First Interstate Bancsystem Inc (FIBK) 2016 Q3 法說會逐字稿

Good day and welcome to the First Interstate BancSystem third-quarter 2016 earnings conference call.

(Operator Instructions)

Please note, this event is being recorded. I would now like to turn the conference over to Kenzie Lawson. Please go ahead.

Thanks, Kate. Good morning, thank you for joining us for our third-quarter earnings conference call. As we begin, I would like to direct all listeners to the cautionary note regarding forward-looking statements and factors that could affect future results and our most recent 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 our management team. At this time I will turn the call over to Kevin Riley. Kevin?

Thanks, Kenzie. Good morning and thanks to all of you for joining us on our call today.

We are very pleased with our strong performance this quarter. Reported earnings per share of $0.56 for the third quarter, which included $1.2 million of expenses related to our acquisition of our Flathead Bank. When you back out the acquisition expenses for this quarter and a legal settlement expense of last year's third-quarter, we generated core earnings per share $0.58 and $0.52, respectively. This represents an 11.5% increase over the third quarter of last year.

The performance this quarter was result of a number of things we have talked about on our past calls. Our organic loan growth and fee income initiatives drove a year-over-year increase in our total revenues. A focus on controlling expense resulted in an improve in our core efficiency ratio which was 58.1% this quarter. Combined with stable asset quality and modest credit costs, we were able to drive a strong improvement in our core earnings per share, as well as higher returns on asset and equity.

Following a seasonably strong second quarter of loan production, organic growth was lower in the third quarter, at less than 1% quarter over quarter. Year-over-year, loan growth was almost 7%, with 5.2% being attributed to organic growth. We continue to believe it will stay in the mid single-digit range for organic growth for the full year.

We generally helped the economic conditions throughout most of our footprint. We are seeing strength in our consumer lending areas. We had a very strong quarter in residential lending business, which reflects a positive trend we are seeing in our housing markets. These strong housing trends have also driven growth in our residential construction portfolio which increased $17 million, or approximately 15% during the quarter on an organic basis. As reminder, we generally hold a portfolio of adjustable-rate mortgages with a 10-year or less term.

We also continued to benefit from our dealer network we have developed in the indirect auto business, which has helped drive an increase of $44 million, or more than 6% in that portfolio during the third quarter. The strong consumer loan growth helped to offset lower demand in our commercial-related portfolios, which was primarily driven by seasonal pay-downs that we typically see in the third quarter.

We are very pleased that we continued to generate solid revenue growth while maintaining a discipline of expense control. We've been able to maintain relatively flat overall expense levels while continuing to invest in the people, processes and technology systems that will support our future growth.

This month, we are implementing a number of enhancements to our accounting system, including a new general ledger and accounts payable system, as well as a new financial reporting system. This past weekend we rolled out a new digital banking platform to all of our customers, which will provide an improved customer experience for online and mobile banking. And next month we are rolling out a new HRS system.

Our technology enhancement initiatives have gone very well. And we are very pleased that we have been able to improve our customer service and upgrade our internal systems and processes, while at the same time driving efficiency within a broader organization.

We also continue to advance on the people portion of the initiative. We have been very fortunate to track experienced personnel in key positions that bring the expertise of having worked at larger regional banks. This week Mike Sherwin joined us as Head of Human Resources. Mike comes with the experience of having built an HR department for Wintrust $25 billion bank headquartered in Illinois.

We also added a new Regional President in Wyoming, Dave Bruni who joined us from US Bank. These additions, along with our strong local leadership teams, will provide us with the experience and expertise we need to effectively manage our growth. I would like to say my team is now in place.

Turning to asset quality for a moment, in general we are seeing good simplicity in our portfolio. Marcy will provide more detail on our trends in her remarks. The proactive approach we are taking to our oil and gas portfolio has helped us stay on top of all of our borrowers direct and indirectly tied to this industry. And we feel we have a good handle on our exposure.

