First Interstate Bancsystem Inc (FIBK) 2012 Q4 法說會逐字稿

Good morning and welcome to the First Interstate BancSystem fourth quarter 2012 earnings conference call and webcast. All participants will be in listen-only mode. (Operator Instructions). Please note this event is being recorded. I would now like to turn the conference over to Ms. Marcy Mutch, IRO. Please go ahead.

Thanks, Sue. Good morning. Thank you for joining us for our fourth 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 in our most recently filed Forms 10-Q and 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.

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 an overview of the Company's results and review credit quality information. Terry will follow up with specific information behind the quarterly results. Ed and Terry are calling in this morning from separate sites, so please contact the operator if you experience any difficulties hearing them during the call. At this time I would 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. Yesterday we were pleased to report earnings of $16.1 million for the fourth quarter and $54.9 million for the year, which is an increase of 5% quarter over quarter and 34% year over year. Earnings per share were $0.37 this quarter, an increase of 6% over third quarter. For the year, earnings per share was $1.27, a 32% increase over 2011. Let's start out by reviewing a few of the details.

Residential loan revenues this quarter were $12.3 million, our highest level ever. Year over year these revenues almost doubled, with 98% growth. Our residential loan team has worked hard over the last two years, and have developed a proficiency and expertise that will allow us to capitalize on continued opportunities in refinance and purchase activity across the region.

Credit quality is another area where we saw significant improvement. As we had said at the beginning of the year, credit quality was our main focus for 2012 and we are pleased with the results. Total nonperforming loans declined 13% this quarter and, more significantly, 41% for the year. That is great progress. The most substantial category of improvement was in the construction real estate portfolio, which declined from 25% of nonperforming at the beginning of the year to 10% of nonperforming at the end of 2012.

Breaking down our nonperforming loans a little further, nonaccrual loans of $108 million at the end of the quarter included $51 million of commercial real estate and $30 million of construction real estate loans. We continue to see the inflow into nonperforming loans slowing and the outflow through paydowns, charge-offs or foreclosures remaining steady. I'm going to say that again, because I like the way it sounds. We are seeing the inflow into nonperforming slowing down and the outflow remaining steady.

Other real estate declined to $33 million as of December 31 from its peak of $54 million just two quarters ago. Inflow into other real estate this quarter was $7 million with the majority of the increase being one commercial property. While we typically see a slowdown in sales activity over the winter months, we were pleased to generate $11 million of sales in the fourth quarter. As we wrapped up the 2012 selling season based on sales within our marketplaces, remaining other real estate properties were written down $3.3 million.

Our remaining other real estate inventory at the end of the year is comprised of $15 million of construction real estate, $10 million of commercial real estate and $7 million of single-family residential properties. About one-third of our other real estate properties are subdivisions, and over half of the single-family residential property is made up of one unique property in a resort community.

We think other real estate peaked in 2012 and although the balance may bounce around a bit from the current level, depending on the timing of sales and foreclosures, our other real estate inventory is expected to decline during this year. So, headed into 2013 we are optimistic and expect to see continued levels of improvement in our asset quality ratios, with our focus on reducing nonperforming assets by at least one-third during 2013.

Let us move on to loan growth. As we indicated at the beginning of 2012, we expected loan growth to be pretty flat, and that turned out to be the case with total loans growing just under 1% for the year. The portfolio with the most substantial increase was residential loans, which were up $69 million during the quarter and $136 million for the year.

With the balance of this portfolio now at $708 million, I would like to provide a little more color about the portfolio. Historically, we have carried a residential portfolio balance of around $400 million to $500 million. About half of these have been traditional mortgages and half consumer and home-equity loans secured by real estate. During 2012, in light of what looked to be a prolonged low interest rate environment, we began retaining 10 to 15-year mortgages that met secondary market standards. As of the end of 2012, we held around $200 million of these residential mortgages.

In this environment with high levels of liquidity, soft loan demand, low interest rates and solid underwriting, we feel good with the growth in this portfolio. Yield on these mortgages is better than we could get on mortgage-backed securities held in the investment portfolio, and this level of volume does not impact our ability to grow new loans as opportunities arise.

