First Interstate Bancsystem Inc (FIBK) 2017 Q1 法說會逐字稿

Hello, and welcome to First Interstate BancSystem First Quarter 2017 Earnings Call -- Conference Call and Webcast.

(Operator Instructions) Please note, this event is being recorded.

I'd now like to turn the conference over to Kenzie Lawson, Investor Relations.

Please go ahead, ma'am.

Thank you.

Good morning.

Thank you for joining us for our first 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 our management team.

At this time, I'll turn the call over to Kevin Riley.

Kevin?

Thanks, Kenzie, and good morning, and thank you, again, to all of you for joining us on our call today.

I'm going to provide an overview of the major highlights of the quarter, and then Marcy will provide us with more details on the financials.

For the first quarter, we reported core earnings per share of $0.52.

While this represents over a 15% increase over the last year, frankly, we are disappointed with our results in our loan growth, which was somewhat weaker than we expected.

While weather was a factor and the first quarter is always seasonally slow, which may explain our mortgage and construction lending being soft, the biggest contributor to the underperformance was a change in the operating environment in our markets.

We've spoken with you -- many of you about how throughout this low interest rate cycle, the banks in our markets have generally competed against each other with a high level of respect for responsible banking and prudent risk management.

But as you know, we operate in a market where economic growth is more subdued than most areas of the country and loan demand is modest, even in the best of times.

However, over the past couple of quarters, with a relatively soft loan demand in our markets, we've seen a greater degree of unreasonableness in both pricing and terms, which we haven't experienced in the past.

Banks are booking 15- and 20-year fixed rate deals at very low rates.

And we're seeing this primarily from the community banks and mainly in the commercial real estate sector.

The old cliche of "the worse loans are made during the best of times" seems to be playing out in our markets.

And you can't blame the borrowers.

Interest rates are increasing.

Borrowers are looking to lock-in low fixed-rate loans with long maturities.

And much to our chagrin, they are finding institutions that are willing to accommodate them.

While we don't understand the motivation, many of these banks appeared willing to take on high levels of interest rate risk.

Conversely, the big banks are not playing in this game.

While they offer aggressive pricing, they are not offering the length in terms, which we're seeing from the smaller banks in our market.

When a good portion of the modest loan demand gravitates toward banks with irrational lending practices, it makes it very challenging to grow loan balances.

As difficult as this report our results this quarter, we simply are not going to take additional interest rate risk or duration risk during this point of the cycle.

We are in this for the long haul, and we believe prudent banking during this time would bode best for the bank and our investors.

So, as I mentioned, this dynamic is most pronounced in our commercial real estate market.

And our CRE loans were down approximately $15 million in the quarter.

On the positive side, our commercial loans were up $20 million in the quarter.

This growth was broad-based across our markets and industries, and there were no large new loans made.

This growth represents true relationship banking with small businesses across our footprint.

We also continue to see growth in our indirect auto lending portfolio, which was up $10 million in the quarter.

In January, we made some adjustments in our indirect auto program to implement and enhance risk-based pricing model.

This portfolio representing just over 14% of our total loans.

The adjustment we made are reducing new origination volumes with shorter terms, while increasing our core profitability on each loan.

What we've been able to do is to scale back on the dealer reserve payments on the longer-term loans, which have an actual duration significantly shorter than the original contractual obligation, which causes the write-off of unamortized reserves.

The credit quality of this portfolio continue to be very good.

Our 30-day delinquency rate at the end of the first quarter was 1.03% compared to 1.56% for the peers that we track in this business.

Our net charge-offs for the first quarter were 28 basis points compared to 78 basis points for our peers.

And only 4% of our loans in the portfolio are classified as subprime loans compared to approximately 12% across the industry.

Since we made the adjustment to our pricing model, less than 1% of our new originations in 2017 would be considered subprime loans.

So level of subprime loans in the overall portfolio will likely decline as this trend continues.

Looking at some of the other notable items in the quarter, one of the other positive trends we are seeing is the expense management.

We continue to do a good job controlling expenses, while still investing in people, processes and technology.

Year-over-year, our noninterest expense, excluding acquisition expense, was up only 1% despite this significant upgrades we've made to our infrastructure to equip the company to better compete in the new era of digital banking as well as prepare for the increased regulatory requirements associated when crossing the $10 billion threshold.

