First Interstate Bancsystem Inc (FIBK) 2014 Q2 法說會逐字稿

Good day, everyone, and welcome to the First Intrastate second-quarter 2014 earnings conference call. All participants will be in a listen-only mode. (Operator Instructions).

After today's presentation, there will be an opportunity to ask questions. (Operator Instructions). Please also note that today's event is being recorded. I would now like to turn the conference call over to Ms. Marcy Mutch, investor relations officer. Please go ahead.

Thanks, Jamie. 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-K and 10-Q. Relevant factors that would cause actual results to differ materially from any forward-looking statements are listed in the earnings release and in our SEC filings. The Company does not intend to correct or update any of the forward-looking statements made today.

Joining us from management this morning are Ed Garding, our Chief Executive Officer, and Kevin Reilly, our Chief Financial Officer, along with other members of our management team. At this time, I will turn the call over to Ed Garding.

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 $21.1 million or $0.47 per share. This was another stable quarter of earnings complemented by strong loan growth and continued improvement in asset quality. I would like to start with loan growth.

We indicated in April that we were beginning to see an increase in loan demand, so it was great to have that translate into loan growth in every major loan category this quarter. This quarter, total loans grew $142 million or 3.2% over last quarter. And total loans are up about 5% over June 30 of last year.

The growth was spread across our footprint with the three strongest markets being Billings, Montana; Casper, Wyoming; and Bozeman, Montana.

Construction real estate grew 2% or $6 million from linked quarter. Within that portfolio, construction on commercial projects increased $11 million and land acquisition and development decreased by $5 million for the $6 million increase.

We are still continuing to make new residential development loans, but, as we have said before, one of our lessons learned during the last recession was to limit our focus to real estate developers with a strong proven track record. We have learned that you just have to respect the profession of real estate developer.

First mortgage residential loans were up $26 million from the first quarter. We continue to retain 5- to 15-year adjustable rate mortgages, 10-year conventional mortgages, along with a few jumbos.

Indirect consumer loans grew $31 million or a 6.4% increase from the first quarter. We really need to give credit to our indirect lending team. This quarter represented the highest volume level in our history and exceeded the next highest quarter by 15%. This level of performance represents the relationship our lenders have with the auto and RV dealers across our footprint, aided by the fact that we have exceptional turnaround time in funding these loans.

On top of that, through May of this year, our loss rate is only 2 basis points on these loans. We are very pleased with the performance of this portfolio.

Ag loan growth of $22 million, a 20% increase from the first quarter, was predictable as this portfolio typically increases during the spring as farmers and ranchers start utilizing their operating lines. We anticipate this portfolio will remain fairly constant through the third quarter and then experience the normal seasonal decline in the fourth quarter.

Commercial loans were up 3% quarter over quarter or $20 million. This growth is not specific to a particular industry or region. The average size of the new loan in this portfolio was less than $100,000 this quarter, which we view as good news, because it gives us diversity and some feedback that we are serving small business.

Headed into the third quarter, we continue to see strong loan demand and are well on track to see loan growth meet our goal for this year.

We also continue to see steady improvement in our credit quality. Nonperforming loans decreased $9 million or just over 10%. With the minimal level of net charge-offs this quarter, this decrease was mainly the result of pay downs, payoffs, and upgrades of loan balances. We are happy with the pace of the decline and are making substantial strides toward achieving our nonperforming asset to total asset goal of 1%.

Sales of other real estate this quarter were modest compared to prior quarters. Inflows approximated outflows, resulting in a very small decline in the balance of other real estate. We continue to see steady sales of residential lots at small gains from some of the land acquisition and development properties we hold. We also do not anticipate further significant valuation adjustments on the properties. Our current strategy is to remain diligent as we work out selling the rest of this inventory.

Increased loan growth and improved credit quality can be attributed to the healthy economies we are enjoying here in the Northwest. With unemployment rates below 5% across our footprint, we would consider ourselves at near full employment. It appears the summer tourism season is off to a strong start. Yellowstone Park recreational visits are up 7% through June. Glacier is about breakeven with last year.

