First Interstate Bancsystem Inc (FIBK) 2013 Q2 法說會逐字稿

Good morning and welcome to the First Interstate BancSystem, Incorporated second-quarter 2013 earnings conference call. All participants will be and 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 [Alison Johnston]. Please go ahead.

Thanks, Chad, good morning. Thank you for joining us for our second-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 that 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 Ed Garding, our Chief Executive Officer, and Terry Moore, our Chief Financial Officer. At this time I will turn the call over to Ed Garding. Ed.

Thanks, Alison. Good morning and thanks again to all of you for joining us on the call. Yesterday we were pleased to report improved second-quarter earnings of $21.5 million or $0.49 per share. This represents our sixth consecutive quarter of improved earnings which is reflective of continued improvement in our credit quality.

Earnings improvement was directly and significantly impacted by reduced credit-related costs, both provision expense and other real estate expense. So while we indicated in April we would not expect another quarter with provision expense of $500,000, we were correct, it's just that this quarter is even lower with provision expense of $375,000. I will give you a sense of some of the puts and takes affecting our level of provisioning.

First, overall loan growth is modest, so we aren't having much provision related to loan growth.

Second, net charge-offs have been very low for three consecutive quarters and we are getting farther away from the quarters in which we experienced our most significant credit losses. We've also had almost $10 million in recoveries of charged off loans this year. Also the historical loss experience component of our allowance methodology is coming down from historical highs.

Third, we've seen a steady decline in our level of criticized loans, which continued again this quarter.

And finally, we are seeing improving economic conditions locally with some increases in collateral valuations in our markets. This is most clearly demonstrated through the consistent gains we are getting upon disposition of our other real estate and the reduced level of additions to other real estate.

Just in case you missed the numbers on that that were in our written report, our other real estate peaked out at $52 million and today it is down to $10 million, so it has gone down substantially. In aggregate these factors indicate that we are well reserved and, if current trends continue, our level of provisioning should be modest until we see more growth in the loan portfolio. Our provisions will be lumpy from quarter to quarter while we continue to resolve the nonperforming loans that remain on the books in conjunction with differing levels of recoveries from quarter to quarter.

The second boost to earnings this quarter was profits on the sale of other real estate versus the normal losses that you have. This is the strongest evidence we have seen of a recovery in real estate values in our markets. Whereas other real estate costs have been a drain on earnings in the past, we reported $915,000 of net profits this quarter. The 30% reduction in our other real estate balance from last quarter and over 50% reduction from last year continued the steady downward trend of our bank owned real estate holdings.

Residential mortgage lending has been an important product for many years both to the Company and to our customers. Clearly residential mortgage lending has been a growing revenue source for the Company over the past couple of years and, as mortgage rates have risen recently, we are starting to see some changing trends.

Although income from the origination and sale of residential real estate loans was relatively stable from last quarter, there was a clear shift in the purchased home volume from 33% in the first quarter to 53% in the second quarter. The total volume of closed residential loans for the first six months of this year was flat compared to the first six months of last year. However, this quarter's activity is down 6% compared to the second quarter of 2012.

With mortgage rates increasing we are beginning to see a decline in mortgage activity. So depending on how rates settle out over the next couple of months, we believe we will see the total volume of originations for the year reduced from last year's record levels largely due to a slowing rate of refinance activity.

Although we've seen some very encouraging signs with respect to economic conditions, we are disappointed we are not seeing higher levels of loan growth. On the positive side both ag real estate and ag operating loans saw modest increases which would be expected this time of year as both ranchers and farmers are in production mode. We have also seen some growth in consumer lending which was mainly the result of an increase in our indirect portfolio. Most of the growth in this portfolio is coming from our Eastern Montana markets.

The residential real estate portfolio has continued to increase, although at a slightly reduced pace from last quarter and last year. As we continue to experience increasing mortgage interest rates we anticipate less mortgage activity and the growth in the residential mortgage portfolio will naturally taper off.

