First Interstate BancSystem, Inc.
Q2 2017 Earnings Call Transcript

Published: 31 Oct 2017

[Operator:]

Good day and welcome to First Interstate BancSystem, FIBK's Third Quarter 2017 Earnings Conference Call and Webcast. All participants will be in listen-only mode. [Operator Instructions] Please note, this event is being recorded. I would like to turn the conference over to Margie Morse, Investor Relations. Please go ahead.

[Margie Morse:]

Thanks, Francesca. Good morning. Thank you for joining us for our third quarter earnings conference call. As we begin, I'd like to direct all listeners to the cautionary note regarding forward-looking statements and factors that could affect future results in our most recently filed Form 10-K. Relevant factors that would cause actual results to differ materially from any forward-looking statements, are listed in the earnings release and in our SEC filings. The Company does not intend to correct or update any of the forward-looking statements made today. Joining us from management this morning are Kevin Riley, our Chief Executive Officer; and Marcy Mutch, our Chief Financial Officer; along with other members of the management team. At this time, I'll turn the call over to Kevin Riley. Kevin?

[Kevin Riley:]

Thanks, Margie. Good morning. Thanks, again, to all of you for joining us on the call. I'm going to provide an overview of major highlights for the quarter, and then Marcy will provide more detail on our financials. For the positive after having a full quarter of banking and cascade operation, we delivered a strong quarter that reflected a higher level of earnings power, following this transaction. We saw positive trends in revenue, net interest margin, operating efficiencies and credit quality which resulted in improved profitability. On a reported basis we had per share of $0.48, merger-related expenses had about a $0.15 impact on this quarter, so excluding those costs, we would have generated about $0.63 in our earnings per share. The Bank of the Cascades system conversion in August was a historic event and a major accomplishment for our company. We consider the conversion a tremendous success for our clients, our employees and our shareholders. And the integration continues to go quite smoothly, we're on track to achieve our project cost savings for this transaction and the majority of those savings will be apparent in our fourth quarter results, especially in light of the time and attention required for the conversion of integration, our team in the west division, which now includes Idaho, Oregon impresses with their ability to stay focused on customer service and business development. As a result of the team's effort, we experienced minimal deposit attrition and consistent loan production across the west division. Our loan totals in the markets increased, with particularly strength in commercial real estate and construction amending. The performance this quarter and this the quarter the importance of our entrance and exposure to these higher growth markets. The growth in our west division helped us to offset a softer quarter in our legacy markets at Montana, South Dakota and Wyoming, which we now refer to these as the Mountain Division. While we have been generating new business, and able to attract new clients, we could do a better job in business development. To some extent the weaker results in our legacy markets was relate to our decisions to let some lower quality credit leave the bank. But we understand we need to replace very strong run off. As we have worked with our new colleagues in the west division and observed their approach to business development we believe we can adopt some of their successful practices across the company in order to have a positive impact on the mountain division. Now that we have completed the integration of the bank and the Cascade our number one priority within the company is to drive higher levels of organic growth. Turning to other side of the balance sheet, we have been able to steadily control our deposit costs since the fed increase in late 2016. Our cost of funds declined by 1 basis points to 29 basis points, despite the impact of the June rate increase. Our deposit betas have substantially declined since the rate increase of last December. We have passed along approximately 46% of the December 2016 rate increase to our depositors 20% in the March rate increase and 9% in the June increase. We set the pace of rate increases within our legacy markets early on but we have been able to slow that down as price powers in our new markets we are aligned with the competition and fairly restrain in raising rates. With a more consumer approach in our legacy markets and the slower rate of increases in our new markets we believe we have a good handle on our deposit costs going forward. Lastly, we continue to execute on the strategic initiatives to strengthen our talent level throughout the organization, including tracking top talent from outside of the company. Earlier this month we welcomed Jodi Delahunt Hubbell, and Renee Newman to our executive leadership team. Jodi is our new Chief Banking Officer to west, with responsibilities for Idaho, Oregon Washington. Jodi joins us from Zions Bancorp with 30 years of diverse experience in the financial industry. Because she spent most of her carrier in Oregon and is very familiar with commercial lending small business retail banking in these markets, we are certain she will instrumental and helping us affecting to capitalize on the business development opportunities in these high growth markets. Renee joins the company as President of Wealth Management. She comes at First Interstate with over 25 years of banking experience including significant wealth management and retail banking experience at Umpqua and Sterling. I'm excited about Renee's energy and enthusiasm and feel confident she will make a positive and lasting impact in growing our wealth management presence throughout our combined footprint. So, with those comments I would like to turn the call over to Marcy for little more detail behind the numbers. Go ahead Marcy.