We have one oil and gas credit and one other commercial borrower in our [castro] market that were downgraded to criticized status this quarter. But other than that, we did not see any significant deterioration in credits impacted by oil and gas. We haven't changed our conservative approach to valuing the underlying collateral of oil and gas credits, and haven't made any adjustments to our valuation from the pricing deck we used earlier this year to reflect a trough in the oil and gas market.

Accordingly, we continue to actively manage down our exposure in the energy market. Our total outstanding loans to customers directly involved in the oil and gas industry declined again this quarter by $5 million to $61 million. These loans now represent only 1.1% of our total loan portfolio. The criticized loans in this portfolio remained elevated at 74.7%. This is largely attributed to the conservative approach we have to managing this portfolio.

Finally, we completed the Flathead Bank acquisition during the third quarter. The bank has been fully integrated and we have realized all the cost savings that we had projected for this transaction. We have been very pleased with the feedback we have been getting from our new customers. And we believe there will be good opportunities to expand our relationships with them in the future as we introduce the expanded products and services that we offer.

So with those comments, I would like to turn the call over to Marcy for a little more detail behind the numbers. Go ahead, Marcy.

Thank you, Kevin. Good morning, everyone. As I walk through our financial results, unless otherwise noted, all of the prior-period comparisons will be with the second quarter of 2016. I'll begin with our income statement and want to start by noting a few unusual items that impacted our results this quarter.

The largest item was a recovery of $1.8 million of previously charged-off interest. Most of this was related to the payoff of one large non-accrual loan where we had full recovery of both principal and interest. This recovery was offset by little noise in our non-interest expense which included a $384,000 loss, primarily related to the write-off of an investment we'd made in a technology company, and a $310,000 deduction from the donation of a building to a local nonprofit agency in one of our smaller rural towns. On a net basis, these items had a positive impact of approximately $0.02 per share on our earnings this quarter.

Now looking at specific line items, net interest income increased $3 million on a linked-quarter basis. $1.8 million was attributable to the recovery of charged off interest and the remainder was due to the growth in our loan portfolio and one additional accrual day. This was partially offset by a $300,000 decline in interest accretion on acquired loans.

As you may recall, our non-interest income was positively impacted last quarter by a $3.8 million litigation recovery. Excluding this recovery, our non-interest income increased $373,000 from the prior quarter. The increase was driven by higher mortgage banking revenue as we continue to benefit from a strong mortgage pipeline, as well as an increase in the payment services revenue, which we typically see during the second half of the year.

Our total non-interest expense increased by $1 million from the prior quarter, but this included $1.2 million in acquisition-related expenses, as well as $694,000 in one-off charges for the investment write-off and donation that I mentioned earlier. Excluding these items, our total non-interest expense decreased by approximately $900,000, or about 1% for the quarter, primarily due to lower incentive compensation accruals. On a core basis, as a result of our revenue growth combined with our expense reduction, our core efficiency ratio improved 58.1% in the third quarter from 60.1% last quarter.

Let's move to the balance sheet. Our total loans increased 2.2% from the end of the prior quarter with most of the increased due to the acquisition of Flathead Bank. Flathead's loan portfolio was very similar to ours and contributed to balanced growth across most loan categories.

We continue to see our typical pattern of seasonal deposit flows, with outflows in the second quarter followed by inflows in the third quarter. We saw the strongest inflows in our non-interest-bearing deposits, which increased by more than 10% from the end of the prior quarter.

Excluding the $200 million in deposits we added to the Flathead acquisition, our total deposits increased $137 million organically, or 2%. These strong deposit flows pushed up our cash balances at the end of the quarter. However, we expect cash to come down to more normalized levels as we redeploy this liquidity into higher-yielding assets during the fourth quarter.

Moving to asset quality, our non-performing assets increased by $2 million, half of which was related to other real estate added as a result of the Flathead acquisition. Non-accrual loans declined by $3 million due to $7 million of payoffs, which were partially offset by the addition of an ag real estate relationship that was placed on non-accrual.

