First Interstate Bancsystem Inc (FIBK) 2012 Q2 法說會逐字稿

Good day and welcome to the First Interstate BancSystem, Inc. second-quarter 2012 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 note, this event is being recorded. I would now like to turn the conference over to Ms. Marcy Mutch, Investor Relations officer. Ms. Mutch, the floor is yours, ma'am.

Thanks, Mike. Good morning. Thank you for joining us for our earnings conference call for the second quarter of 2012. Before we begin, I'd like to direct all listeners to the cautionary note guarding forward-looking statements and factors that could affect future results and our most recently filed Forms 10-Q and 10-K.

Joining us from management this morning are Ed Garding, our Chief Executive Officer; and Terry Moore, our Chief Financial Officer. Ed will begin by giving you a general overview of the Company's results and review credit quality information. Terry will follow up with specific information behind the quarterly results. Bob Cerkovnik, our Chief Credit Officer, will also be available during the question-and-answer time to address specific questions concerning asset quality.

At this time, I'd like to turn the call over to Ed Garding. Ed?

Thanks, Marcy. Good morning and thanks again to all of you for joining us on the call today. Last night we were pleased to report earnings for the second quarter of $12.1 million, which equates to earnings per share of $0.28. This represents an increase of 7% from last quarter and the increase of 33% from the same quarter a year ago.

Let's start by discussing the loan portfolio, which overall was fairly stable. This is notable to us, given the higher level of charge-offs that we had during the quarter. We saw modest loan growth in a number of the loan types, but that was offset by the expected runoff in the construction portfolio -- specifically, land acquisition and development portion of the construction portfolio.

Terry told you at the end of last year that our total construction portfolio could shrink to around $300 million, and that's looking like it will be pretty accurate. 28% of that construction portfolio is still considered criticized, and so although we continue to make new construction loans, we will likely see further declines in that category as we clean up the remaining criticized loans.

Residential mortgage lending continues to be a source of strength for us, with volume being over twice what it was last year. We've indicated in the past that we're retaining some of our residential mortgages. These are typically the 10- to 15-year mortgages that do meet secondary market standards. Because of soft loan demand in other areas, we anticipate continuing to retain many of these mortgages.

As we looked across our footprint for the quarter, we saw modest levels of loan growth in the majority of our markets. However, these were offset by significant declines within the Jackson and Flathead markets, not only from charge-offs and transfers to other real estate, but also from paydowns on loans.

Overall, we think loan growth will be flat for the calendar year. There is some pickup in economic activity in the region, especially in the areas where they're drilling for oil, but there are just too many banks chasing too few loans to predict any significant loan growth.

We've made meaningful strides this quarter in coming to resolution on some of our problem credits. Our current credit trends reflect the later stages of a typical credit cycle, where there's a slowdown in the emergence of new problem credits, and charge-offs exceed provision expense as we resolved the problem assets that we've already reserved for.

While we still consider our ratio of nonperforming loans to total loans of 4.13% to be elevated, it does reflect a decline of over 200 basis points year over year, and a decline of 123 basis points from last quarter, which is a significant improvement. The overall decrease in nonperforming loans of $51 million was mainly due to $27 million in charge-offs and $20 million of inflow into other real estate.

So 90% of that increase in nonperforming loans was due to charge-offs and transfers to other real estate; 10% is from payments. That doesn't tell the whole story, though. The actual decline in nonperforming loans on a gross basis was $66 million, and we added some $15 million. So the good news is that we were able to offload about $66 million. So there were actually more payments and upgrades than the net results would show.

This quarter the pace of inflows into nonperforming loans continued to decline -- was substantially lower than the inflows we saw at the peak of this credit cycle. As we said last quarter, we didn't expect charge-offs to remain at that low level, and obviously, with $25 million in net charge-offs this quarter, they didn't.

While this was a much higher level of charge-offs than we typically see during any one quarter, this wasn't a shock to us. There was nothing particularly unusual driving the higher level of charge-offs this quarter. It was simply a matter of a large number of credits that had been nonperforming for quite a while, all reaching the point where it became appropriate to take them into other real estate or take partial charge-offs at the same time.