[Marcy Mutch:]

Thanks, Kevin, and good morning everyone. Most of our variances relative to the second quarter are results of the full quarter impacts of Bank of the Cascades, so while I walk through our financial result, I’ll focus on the areas where there were other factors contributing to the quarter-over-quarter variances. As Kevin indicated earlier in the call, we’re pleased with our strong quarter of operating earnings and I’ll begin with our income statement and our net interest margin. Our reported margin increased 11 basis points to 3.71%. Excluding the impact of charges-off interest and non-accretion income, our operating net interest margin increased 11 basis points to 3.54%. The expansion in our margin is attributable to more of our floating rate loans rising above their floors. We’re also benefiting from a higher mix of variable rate loans in the portfolio which now represents approximately 50% of total loans and as Kevin mentioned, we’re seeing more stability in our deposit cost. Total accretion income on the acquired portfolio was $2.7 million this quarter an increase of $1 million compared to the prior quarter. Early pay-offs contributed $1.7 million to accretion income this quarter up from $300,000 in the prior quarter, while the unpredictability of early pay-offs continue to cause volatility in our accretion income, we anticipate that scheduled accretion income will contribute approximately $1.8 million next quarter which will take us up to an average of $1.4 million per quarter in 2018. Looking forward, absent any official fed rate increases we would expect to see a relatively stable operating net interest margin. Moving to non-interest income, we generated $38.3 million of revenue in the third quarter. As you may recall, we sold the custodial rights of our health savings account held by both First Interstate and Bank of the Cascades which resulted in a $3.4 million gain in the second quarter. Then during the third quarter, we recorded a $300,000 purchase price reduction due to accretion in the HSA portfolios between the date of the sale and the conversion of the account balances this quarter. When the impact of HSA sale is excluded from both quarters, our non-interest income increased $4.8 million or 14.3% which was primarily due to the full quarter contribution of Bank of the Cascades as well as the positive impact we typically see in payment services revenue during the third quarter, which stems from seasonal spending habits. Mortgage banking revenues increased by approximately $600,000 from the prior quarter with originations for home purchases accounting for 78% of our total production this quarter. Consistent with national trends we continue to see lower demands for refinancing given the rising mortgage rate environments. Wealth management also had a strong quarter with revenues increasing 9% over the prior quarter and 11% over the same period in 2016. At the end of September our assets under management were approximately $4.8 billion. Investment security losses of $357,000 this quarter include $771,000 of gain on the sale of securities which was offset by a $1.1 million payment to terminate our existing interest rates swap contract. As a result of the acquisition, our higher levels of core funding available made it unnecessary to execute the swap contracts and take down the digital funding. Moving to total noninterest expense, this increased $14 million quarter-over-quarter mainly as a result of the acquisition cost and the addition of the Bank of the Cascades, during the quarter we recognized $13 million of acquisition related expenses. Another significant contributor from the variance from the prior quarter was approximately $1 million of non-acquisition related severance expense along with the hiring cost of our two new executives. So as Kevin mentioned earlier acquisition expenses had a $0.15 impact on earnings per share, non-acquisition related employee expenses along with the purchase price adjustment on has sale had another $0.02 impact. If you back out acquisition expenses and security losses our normal operating efficiency ratio this quarter was a new low of 56.4%. In terms of the future expense run rate last quarter I was at little prematurely optimistic and as we updated our model, the majority of the cost savings from the Cascade integration will be in place for the fourth quarter however the cost saves will be more in line with our originally modeled 28% expectations, which means our total operating expenses will be closure to $78 million per quarter. Looking at the balance sheet, our total loans were just about flat from the end of the prior quarter, we start our strongest growth in the construction portfolio which was offset by declines in commercial loans and residential real estate loan balances. We also continue to see consistent growth in the indirect auto portfolio which was up nearly $10 million in the quarter. Our total deposits declined by 87 million which was mainly attributable to the sale of the HSA portfolio which resulted in an outflow of $55 million of interest bearing deposits. Moving to asset quality, we saw general improvement across the portfolio, with decreases in non-performing assets, other real estate, non-accrual loans and criticized loans. We had net charge-off of $4.6 million or 24 basis points of average loans which was higher than our loss experienced in the last couple of quarters. Our net charge-off this quarter was comprised of several loans for which $2.6 million was specific reserve that been established in prior quarters and we took those charge-offs as part of the final resolution of these loans. Due to the higher level of charge-offs, our provision expense increased a bit to $3.4 million for the quarter, this brought our overall allowance level to 99 basis points of total loan. Adjusting for the credit mark on acquired loans the allowance level was 1.39% of total loans as compared to 1.38% at the end of the second quarter. With that I will turn the call back over to Kevin. Kevin?