Our accruing loans 30 to 89 days past due were up $7 million. However, this was primarily due to two loans that had been brought current subsequent to quarter end. Our criticized loans increased by $10 million, primarily due to the downgrade of two large borrowers in our markets most impacted by the energy sector.

Our net loan charge-offs remain low at an annualized rate of 11 basis points of total loans. And to provide a little bit more insight into our indirect portfolio, year-to-date net charge-offs are 24 basis points compared to 22 basis points at this time last year. So we remain well below industry standards. At the end of the third quarter our 60-day delinquency rate on the indirect portfolio was 38 basis points.

Lastly, we recorded $2.4 million in provision expense which kept our allowance for loan losses essentially flat at 1.47% of total loans, and our coverage of non-performing assets to a little less than 100%. And with that, I'll turn the call back over to Kevin.

Thanks, Marcy, nice job. I'm going to wrap up with a few comments about the general economic conditions and our outlook. We're having a record-setting year of tourism at our National Parks, as the low gas prices seem to have been having a positive impact on visitations. Both Yellowstone and Glacier National Parks are on pace to set attendance records, with Glacier up more than 20% over last year.

The unemployment trends continue to be very positive in Montana and South Dakota, with South Dakota still having the lowest unemployment rate in the country, at 2.9% for August. In Wyoming, where the weaknesses in oil and gas industry has had more of an impact, we have seen some more encouraging trends recently. The unemployment rate in Wyoming declined to 5.5% in August from 5.7% in July.

In the last month we've seen some recovery in prices in many parts of the agricultural market, although prices on livestock continue to be under pressure. But as we have indicated before, our ag customers are very well seasoned and have very solid balance sheets that can withstand periodic weaknesses in commodity prices.

So far this year, our organic loan growth has pretty much been right on the pace as we expected. And we still expect to reach mid single-digits of loan growth for the full year. With this pace of growth and continued momentum in our fee generating businesses, and the continued focus on expense control, and a full quarter of earnings from the Flathead Bank acquisition, we should see a positive trend continuing in the fourth quarter.

Since the Flathead Bank acquisition is behind us and our scalability initiatives are well underway, we will continue to look for other M&A opportunities that can provide strong strategic and economic benefits. Through the solid execution of our organic growth initiatives and continued accretive virgin acquisition transactions, we're optimistic about the opportunity to continue to create additional shareholder value going forward.

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

(Operator Instructions)

Jared Shaw, Wells Fargo Securities.

Hi, good morning.

Good morning, Jared.

On your comments on the improving unemployment rates out in Wyoming, is that due to energy coming back at all? Or is that just a repurpose of people finding other jobs outside of the energy space? Can you give us an update with what you're seeing out there in terms of the actual level of drilling and pumping and things like that?

I think it's more a repurpose but there is a start there. Some drilling is starting to start all over again in those markets. Though be it kind of slow and slight, but there is starting to have some more drilling happening in our energy areas.

And are you writing any new loans on the energy space> Or are you just dealing with what you got right now?

We are not writing any new loans in the energy space.

Okay. Shifting a little bit to the expenses with the move, with the move down in salaries and wages from incentive comp, what's a good rate to use going forward? How much was due to lower incentive comp? And now that we have the new operations from Flathead in there, what's a good base to use (multiple speakers)?

I think somewhere right around $61 million a quarter is probably a good rate.

Say that again, I'm sorry.

About $61 million. $60.5 million to $61 million a quarter, I think, is a good rate.

Okay.

If you're talking about total expenses, non-interest expense?

No, no, I'm sorry. Talking about looking more at the salaries and wages (multiple speakers).

Okay, I was commenting on (multiple speakers).

Jared, this quarter our incentive comp was right on what we expected. In last quarter it was a little bit higher. So incentive comp this quarter was about $1 million less than it was last quarter.

As far as expenses, we have three payrolls for the Flathead employees in the run rate this quarter and that's a $200,000 that we have in this quarter. So if you take that over, it's like $600,000, $700,000 a quarter that Flathead would add.

Okay.

Part of the reason that they remained a little bit down too, is last quarter we also had some separation pay in that number. And so basically the separation pay from last quarter was offset by the Flathead acquisition this quarter.