It doesn't signal any change in our approach to managing our problem credits. It's just a matter of cleaning up what was there.

A breakdown of total net charge-offs of $25 million by percentage is 56% of it was construction loans; 24% commercial real estate; 10% commercial loans; and the other 10% was consumer and consumer real estate loans.

We are on the downward side of the credit cycle, and we expect to see some lumpiness in our charge-offs. As we stated last quarter, at the end of 2012 we would anticipate total charge-offs for the year to approximate 2011 levels.

I mentioned a minute ago that we saw in total inflows of $20 million into other real estate. This consisted of 27 properties, five of which made up the bulk of the additions, and totaled $15 million or 75% of the inflow. Three of those five properties came out of the construction real estate portfolio, and two were commercial real estate properties.

Summer months are typically our strong selling season, and we are pleased with the $10 million in other real estate dispositions during this quarter. These properties were disposed of at a small net gain -- yes, I said gain -- which provided us with some confidence that we continue to take marks when appropriate, and that our other real estate is valued at close to the amount we'll see on its ultimate disposition.

Terry is going to provide you with a little more color around the marks we've taken on our other real estate in just a couple of minutes. On the front end of the problem loan pipeline, total criticized loans continue to trend downward in all categories and declined $66 million from last quarter.

At $546 million, criticized loans are almost back to the level we saw in the second quarter of 2009. We do expect the overall downward trend in total criticized loans will continue.

Our economies continue to stabilize with the few bright spots. Eastern Montana, which would include Billings, our largest market, continues to be positively impacted by the Williston Basin oilfield. In the last year the average price of a house in Billings has increased by 3%. Additionally, the vacancy rate for residential rental property in Billings is at 2%, which as you know, is extremely low. We are seeing generally positive trends in the economic data across our footprint, although it certainly doesn't point to the level of economic recovery that we would like to see.

Through the first quarter we experienced a positive housing index in Montana, Wyoming, and South Dakota. While we think the rest of the nation is still flat or going down, we are happy to see housing values increasing in our three states.

Similarly, we've had percentage increases in building permits across our three states which exceed the national average. Overall, individual bankruptcy filings continue to trend down at a faster pace than the national average. And as of May, unemployment rates in our three states were still well below the national average.

At the end of the second quarter, national park visits within our region were up over last year, as were hotel occupancy rates. So it looks like we're going to have a good tourism season. Our customers doing business in this industry are telling us that activity related to tourism is well above last year's levels, and that hotel/motel bookings for the rest of the season look good.

While commodity prices remain high right now, we are facing drought conditions. You've probably seen the news of that pretty much across the country, so we are anticipating a decrease in crop yields and a lack of feed for livestock. So many of our ranchers are being forced to sell cattle before they would otherwise like to, which has led to some pricing pressure in the cattle industry. That said, most of our agriculture customers are in much better financial condition than they've been in past years because of the recent high commodity prices.

So with that overview, I'm going to turn it over to Terry for some more detail.

Thanks, Ed, and thanks for joining us this morning.

Our net interest margin, which was 3.74% for the second quarter, was up two basis points from last quarter. As we stated in the press release, the main factor behind the increase related to the recovery of interest on loans upgraded to accrual status.

This factor also contributed to the increase in average yield on loans quarter over quarter. Having meaningful recovery of interest as opposed to a net charge-off is another indicator of improving credit quality and where we're at in this credit cycle.

The continued shift in the deposit mix that we've seen for the last couple of years helped drive the declining cost of funds to 49 basis points, down three basis points from last quarter. The yield on the investment portfolio remained flat quarter over quarter, as well. However, we're still seeing new purchases priced at lower yields than what is maturing or paying down, so it remains a challenge to maintain yield on the portfolio.

On an average basis, our interest-bearing deposits, which are mainly funds held at the federal reserve bank, were higher than in the first quarter, but by the end of the quarter we had reduced these funds to $387 million.

When we consider where our net interest margin will be going on a go-forward basis, we anticipate the average loan and investment yields will continue to be pressured, and with limited room to improve cost of funds, it would be natural to expect a decline of a few basis points in each of the next few quarters.