Our indirect portfolio increased $7 million over last quarter and $31 million over last year. This is a solid portfolio with good yield. We see additional potential to grow the indirect portfolio in South Dakota and in markets contiguous to where we are currently doing business.

We are encouraged by the growth in the commercial construction real estate portfolio. We believe the $9 million in net loan growth in this portfolio is indicative of our improving economies. We are seeing more commercial and commercial real estate loans in the pipeline, particularly in Billings and Casper markets, and are cautiously optimistic that we will see modest loan growth this year.

I want to briefly touch on regional economic conditions. Unemployment rates have declined even further with both South Dakota and Wyoming now under 5% and Montana at 5.7%. Despite depressed coal and natural gas prices, the energy industry remains strong. Billings, Montana, home to our headquarters and our largest branch, is the closest trade center to the Bakken oilfield and continues to enjoy a positive impact from that activity. Home sales in Billings were up 20% from 2011 to 2012.

Proximity to the Bakken is one of the factors impacting the Billings housing market, as Billings is considered a commutable distance from the Bakken and families have moved into our area. So, with that overview, let me turn it over to Terry for more detail regarding earnings.

Thanks, Ed. As usual, I'm going to start with net interest income. As you saw in our release last night and continue to hear across the banking industry, the pressure on net interest margin has not subsided. Net interest income revenues were flat quarter over quarter. And additionally we recovered $425,000 of net charged-off interest this past quarter, which helped to offset margin compression. Even with this interest recovery, the net interest margin declined 8 basis points quarter over quarter.

Average loan yield was also flat compared to last year, but again, -- the prior quarter -- but, again, 4 basis point of this quarter's yield can be attributed to the recovery of previously charged-off interest. Competitive pressure on loan rates continues.

However, part of the decline in loan yield is attributable to the growth in the lower-yielding residential mortgage loans that Ed just visited about. The yield on the investment portfolio declined by a significant 18 basis points from the third quarter. At $450 million, investment purchases during the quarter were substantial as liquidity from mortgage-backed securities and callable agencies were reinvested.

As you all know, it is a real challenge to find investment products with an acceptable duration that generate a reasonable yield. The duration on our investment portfolio has extended slightly to only around 2.5 years and the yield on securities repurchased during the fourth quarter was about 1.1%. Liquidity remains high, but we remain disciplined in our investment approach.

Deposit balances continued to increase and shift into demand in noninterest-bearing deposits, further driving down our cost of funds to 39 basis points, a 4 basis point decline from the prior quarter. As we get closer to zero, the opportunity to reduce cost of funds is limited to just a few basis point in any given quarter.

We saw some benefit in our net interest margin this quarter as $36 million of fixed-rate trust preferred securities repriced from five-year fixed-rate to 90-day LIBOR in the fourth quarter. By next quarter, all tranches of the $80 million of trust preferred securities will be variable-rate at an average 90-day LIBOR plus 2.6%. There is no doubt we will continue to experience net interest margin pressure going forward.

While we do expect loan growth to help mitigate the net interest income revenue decline, we don't anticipate enough loan growth to offset the compression caused by low yielding investment repricing and competitive loan pricing. Therefore, we expect continued pressure on net interest margin of a few basis points each quarter during 2013.

Next, I will talk about noninterest income. With growth and spread income challenging, our diversified business model and the numerous channels we have for generating noninterest income become even more important. With noninterest income at 33% of total revenue this past quarter demonstrates our success in this area.

As Ed has already discussed, income from residential real estate hit a record high for our Company. Low rates resulted in 68% of the activity for the quarter related to refinance activity and 32% to purchase activity. The pipeline in January has continued to be strong, and we are confident about opportunities in 2013. However, we don't expect 2012's record-breaking residential origination revenue levels to be sustainable in 2013.

Reviewing other categories of noninterest income, service charges and other fees were up 8% for the year. We continue to focus on expanding services to our current customer base and are seeing success in our cash management and credit card products.

