First Interstate Bancsystem Inc (FIBK) 2011 Q3 法說會逐字稿

Good morning. Welcome to the First Interstate BancSystem Inc. Q3 earnings conference call and webcast.

All participants will be in listen-only mode. (Operator Instructions). After today's presentation, there will be an opportunity to ask questions. (Operator Instructions). Please also note this event is being recorded.

I would now like to turn the conference over to Marcy Mutch. Ms. Mutch, please go ahead ma'am.

Thank you Rocco. Good morning. Welcome and thank you for joining us for our third-quarter investor conference call.

Before we begin, I'd like to remind everyone that some of the remarks today may constitute forward-looking statements particularly regarding revenues, quarterly provisions for loan losses, net interest margin, loan growth and nonperforming assets. We may also make other forward-looking statements, including statements about our plans, strategies and prospects. I would remind you that all forward-looking statements are subject to various risks and uncertainties and our actual results may differ materially from those expressed or implied by such statements. For a full discussion of the risks and uncertainties associated with our forward-looking statements, please refer to our Securities filings, in particular the Risk Factors section of our most recently filed Form 10-K.

Joining us from management this morning our Lyle Knight, our Chief Executive Officer, and Terry Moore, our Chief Financial Officer. Lyle will begin by giving you a general overview of this quarter's results and review economic conditions within our footprint. Terry will follow up with more specific information behind the quarterly results and provide a general review of credit quality information. Bob Cerkovnik, our Chief Credit Officer, is also with us this morning. Bob will be available during the question-and-answer time to address specific questions concerning our loans and asset quality.

At this time, I'd like to turn the call over to Lyle Knight. Lyle?

Thanks Marcy. Good morning. Thanks to all of you for joining us on the call.

Last night, we were pleased to report earnings for the third quarter of $11 million, which equates to diluted earnings per common share of $0.26. We had a solid quarter with net income exceeding second-quarter earnings by 23% and 41% over third quarter of 2010.

Let's talk about revenues. Our net interest margin held steady despite a challenging interest rate environment and weak loan growth. The key was to maintain our focus on lowering funding costs along with a favorable shift in our deposit mix. Terry will discuss our net interest margin in more detail in just a few minutes.

Now, at the same time, we saw 7% growth in non-interest income this quarter compared to last quarter as a result of fee adjustments implemented earlier in the year, along with a 10% increase in credit card volume mainly driven by our small business customers, which led to an increase in credit card interchange income.

As I look back to the beginning of the year, I would never have predicted residential mortgage rates would get as low as they are now and create another refinancing boom, but that's exactly what's happened in our markets. Income from the origination and sale of loans was up 34% on a quarter-to-quarter basis with refinancing activity accounting for 53% of our originations this quarter. Now, while this is good news, the real silver lining is that purchased home activity made up almost half of the volume for the quarter. Some of our competitors for this line of business have left our markets, so purchase loan activity should continue to grow.

As far as refinancing activity, we expect it to stay strong through the fourth quarter, but then we anticipate it tapering off as we head off into next year.

Last quarter, we spoke about our Wealth Management business. Wealth Management revenues, while up on a year-over-year basis, took a small dip this quarter mainly due to market conditions which resulted in a decrease in Assets Under Management. But still there's a lot of momentum and Wealth Management as we continue to see new activity, primarily in the trust area. We believe they'll be a steady revenue generator for us on a go-forward basis.

Let's move to expenses. We've made progress managing our non-interest expense which, apart from mortgage servicing impairment, has decreased $2.6 million year-over-year. We continue to look for better, more efficient ways to do business and are making headway with our cost structure initiatives. We have been successful in implementing business process improvements, renegotiating contracts, and restructuring our data communications network.

From our high point in September of 2008, we're down 105 FTEs. We feel our current FTE levels can be sustained and even improved upon going forward.

On the balance sheet, we find that generating low growth remains one of our largest challenges. We continue to see declines, primarily in our construction portfolio, and expect declines to continue until we see some improvements in the overall economy.

Over a year ago, we decided to hold some of our residential mortgage loan originations. Now, remember, these are 15-year mortgages made within our footprint and underwritten to secondary market standards.

Our Commercial Real Estate portfolio remains steady and we're hopeful that we can replace the current run-off. We do have markets with fairly strong economies that have the potential to generate new loan growth. However, in the near future, we don't think the uptick in those markets will result in any meaningful overall loan growth.