However, there are a couple of positive factors that will help offset some of this margin compression. As we indicated back in April, we redeemed $40 million of TruPS at the end of June. Going forward, beginning this third quarter, this redemption results in a two basis point impact on net interest margin.

Additionally, we have $45 million of remaining TruPS, which are currently at a average fixed rate of 7.06%, which we'll reprice on a variable rate basis at the end of this year. Based on current LIBOR rates, the additional lift in net interest margin next year from these TruPS repricing is an additional 3 basis points, which will help mitigate net interest margin compression in 2013 as well as improve earnings per share.

Provision expense remained relatively flat, up $750,000 from last quarter. You shouldn't take this minimal uptick as an indication of a weakening credit portfolio. On the contrary, as Ed explained, we continue to see positive credit metric trends and don't anticipate any change of a downward trend in the coming quarters. Overall, we still anticipate 2012 provision to be less than last year's.

In the second quarter, non-interest income, which was $28 million, was an increase of almost 5% on a linked quarter basis. Origination of residential real estate loans continues to be the main driver behind the increase.

We talked some last year about the exodus of mortgage originators from our markets and that we were hoping to gain market share as a result. We've added additional real estate lenders across our footprint and we are experiencing a significant increase in the volume of originations as a result.

Total volume of this quarter was up 52% from the same quarter last year and up 111% over the first two quarters of last year. Now, while we don't feel that the pace of refinance activity is sustainable in the long term, perhaps not even much past the third quarter, our efforts are focused on gaining market share and replacing a portion of the refi activity we're enjoying with purchased activity.

We've been in the residential origination business for a long time and consider this to be one of the core products we offer our customers. Because of the positive housing trends in our markets that Ed shared with you earlier, along with less competition in our marketplace and low interest rates, we think this will continue to be a good revenue source for us for years to come.

Non-interest expense remained flat at $57 million on a linked quarter basis. There's really only one item I would add additional comment on. As we discussed briefly in the press release, we sold the building to a charitable organization this past quarter. This transaction resulted in a gain on sale of about $500,000, which is included in other income, and a large non-cash contribution expense of $1.5 million, which is included in the other expense line item.

Other real estate expense was up quarter over quarter, but down from last year, with expenses higher this quarter due to the volume of property coming into other real estate. Other real estate expense will remain high, and like our provision expense, may be a bit lumpy.

We expected other real estate expenses to be higher -- we expect OREO expenses to be higher during the second half of this year than what was recorded in the first six months. All in, total other real estate expense for the year is likely to approximate or possibly exceed the 2011 levels.

The largest other real estate properties we currently hold, if we looked at the top five, are recorded at $24 million and make up 44% of our total other real estate. Charge-offs and write-downs related to these five properties have been $25 million, which is a 52% haircut.

On the other and of the spectrum, $9.2 million, or 17% of our other real estate is related to 66 different properties, each valued at $500,000 or less. At an average carrying value of $139,000, there is limited exposure to further significant adjustments on those properties.

Overall, throughout this credit cycle we haven't had to take any material losses on other real estate upon sale, so we're relatively comfortable that our marks have been timely. We continue to be -- to aggressively market our other real estate properties, and early indications are that the sales of OREO will continue to hold up in this third quarter.

Capital levels remained strong, with Tier 1 capital increasing to 11.51%, nearly 1% higher than just a year ago. Also, net tangible common equity increased 20 basis points over this past quarter to 8.52%.

Along with the rest of the banking industry, we're in the process of evaluating the impact of the proposed Basel III would have on our organization. As we understand the current proposal, we expect the short-term implications to be minimal, and we will comfortably exceed proposed regulatory guidelines.

With that, I'll turn it back to Ed to wrap up.

Thanks, Terry. As a general comment on our outlook, we continue to be committed to seeking new ways to improve revenue growth and become more efficient on the expense side -- that probably sounds like every other bank in the country, too.

Credit costs should continue to decline going forward, resulting in improved earnings for us. With the lack of organic growth opportunities in the marketplace, M&A activity is always a question; we do continue to have conversations, and as you expect, would be interested in opportunities that would add value to our franchise.