[Kevin Riley:]

Thanks, Marcy, nice job. I'm going to wrap up with a few comments about our outlook. Over the past several years we’ve utilized an active M&A program to grow our total assets, to gain scale to improve efficiencies and to drive earnings growth. The transformational acquisition of the Bank of the Cascades as well as the number of smaller bolt-on acquisition that has helped us enhance the value of the First Interstate franchise. We will continue to look for acquisition to have a strong strategic and cultural fit as well as sound economic and performance rationale. At the same time, we want to improve our ability to generate organic growth and we believe we could do so by leveraging the strength of the combined company. We’re pleased with the effective business development approaches in the west division and want to adopt some of the same urgency within our Mountain division. In addition, we believe our ability offer an expanded product set within both divisions will have a positive impact on our organic growth. We are confident many First Interstate core product offering will do well in the high growth markets of the west division, including our credit cards, our indirect auto, our small business lending, our residential mortgages, and our wealth management. In fact, we have already begun to expand our offerings and have strategies and plans in place to invest in tools and resources to increase sales in these areas. In particular we are excited about the opportunity for growth in commercial credit cards, specifically for treasury clients as a purchasing tool. Further our new markets are some of the strongest housing markets in the country and with the acquisition we gained some very specialized expertise in residential construction lending to consumers. On a foot side we see an opportunity to expand the Bank of Cascades SBA lending platform into our mountain division. It’s a high priority for us to train our employees, market these products across our expanded footprint and it will take some time to gain traction but over next few quarters we feel confident that our focused efforts have the potential to drive higher levels of organic growth than we have seen historically. Heading into the fourth quarter we expect to see the continuation of our positive trends in revenue and efficiencies as we realize the synergies from the Bank of Cascades acquisition. And we are also fully committed to improving our business development capabilities so that we have a stronger foundation for driving sustainable growth in the coming years. So, with that we will open up the call for questions.

[Operator:]

[Operator Instructions] Today's first question comes from Jared Shaw of Wells Fargo Securities. Please go ahead.

[Jared Shaw:]

Maybe starting on the margin, I know you said that barring any move in the fed it should be stable here but if we do see at December rate hike and we look at the trends in deposit beta should we expect to see that you tried to keep more of that next rate hike for the bank or at that point you feel like you need to go back into the market and be a little more proactive with deposit funding cost?

[Kevin Riley:]

Right now, we are probably one of the higher deposit rate payers, so we will have to look at what the market does. But at this juncture we don’t see the reason really to pay a lot more on deposits.

[Marcy Mutch:]

In the west footprint we will just ...

[Kevin Riley:]

In the west footprint we will just continue to keep on watching the competition out there.

[Jared Shaw:]

And then Marcy you mentioned that you had more loans moving above floors. What percentage of those floaters are above a floor at this point?

[Kevin Riley:]

We have less than 40 million that are still --

[Marcy Mutch:]

It's actually about 62 million because on the combined footprint, so last quarter it was 40 million in our footprint now that we have everything recombined on the same system it's about $62 million that won't reprice and in up 100 basis points sharp.

[Jared Shaw:]

And then you had mentioned that in the mountain division you were exiting some of the lower I don’t know how to describe it, maybe weaker credits. Is that a onetime thing that we saw this quarter or should we expect to see if that sort of has a little bit of tail on it over the next few quarters?

[Kevin Riley:]

As I put my comments, we should be pricing that and then some. So, we’re going to continue to work out some credit issues, but we’re not anticipating that it should have a real headwind to us.

[Jared Shaw:]

Okay. And then just finally for me on the M&A side, appreciate your comments there. How would you describe I guess the view of M&A here, is it more opportunistic and that you’d look at both markets or with will the focus of future M&A shift more to the newer markets?

[Kevin Riley:]

I would say our focus will probably be more towards the newer markets.

[Operator:]

And our next question comes from Jeff Rulis of D.A. Davidson. Please go ahead.