We are encouraged that our nonperforming assets are headed in the right direction. We had loans flow into the nonaccrual bucket which were offset with reductions from charge-offs, payoffs, and a $1.4 million transfer to OREO. Along with minimal net changes to TDRs and OREO, we had a modest decline in nonperforming assets this quarter.

We're equally encouraged by the continued downward trend in criticized loans which we expect will continue to further improve in our -- will give us further improvement in our nonperforming asset levels in future quarters.

When we talk about credit, particularly nonperforming assets, remember we take a long-term view of creating and protecting shareholder value. If you were to look back at our historical loss percentages, say go back 20 years, you'll find that we were lower than our peers in 16 of those 20 years. During the four years that we exceeded peers, it was by 3 basis points or less. We have a long history of managing difficult credits through trying economic times. Even with this prolonged credit cycle, we believe our approach is successful and in the best long-term interest of the shareholders, of course the Bank, as well as the communities we serve.

Now, as far as our local economic drivers, things are holding relatively steady. The Office of Tourism said last week that Montana tourism should hit the 2% growth predicted for the year. This increase, which of course exceeds the national average, is due to the influx of people that were here cleaning up the Yellowstone River oil spill, along with a favorable Canadian exchange rate and a targeted advertising campaign by our tourism department. In August, visitations to Yellowstone National Park topped the 800,000 mark for only the second time in history. So while overall visitations were down from the 2010 high level, we still had a very meaningful tourism season.

Jackson Hole, Wyoming reported encouraging news with August generating the highest level of sales tax revenue they've seen since 2008. Despite a slower year for tourism in South Dakota, which is estimated to be down about 4% from last year's record high, the state remains very strong and has a very low 4.6% unemployment rate. This is interesting when looking at central and eastern Wyoming, because they continue to be positively impacted by energy production, and the banking markets in those areas are healthy. Now, year-to-date, if we were to exclude the Jackson market, we would've seen a $72 million increase in new loan growth in Wyoming.

I spoke a lot about agriculture last quarter, so I'll just summarize by saying the good fall weather has helped by extending the harvest season and cattle and crop prices and production both remain strong.

With that, I'll turn it over to Terry to drill down into some of the specifics for the quarter.

As Lyle has reported, earnings for the third quarter were $11 million with diluted earnings per common share of $0.26. This quarter's 7 basis point decrease in cost of funds allowed our net interest margin to remain stable and steady at 3.84%. We believe that we can still reduce funding costs going forward. However, with a cost of funds of just 61 basis points, those opportunities are somewhat limited. Therefore, it will be more difficult to offset the declines we expect to see in asset yields through a reduction of cost of funds.

The effective life of our investment portfolio has remained short and at a current effective duration of only 1.9 years. We continue with a consistent, conservative investment philosophy and with normal turnover in the $2 billion portfolio, expect yields to reflect declines over the next few quarters. The decline in investment yields will largely offset improvements expected in our cost of funds.

Now, loan yields declined 11 basis points quarter-over-quarter and 23 basis points from third quarter 2010. Although some of this is due to elevated levels of nonaccrual loans, most of the decline reflects the competitive pricing pressures within our markets. Because we expect loan yields to continue to decline due to competitive pressures, without meaningful loan growth and considering the current low interest rate environment, we are likely to see net interest margin decrease by a few basis point each quarter over the next several quarters.

Now to non-interest income. Low mortgage rates have led to a new wave of refi activity, which accounted for 53% of our activity this quarter and the increase in income from the origination and sale of residential loans. Purchased home activity has stayed stable compared to prior years with between $85 million to a little over $100 million in purchased home originations being generated during each of the second and third quarters for the last three years. While mortgage rates impact the refinancing activity from quarter to quarter, we're encouraged to see purchased home activity remaining fairly consistent and at significant levels over the recent years.

Other income decreased from the prior quarter, mainly due to fluctuations in the value of securities held under our deferred compensation plans. I mention this only to explain some of the decrease in salaries and benefits as well. While this has zero impact on our financial statement, market volatility resulted in a $769,000 swing in these accounts from the third quarter of last year to the most recent quarter. Yet despite a large part of the quarter-to-quarter reduction in salaries and benefits being due to this adjustment, we have made progress managing salaries and benefits. We've reduced FTEs by 42 over the last 12 months. Because the reductions have been spread across our company and other employees have been able to pick up additional responsibilities, we believe this reduction is sustainable and will equate to further savings in salaries over the long term.

