rate on deposits was 2% and $303,000,000 was the margin in September.

Speaker 4

On a reported basis or core?

Speaker 3

No, that's core basis ex purchase accounting.

Speaker 4

Okay, great. Thank you.

Speaker 3

You bet.

Operator

Thank you. We'll take our next question now from Andrew Terrell at Stephens.

Speaker 6

Hey, good morning.

Speaker 2

Good morning, Andrew.

Speaker 6

On the ag credit that you guys On the ag credit that you guys discussed, can you just remind us the size of that loan? And then I'm assuming the commentary around the expectation for some kind of resolution. Is that probably what's influencing the 20 to 25 basis point charge off guidance for the Q4?

Speaker 3

Yes. And so the ag loan was around $20,000,000 and yes, we feel comfortable with the 20 to 25 basis point guide on net charge offs excluding again the large C and I credit.

Speaker 2

But we don't really anticipate taking really a loss on net add credits

Speaker 7

specifically. No.

Speaker 6

Got it. Okay. I appreciate it. And then Marci around the $1,700,000 of borrowings that are fixed currently but start to reprice earlier in the Q1. Can you just talk through maybe some of your expectations or how we should be thinking about that?

Speaker 6

I guess should we expect it just kind of flips to overnight funding and makes you a little more liability sensitive? Or are there any opportunities out there in the market to maybe lock in, get any kind of puttable FHLB advances at kind of a more advantageous rate? I'm just curious how we should think about that.

Speaker 3

Yes. And so, Matt, we have about $1,000,000,000 of that that's going to reset in January. And I really feel like at this point we have ultimate flexibility with regard to how we kind of stage that out going forward. And so we're watching it now. Any rate cuts will be accretive to us as to where they're priced right now.

Speaker 3

So again, I just we'll evaluate that as the time comes.

Speaker 6

Okay. Makes sense. And then could you also maybe just rehash, I missed some of the commentary around the I think you mentioned swap termination in the Q3. Could you just walk through maybe some of the dynamics there?

Speaker 3

Yes. So again, I think we've said before we use those swaps as a tool to manage our balance sheet sensitivity. And at this point, we're relatively neutral. But as we move into 2025, we become naturally more liability sensitive. And so we terminated that $550,000,000 of swaps because they were in a favorable position to do so.

Speaker 3

And that's just going to reduce our exposure going forward into 2025.

Speaker 6

Did that positively contribute any level of interest income in the quarter?

Speaker 3

A tiny bit, yes.

Speaker 6

Okay. I appreciate it. Kevin, congrats on everything and wishing the best of luck in retirement. It's been fun working with you.

Speaker 2

All right. Thanks. Thanks, Andrew.

Operator

Thank you. We go next now to Jared Shaw with Barclays.

Speaker 8

Hey, good morning, everybody.

Speaker 2

Good morning, Jared.

Speaker 8

Kevin, I got to say, I think I'm probably one of the only ones that was there 17 years ago on that first Berkshire call with you. So it's been a great run and looking forward to staying in touch with you. But congratulations on a strong career.

Speaker 2

Well, it's interesting you said that the team that you were the only one that probably was there 17 years ago. So I'm glad you confirmed it for the team.

Speaker 8

Thanks. So maybe just drilling into the margin trends a little bit more, and how I guess we should be thinking about some of the moves that you just called out with the swaps and maybe on the transition of construction to CRE. What would be sort of a good place do you think that we end Q4 at jumping off into next year? Are some of these moves going to continue to provide some benefit as you go through the quarter?

Speaker 3

Yes. So I think I just mentioned that ex purchase accounting our margin was at 3.03% in September. And so because we have no borrowings that are maturing this quarter, I don't think it will go significantly higher than that, but we do again expect expansion from the $297,000,000 where we were into the Q4. And by September's rate, you can see we're already there.

Speaker 8

Is there an impact on that margin from interest accrual reversals from some of the larger non performers?

Speaker 3

That doesn't anticipate interest accrual interest accrual conversions.

Speaker 2

Are you talking about this quarter, Jared? Yes.

Speaker 8

Yes. Well, I'm just saying, I guess, like this quarter, was there a negative impact from that that is going to be reversed that we should be thinking about in 4th quarter or something that maybe through Q4 then it gets reversed in Q1?

Speaker 3

Yes, that's included in that September number.

Speaker 8

Okay. And then did you pay down any of the BPFP at all this quarter? And what's your outlook on that going forward?

Speaker 3

Yes. So we haven't paid down any of that at this point. Again, that rate is 4.76%. And so as rate cuts happen, we'll kind of make decisions from there, what our options are. Again, that has no payment penalties.