The commercial loan activity is where things continue to be more difficult. We are booking new loans, but this activity hasn't significantly exceeded the pace at which we are experiencing regular monthly loan pay downs along with payoffs, charge-offs and foreclosure activity related to the problem loans. We remain cautiously optimistic we will see modest loan growth by the end of the year and by modest we mean something like 2% to 3%. We continue to be focused on quality first and then margin and are not willing to grow the portfolio at any cost.

Nonperforming assets decreased nearly $5 million from last quarter and $62 million from the same quarter last year. We are pleased with the strides we are making in resolving our credit quality issues. As you noticed in our release, there was a $5 million increase in nonperforming loans this quarter, the largest factor in this increase was an $8 million relationship which was placed in nonaccrual.

We do have a workout plan in place with the borrower and have adequately reserved for the credit. Although there was a net increase in nonperforming loans this quarter we don't believe this changes our outlook as we are still seeing significant resolutions of our nonperforming loans as we head into the third quarter. We are targeting total nonperforming assets to be below $110 million by the end of the year.

At this time I'd like to turn the call over to Terry Moore for a more granular look at earnings for the quarter. As you probably saw earlier this month, Terry is retiring as CFO in the middle of August, although he will remain in a consultative role until next June. Terry has been with the Company for 35 years and has been an integral part of the Company and our growth and success over the years. And I'm going to speak to that a little bit more later when we wrap up. So, Terry, go ahead.

Thanks, Ed. It's great report such a strong quarterly earnings of $21.5 million and $0.49 earnings per share on my final call. As Ed indicated, our improved results are due to a number of factors, but obviously reduced credit costs were the primary driver. Since we talked in detail last quarter about the factors impacting provision expense I won't repeat that conversation but would be glad to address any questions you might have at the end of the call.

It was encouraging to see the net interest margin improve 1 basis point quarter over quarter to 3.56% for this latest quarter. Exclusive of recoveries of charged-off interest we saw a 4 basis point improvement in net interest margin from Q1. The improvement in margin was a result of an increase in average loan balances outstanding along with a reduction of cash balances that were earning only 25 basis points. It was further aided by a further reduction in cost of funds of 3 basis points.

The yield on earning assets declined just 2 basis points from last quarter to 3.87%. Our investment strategy has remained unchanged. However, the increase in the yield curve caused an unexpected extension in the duration of our investment portfolio of about one year, from 2.7 years last to 3.6 years at the end of June. A gradual upward movement in the yield curve should help us and could help mitigate some of the decline we would otherwise expect in the net interest margin.

If we look out over the next year we have over $300 million of our investment portfolio that will roll off which we hope to redeploy in part in the loan portfolio. However, even if loan growth is limited we should be able to reinvest at a higher rate in the investment portfolio than we've seen over the previous 12 months.

Non-interest income remained steady at 33% of total revenues, this was aided by strong debit and credit card revenues along with proceeds from a company owned life insurance settlement. We have had a long-term commitment to providing card-based services to our consumer and business customers. Credit card and debit card revenues have been consistent and strong as we market to our customer base in our market areas.

For the first six months of this year compared to last year credit card revenues have increased 8.6% and now top $5 million. Debit card revenues have been consistent year-over-year at around $6 million for the first six months. Although mobile banking fees are nominal at this point the adoption and utilization of mobile banking by our customers has been exceptional. Currently over 15,000 customers are using mobile banking services regularly with the average customer accessing one of our mobile banking services 17 times per month.

Total noninterest expense was down $1.7 million from last quarter, this was mainly a result of the swing in other real estate activity Ed discussed earlier from the typical net expense to net revenue for the quarter. However, there are a couple of other noteworthy items.

First, salary expense remained relatively flat again this quarter as reduced overtime and commissions were offset by an increase in the incentive bonus accrual.

Second, employee benefits decreased due to a $500,000 reversal of group health insurance expense. We have experienced lower medical claims in the last year than expected in part due to the focus on wellness and fewer larger claims.