Our commitment to wealth management has resulted in growth in 2012 with revenues up 3% for the quarter and 5% year over year. Assets under management have increased $500 million and investment of discretionary assets has grown 28% over the prior year. We are actively engaged in expanding our customer base along with assets under management and foresee continued growth in this line of business.

Another area we saw improvement this year was with credit cards. Credit cards are an essential payment mechanism for consumers as well as business. As a community bank, offering and supporting credit cards is an integral part of serving our customers' financial needs. Although outstanding credit card balances comprise only about 2% of our loan portfolio, this does not tell the whole story.

Credit card revenues are up 9% from 2011 and now exceed $10 million. In addition, the nearly $7 million of interest income. Over 50% of our volume can be attributed to our strong small business portfolio. Additionally, loss and delinquency rates on the portfolio are well below national averages.

Reflective of continued asset quality improvement, revision expense continued to decline and is down 16% quarter over quarter and 30% year over year. As Ed said, we expect credit trends to continue to improve in 2013 and therefore expect a similar improvement in credit costs.

Now to noninterest expense. First, salary expense was relatively flat this past quarter. However, employee benefits did decline $1.3 million from last quarter largely due to a reversal of previously accrued group health insurance expense. Medical claims in 2012 have been favorable compared to prior years, so this was a pleasant outcome. It is too early to know whether the medical claims level we experienced in 2012 is sustainable or not.

I would like to next talk about capital. Our capital structure has changed considerably over the past several years. The IPO in March 2010 resulted in over $150 million of new common capital. In July of last year we redeemed $40 million of trust preferred securities, and then just over a week ago we completed the redemption of $50 million of perpetual preferred stock. These redemptions had no impact on common capital and related common capital ratios. Which remain strong on our -- and are expected to grow.

Redemption of the perpetual preferred stock will have positive impact to earnings per share in 2013 as a result of the elimination of the preferred dividend. Accounting rules require the reclassification of the perpetual preferred stock as a liability rather than capital as of year-end. Therefore, the capital ratios reported in the earnings release already reflect the elimination of perpetual preferred stock as though it were redeemed at year-end.

At this point, with the redemption of the perpetual preferred along with the trust preferred redemption last year, we don't expect any further redemption of trust preferred securities in the near future. Our efforts have been rewarded with positive earnings for over 20 years that have been accretive to common capital. Now that we are a publicly traded company, access to capital markets in the future has significant strategic benefit for the Company.

In November, we announced a dividend increase to $0.13 per share and the acceleration of dividends from the typical January 2013 payment date into December 2012. We are pleased with the long history of quarterly dividends and an improved level of earnings which has allowed us to increased our return to shareholders. With that, I will turn it back to Ed to wrap up.

Thanks, Terry. Across Montana, Wyoming and western South Dakota, we have established great locations along transportation routes and in the major retail trade areas. However, we recognize the banking industry, along with the needs of our customers, is changing. Our customers are more technologically savvy than ever before and demand is growing for online and mobile banking services.

In October, we rolled out a new mobile banking platform. Along with that we continue to be diligent to look at opportunities to make our branches more efficient, use technology more effectively, and take advantage of business improvements available through the centralization of processes.

First, I will tell you about our mobile banking platform, which is comparable to any platform offered by the national banks in our region and surpasses anything our community bank competitors have available. Referred to as the Triple Play, it allows the customer to access their financial information, make inquiries and initiate transactions through Web, text or mobile applications.

This platform also includes a mobile check deposit feature where a deposit can be made simply by taking a picture of a check. Since introducing our mobile banking platform in October, we have signed up 6400 mobile banking customers that, on average, are accessing their account through the mobile platform over once a day.

Second, I want to talk about efficiency opportunities. We have invested in new technology this year that will allow us to more effectively roll out software products along with providing better support for products we currently use. All of our people are connected through servers versus individual personal computers, so we will also see about 75% energy savings through the new server technology. Which isn't big dollar savings but shows good energy stewardship.