With the exception of wheat, commodity prices are up across the board. As of June 30, natural gas and coal prices were up over 20% from a year ago and oil was up 9%. Cattle prices were up almost 26%. So, the largest contributors to our economy -- energy, agriculture, and tourism -- are all doing very well, which is helping to drive the uptick we are seeing in loan demand, both from consumers and our commercial customers.

I would like to turn this over to Kevin for a little more detail behind the numbers, and then I will wrap up with an update regarding our pending merger. Go ahead, Kevin.

Thanks, Ed, and good morning, everyone. I would like to start off by reviewing the balance sheet. As Ed has indicated, loan growth was just over 3% for the quarter and almost 4% year to date.

Deposits [grew to] approximately 1% for the quarter and also on a year to date basis. The primary driver of the increase was non-interest-bearing deposits which were up about 5% for the quarter. This resulted in an improved deposit mix and a lower deposit cost. With loan growth outpacing deposit growth, we had a loan/deposit ratio of 72.9% as of June 30, a 210 basis point increase from that of last year.

The investment portfolio declined slightly again this quarter, but still represents 27% of our total assets. We have been very successful in continuing to shorten our duration in the portfolio, which declined to 3.1 years this quarter from 3.4 years as of March 31. We continue to work at insulating our balance sheet to sensitivity from interest rate movements. We know at some point rates will eventually rise, and if and when this occurs, we are positioning ourselves to be ready.

To reiterate what we have said in the past, we think our customers are patiently waiting for opportunities to earn better rates on their money. When rates are moving, we believe they are going to demand higher interest rates, but for now, the continued shift to short-term deposit has allowed our cost of funds to continue to decline slightly to 27 basis points.

Capital remains strong with our tangible capital ratio increasing to 8.72%, and total risk-based capital at 16.69%. As part of our capital management strategy, we continued to look for the right opportunity to repurchase our shares. This resulted in over 225,000 shares of stock being repurchased this quarter at an average price of around $24.91. Even considering the impact of the stock buyback, tangible book value grew $0.34 per share for the quarter.

As you can see, our operations continues to generate a significant amount of capital. And we are highly focused on efficiently managing our capital position. We are returning capital to our shareholders through a strong dividend and the ongoing share repurchase program, while also investing in the business to support organic growth and the acquisition growth. We believe this formula of balanced capital management will continue to optimize our level of returns and to create value for our shareholders.

We recently received regulatory approval and will consummate the Mountain West acquisition at the end of this month. While this will result in a temporary decline in our capital ratios, we anticipate an earn-back period on our capital of less than three years. At the anticipated earnings level, however, the actual tangible book value per share should return to its current level within two months.

Moving to the income statement, while core income was stable quarter to quarter, pretax pre-provision income was up $2.5 million or about 9%. We were pleased to see our net interest income increase on a linked quarterly basis. This increase is mainly attributed to loan growth and one additional accrual day, and the recovery of interest on nonaccrual loans.

The net interest margin increased to 3.54%, a two basis point improvement over last quarter. This improvement was, however, the result of two factors: increased loan growth and the recovery of interest. Omitting the impact of interest recovery on a quarter to quarter comparison, the net interest margin would have declined 3 basis points from the prior quarter.

As for our outlook for our net interest margin, we don't believe this quarter improvement is indicative of an upward trend. Continued loan growth will help maintain our margin as the ratio of loan to deposits increase. We also anticipate purchase accounting on acquired loans from Mountain West will create a little noise in our net interest margin over next several quarters.

For the fourth consecutive quarter, we have had a negative provision. The $2 million reversal this quarter was a result of the declines in criticized loans, along with the continued improvement in our economic indicators and our historical loss rates. Going forward, depending on how quickly nonperforming loans continue to decline and the level of new loan growth, we may continue to be in the position where we will be required to release reserves. However, we are conservative in our current outlook and we believe we may even have a small provision during the next two quarters.

Noninterest income was up $2.5 million or 10% from last quarter. Higher volumes of debit and credit card transaction resulted in higher fee income.

Income from origination and the sale of home loans increased 37% over the first quarter, with 76% of this production was purchase activity, while 24% was refinanced activity. As of June 30, the volume of production was in line with our goals for the year. We believe that third quarter will look a lot like this quarter and then we will probably slow down again as winter approaches.