[Jeff Rulis:]

Question on the -- you’ve talked a little bit about the outlook on growth and I just wanted to kind of maybe tighten that up in terms of your mountain division, the west division, the balance of that I guess historically legacy kind of organic growth was in the maybe be the 4% to 6% level. I guess as you look into 2018, is that a high single-digit number you can put some context on that? Thanks.

[Kevin Riley:]

Our goal is somewhere between mid to high single-digits next year. So, let me comment a little bit about the amount division or the legacy group. As we continue to upgrade talent that you can see that we’ve done that at the executive level but we also are trying to upgrade some talent across our footprint and in the maybe the lending area. And so, we’re some of that turnaround these people came in we’re getting them up speed and getting their betting averages up. So, right now we are anticipating that these guys will come online and [gauze] sooner than later.

[Jeff Rulis:]

Okay. And maybe a similar question on the mortgage banking outlook now that should got two entities together, maybe for the balance of 2018 kind of expectations on the income from sale of loans within the income statement?

[Kevin Riley:]

I think we’re -- the remainder year is going to be a little higher and rates are up. But, I think that we’ll have a decent fourth quarter. I think the growth that we’re going to see in the mountain or the west division going forward will continue to increase as we give our new employees tools that we’re building out more online application, more online work with regards to some of the individual you have heard us mention before. Some of our employees that we got from the west division don’t have the experience really to do some of this lending. So, we’re going to give them some more automated tools that we’re building out in order for it to make it easier for them to help customers in those efforts. So that will start taking shape as we move into probably 2018.

[Jeff Rulis:]

Okay. So, you had a combine a little over $8 million in the quarter. Maybe some seasonality is kind of Q4, but as you roll into 2018 kind of grow or maintain that base is the expectation?

[Kevin Riley:]

Yes. Actually, we hope that the growth pace really picks because as there is a lot of opportunity in the west that has not historically been tapped into.

[Jeff Rulis:]

Great, one last one on the credit side, just the net charge offs, do you have the detail of type of loan segment that those were coming from. And then may be a similar question, out of the NPA bucket, the decline there obviously, some of there were charge offs but, you can give us a color on what was declining in the quarter of each of those balances that will be great.

[Kevin Riley:]

We're going to our Stephen Yose our Chief Credit Officer kind give you some color on that.

[Stephen Yose:]

On the commercial side the mix as some mentioned on the call some of were principal loans that we already have specific allocations on the allowance, a few of those were energy related credits, as well as those in the hotel sector, so I think as we discussed our trying to continually improve on asset quality front. We look at those that are -- we already had specific allocations, non-accrual how we move those quicker and so the sector is principally impacted with the hotel and oil and gas.

[Operator:]

And our next question comes from Matthew Clark of Piper Jaffray. Please go ahead.

[Matthew Clark:]

On the core loan yields they are up nicely linked quarter, I noticed some of that was floating rate, with the benefit of higher short-term rate, but also curious what the weighted average rate was on new production, how that compared to last quarter.

[Marcy Mutch:]

it was 4.99%.

[Matthew Clark:]

Do you have that comparison for last, in case I don’t have it?

[Marcy Mutch:]

I think it was just couple of basis points down from last quarter.

[Matthew Clark:]

Okay, and then on the loan pipeline, I know you reiterated your expectations for mid to high single digit growth for next year but going in to fourth quarter here, I know it tends to be a little bit seasonally slower but I would think it would be better then what we just saw, may be with less run off, just curious how the pipeline looks this quarter versus last, whether or not we should see an uptake here in growth.

[Kevin Riley:]

The pipeline I would say looks about the same as last quarter, so absent some run off, it should bode well for us.

[Operator:]

[Operator Instructions] Today's next question comes from Matthew Forgotson of Sandler O'Neill. Please go ahead.

[Matthew Forgotson:]

Mark, you mentioned that 50% of the portfolio is now variable rate, can you give us a feel for what those loans are benchmark to and a sense of how much are free to move with the next moving move in rate.

[Kevin Riley:]

I think, she mentioned there is about 60 million on floor so everything else is free to move in, so it's probably a combination of that both, some are tied to LIBOR which are bigger credits and the smaller credits which are small business with more of prime base thing but both move with movement of rates.

[Matthew Forgotson:]

And the NIM guide for the core margin is to hold the current range, but I guess if we get a 25 basis points increase in fed funds, is it fair to say that this quarter's bump in the core margin I guess up 11 basis points sequentially is a fair reflection of how we should expect margin to react if that comes to fruition?