Third, the other expense category increased due to additional advertising costs recorded this quarter and the $616,000 write-down of the value of banking facilities being held for sale.

I'd like to talk about capital and the impact of the mark-to-market adjustment on our available for sale, or AFS, securities along with Basel III implications. First let's discuss the mark-to-market adjustment.

With the rising yield curve in the second quarter, net unrealized gains in the AFS portfolio of $14 million as of March 31 swung to net unrealized losses of $7 million at the end of June. Due to the shorter duration of our portfolio, along with our asset classes, we are impacted most by the five-year part of the treasury curve which went from 76 basis points at the end of March to 139 basis points at the end of June. Of course this mark-to-market adjustment has no impact on this quarter's or future quarters' earnings, nor any regulatory ratios -- capital ratios.

While a $21 million swing in accumulated other comprehensive income does not have significant impact to our strong capital base, I'd like to discuss the potential impact of further increases in the treasury yield. Although hard to imagine, yet a further immediate 300 basis point parallel shock to the yield curve would only extend the duration of the investment portfolio to about five years because of the solid structure of estimated lives of the underlying securities. Additionally, we have the intent to hold the AFS securities to maturity and so we don't anticipate a situation where we would recognize losses on the disposition of these securities.

As you know, the regulators finalized Basel III capital requirements earlier this month and final rules resulted in good news for community banks. One key win was the ability to opt out of including the unrealized gains and losses on AFS securities and our regulatory capital ratios. Additionally, clarification that our trust preferred securities are grandfathered and will remain a component of Tier 1 and Tier 2 capital is the second outcome worth noting. So we're confident we will meet all well-capitalized requirements under the proposed fully implemented Basel III rules today.

I will wrap up by saying I have enjoyed an awesome career at First Interstate. While I'll miss the First Interstate team and these opportunities to communicate with the investment community, I also look forward to this next chapter in my life. I have full confidence that Kevin Riley will serve the Company well for years to come and I look forward to working closely with him through a transitional period. With that I will turn it back to Ed.

Thanks, Terry, I am changing microphones here for a second. Thank you. Okay, I'll wrap up the financial part by saying it was a great quarter. While earnings have improved substantially over last year we do have our challenges ahead of us. We want you to know we are working hard to make loans and as always we have our eye on ways to increase non-interest income. We have a long history of controlling expenses and won't let up on that focus either.

Back to Terry's retirement for a minute though, I did mention briefly that he had announced his retirement; he actually announced over a year ago and gave us lots of time to plan and is going to stay with us for almost another year so that we have a very smooth transition and we are happy about that. And Terry has pledged that he will find the balance between being available and not looking over Kevin's shoulder. And I think so we will have a good transition.

And I wanted to mention more about Terry's retirement because he and I literally grew up together in this Company. When we started we were young men in our 20s who didn't know the first thing about banking, and now we are mature men in our 60s who don't know the first thing about banking. But we are still here, nevertheless.

And then finally, we are excited to welcome Kevin Riley, who is in the room with us this morning. And if you read the release you realize that Kevin is well-qualified to take on the role of CFO, 27 years of banking experience with several different companies -- actually it's not several, just a few, but that does make him well-qualified.

And another thing I would mention about Kevin is that he started at the beginning of last week and we spent the week just allowing him to get to know us. And the surprising thing is that he came back this week. So we were pleased to see that. So with that I'll open up for questions.

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

Ed, just wanted to clarify that -- I missed the loan growth number you said for the rest of -- it was at 2% to 3% for the full year or the remainder of the year? What was that figure?

That would be for the full year.

Okay. And then more on the capital side -- I guess as you have got -- you've received some clarity on Basel and continue growing earnings. I guess questions on capital deployment, whether alternative uses on the dividend front and/or if you could give us an update on any potential sort of M&A discussions if that in general has picked up in your view?