We successfully centralized our compliance function during 2012. This process allows us to man a strong compliance program and save money in the long run as more of the Dodd-Frank regulations come into place.

Lastly, while we have larger average asset size per branch than most of our peers, we are clearly defining the services provided at each location, which will allow us to maintain an even higher level of customer service and, at the same time, drive efficiencies that will be effective in allowing us to manage our expenses.

Lastly, you are always curious about acquisitions, so I will give you our thoughts. Current conditions in banking would indicate that there are some acquisition opportunities out there. Our criteria for acquisition is that the price has to be reasonable; it has to have the potential for growth; and the ability to add to earnings. So with that, let's open it up for questions.

(Operator Instructions). Brett Rabatin, Sterne Agee.

Wanted to ask some questions around fee income and what you discussed in the press release. I guess, first, can you give us the dollar amount that you originated on the mortgage banking platform? And then how much you sold during the quarter?

I can tell you that we originated $1.4 billion throughout the year. And in regards to -- was your next question is how much did we originated in the quarter or what was the fee income for the quarter?

No, I know the fee income. It is -- what I am trying to figure out is what was the gain on sale margin in the fourth quarter and then how much you originated versus how much you sold during 4Q?

Okay, I don't have that in front of me. Terry, do you have that?

Ed, I do not have that specific information.

Okay. Maybe we could follow up with that. The other thing I was trying to figure out was in the press release you talked about growing fee income in 2013 and you also mentioned during the call that the mortgage was probably going to be somewhat unsustainable given the high percentage of refi business in 2012. Can you talk about the growth you are expecting in fee income and how you guys get there if mortgage does soften a little bit this year?

I can talk to that a little bit, Brett. First off, we mentioned wealth management and we continue to see gross revenue increase in wealth management as the level of assets under management goes (technical difficulty). Secondly, we continue to see increased income in our credit card department. And we are continuing to rollout what we call cash management products to business customers, so we plan to see at least a modest increase there.

In regards to residential loans, you would think that that simply has to slow down from where it has been on the refi side, but at the same time, we think that we have positioned ourselves to take more market share than we have previously had.

Okay. And then the other question I had was if you had a number for -- a guesstimate of where your originating loans, today, what you see average pricing-wise, aside from the single-family portfolio?

You are talking about commercial loans and (multiple speakers).

Right, commercial real estate. Mainly those two segments.

And so I guess the question is, what price are we originating at?

Right. What are the yields that you're getting today?

Bob Cerkovnik is our Chief Credit Officer and I'm going to ask him to speak to that. Bob, go ahead.

Brett, it varies by market but, generally speaking -- and also it varies by amortizations schedules that people are wanting -- but, generally speaking, we are seeing anywhere from 3.75% to 4.25% fixed, for five years. We are seeing a little lower than that on real good quality stuff. And it also depends on the size dollar amount, because once it gets over a certain size -- $5 million over, you get a lot more competitors in that market. And if it is good quality the price is being driven down by simple competition.

And since we are very focused on pricing for risk, some of that we will go down on. And if it is an existing customer, we will lower rates. But, again, we are picking and choosing how we are going to strategically go into some of those deals on pricing.

Okay, thanks for the color. I will step back.

Brad Milsaps, Sandler O'Neill.

Just to follow up on Brett's question about loan yields, looks like, excluding the interest recovery, they were only down about 5 basis points. Did you guys anticipate the pace of shrinkage in loan yields to pick up in 2013? In other words, do you have a higher level of loan refis coming up in terms of your commercial book? I am just curious how you guys have been able to hold those in a little bit better, at least on a linked-quarter basis, relative to where your loan growth is coming from, which has been mostly out of the mortgage book?

Once again I'm going to ask Bob Cerkovnik to address that.

Yes, we really -- I will give a broad answer to that is we price for risk. So, what we have said, basically, is we want potential new customers, we are going to look at the deals. If they are shopping the deal around, we're going to take a look at it, but we are not going to -- in some cases we may go lower on it, but -- and others we may not. It is on a case-by-case basis.