[Kevin Riley:]

Yes, absolutely, I mean as you have heard in past at some point in time there is going to be an inflection point in regards some of these deposits and the competitors are going to start paying off. So, absence that I would agree with that statement.

[Matthew Forgotson:]

And then how should we keep thinking about loan loss provisioning here going forward?

[Kevin Riley:]

I would say that probably similar to what we saw this quarter.

[Matthew Forgotson:]

And then just lastly and then I'll hop out. Kevin could you just fleshing out in your M&A comments a little bit more, can you give us a feel for level of activity in the market and your enthusiasm for maybe getting something else done in the not too distant business future?

[Kevin Riley:]

Well there is a lot of activity out in the market. We see a number of deals and I think we are being picky to what deal that we are going to enter into and partly is because we are really trying to build our infrastructure, [indiscernible] a little bit on this aspect and part of it is that as we grow the company through acquisitions we also want to have a company stay relevant in the financial industry and when I talk about relevance, I talk about making sure that we have a digital platform that competes with likes of rocket mortgage and lending tree and stuff like that. So, we are continually building out our technology in order to serve the customers that now want a different experience in coming into the branches. So, we are balancing out our infrastructure build and staying relevant versus just doing a bunch of small little acquisitions and taking our eye off the ball for the future, so kind of balancing that. We are making sure if we go into an acquisition which is a number out there, that is the right acquisition for the company and not just to grow and take our eye off the ball and staying relevant. And I always make the analogy between Walmart and Kmart, the both sell the same products, Walmart is still relevant and Kmart is probably going out of business. So, the thing is we as a finance institution want to grow and stay profitable but we also want to stay relevant for the future.

[Operator:]

And our next question comes from Jackie Bohlen of KBW. Please go ahead.

[Jackie Bohlen:]

Do you have any onetime merger cost left?

[Marcy Mutch:]

It will be pretty minimal, I'm sure that will be a few stragglers, but there is nothing significant Jackie.

[Jackie Bohlen:]

And then the severance that was in the quarter was that driven by the talent upgrade that you referenced?

[Kevin Riley:]

Yes.

[Jackie Bohlen:]

And do you anticipate any more of that activity in the future?

[Kevin Riley:]

Not at the same level.

[Jackie Bohlen:]

And then just lastly on -- obviously you brought on somebody new in wealth management and it's an area of focus how do you see that line item playing out over the next several quarters?

[Kevin Riley:]

I think that line item is going to play out nicely as the new individuals -- again as we have done trying to build the infrastructures company part of it as we’ve done is restructured the various groups to be more aligned to a bigger organization. So, I think Renee's impact will have a positive reflection of that. And again, one of the things that I go back to digital is to build out our global wealth management platform in order to track some of those small customers. So, we’re going to look at some reorganization and shifting things around as we focus on taking care of our customers.

[Jackie Bohlen:]

So, is it fair to say that there would be a ramp up period and then you could see some increasing growth that gains tractions as we go forward?

[Kevin Riley:]

Yeah., I would say that probably will start carrying again in the prior to first quarter of 2018.

[Jackie Bohlen:]

Okay. And when you look at the two divisions that you have Mountain in the West. Does one have more opportunities and the other or other opportunity is fairly equal?

[Kevin Riley:]

Well, the West we don’t do much wealth management business at all. We only acquired with the West division about $50 million of assets under management. So, the is a sky limit for the West and I think we can continue to grow and rationalized our product offering in the Mountain division. But, I think the best growth opportunities would probably be in our new markets starting with Boyce and band which we have a strong presence, which I think we can – and we already have hired some wealth management advisors within those markets to try to start expanding our presence in those markets.

[Jackie Bohlen:]

Okay. So, the majority of the growth would come from the new added markets rather than a rescheduling of what you have with the legacy footprint?

[Kevin Riley:]

Yes, that’s correct.

[Operator:]

And ladies and gentlemen this concludes our question-and-answer session. I would turn the conference back over to management team for any closing remarks.

[Kevin Riley:]

I want to thank everybody for joining us on the call today. And as always, we will compose from our investors and analyst. Please reach out to us if you have any follow up questions. And thank you again for turning in today. Good bye.

[Operator:]

And thank you sir, today’s conference has now concluded. And we thank you all for attending today’s presentation. You may now disconnect your lines. And have a wonderful day.