Additionally, we've experienced a reduction in health insurance costs due to a significant decline in the number of large health claims.

Now, OREO expense was $3 million for the current quarter. $2.4 million of this amount was valuation adjustments made to eight properties. 52% of the valuation adjustments of this last quarter related to properties in our three stressed markets with the result being 68% of our OREO balances in these same three markets.

Now I'd like to turn to the balance sheet. There was a $30 million overall net decrease in loans held for investment as of September 30. While we had $20 million in charge-offs, this doesn't tell the entire story.

Construction loans continue to decline in large part because of the lack of demand within our markets. Construction loans declined $25 million this quarter and are expected to continue to decline quarterly until we see some meaningful growth in the economy.

Our three stressed markets accounted for a decline in outstanding loan balances of $38 million this quarter compared to the remainder of our markets, which reflected combined loan growth of $8 million. As Lyle said, we don't anticipate growth in outstanding loan balances over the next couple of quarters.

We've been pleased with the steady downward trend in our OREO balances over the last several quarters with sales of property of $4 million this quarter and $12 million year-to-date. We continue to record modest gains on the ultimate disposition of OREO properties, which increases our confidence that we have been recognizing valuation adjustments appropriately. However, now that the selling season is over, we can anticipate that there will be some borrowers that won't have the capacity to last over the winter months. So as some of our problem loans work through the credit cycle, we expect some improvement out of nonaccrual loans and into Other Real Estate. We don't anticipate OREO growing dramatically, but it is likely to show some increase over the next few quarters.

As I just mentioned, net charge-offs this past quarter were $20 million, 48% of this amount which is related to the three stressed markets. 73% of the charge-offs related to three borrowers and involved one Commercial Real Estate and two land development projects. We believe charge-offs will continue to be high for the next few quarters, but probably not to the level they were this past quarter.

We continue to believe nonperforming assets peak and will continue to improve over the next several quarters, but improvement may be a bit chunky as we work through some of the larger problem credits. With the continued downward trend in criticized loans and based on our migration analysis of historical losses, we anticipate loan loss provisions declining modestly as we go forward. The continued decline in time deposits is due to historically low interest rates with CD rates not high enough to entice many customers to tie up their funds for a period of time.

Additionally, our municipal CD balances have declined $70 million over the last six months as we've been less aggressive in pricing for those deposits. On the other hand, demand deposits have grown $300 million over the last 12 months.

Capital continues to remain strong and reflects improvements from all measures this quarter. Tier 1 common capital increased to 2.78% as of September 30 -- 10.78%, excuse me. We continue to far exceed well-capitalized requirements under all regulatory capital guidelines. Over the coming years, we expect to continue to generate excess capital, allowing for organic growth as well as strategic acquisitions.

With that, I'll turn it back to Lyle.

Thanks Terry. If you saw our press release last week, you know that the Board of Directors recently appointed Ed Garding as my successor, which will be effective next April. I am pleased with the Board's decision and feel that Ed is the right leader at this time for our Company. Ed couldn't be with us today, but I know you'll enjoy working with him and you'll have a chance to hear from him next quarter.

At the beginning of the year, we told you that, in 2011, we would have a three-pronged focus -- credit quality, revenue generation, and cost structure. Well, we've made progress in all three areas. We've seen NPAs decline modestly and levels of criticized loans improve. We're also seeing reductions in delinquency rates in both commercial and consumer credits.

As we discussed earlier, from a revenue standpoint, we've seen positive trends in key contributors to our non-interest income.

Lastly, we have implemented changes to the ways in which we do business that have saved us money and have resulted in less FTEs, and which should continue to result in non-interest expense savings in the coming quarters.

With that, we'll open it up for questions.

(Operator Instructions). Jeff Rulis, D.A. Davidson.

Good morning. Terry, a couple of follow-ups on some line item details. On the mortgage revenues, $5.5 million this quarter. I guess if you could discuss your expectations for 2012, or even just maybe a run rate going forward.

On that particular area, of course we'd expect fourth quarter to look reasonably strong with the current refinancing activity, but we would not expect that refinance activity to be sustainable, so certainly we would see it declining. We've indicated that about half of our revenue are solely attributable to the purchased homes, so that will get you to roughly $2.5 million plus whatever refinance activity the market will hand us.