That being said, we continue to think the real opportunities for us along M&A lines are probably in 2013. So with that, let's open up for questions.

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

Terry, I had a question about -- just a follow-up on the noninterest expense. Some moving pieces in there, and wanted to make sure I understand what's happening.

In Q1 you had $3 million in collection and settlement costs. I'm looking at that other noninterest expense line item around -- it was $13 million and change, and if you back out the cost of the trust preferred move, that was roughly flat quarter to quarter. I was a little surprised that that number didn't come down.

Granted, it sounds like you had the $1.5 million donation, but what made up the other -- was it OREO costs that had increased linked quarter? Why that $3 million was an option, I guess, quarter to quarter is really the question.

Yes, a great question, Jeff. I think you've got most of the large elements there. If you looked at the $3 million -- is no longer there that was there in the first quarter. But the other expenses you identified were the donation expense of about $1.5 million and roughly $500,000 of the TruPS costs, so there is $2 million if you are tallying the difference.

There were -- second quarter we have a little bit higher director fee expense from our shareholder meeting and some of the one-time retainer costs that are expense. So that was about $250,000.

A little bit higher Visa debit card expenses -- just from what we can best tell, just associated activity levels being a bit higher. So those would be the main elements that nearly offset that $3 million from a quarter-to-quarter basis.

Certainly as we would look on a run rate basis, we would not anticipate it being between $13 million and $14 million, but outside of some unusual surprises like this, that it might approach something closer to $11 million -- in the $11 million range.

Okay. And with that backdrop, then, coupled with your comments on the -- expecting OREO costs to be higher in the second half, I guess there's some offset to that, but again, on a net basis, expect noninterest expense to be down from this level?

You know, probably a little bit, Jeff. I was talking particularly about other expense line item, and so other real estate expenses are not included there. But I do think that it's reasonable to expect that there'll be some higher level of OREO expense from what we've recorded the first two quarters.

And I think all in, last year we were maybe in the $8 million range for total other real estate expenses. I think a reasonable estimate is that's where we'll end up. And I think we are at $3 million, $3.5 million year to date so far. So we're expecting those to maybe increase slightly, and other real estate, probably as you are surmising, that would offset in large part some of these other savings that we'll have in other expense.

I got you. I didn't mean to talk about the two line items. I follow you there.

Just a follow-up on the trust preferreds, I guess, the remaining balance -- you talked about some -- the rate adjusting, but any idea on additional redemptions that you'd consider with the remaining balance?

You know, they are certainly up for consideration. At this point there are no specific plans to have further redemptions of the TruPS. And I would find it probably unlikely that it will occur in the short, next couple of quarters. So it might be out in the future little longer when we'll really evaluate that.

Obviously, we know they are going away over time in the count of risk-based capital, but they still -- the offset is they're still a fairly low cost of funding if we want to retain it and think there is a good leverage proposition there. So at this point, no specific plans to redeem.

Okay. And last one, if I could, on the tax rate. You've been running a little higher, north of 33% the last three quarters or so. Is that now the new run rate? I think last year you were closer to 32% and change. But just wanted to get some clarification.

I think it is. It's largely driven because of our increased profitability, and the other primary item would be a municipal securities haven't kept pace -- or that tax-exempt income hasn't kept pace with our increase in overall pretax profitability. So I would think that the 33% is a better run rate than 32%.

Okay. Appreciate it. Thank you.

You bet, Jeff.

(Operator Instructions). Fred Cannon, KBW.

Just a question -- it sounds -- that was very interesting in terms of seeing a bit of a rebound in the housing market out there. And I was wondering if we might be seeing a bottom in your construction portfolio in terms of the continued runoff that we've seen there, if we may be near a bottom given perhaps some opportunities to either stabilize or grow the portfolio?

Fred, I am going to have Bob Cerkovnik, our Chief Credit Officer, address that one.

Yes, Fred, it's a very good question. We are seeing some stabilization across the market and in our construction portfolio. We do think we're on the downward cycle of that portfolio as far as problems go.