We have been matching rates if our customers are being approached by other competitors. On the high-quality customers, we are matching lowering rates. It is a real -- it depends, again, market by market. If we are seeing more refis out there, to get to your basic question is, more refis that we are seeing as a percentage. That doesn't stand out in my mind. That gets to your question as far as we have what is coming due over the next three years or in 2013. I really don't have that information in front of me. I can get it for you, though.

Okay. And then maybe a question for Terry. I know the deposit growth has been really strong. It looks like during the quarter, though, your average fed funds was around $600 million or so. Can you talk about anything you might do with that money? Obviously, you would like to put it into loan growth, but -- it is sitting at 25 basis points. Obviously that represents a big drag. Just curious where your thoughts are there from an overall balance sheet management prospective?

Brad, that level of fed funds is higher than we would target and we would expect and plan for a lower level and so most of that would get invested in the investment portfolio to the extent it is sustainable. So, it could help us a little bit on that front. But we would move from a 0.25% to roughly 1% perhaps on $100 million.

We are still hopeful that we will see some loan growth this year and some deployment of that liquidity in that front as well. I might circle back around. I think you were also inquiring in the last question, Brad, about do we have any unusual liquidity occurring in our loan portfolio, where there would be a significant amount of repricing occurring. And I would say no. It has been very consistent. We do have a lot of turn on that portfolio, because some is variable rate and just the normal activity in the portfolio.

But there would be an expected decline in the yield of the loan portfolio based on competitive pressures, as well as the change in mix that has been occurring over the last year associated with the mortgage residential loans that we have been including in our portfolio.

Okay, great. Thanks, Terry.

Jacque Chimera, KBW.

I have a question about the text you had in the press release about the credit card loyalty program. From your prepared remarks it sounds like credit cards are doing really well, so I was curious what drove that reversal?

I will respond to that. The credit card program, we have a reward program like most credit card programs have, and as we begin to analyze this and look at some of reward points that were earned 20 years ago that had still not been redeemed, we were still holding a fairly high liability associated with those. And as we reevaluated those and assessed in a more statistical way what the likely redemption would be of those old points earned a decade ago, that we didn't need to retain as much liability as we had. So, there continues to be an amount accrued for a reward program. So it is was just a one-time thing that we have assessed in there, Jacque.

Okay, so just a true-up, not anything that is an ongoing trend?

That is exactly correct.

Okay. And do you -- the mobile platform that you spoke to, will there be any fees associated with that?

There will. The sign-up for the mobile product is free. But there are many different things that you can use it for and there will be fees assigned to the various different uses. For example, to photograph a check and deposit that check I think the fee for that is $1.

So is it something where this new fee generation takes away from old fee generation or will it be net new fee income?

It should be net new fee income.

And then one last one. On the commercial construction and the improvement in the economy, where in your footprint are you primarily seeing that? And where do you think we might see more growth in 2013?

Eastern Montana has been highly impacted by that Bakken oilfield, so we are seeing that in Billings, our biggest market, and some of the other Eastern Montana towns. And then, also, Casper, Wyoming, seems to have a very robust economy, a lot of which is driven by oil exploration. And those would be the two primary areas, along with Cheyenne, Wyoming, which, again, has a very robust economy going on, partly because they are somewhat near some oil exploration activity and also an awful lot of wholesale and distribution type activity.

Okay, so is it safe to say that to the extent that the oil exploration continues to do well and the net migration continues, that we could continue to see growth in the construction portfolio?

Yes.

That was all I had. Thank you very much.

Jeff Rulis, D.A. Davidson.

This is Simonas filling in for Jeff. I had a question on the health insurance reversal. Could you explain what went on there and if we could expect anything similar in the future?

And I will hand that one off to Terry.

Yes, essentially we are self-insured with reinsurance on large claims. And having went through several years of increased medical claim cost, 2012 brought us actually lower claims cost, which was not what we had estimated or predicted. And so we found ourselves at a position where we had more funds set aside for that than needed, or appropriate. And so we reflect that that change has occurred.