This is Lyle. This is certainly predicated on continuing economic recovery in our states, but also renumber we've had some competitors that have left the market. These are mortgage companies along with BofA; they've pulled out. So we think it's reasonable to expect our market share to increase next year.

Okay. On the OREO costs, anything seasonal? I mean, you broke out the percentage of the valuation adjustments, but would there be anything going into Q4 that would suggest either a higher or lower figure on the OREO costs next quarter?

There would be nothing from an expense perspective that would give us a reason to believe that would increase and we'd be helpful that, over the next several quarters, we'd be at a lower OREO expense than the $3 million that we reflected in the last quarter. We do expect some increases in other real estate transfers into OREO, but most of the dollar expense has been around impairment. We'd expect those impairments to decline in future quarters.

That's helpful. Then lastly, Lyle, just to follow-up on Ed Garding's promotion, your -- I guess your retirement was consistently updated on a time line. [Was] any such sort of time guidelines for Ed's role as CEO, or is it no such time line?

I'm not sure I understand the question, but I'll answer what I think you asked. My retirement date is April 1 of next year, 2012. Ed is currently the Chief Operating Officer, and he and I are working together daily, transferring duties and responsibilities with the expectation that I have fully transferred everything to him by that April 1 date.

Right. I guess I'm asking it a different way I guess. Ed doesn't have a term of service, given his -- the announcement, as in you had a stated end date and it was well communicated. Ed's is -- he doesn't have a date that he intends to serve through; there's not a date assigned to that.

That's correct. We thought we'd give him the job before we asked him for his end date. He is healthy. He is ambitious. He's energized, so he'll be here a while.

Got it. Thanks guys.

Matthew Clark, KBW.

Good morning guys. First, maybe on your reserving methodology and how you thinking about it going forward, I know you had suggested that if we saw a decline in nonperformers we might start to see charge-offs exceed the provision, and we obviously saw that this quarter. But can you give us a sense for certain coverage ratios that you would like to manage to give us a better sense for trying to model out the magnitude of reserve release going forward? Is it you'd like to see the coverage on nonaccruals strengthen from here? Is it the annual -- reserves on annualized charge-offs, a combination of both?

This is Terry. I'll take the first half of the general question there.

We don't manage to a particular financial metric there that is a bright line in the sand. However, if you look at just your traditional reserves to nonperforming assets at a current level, it could perhaps decline slightly, but it's probably approaching the bottom at that level. We have not had to have higher levels of reserve for a number of reasons, but principally, as Lyle mentioned, our embedded loss is historically and even in the last couple of years has been modest and measurable. We're confident that in our reserve adequacy that we have taken into account all factors of potential losses embedded in our loan portfolio, and in particular in our non-accrual loan portfolio.

I'd just add to that, Matthew, is that we have -- our methodology really hasn't changed. We consistently apply that, but we are adjusting on a quarterly basis to factors that are impacting our market, various markets. As we look -- we look at the current loss history on our loans, and then we also look at the current -- our consumer portfolio utilizing a one-year loss history. So we feel very comfortable that we have our problems identified, we them an adequately reserved for, and will continue to do so. That's a lot of our culture that we have is that we don't likes surprises. We ask our lenders and counsel our lenders on a continuous basis that we don't like surprises, and risk [rating] changes or additional specific reserves, so we feel very comfortable in that regard.

Great. Then on the securities portfolio, Terry, the -- it didn't move much this quarter in terms of balances. But just curious as to any change in strategy, given the dramatic move in rates during the quarter.

No change in strategy is the short answer. We'd certainly like to have a lot higher yields on the individual securities that we're acquiring, but unwilling to extend the maturity of these securities for one little yield pick-up could be had, so we have not modified our strategy of investment.

To some degree, we've increased our -- not degree. We actually have increased our portfolio most quarter ends as liquidity becomes more abundant and reliable so -- but we haven't changed our investment strategy other than to build our portfolio over time. The market has given us a shorter ration, but it wasn't a strategy that we implemented.

Okay. Then on the borrowing front, do you guys have any slugs of borrowings coming due maybe this quarter or next year?

We do not. We have very little borrowings. We have a few borrowings with the Federal Home Loan Bank that are amortizing. I think it's something less than $20 million at the bank level, and no borrowings at the parent company level.

Thanks guys.