Okay, great. And then finally, on the M&A front, could you say have you seen an increase in the number of conversations or people willing to start having conversations? Or has that been relatively stable?

I would say it is relatively stable but there's a number of conversations always being had.

Great, thank you, that's it for me.

Jeff Rulis, D.A. Davidson.

Thanks, good morning.

Hi, Jeff.

Marcy, on the margin, could you segment out you have got reported 3.58% and 3.42% core. What's the makeup of the addition from the interest accretion and the interest recovery in the quarter in basis points?

So the interest accretion makes up -- the reduction in the interest accretion is about 3 basis points.

What was it the previous quarter?

Well, you know --

I'm just trying to get -- go ahead.

You know, Jeff, let me get back to you will all the pieces in that. The impact from the total accretion and the recoveries charged-off loans had a 4 basis point impact. And so if you back out the regularly scheduled accretion, that would been another 3 basis points lower. So does that help?

Yes, sequentially, it looks like you had in total, you had 16 basis points of benefit from both accretion interest and the recovery of interest. So I'm just trying to figure out what is accretion and what is the interest recovery. Assuming, did you have interest recoveries in Q2?

Say that one more time?

Did you have any interest recoveries in Q2?

Yes, just a little over $100,000.

Okay, so a little over $100,000 versus I think you said --.

$1.8 million.

Got you, thanks. And let's see, on the -- Kevin, on the loan growth you commented on how you expect to finish the year, but any early gauge on 2017? Is that shaping up as, again, a mid-single digit for the full year?

I would say that's mid single-digits. Again, loan growth is kind of uneven. Montana is probably the highest growth state, then comes in South Dakota, then comes in Wyoming. You average it all out, I would say we're probably still looking at mid single-digits for next year.

Great, and as we are projecting things, one of the question on the mortgage total revenue as you budget into 2017, how do you expect that number to shake out relative to what you saw -- well, what we've seen annualized for 2016 on just the mortgage component alone?

I would say the housing market is pretty strong so I would say it is going to be at or maybe a little bit lower, but right around the same area that we did this year.

Okay, fair enough. Thank you.

Matthew Clark, Piper Jaffray.

Hey, I think I can help on that last question. I think prepaids contributed 9 basis points this quarter versus 1 basis point last. 7 basis points of accretion this quarter versus 9 last quarter using day count. My first question is really on -- curious what the weighted-average rate was on new production this quarter?

It was about 4.68%.

Okay. And your core margin down 4 basis points looks like it is because the core loan yield ex prepaids and accretion was down about 5 basis points to 4.58%. So new production going, still 10 basis points above that core loan yield. Curious what your thoughts are on the core margin outlook here.

So we think it will remain stable. It may go down a couple of basis points, but we don't anticipate any more than that.

And again, that pressure point with new business going on above portfolio is what?

Say that again, Matt. What's your question exactly?

I'm sorry, I'm just curious what the pressure point is there with you thinking may come down a couple of basis points, given that you're putting on new business about the portfolio yields? The core margin.

You always can have the mix of -- we always get concerned deposits could continue to increase and our loan-to-deposit ratio could come down a little bit. That would have pressure on the margin.

Yes, it's just that mix.

We're just being conservative. I don't think it is really the pressure of assets, it's just kind of a mix on the balance sheet that could have a little bit of impact.

Okay. You have been seeing a favorable mix shift in assets with securities into loans, it looks like, over the last few quarters, so that should help mitigate it, I would think.

(multiple speakers) the first part of the year we have less deposit growth so that we had that shift. And then in the later part of the year we had (multiple speakers) -- reverses that shift. So it takes some of the benefit away.

Got it, okay. And then any share repurchases this quarter?

No.

Okay. That's it for me right now. Thanks.

Matthew Forgotson, Sandler O'Neill.

Hi, good morning.

Morning, Matt.

On the expense guidance, is $60 million to $61 million, is that base and then we layer in the incremental from Flathead? Or is that stabilized for Flathead?