So, the future, frankly, is an unknown. And, generally speaking, we would see healthcare costs increasing from year to year, and whether this was a one-time aberration in 2012 or whether it will recur that way in 2013 or 2014 is unknown. For the most part, it had been influenced in prior years largely by large claims, that move up toward the reinsurance amount. And in 2012 we only had one or two that were approaching that, as supposed to half dozen.

Okay. Yes, that is helpful. And then my second question is on the loan pipeline. What trends have you seen so far in the first quarter and what can we expect?

Okay, Bob Cerkovnik, would you answer that please?

The loan pipeline -- we are seeing activity again, as Ed mentioned, in Billings and Casper. It is really early to tell, but we are encouraged. We expect moderate growth this year and in those portfolios, primarily in our commercial and commercial real estate portfolios, is where we expect a lot of that growth to come from.

Okay, thank you. And that was it for me. Thanks, guys.

Matthew Keating, Barclays.

I appreciate the color on the net interest margin of several basis points -- or, a few basis points of compression in each quarter of 2013. We heard a similar guidance last quarter, but you noted that, at least for the next quarter ahead, it would probably be less in magnitude than the third quarter. So, as we look out to 1Q 2013, are you expecting, again, less NIM compression than we saw this quarter with 10 basis points of core NIM compression? Thanks.

Go ahead, Terry.

In summary, yes, we would agree with you that we would see smaller compression of -- being expected from the 8 basis points that we reflected in the last quarter. Certainly, one of those factors that positively higher or even flat in any given quarter could be the level of (technical difficulty).

Okay, thank you. And then my second question would be on the mortgage loans. Obviously, we are up to over $700 million. Could you refresh our memory on the ceiling there or how high you want mortgages to go as a percentage of the overall portfolio? Thank you.

I will answer that one, Matthew. First off, again, part of that portfolio is home equity loans and consumer loans secured by homes, and that, for us, has performed very well. We don't do 100% and 100 plus percent home equity loans. We stay pretty close to 80% and on occasion we'll go to 90%. So, that piece of the portfolio has performed very well.

And in regards to first mortgages on single-family residences, we watch that level and make sure that it is not going to become a concentration, and we have got some room to go before that would happen. And so we will watch how that grows or if it grows and continue to recognize that we just wouldn't allow a concentration there.

Fair enough. Thank you. I guess my final question would be I know it is quite difficult shoes to fill, obviously, but now that we are in 2013, can you give us an update on the timing of Terry's announced retirement? Have you had any more information there? Thank you.

Yes, and I will respond to that one, Matthew. Terry has given us quite a window there. His retirement will take place sometime between June of 2013 and June of 2014, so you can see we have got a 12-month time span there. But in the meantime we want to make sure that we find the right person and give them ample time to transition.

So, we have contracted with a search firm and we're going to search both internally and externally and we'll probably start that search in earnest within the next couple of weeks.

Great, thanks so much.

(Operator Instructions). James Rose, UBS.

What opportunities do you see for the greatest upside surprises going forward?

I am not sure I understood the question, James. Could you ask it again?

Sure, sorry. What opportunities do you see out there for the greatest potential for upside surprises over the near- to medium-term future?

Okay, upside surprises?

Surprises.

Would be a continuation of the mortgage volume. Because we fully expect that to drop off by 20% or so. Another upside surprise -- and actually it wouldn't be a surprise -- we still see an awful lot of activity around that Bakken oilfield that spills over into Montana and specifically into the Billings area, because we are the largest regional trade center -- well, not the largest, but the closest regional trade center to that. And so we continue to see economic activity because of that.

And, finally, I would say if an upside would be if that resort housing market would start to come back. We think it is finally stabilized and now we would like to see it make a comeback.

Thanks.

This concludes our question-and-answer session. I would like to turn the conference back over to Ed Garding for any closing remarks.

Thanks very much for your interest in First Interstate today. As always, you can contact us through investor relations, on our website, and we would be glad to respond to any follow-up questions. And, Brett, we will send you an e-mail and follow up to your question that we didn't get answered. So, again, thanks for your time and goodbye.

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