(Operator Instructions). Tim Coffey, FIG Partners.

Good morning everybody. To follow-up on Matt's question, could you give me the dollar amount of the specific reserves or the reserves that were allocated towards impaired loans?

This is Bob. Specific reserves are at $37 million on those impaired loans.

It seems the specific reserves as a percentage of total reserves have come down from the last quarter at least. Is that an indication that you do see the nonperforming loans or the impaired loans declining or becoming less of a problem?

That would be correct.

If you looked at quarter-over-quarter, it's a reflection and a good part as well because we charged off $20 million of loans. A good portion of those we had specific reserves against.

Great. Then Terry, was there a general location where you saw a lot of this purchase activity in the mortgage business with like Billings or the majority of eastern Montana?

No. It would be throughout our footprint. We have some good, strong markets, but actually there's loan activities. We have good activity even in -- some activity in the Flathead area but our strong markets would be Casper in particular, and Billings. But it is throughout the footprint from a purchased home activity and refi business. They're both strong throughout the whole footprint.

Then you guys made some comments about competitors leaving the market, mortgage competitors leaving the market. Which ones were they?

Bank of America was probably the largest. They've announced that they're leaving. We've had a number of small -- you'd called independent mortgage companies that have just folded up shop in the last year.

We've not see banks leave other than Bank of America, but BofA was here with the old Countrywide offices but they branded them Bank of America.

Okay. Thanks. Those are all my questions.

(Operator Instructions). Matthew Keating, Barclays Capital.

Thank you. Good morning guys. You noted earlier today that you continue to make progress on your expense reduction initiatives in 2011 which you expect to continue over the next few quarters. Have you thought about any specific quantitative targets for '12 in terms of expense reductions? If not, have you thought about whether expenses can stay stable even if revenues grow or what you're thinking there at this point?

This is Lyle. We're not disclosing our specific targets for next year; we've set them internally. We do think there's progress to be made yet in process improvement. We've got a two-pronged approach today. Right now, we're sort of picking the low-hanging fruit, if you will, and implementing changes in our processes that would give us savings next year. But secondly we've got a full-blown strategic planning process underway that's also looking at that same area. So, I would expect that we'll continue to see improvements there.

Fair enough. Just on that strategic planning process, I know, Lyle, you mentioned it in mid September that you recently embarked on sort of a longer-term strategic review of the Company. Are there any early leads on the direction this process might take or might formulate, or is it too early in that process to really talk to that?

Still too early. We're looking at early next year before we'll have a full plan ready to present. This is a very engaging, very involved process that we're not rushing through. Historically, we've had a two- or three-day planning retreat that's given us our direction in the short-term. This one is much more encompassing. It's three to four months to really give a good look to the whole Company. So you've got us still a little bit on the front end.

Just the final question -- you talk about the strengthening capital. Any update, if any, to your view on M&A opportunities? I know you had spoken previously that nothing obviously this year, but as you look out to '12, do you still see potential opportunities in the pipeline, or what is your outlook there?

My gut sense is there will be more rational pricing next year. I think that some of the banks that we tend to follow are having difficult years. They still have capital, but when they post their year-end numbers, I would think they would sit down with their boards and discuss what the appropriate action is.

My guess is we'll be talking to people next year, but I'm not sure we'll see deals go together next year. It could be off into 2013. This low-rate environment that we're in and the fact that Chairman Bernanke is using the word instead of low rates for a year he now says at least for a year, I think will cause lots of smaller banks in our space to revisit what their strategy is. But there just isn't much going on right now, so we're really kind of speculating how much we'll see next year. I think people are just waiting to get year-end numbers posted and decide on their own direction.

Great, appreciate the color.

I'm showing no further questions at this time, so I'd like to turn the conference back over to our speakers for any final remarks they may have.

No, other than just to say that we're feeling better about not only the local economy but it almost feels temporarily that the world is settling down and getting some direction and the country is pointed in the right direction. So a good banker is always optimistic, and we're certainly optimistic, anxious to see a yield curve and anxious to see loan growth and hope that begins to come our way next year, or maybe the year after. In the meantime, we've hunkered down. We've learned how to do business in this economic climate we find ourselves in and we're pleased with the results that we've reported this quarter.

So thank you for joining us. We'll talk to you in person soon.

Thank you. The conference has now concluded. You may now disconnect your lines and please have a wonderful day. Thank you.