There is still a shortage of builders to keep up with the demand in our area, particularly in the starter home market.

Wealth management continues to grow. Revenues were up 3.5% quarter over quarter. Assets under management this quarter grew $73 million or 6.7% on an annualized basis.

Core noninterest expense was in line with our expectations of approximately $55.5 million per quarter. However, salary and wages increased this quarter as a result of an additional day, commissions paid to mortgage originators, and an increase in incentive compensation accrual. Continued improvement in the levels of health insurance claims led to a decrease in our employee benefits and there really is nothing else that stands out within our core noninterest expense.

To date, we have occurred about $600,000 in merger related expenses. We have disclosed earlier that we anticipate one-time deal costs to be approximately $7.2 million. At this point, we are optimistic that this may be a little high. We stated in the past that we thought all of our cost saves would be realized by the end of the third quarter. With regulatory delays we had to push back our bank conversion to six weeks, so we are now -- believe that they will all be realized by the end of the year.

To wrap things up, I would like to say we continue to be bullish on the future. Higher levels of loan growth, improving asset quality, and a successful integration of Mountain West acquisition will lead to higher returns for our shareholders. So with that, I would like to turn the call back over to Ed.

Thanks, Kevin. Kevin just mentioned the Mountain West acquisition and I would like to wrap up by providing you with an update on that transaction. We have received the necessary regulatory approvals and will close on July 31. Following that, as we indicated in a press release last week, we anticipate the bank merger will occur in mid-October.

Because of the 100% market overlap and the proximity of the Mountain West locations to existing First Interstate branches, we will be consolidating eight of their locations into our branches. So now, our focus is on our combined customers. We are striving to ensure that our integration efforts don't have a negative impact on the banking experience of our customers in any way.

We are excited about the possibilities created through the combination of our two companies and are honored to have Mountain West become part of the First Interstate organization. They have worked hard to create a strong franchise and are a recognized leader in our shared communities. We believe the combined organization will be stronger and will enable us to better serve all our customers.

So with that, I will open up for questions, but before I do that, I have found out that we had the wrong telephone number posted for this call. I am not sure how that happened, but some of you may have had to join late. So don't feel bad about asking me to go back to the beginning if there is something you want to know. And, for those of you that did join us, thank you for persevering and figuring out what the phone number actually was. So now, do we have any questions out there?

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

Ed, just to follow up on the branch closure announcement, any expected financial impact, either near-term costs or long-term savings, that you could quantify?

I think the best way to say is that it will be a wash, because we have appraised all of those buildings and there is a lot of interest from people who would like to buy them. And so it would appear that we are going to be able to sell those buildings very near, if not above, what we booked them for. And, fortunately, in most cases, we will be able to sell them to nonfinancial institutions, so that we are not helping our competitor come into the market.

Okay. And, do you have updated balances on the loan and deposit balances for Mountain West as of June 30?

Yes. And I think I will ask Bob Cercovnik; give us the ballpark numbers, would you, Bob?

In our earnings release, we had talked about they're roughly -- is about -- sorry.

$623 million.

$623 million in total assets and the loans are right around [300 and] --

[$80 million].

[$80 million] and deposits about $520 million.

$520 million. Okay. And then just one last one on -- Ed, you talked about your loan growth goal and it sounds pretty positive in terms of the loan pipeline, I guess coupling together what you are seeing from or hearing from Mountain West, but also just the legacy business. Maybe if you could remind us what that goal was or quantify what you'd see for the year.

I'm going to say between 4% and 5%. We are all looking at each other, saying, well, what was our goal, and I think that the stretch goal would have been in the 5% range. And I say the stretch goal, that was in January and now we are feeling pretty optimistic about hitting that number.

Brett Rabatin, Sterne, Agee.

Wanted to first ask, there has been a lot of commentary this quarter from banks bigger than you guys about regulatory cost, and I know you are not going to be $10 billion post Mountain West. But, was just curious, on efficiency, I guess one is, are there going to be any new, do you think, levels of investment you will have to make as you approach $10 billion?