Speaker 3

So we're extremely flexible with regard to those that funding.

Speaker 2

I think, Jared, we're just trying to see where the market goes from now until that period of time and keep that flexibility or optionality intact until we see clear what might be happening in the range in 20252026.

Speaker 8

Okay. All right. Thanks. And then just I guess finally for me on those two office loans, that's a little bit of a different trend from what we've seen at other sort of mid cap banks with similar type structures. Any additional color you can give us just on what was maybe uniquely negative about them compared to more of a traditional portfolio and why you feel comfortable with the rest of the portfolio?

Speaker 2

Well, on the two things. The one loan, the one that we the construction loan, we've looked at it in detail and we just wanted to get it behind us. So we wrote it down to 0. And that not to have that exposure out there anymore. We'll see what happens with that.

Speaker 2

But on the larger one, I mean, it's actually still paying, but we can see that the end was coming near and the borrower probably would not be able to keep it. So even though it was still paying, it was going to come to a close. So we just want to get that loss behind us and not have it carry forward. So we were proactive, got an appraisal and wrote it down to a reliable value after selling cost. And just get and so that we don't continue to have this noise in our Metro office.

Speaker 2

We just wanted to get it all behind us and clean up the portfolio and not have to deal with this anymore. As you know, there's a slide in our deck that shows that we have $90,000,000 in Metro Office and there's only 4 loans now over $5,000,000 of which one is one of the ones that we whacked pretty heavily. So we don't believe there's any real loss at all left in the Metro office, but we got that behind us.

Speaker 8

Okay. Thanks for the color and congratulations again and looking forward to staying in touch.

Speaker 2

Thanks, Jared.

Operator

Thank you. We go next now to Tim Coffey with Janney.

Speaker 9

Thank you and thanks for the opportunity to ask the question. Marci, did I hear you correctly, you think earning assets could come down quarter over quarter? And if so, by how much?

Speaker 3

Well, we don't really say by how much, but if you we had some loan runoff right at the end of the quarter. And so if you just kind of look at that, that's why we think average earning assets are going to come down quarter over quarter. Again, I think we said in our guidance that we expect deposits to be relatively flat, loans to be relatively flat, but they'll just naturally come down because of the runoff in the loan portfolio we saw at the end of the quarter.

Speaker 9

Okay. Okay. I appreciate that color. Thank you. And then Kevin on the Metro office portfolio, if you look at the 3 remaining loans that are over 5,000,000 dollars are any or all of them in some form of rehab and transitioning to the lease up process?

Speaker 4

Any hold on.

Speaker 8

Go ahead, David. Hey, Tim. There's we have some notes on the Metro office slide. So, a couple of them are already leased up, have adequate debt service coverage, one recently completed and then the remainder is the one we've discussed. So there's commentary on that slide, Slide 7.

Speaker 4

Yes. And in the 1

Speaker 2

the 2nd largest one, we took a loss on that earlier in the year, that's in Seattle. And we have an investment grade, lessor going in there. So we feel very comfortable with that one and that one's not a concern. So we feel pretty good with what's left there.

Speaker 9

Okay. Would kind of these the markets where you're having where you're seeing kind of these problems, would they those problems prevent you from continuing to do business in those markets, in these type of properties?

Speaker 3

No, we don't anticipate that at all, Tim.

Speaker 2

No, we're not doing that.

Speaker 9

Okay. Okay. Yes, I just asked because the vacancy rates in off metro office have been higher on the West Coast than probably other places I've seen. So I appreciate that. And then Kevin, yes, it's been great working with you.

Speaker 9

Yes, I hope you enjoy your retirement. Happy hunting.

Speaker 3

Thanks.

Operator

Thank you. We'll go next now to Timur Braziler at Wells Fargo.

Speaker 7

Hi, good morning.

Speaker 2

Good morning, Timur.

Speaker 7

Can you provide the locations

Speaker 1

of

Speaker 7

these 2 office charge offs?

Speaker 3

No. Timur, it could potentially compromise our negotiating position and so we're not providing the locations of those. But suffice it to say, we define Metro office as Portland, Seattle, Denver, Phoenix and Minneapolis, St. Paul, Kansas City. It's in one of those locations.

Speaker 7

Okay. Got it. And then, appreciate the color on the Metro office slide. I just want to make sure, does that include construction loans as well? Or is that the permanent CRA?

Speaker 8

It does. Okay.

Speaker 3

Yes. Okay. Yes.

Speaker 2

It includes it. Yes.