We're focused on achieving operating leverage as we scale the company, and we expect the ability to manage expense levels will translate into higher profitability as we see greater revenue growth in the future.

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

Go ahead, Marcy.

Thank you, 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 fourth quarter of 2016.

And I'll begin with our income statement.

Net interest income decreased $4.7 million on a linked-quarter basis.

As you recall, we had a $1.8 million interest adjustment in the fourth quarter that accounted for 38% of this difference.

Additionally, 2 less accrual days, lower accretion income, and a higher cost of funds account for the remaining balance.

Our reported net interest margin decreased 13 basis points in the quarter.

However, excluding the impact of the onetime interest adjustment, which had a 9 basis point impact on our margin last quarter, and excluding interest recoveries and accretion income, our core net interest margin decreased 3 basis points.

This 3 basis point decline was primarily due to a decline in outstanding loan balances.

I don't want to skip over funding cost, and as we stated many times, we believe our clients have been waiting to see some type of return on the funds they've entrusted to us.

And we've positioned ourselves to able to meet this expectation once rates increased.

As a result, we've returned approximately 27% of the last 2 rate increases to our clients.

As a leader in the communities we serve, we feel like this is our responsibility.

And as we continue to meet the needs of our clients, our shareholders will be well served.

Moving to noninterest income, the $5.7 million decrease from the prior quarter reflects the seasonal weakness we experienced in fee income during the first quarter.

Mortgage banking revenues were down $2.4 million from the prior quarter were relatively flat compared to the first quarter of last year.

Mortgage originations for home purchases accounted for 54% of our first quarter loan production, down from 59% in the prior quarter.

Wealth management revenues were down $711,000 from the prior quarter, primarily due to lower brokerage revenues, but were up $438,000 compared to the first quarter of last year, reflective of the growth we had in assets under management over the last year.

Our total noninterest expense decreased by $5.9 million or 8.5% from the prior quarter.

If you exclude acquisition-related expense, our noninterest expense decreased approximately 7.3%.

The decrease was primarily driven by decline in salaries and benefits expense as lower incentive and profit sharing accrual more than offset the higher employee benefits expense that we incurred in the first quarter.

In addition, we incurred $727,000 of separation expense related to the restructuring of departments as a result of the internal assessments we told you we were performing last year.

Looking at the balance sheet, total assets were flat quarter-over-quarter.

And Kevin's already discussed the major trends in our loan portfolio, so I move to deposits.

Total deposits declined by approximately $76 million or about 1%.

We saw some shift in the mix within our core deposit accounts during the first quarter, along with some runoffs in our CD balances.

Now moving to asset quality, our nonperforming assets increased by approximately $2 million in the quarter, which is in the normal range of quarter-to-quarter variances that we've been seeing.

Our total criticized loans increased by approximately $11 million.

This increase was driven by the downgrade of 2 commercial borrowers aggregating $23 million.

The increase was partially offset by a decrease in special mention loans.

The new loan grading system we implemented in the first quarter is improving the granularity of risk ratings within the portfolio and is allowing us to understand which borrowers require heightened level of attention in monitoring at an earlier stage than we've had in the past.

And while overall criticized assets have continued to increase over the last year, as we've implemented these new processes, we are not seeing a systemic issue throughout the portfolio.

The implementation of these changes and the resulting increase in criticized loans have had minimal impact on our credit costs.

Net charge-offs in the quarter were just $1.7 million or 13 basis points of average loans.

Our provision expense of $1.7 million cover these net charge-offs and increased our overall allowance level to 1.4% -- 1.41% of total loans from 1.39% at the end of last quarter.

We believe the allowance is more than adequate to cover the risk within the portfolio.

Further, since you always ask about oil and gas, the allowance against that portfolio remains high at 10.3%.

And then lastly, as we noted in the earnings release, changes in accounting rules allowed us to record a $1.4 million benefit in income tax expense, which was related to the exercise of stock option.

With that, I'll turn the call back over to Kevin.

Kevin?

Thanks, Marcy.

Nice job.

I'm going to wrap up with a few comments about our outlook.

The economic trends in our existing footprint are relatively stable.

While challenges in the energy and the commodity markets have -- had a negative impact on some areas, Wyoming is beginning to show some signs of stabilization.