And then, just secondly, you have had a lot of initiatives over the past year. Should we see anything else aside from Mountain West potentially have a positive impact on the efficiency ratio?

I am taking a minute to think about how to answer all of that, Brett, but I think I would start with the $10 billion subject. And there is just no question that there are increased regulatory and reporting costs when you approach and exceed that threshold. And the cost is enormous.

But, that said, we also think that, with that growth, you move your non-interest and your interest income up to the point where you achieve critical mass. And so, in a sense, that will net out.

We have experienced a higher cost of doing business because of some of the provisions of Dodd Frank becoming active over the last year. The best example I could give you is that in mortgage lending, it just flat takes more people to do the same amount of volume as you previously did, to stay up with the regulatory requirements. That is just the nature of the game. But, again, if you continue to grow, I think you can grow into that.

In regards to efficiencies with Mountain West, with that acquisition, this is the first in-market acquisition we have ever done. We have always gone outside of our market, even if it is just a little bit outside. So this is our first in-market acquisition and we think that we are going to create some tremendous efficiencies by gaining a lot of new customers without adding a lot of new expense.

Okay. Thanks for the color around that. The other thing I guess I was curious about was just thinking about your loan generation in terms of rate compared to the present portfolio. Any thoughts around what new generation is coming in at, and just sort of thinking about the margin going forward, aside from Mountain West and any changes in interest rates?

I am not sure I am understanding the question. But, in general, we are -- new loans are going on the books at an average of around 5%. As we have stated, we saw a 2 basis point increase in the net margin. That was driven not just by loan growth or loan interest rate, it was driven somewhat by interest recoveries from previous losses, too. But, nevertheless, we are gratified to see that that margin is holding and we don't see that dropping off significantly in future quarters. Does that answer your question?

Yes. That is exactly what I was looking for. Thanks for all the color.

Jacque Chimera, KBW.

Looking to the loan growth, you had really good loan growth in the quarter. Was part of that related to loans that may have been delayed from first quarter, just due to the weather and everything?

Yes, definitely. The construction industry, whether it was commercial, highway even, or mostly the homebuilders, they were very stagnant during that tough winter weather. And that is not always the case. These days, they have the technology to build 12 months a year, but this was a tougher winter than we had experienced in some time. And you could just feel it and see it open up as springtime came around.

So I would have to say yes. Now, that said, we don't think it is a one-time event because we are seeing development in both residential and commercial ramp up. And so we are feeling pretty good about third quarter loan growth, too.

So, to make sure that I heard you correctly in the prepared remarks, did you say that the average size of new bookings in the commercial portfolio was around $100,000?

No, just the average size of new commercial loans. That does not include commercial real estate.

So just the straight commercial portfolio.

Correct.

Okay. So did you take on a lot more customers this quarter, then? Because, just looking at it, with the $100,000 versus the substantial growth you had in the quarter, that is kind of where I am going with that. Am I thinking about it properly?

You know, I wish I could say a whole lot of new customers, but, no; a modest number of new customers and an awful lot of business owners with renewed confidence in the future, that are either expanding or building inventory and those kinds of things.

Okay. So it sounds like increase in line utilization and consumer confidence is building, that sort of thing.

That is correct.

Okay. Then just one last quick one. Do you have -- given that you have had some nice interest recoveries over the past couple of quarters, is there still a sizable pool for that left?

Bob Cercovnik, will you address that?

Good question, Jackie. We don't see a significant pool out there, but it comes -- we are working hard on collecting that interest on those nonperforming loans as our nonperforming loan balance comes down. We will see some of it, but, to that level, I really can't give you a real strong answer in that regard.

Okay. So it'll just continue to fluctuate over the next couple of quarters?

Yes.

Brad Milsaps, Sandler O'Neill.

Kevin, sorry if I missed this, but just curious, what drove the decision to be maybe a little more aggressive with the buyback this quarter relative to other quarters? And how do you feel about that going forward, maybe weighed against pursuing other acquisition opportunities that might be out there?

What really probably highlighted the reason why we bought back is our stock price dropped to a level we believe that it is a good return to the shareholders at that price. We have a kind of a price target and we were under that price target, so we acquired shares during that time.