Speaker 7

And then I guess, the transition from construction to permanent finance. I'm just wondering what your appetite is to continue doing finance and some of your own construction projects as the construction term comes due? And then just maybe talk us through the pricing dynamics as these loans roll from construction to permanent finance?

Speaker 2

Well, I mean, I think the dynamics of moving from construction to perm, I think that we've kind of covered that once they get finished and then they stabilize, we move them into permanent commercial real estate. We continue to look at loans, not in the metro markets, but look at loans that our customers and communities need and we look at them on an individual basis. And we're not out of the construction business. We're just going to be pretty particular about what we do. So we're going to continue to stay in business, but it's just a normal transition from doing a construction loan, building stuff up, stabilization and then moving into commercial real estate.

Speaker 3

And again, I think we said all year, we're really focused on making sure that we have the full relationships and not just a transactional construction loan that we want the full relationship. And so that's where we're focusing, again outside of the metro areas and on full relationships.

Speaker 7

Okay. And just from a yield perspective, are those construction loans, are those variable rate and then they get locked into permanent finance, it's like a 5.1% or is that coming off a lower fixed rate into a higher fixed rate on the CRE permanent tax?

Speaker 3

So most of it's variable, but there is a portion that are those all in one construction loans that we talked about earlier and that's considered in that 6% number that we gave you earlier. So the all

Speaker 2

in one construction loan, Tim, just a few words, just to refresh your memory is that we do a fixed rate during the construction period and then through the stabilization period. So that rate carries on then for a short period of time after that loan is stabilized and moving the commercial real estate.

Speaker 7

Got it. Okay. And then just last for me, just looking at the deposit rates, appreciate the 2% spot spot. I think Marci, you had said that some of the pressures were starting to abate in the Q4. I guess, you guys are starting at such a low level that maybe continued mix shift just puts additional pressure on that.

Speaker 7

But how has that 2% been working through the month of October? And are you thinking that's kind of a peak there for deposit rates? Or do you think just again starting at such a low basis maybe there's some additional pressure there?

Speaker 3

I think it will be stable to down going into the rest of the quarter.

Speaker 7

Okay, great. Thank you for the color and Kevin congratulations on the retirement.

Speaker 2

Thanks, Stuart.

Operator

Timur. Thank you. We'll go next now to Chris McGratty at KBW.

Speaker 5

Hi, this is Nick. Mutavik is on for Chris.

Speaker 2

Hi, Nick. Hi, Nick.

Speaker 5

Maybe just on expenses, you guys have done a nice job kind of grinding that efficiency ratio down this year, but maybe any other opportunities to work on expenses as we move into 2025?

Speaker 3

Nick, I think we're doing a pretty good job on our expenses. Right now, I really our efficiency ratio is more of a revenue issue than it is an expense issue. So as we see our NII build going into next year and hopefully get some traction on our fee income, we should see that efficiency ratio continue to come down.

Speaker 5

Great. And then maybe just

Speaker 8

a comment

Speaker 5

on loan demand as we move into next year. Do we see that picking up? Is there

Speaker 8

a rate level where you

Speaker 5

think people are waiting to pick up activity? Or is it kind of tepid in your mind as we move into 2025?

Speaker 2

I would tell you, Nick, there's a couple of things. I think, one, people are looking for what's going to happen with the election happening in the next couple of weeks and I think also rates. So I kind of stopped looking at my crystal ball because it's very cloudy because over the last few years we haven't really picked that. So I think we're just going to have to wait and see what the rates look like. But I think there's a pent up demand.

Speaker 2

I just don't know when that pent up demand is going to take hold. So we're poised and we're ready and the team is ready to go. But I don't want to pick a time when that's going to pick up because I'll probably be wrong. So let's just hope it does start early going into 2025.

Speaker 5

Great. Thank you and congratulations, Kevin. We've enjoyed working with you at KBW. Thanks.

Speaker 2

Thanks, Nick.

Operator

And ladies and gentlemen, it appears we have no further questions today. Mr. Riley, I'd like to turn things back to you, sir, for any closing comments.

Speaker 2

Okay. I'd like to thank everybody for their questions. And as always, we welcome calls from our investors and analysts. Please reach out to us for if you have any follow-up questions. And thank you for tuning in today.

Speaker 2

And I really appreciate working with all of you over the years. So hopefully, our paths will cross and I will see you. So thanks for all your support. Bye.

Operator

Thank you. And again, ladies and gentlemen, that will conclude the First Interstate Baked System 3rd quarter earnings call. Again, thanks so much for joining us everyone and we wish you all a great day. Goodbye.

Earnings Conference Call
First Interstate BancSystem Q3 2024
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