The latest gross state product, GSP data, which reflects the third quarter of 2016 activity showed Wyoming with a 0.3% annualized growth rate in GSP.

While this number alone is below the national average, it is important to note that this marks the first time in 10 quarters that Wyoming State GSP wasn't negative.

While we don't expect to see much growth in our Wyoming market, it appears as though it won't be much of a headwind as it has been over the last -- past couple of years.

We also see some improvement in Wyoming's labor trends, which is now at 4.7%, down from 5.6% at this time last year.

As for Montana and South Dakota, improving commodity prices have assisted in providing some stability to farm incomes.

Tourism also remained strong as consumers feel the tailwind of favorable national economic trends, rising asset prices and a continuation of low fuel prices.

Labor markets in Montana and South Dakota remained tight, with unemployment levels at 3.8% and 2.8%, respectively.

We're also very excited about the opportunity that lies ahead in the new markets as a result of the up and coming merger with the Bank of the Cascades.

Economically, these 3 states in which the Bank of Cascade operates, Idaho, Oregon and Washington, provide a highly complementary profile to our existing footprint, with exposure to high-performing industries and favorable population growth metrics throughout the region.

In addition, key economic metrics such as home price indices and labor markets, future validates the health of these markets, particularly in Oregon and Idaho.

Heading into the second quarter, we typically see a pickup in loan growth.

Over the past 3 years, the second quarter has been the strongest quarter with total loans increasing around 3% on a linked-quarter basis.

As we indicated earlier, commercial loan production was healthy in the first quarter, and we continue to have a good pipeline of business development opportunities.

Indirect auto continues to perform well.

We're heading into the seasonally strong periods of residential loan production, and the inventory of available homes in our markets is extremely low, which should drive an increase in demand for residential construction.

Collectively, these favorable trends should help us to offset the headwinds we are seeing in the commercial real estate lending area.

At the same time, we are stepping up the activity with our lending teams to make sure that we are getting a look at every possible commercial real estate deal in our markets.

With volume of attractive opportunities decreasing, it is critical that our team get us involved in every lending opportunity that meets our criteria.

Since the start of second quarter, we're seeing increases in our total loan balances and in every loan category in each of the first 3 weeks.

So we are confident we are on track to produce a good quarter of loan growth.

Finally, we are ahead of schedule in completing our merger with the Cascade Bancorp, and now expect to close the transaction at the close of business on May 30.

We're very excited about leveraging the strength that Cascade would bring to our franchise and capitalizing on the higher growth markets in which they operate, Washington, Oregon and Idaho, states all rank in the top 10 in home price appreciation, with Oregon and Washington being first and second, which speaks to the underlying strength of these states' economies.

Cascade markets will also provide important diversification to our franchise.

Oregon and Washington and Idaho are more influenced by manufacturing, information technology, professional services and real estate sectors than our existing markets.

As reflected by Cascade's strong first quarter loan growth, getting into these markets will reduce the impact of more cyclical industries like energy and commodities have on our overall performance.

We have a number of products that we've had a lot of success with such as indirect auto lending and our business credit card that aren't currently offered by Cascade.

And we think we'll be able to generate some valuable revenue synergies by rolling out these products in our new markets.

Also, Cascade has a strong SBA platform that we'll be able to leverage across our existing current footprint.

In terms of additional synergies, we've been impressed by the employees at the Bank of the Cascades and have seen a number of complementary aspects between the 2 companies' cultures.

We look forward to welcome our new colleagues to the First Interstate's family.

With the revenue, cost and cultural synergies that we have projected from this merger, combined with the entrance into markets with more robust economies than our current footprint, we're excited about our opportunity to generate profitable growth to our shareholders of the combined company in the years ahead.

So with that, we'd like to open the call up for questions.

(Operator Instructions) And the first question comes from Jared Shaw with Wells Fargo Securities.

Can we spend a little time on the margin here?

I guess, the deposit cost increase is more than we've seen at other banks in light of sort of the move in fed funds.

As you're looking at deposit betas now, I guess, one, were you surprised at how much you had to pass-through, that 27% does seem a little high compared to where we've seen other banks?

And then going forward, do you think that we're starting to migrate now into a higher beta environment almost immediately for you, if we see more rate hikes?

Yes, I don't usually get that question, Jared.

Good question.