Well, as you know, I have to be very general on that. And so, certainly we will continue to pay dividends and certainly we continue to be open to acquisition. We are not visiting seriously with anyone at the moment; we still think that we would like to spend time identifying the locations we would like to be in and who we would like to partner up with in those locations. And we are also open to reactive type acquisitions if someone contacted us. But there isn't anything going on today.

Okay, thanks.

Brad Milsaps, Sandler O'Neill.

Terry or Ed, just a question about the balance sheet. I know you guys have benefited the last few quarters from reducing the securities portfolio and, more importantly, the Fed funds position. Just your thoughts on how much more room you have to reduce Fed funds there. And I appreciate the color on 2% to 3% loan growth. I guess if you had to subdivide that by category I know most of it has come out of the residential real estate bucket, what would your outlook say for maybe asset sensitive commercial type loan growth?

Terry, will you address that?

Yes, on the Fed fund, Brad, and good morning, we would see -- we have reduced that level down to in the $200 million range. And we would see that as kind of a normal operating run rate and are comfortable with that particularly at this season of the year which would typically be when we would see the tightest amount of liquidity.

So we would see that more comfortable and more sustainable than the Fed fund levels that we operated in over the last two or three years in more uncertain times and changing times. So, I think that might -- where we are at today would be more typical. Do you want to cover the loan side?

Yes, I think you were asking for categories. And we are optimistic about commercial and commercial real estate and when I say commercial real estate, really more specific to construction because we are seeing the home builders gearing up again in literally all of our territory. And so, we think that we will see a little growth on that side. We know that we will continue to see a little growth in that indirect portfolio because we have opened up with some new dealers that we weren't purchasing contracts from before. And as I said earlier, we think that that residential piece will probably level off.

Okay, great. And then just kind of a small follow-up question. Terry, you mentioned some insurance proceeds during the quarter. I assume that's not necessarily repeatable, but just curious kind of what the size of those proceeds were that helped you out in the second quarter?

It was a little over $600,000, Brad. And we are also hopeful that it would be nonrecurring again next quarter.

Sure, okay. thanks, Terry, and just want to say congrats on your retirement and certainly been a pleasure to work with you. Thank you.

Thanks, Brad.

Brett Rabatin, Sterne, Agee.

Wanted to ask about the margin and just kind of thinking about loan pricing and just until the short end of the curve lifts. Maybe if you guys could talk a little bit about if the margin from here might be under some pressure just kind of given the loan yield is continuing to abate. And I know you are still thinking about the cost of funds, but would assume the margin drifts down. Can you give any additional color on that maybe for the next few quarters?

We can and I'm going to ask Terry Moore to address that.

Yes, Brett, really the color hasn't changed too much from where we have been. There has been margin compression the last several years with this near zero interest rate. And I think the outlook will still continue to be some compression; it might be mitigated a little bit to the extent that the yield curve is steeper going forward than it has been in the last couple of years.

I might make a brief comment -- certainly there is pressure on loan pricing from a competitive perspective, which continues. And we are no different than any other bank in that regard. When you look at linked quarter, and we look like we are down about 17 basis points on the loan portfolio, some of that is the growth of residential, which was less than the average portfolio yield. But some of it was that charged-off interest, perhaps upwards of about a third of that decline is just attributable to the timing differences of when we collect interest on charged off loans.

Okay. And then just going back to the loan growth question and the guidance that you gave, 2% to 3% for the year. I mean that kind of implies the back half is pretty flattish. And I guess I am just -- I know you're talking about mortgage not being as strong in the back half of the year. But I'm just trying to kind of figure out the back half of the year, is that a function of payoffs maybe happening to offset some of the growth you are seeing or why kind of the flattish back half outlook?

We are basing our prediction on what we are seeing in regards to loan requests. And again, we are not seeing enough requests to offset the payment stream that just continues to come in. We are very happy that that payment stream comes in. But you have to make a lot of loans to stay ahead of that.