Got it. Okay. So -- and then, in terms of M&A going forward, can you guys just talk about that? Maybe once you get Mountain West closed and converted, is it something you would maybe begin to pursue again in early 2015? Or what are you thinking there?

Mostly I am thinking that we want to do a good job of integration with the Mountain West people and the Mountain West customers before we think seriously about the next acquisition. And so I certainly wouldn't expect to do any hunting in the next couple of quarters.

Okay great. Fair enough. Thank you.

Brett Rabatin, Sterne, Agee.

I just wanted to ask about capital pro forma sort of related to the share repurchase question, and if you are not going to be -- maybe not doing any acquisitions until next year, you are focused on the Mountain West integration, what do you guys focus on at this point in terms of the most important capital ratio? I know the regulators have been all of them. But, what is your primary capital ratio? And maybe you can just give us an idea of a target ratio or a number you wouldn't go below.

Well, I am going to have Kevin give you the specifics, but I would say that our thoughts along capital are to have a little more than the regulators want us to have and a little less than the investment community thinks we should have. There is a fine line there. But, Kevin, would you be more specific than that?

Well, as, Brett, you know there is a number of ways to look at capital. So the big biggest thing, I think the driver or what we are trying to look at our capital management, one, I agree with Ed, we want to keep substantial amount of capital around, most ratios.

But, I think what we try to focus on is keeping our tangible book value per share increasing and return on equity. I think that we want to continue to drive a higher return on total equity and we do have aspirations of increasing from where we are at. So we are trying to manage capital appropriate, one, to keep the tangible book value per share growing as well as return equity, and again, with that, also drive earnings per share growth.

So we are always going to keep adequate capital ratios, but we are trying to drive that return with good capital to our shareholders.

Okay, I appreciate the color.

Jeff Rulis, D.A. Davidson.

Kevin, you mentioned some noise on the margin with Mountain West. What, in specifics, does that mean? I guess up or down is the expectation.

Well, we had original model when we did the original marks on the various loans -- deposits, as well as investments and borrowings, [comfortable] margin. The final numbers when we go through purchase accounting will post that margin. So we would say noise is that, as you know, in purchase accounting, you amortize some of your marks in, you reprice your investment portfolio, and deposits.

So we believed it might have a slight positive aspect. But, at this juncture, since we haven't gone through all the purchase accounting, we don't know what that impact might be.

Great. Thank you. And then, just one quick one on the mortgage sale gains. What have you seen so far in Q3 and what do you expect to trend on the fee income line from mortgage?

We think the third quarter is going to be very similar to second quarter in total volume.

And then perhaps a taper in Q4.

Yes.

Okay, fair enough, thanks.

And, gentlemen, at this time, I am showing no additional questions. I would like to turn the conference back over for any closing remarks.

Yes. I would make a closing remark, which is just kind of an anecdote about the economy, because I didn't mention anything about the Bakken oil field. And that is still having an impact, especially on eastern Montana, but in many cases all across our footprint, over in northern South Dakota and even Casper, Wyoming, where there is a lot of oil industry people.

But, the story I would tell is, here in Billings, where we are very bullish about the economy in Billings, we did have a hailstorm early this summer that did about $900 million worth of damage to homes and buildings here in Billings, which is causing a lot of rebuilding, so to speak. And one of our leading house builders in town, who has been very busy, is building a house right next to me. And it has sat idle for quite a while. I know the house is sold because I know the buyer.

And I asked the builder, when I saw him in the bank, what is going on? Why don't you get that finished? And he said, I can't find roofers. I cannot get the roof completed because I can't find the roofers.

And, interestingly, I said I could talk my son into trying to help you out, but it would have to be just at certain times because he is making a fortune driving a gravel truck over in the Bakken in North Dakota, and has parked his roofing tools in my garage. But, that type of story you hear a lot; kind of a combination of a lot of building going on and people taking the opportunity to make money over in that oil field.

With that, I think we will conclude. Thank you, everyone, for joining us.

Ladies and gentlemen, that does conclude today's conference call. We do thank you for attending. You may now disconnect your telephone lines.