With regards to passing back, I think, Marcy explained it, we believe that we can hold our margin -- net interest margin, and I know the cost of funds went up and I know it might be a little higher than what other banks are doing.

We believe we have a social responsibility since we're the largest bank in these markets to give back what we can afford to our customers.

I think other banks are not being realistic with regards to deposits.

And I think you would have seen it written in a number of places that their betas and -- because we haven't seen a rising rate environment for like 10 years.

So the thing is that the average beta on a raising rate environment is about 50 basis points.

And people believe that this is going to be different at this time and it could run as high as 70%.

So my belief is, we'll continue to bake that into our results moving forward.

And if we have to put some stress on other institutions, because they can't afford it, then so be it.

But we believe that we can afford to keep our margin.

The only drop in our margin really is because our loan volume dropped.

If that didn't drop, our net interest margin on a core basis would have stayed flat.

But we believe that at some -- you're going to have to pay that price due to the fact that online providers are offering 125 to 130 regards to deposits.

And in today's environment, deposits can move by a click of the finger.

When you look at the, specifically like the decline in noninterest-bearing demand, did you see that just get reallocated within the bank?

Or was that actually where you're seeing some outflows?

I do see in the first quarter, we see outflows.

And it always happens in the first quarter, if you look at our trends.

It's nothing that's unusual than we normally see as the outflows in the first quarter.

And then once tax season is over, we start to seeing deposits increased throughout the year.

That's consistent.

So we haven't seen anything that's been unusual this quarter.

Okay.

And then, on the indirect auto yields, are those moving pretty much in lockstep with rate hikes?

So as we see a 25 basis point move, are you able to pass that through on the new production pretty quickly?

Yes.

So in terms of like your buy rate, it goes up basically 25 basis points when the fed funds do?

Actually, as I mentioned earlier, our buy rates are actually getting better because we're putting a little pressure on how much we're paying for dealer reserves now.

Okay.

Okay, right.

And then finally, you've got -- as you look at the $10 billion threshold and the closing of the Cascade deal, can you remind us of what you look at is the sort of the time line of layering in the expenses -- the increased expenses or the change in revenue from crossing the $10 billion threshold and what we should be looking for in the next few quarters after closing?

As we've said in the past, we've been preparing for the $10 billion guys.

So we don't anticipate any real additional costs.

We've been layering compliance, people, and we've been layering in the systems in the stuff already.

So we're not anticipating our cost will really increase at all.

That's already been pretty much baked in.

But we are going to lose about $11.5 million, as we've mentioned before, on the Durbin Amendment, and that actually comes out in...

Mid-'18.

Mid-'18.

So the compliance costs are baked into the 64.5 run rate that we provided for expenses.

(inaudible)

And that includes like anticipated cost from DFAST filing and things to -- I mean that's all through the personnel line?

Yes.

The systems we bought, we paid.

Again, we've been putting the systems in the last couple of years through the loan stress testing and stuff.

So that's all been baked in.

And the next question comes from Jeff Rulis with D.A. Davidson.

The loan growth, I guess, Kevin, you had expected mid-single-digit growth for '17.

Does the start of the year and some increased CRE to competition, does that dampen that year outlook?

Not that much, because certainly, like we said, we've always looked to like mid-single-digits.

And our second quarter usually is a robust quarter.

So I'd say, it might have a little impact, and I don't think it has a lot.

We're hoping for a flat first quarter.

Got you.

The -- if you're pulling back a little bit on CRE, is there other areas of the loan book that you put a little more attention to or can drive growth, not straining, but just applying more resources elsewhere?

Is there anything that looks more attractive in your view?

I think the overall -- Bill, you want to answer that question?

Certainly.

This is a Bill Gottwals.

We aren't really pulling back on the commercial real estate side.

We've just seen increased competition there, which is what we saw in results for the first quarter.

If there is an area that we're probably putting additional resources to and focus, it's really around the small business area.

It's something we've done well in the past.

But there is certainly a different level of pricing competition there.

So I think that's an area we're putting more attention on than in the past.

Great.

And then, maybe on the mortgage revenue outlook, in terms of origination sale of loans at line item, any outlook there?

I think normal seasonal patterns in Q2 that figure was up 50% sequentially last year.

Any thoughts on the outlook for that line item?

We think it's going to kind of pattern -- same pattern as last year.