And then secondly, we are a bit of a seasonal company because of the geography we are in. And so, agriculture at this time of year tends to grow and then in the fall obviously with the sale of crops and livestock it comes back down. And in some ways the retailers do that too, it's somewhat of a summertime season for many of our retailers.

Okay, fair enough. Good color. And then maybe just one last quick one. I was just thinking about ORE and you mentioned pricing getting better. I was just kind of curious if you thought you might have some additional gains in some of the properties that you're trying to market?

Well, as long as you brought that up, first I want to mention that I had said that our other real estate peaked out at $52 million and is now down to $10 million and I misspoke there. What I meant to say it is down another $10 million to a total of $23 million. But our Chief Credit Officer, Bob Cerkovnik, is here with us. So I am going to ask him to speak to is there some gains to be had in that remaining $23 million.

Good morning, Brett. We don't expect to see that large of gains in the future. And it just goes to as we look across our portfolio we -- overall we are realizing some small gains on that. But anything that significant that we just experience we don't expect that, but we do feel we have everything written down to the -- what we consider realizable value.

Okay, fair enough. Thanks for all of the color.

Matthew Keating, Barclays.

I will add my congratulations, Terry, that is good news for you. I guess just going back to NIM, though briefly. I think last quarter we talked about securities purchases with an average yield of about 1.26% during the quarter. I'm hoping you can provide an update on how that kind of trended in 2Q? Thanks.

Yes, thank you, Matthew. We acquired about $200 million of additional securities in the second quarter at a comparable yield around 1.25%, I'm estimating on that, but so we would anticipate just (multiple speakers). What was that?

So some benefit but not that much. You think it's a little better though this quarter given the move the long end of the curve?

That is correct.

Okay. Separately on expenses, it sounds to me as though mortgage banking trends may decelerate a bit in the second half of the year. I know you typically run a pretty lean operation in terms of your mortgage banking operation. But are there any offsets on the expense side there to the extent that revenues in that business do decline? Thanks.

Yes -- that is the short answer. We have, I am guessing here, about 70 mortgage originators across the Company. And most of them are paid in part based on the volume that they are doing. And so, that I think we classified as commission income even though it is not actually commission. Anyway, that will go down correspondingly with the volume.

Okay, that's helpful. Actually I think the rest of my questions have been addressed already. So thanks very much.

(Operator Instructions). Jacque Chimera, KBW.

I just wanted to clarify a number, the purchase volume was that 43% or 53% in the quarter?

53%.

It was 53?

Yes, 53 for the quarter, so we were pretty happy to see that.

Yes, that is a nice number. Good to see people out buying new homes and everything.

Yes.

And then the expansion you spoke about for the indirect auto portfolio, is the growth in that purely due to the expansion or is part of that pent-up demand from a better performing economy?

I think it is a little of both, I mean there is no question that we picked up some dealers that we hadn't been doing business with before. But we also have some dealers, especially in Eastern Montana, whose volume has reached all-time highs.

Okay. And then how is the economy faring in some of the resort towns? Is that expected to be a good season this year?

Yes, from the standpoint of tourism numbers they, are looking for near record number of people, one thing we have seen the last few years though is while they are showing up they may not be spending as much as they used to while they are in town, so to speak. But we are pretty optimistic about how the season is shaping up and of course we are halfway through it right now. So we have got a little bit of data to prove that the season is going to be a good one.

So hotel occupancies are looking good, maybe up a little bit year on year?

No, looking good, not up year over year because they were pretty good last year.

Oh, okay. So kind of a continuation of the trend then more --?

Yes, yes.

Okay. Okay, great, the rest of what I had was answered. Thank you.

(Operator Instructions). [James Orse], UBS.

No questions. I just wanted to complement Terry on a hell of a job, well done.

Thank you.

Thanks, James.

You bet.

There appear to be no further questions at this time. So I would like to turn the conference back over to management for any closing remarks.

Thank you and thanks 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 any follow-up questions. Thanks for your time and goodbye.

Thank you very much. The conference has now concluded. Thank you for attending. You may now disconnect.