That's stabilized with Flathead. Flathead didn't add too much of an expense base. We were able to pretty much absorb that with the efficiencies that we're achieving in the institution. So you're not going to see much of an increase from Flathead, if any.

Got you. And then in terms of your balance sheet positioning for rising rates, I know you got some pretty nice lift in the first quarter of the year from the December rate hike, but what's your current sensitivity, say, to another 25 basis points hike if that in fact comes to fruition?

It should benefit us like the last one.

Okay. And then, in terms of the $10 million uptick in special-mention loans, you attributed that to two specific credits in Wyoming. Can you tell us a little bit more about those credits?

Yes, this is Steve Yose, the Chief Credit Officer. One of the credits was directly energy-related as far as the risk-rating change. And then the other was related to -- it was a C&I credit that was impacted just from the general economy there slowing down a little bit.

The net decrease, if we wouldn't have had those increases in Wyoming, would actually be lower. I think we had a $14 million increase in the oil and gas sectors so our net decrease would've been less than $10 million.

So it really is really in the oil and gas sector what we've seen, the impact on criticized. However, our specific allocations have remained steady in the oil and gas portfolio.

Okay. And you said the first credit, that's direct? So that's collateralized by oil and gas? Or is it a borrower who services that industry?

One is direct oil and gas. And the other one services -- it's not an oilfield services, it's one that's just in the economy and impacted by a slowdown in the economy.

Got you. And then lastly, if you would please remind us what your current balance of unfunded oil and gas credits is today?

The unfunded is approximately $24 million.

Thank you very much.

Tim Coffey, FIG Partners.

Thank you, good morning, everybody.

Good morning, Tim.

Kevin, Marcy, you talked about bringing cash down to a normalized level. What is that level? Because it seems that cash has always been a sizable portion, relatively sizable portion, of earning assets?

We try to target to about $0.5 billion.

Okay.

It may be a little higher than that but we try to target $0.5 billion.

Do you feel any pressure to stay above that level, given that are discussions about M&A ongoing right now?

No.

Thanks. The rest my questions have been answered.

Thanks, Tim.

(Operator Instructions)

Jackie Bolin, KBW.

Hi, good morning, guys.

Good morning, Jackie.

Looking at the mix of refi versus purchase in this versus last quarter, was the uptick in refi volume, was that due to higher refis or lower purchases?

Higher refis.

And is there anything unique going on or any marketing efforts behind that? Or is it the natural ebbs and flows that you're seeing in your market?

Natural ebbs and flows.

Okay. And as I look at that number, when you think about volume obviously 4Q tends to be a little bit seasonably weaker. How has generation been so far in the quarter?

For the mortgage portfolio?

Yes.

Generally we do see a slowdown in September, but we haven't seen that yet. So through the month of October we have continued to see a pretty strong stable pipeline.

The weather's holding out pretty well out here, so as long as it stays warm, people are out buying.

Okay. And then, Kevin, this one might be a question for you. In light of a lot of the investments you've been making in IT, and obviously cost saves from the acquisition go into this as well, how do you manage to hold the expense line in light of some of the growth you may have had in some areas?

How do we manage to hold the expense line?

What I'm asking is are there other areas where you have been able to trim that we might not be seeing or perhaps haven't been discussed?

Well, what we continue to do, and I'll be honest with you, we continue to rationalize our staffing levels in our branches. We continue to rationalize and we talk about some process improvement, rationalizing staffing levels in some of our operation in backroom areas. So we're going through department by department, and actually restructuring departments around what it takes to be scalable. So we are seeing some efficiencies as we go through that process.

And really, Jackie, even with natural attrition that we have, we reevaluate at each point that someone retires or chooses to leave, do we need that position and refill it? Do we need to refill that position?

Okay. So a lot of the staffing is happening through attrition?

Yes.

Okay, thank you. That's good color. Thanks, guys.

There are no additional questions at this time. This concludes our question-and-answer session. I would like to turn the conference back over to Kevin Riley for closing remarks.

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

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.