Okay, great. And then I was wondering if there's any more color on the building that you did the donation and the gain on. In particular, did you maintain any kind of loan on that property? Or is there no lending relationship still there?

Terry Moore will answer that one, Fred.

Yes, Fred. This was a bank building that we had vacated and had built a new building. And so it had been empty for a couple of years. And so it wasn't through a customer relationship or another real estate, so it was a bit unique. And it was a very large building and still a usable building. And this looked like a great opportunity and disposition for that property.

I would make the comment that we don't have any other buildings that are like this that are being held for sale in any kind of a portfolio, so this was a one-time item.

Great. That is helpful. And then just one final question.

On your loan yields, they seemed to be quite stable this quarter. I was wondering if there's any color on that. I mean, I think we would have to expect them to tail off in the future, given where the yield curve currently is in loan pricing. So any kind of color on that, any kind of discussion about loan pricing would be helpful.

Absolutely, Fred. This is Terry again. Take you back to the recovered interest from loans put back on accrual, and there were several hundred thousand dollars in the quarter. And when you annualize that impact on the loan yield, the loan yield is -- without that would have went down several basis points, maybe around four or five basis points instead of reflecting a slight increase.

Right, okay.

And so we would expect without -- that we may have some quarters of having charged-off interest recovered or charged off, but when we net that impact out, we would have otherwise and would expect in the future that our loan yield would go down.

And certainly we're still seeing compressed yields from the new generation, new loans being generated. There's still a lot of competitive pressure in that repricing front. And I think it's reasonable to expect a few basis point decline in that loan yield on a run rate basis for the next several quarters.

And just as a follow up on that, are you seeing a lot of push out in terms of the duration of some of the loan requests -- out -- for multiyear kind of lending?

I would say yes. I'm not sure a lot is the right terminology, but certainly there's a lot more interest in that. So there has been some extension in fixed rate, but nothing that would change the substantial makeup of our portfolio. So certainly a lot more interest.

For the most part, when you offer three-, or five-, or seven-year rate that's fixed, if you just price it right, the customer will tend to opt for a shorter-term fixed rate as opposed to pay the higher rate for the long-term fixed rate.

Okay, great. Well, thanks so much for the color.

You bet, Fred.

Tim Coffey, FIG Partners.

Terry, you gave some good color about your forward outlook on the gain on sales from the mortgage origination business. And I'm wondering, do you anticipate seeing a ramp-up and gain on sale or originations? Or do you see more of a leveling off at these elevated levels?

Well, I see that it will probably level off here this third-quarter and not ramp up. But if we went back and looked at the purchase activity and were to segregate the activity as purchase versus refi, we have certainly committed to this line of business, this product that is offered to our customers, and would like to have higher penetration and market share in the markets we're serving in capturing that business.

So overall on the macro side, we would see it having -- peaking here this year, and perhaps in this quarter or next, and beginning to tail off as refi business will -- we're expecting that maybe rates are approaching their low. We were expecting that a year ago as well. But so -- to the extent that rates are near their low, that we're about there. And that revenue would decline some in years to come on a total basis, but increase on a purchase basis.

Okay. Do you feel that you have adequately traded markets for the mortgage origination business that you want to? Or do you see potential for more expansion?

For the most part, we've tried to stick to the states that we operate in, Tim, so we're not looking to make this a national growth engine with a separate product. It's largely occurring in the markets that we have our banking footprint in, and we've just tried to do a much better job of penetrating that, and having the right people and adequate number of people to capture the opportunity that is fair.

And you feel you have the adequate number of people for your footprint?

Well, with the refi business in the last six months, I suspect that team of folks would suggest that they could have used some more help. But we do think that we're adequately staffed on a go-forward basis, certainly for that purchase growth.

Very good. Those are my questions. Thank you.

All right, Tim.

Gentlemen, it appears that we have no further questions at this time. Did you want to make any final comments?

No, we don't have any final comments.

Okay, well, thank you, sir. The conference call has now concluded. We thank you all for attending today's presentation. At this time, you may disconnect your lines. Thank you and take care.