We are anticipating that our mortgage revenue will be flat to last year.

I think the....

For the full year?

Yes, I think, we disclosed that in the past.

Got it.

Okay, thanks.

And then one last one.

That's supposed to stay stand-alone, not with the acquisition.

Sure.

And in terms of the -- one last one just -- the goodwill and other intangibles went up a bit.

Do you have the breakout of the 2 buckets in the most recent quarter?

It will be in our 10-Q.

We bought her name.

So that was the increase and that was disclosed, but we're not supposed to disclose, actually, what we paid for a name underneath the agreement, but that was the increase in our intangibles.

Okay.

And then the, I think, the goodwill on the Cascade and other intangible CDI, are those $275 million and $40 million, respectively, in the ballpark of those 2?

I don't have that -- that sounds close.

We'll have to get back to you on that question.

Yes.

And the next question comes from Matthew Forgotson with Sandler O'Neill.

Just wondering in terms of the margin outlook from here.

I guess, just on a core basis, as you said, you're down about 3 basis points sequentially to 344.

What's your expectation for the trajectory from here?

Do you think, if loan growth accelerates, could you see some margin expansion?

Or you kind of running to hold it in line?

What's your view here?

We're anticipating margin expansion as loan growth comes back.

What we've lost, Matt, really, we believe we're going to make up in the second quarter and then some.

Okay.

And on the expense side, I know you said for stand-alone First Interstate, you're targeting $64.5 million average run rate for the year.

In light of the first quarter's performance and updated expectations, can you give us a sense of -- is that guidance still intact?

Or do you see -- is there some downside may be to that?

I think there could be some downside in that.

I think it could be more like $63.5 million.

Okay.

And I guess, just lastly, can you give us a little bit of color on the decline in special mention this quarter?

Tough to discern in the release if there was any migration from special mention to substandard that resulted in that decline in special mention.

Or are you just seeing an overall decline in new "problem loans?"

I'll answer from my perspective and then I'll have Steve Yose, our Chief Credit Officer.

What I would say there was a lot of movement in the first quarter with regards to classifications and part of it was because, as Marcy mentioned, we instituted a new grading system in the first quarter to look at our loans in a more granular sense and actually get heightened awareness about loans that might be deteriorating.

So in my remarks, we have people who are doing some irrational banking.

Some of those loans that were criticized and actually some nonaccrual loans were actually passed off to some of our competitors nicely.

But with a new grading system, we had some auto loans that we put into that bucket so we could have better attention on.

But I would say, the portfolio today is in good shape or better than it was last quarter just due to the fact that we have more visibility on the loans that we're looking at.

And we're able to move out some loans that were -- loans that were not going to get any better anytime soon.

Stephen, you want to add anything to that?

Yes.

I would agree with Kevin.

We're looking very closely the timeliness of risk ratings and our new risk rating system also has some more granularity that helps us look at say a watch category more.

So we're looking very closely at the special mention category.

And so we did have some upgrades in risk ratings for those through a past risk rating from special mention.

And we are also focusing in a very disciplined approach with our special assets group in our substandard category to look more closely like we were able to exit, we said, $4.8 million nonaccrual.

We're hopeful that we can continue to have increased discipline to exit those nonaccruals or improve them in a way to improve that, which will also improve asset quality.

(Operator Instructions) And the next question comes from Jackie Bohlen of KBW.

Do you have an updated time line on integration on -- just as given the earlier close date for Cascade in terms of conversion and everything?

Conversion, we're keeping at the same weekend of August 11.

We've moved up the close date, but we plan the conversion for a period of time, that'll happen on August 11.

So that's when it's going to happen.

Okay.

And assume that just given how quick you have been on other integration that probably by the end of third quarter, you should have everything nice and cleaned up?

That's correct, Jackie.

Everything should be cleaned up and all wrapped around it by the end of the third quarter.

Great.

And then, in terms of the tax rate with and without Cascade, do you expect there to be any meaningful change there?

No.

There shouldn't be a meaningful change.

It should equate to about what our tax rate is.

Okay.

And bounce back up from 1Q level?

That's correct.

And as there are no more questions at the present time, I would like to turn the call over to management for any closing comments.

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.

Thank you.

The conference is now concluded.

Thank you for attending today's presentation.

You may now disconnect.