First Interstate Bancsystem Inc (FIBK) 2014 Q4 法說會逐字稿

Good morning, and welcome to the First Interstate Bancsystem fourth-quarter 2014 earnings conference call.

(Operator Instructions)

Please note this event is being recorded. I would now like to turn the conference over to Marcy Mutch. Please go ahead.

Thanks, Amy. Good morning. Thank you for joining us for our fourth-quarter earnings conference call. As we begin, I'd 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 form 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. 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 Riley, our Chief Financial Officer, along with other members of our Management team. At this time, I'll turn the call over to Ed Garding. Ed?

Thanks, Marcy. Good morning and thanks again to all of you for joining us. I want to start by saying we had a good solid year. Yesterday we reported fourth-quarter earnings of $22.8 million, or $0.49 per share. Included in our net income this quarter were acquisition costs of approximately $2.4 million, which had a $0.04 impact to our earnings per share.

The integration of Mountain West Bank and realization of our planned cost savings has gone well. Total acquisition costs related to the deal were approximately $4 million, well below our anticipated cost. Of the 18 branch and bank-owned properties we acquired, all but 3 properties have been sold or are pending sale. And since the acquisition, we have achieved the staffing reduction levels we anticipated.

Moving to loan growth, in total we had organic loan growth of approximately 1% for the quarter and 4.4% for the year, with growth in most of our major loan categories. For the quarter, organic growth in real estate loans increased $55 million, or 1.7%. The fluctuation between commercial real estate and construction real estate was mainly due to a reclassification of loans acquired from Mountain West Bank.

Residential loans were up 4.5% and ag real estate loans were up 5.5% quarter over quarter. We continue to see growth in consumer loans, which were up 2.3% from last quarter with the indirect portfolio once again accounting for most of this growth. As anticipated, ag operating loans were down quarter over quarter by 8.6% as lines were paid down. The good news is that year over year, these loans were up by over 11%.

Moving to credit quality, we all thought Bob Cerkovnik, our Chief Credit Officer, was a little optimistic at the beginning of 2014 when he indicated our non-performing asset to total asset ratio would be at 1% by the end of the year. Well, now we have to applaud Bob, and all of our credit people, because we decreased non-performing assets to total assets by 17 basis points this quarter, down to 91 basis points as of December 31. With net charge-offs at virtually nothing for the quarter, this was a significant improvement.

Breaking down the decrease in non-performing assets, non-accrual loans were down $9.7 million, mainly due to the payoff of one large credit. Our other real estate owned had a net decline of $5 million, which was very positive considering real estate sales generally slow down in the fourth quarter. Total criticized loans remained stable for the quarter and are about 7% of total loans. While we would like to see this number continue to decline, it is within an acceptable range.

Despite declining oil prices and the layoffs we hear are happening in the Bakken, we are continuing to enjoy a strong economy across our footprint. Unemployment rates are still low and we haven't seen a noticeable impact from North Dakota. In order to get a little better understanding about the impact declining oil prices might have on Montana and Wyoming, we hosted a discussion with some of our local oil and gas developers and service providers. I would like to share some of the feedback they provided.

First off, they were all quick to point out that this cycle should not be compared to the 1980s. The 80's boom was driven by more speculative exploration, while this has been more of an expansion cycle. Better technology has allowed a much higher success rate on drilled wells, close to 90%. Right now the Bakken produces about one-ninth of the US oil production and there are now over 11,000 producing wells in North Dakota. These wells will require an ongoing support network of about 2.2 persons per producing well. At the peak there were over 180 rigs drilling in the Bakken. We all know this number has declined and yesterday there was 161 rigs drilling in the Bakken, so there definitely is a slowdown.

In general, the feeling was that a temporary decline in oil prices, with temporary meaning 12 months or less, would actually cause a positive reset. They indicated there would be some short-term pain as companies scaled back on staffing but that this reduction would also translate into lower servicing costs, allowing producers to be more efficient. The general consensus was that they had been paying about a 30% premium on services over in the Bakken during the last few years. Additionally, to the extent there are small service companies that have weaker positioning now, there will be merger and acquisition opportunities for mid-sized companies.

On a positive note, they indicated the Powder River Basin in Wyoming has the potential to be very competitive with the Bakken in terms of volume, with oil extraction costs being a little more economical for producers. This is good news for the long term. They provided a lot of insight into global demand for oil and that based on this demand, oil prices cannot stay low indefinitely. However, no one wanted to place a stake in the ground that this decline was sure to be short term and indicated that we'd need to revisit this discussion if oil prices were still low 12 months from now. In general, they would like to see oil prices at around $70 to $75 a barrel.

We did talk specifically about the reduction in workforce and what that might do to our unemployment numbers. They pointed out that the Bakken workforce has come from all over the nation, not just from the surrounding states, so that this staffing reduction will not hit just our region. The question is how this might all impact the bank. First, we feel like we could see some influx of workers back into Montana, but we don't anticipate this to be a dramatic inflow or an impact to our economy at this time. Second, low prices at the pump should translate into good news for our tourism and ag industries.

Lastly, as we have said before, we don't have significant exposure in our loan portfolio to oil and gas production. At the end of December we had roughly $73 million in loans directly to producers, with an additional $37 million committed. Our indirect portfolio has about $16 million of loans into the Bakken. There have been no early warning signs of potential changes to the delinquency rate on these loans. Should oil prices remain low for a longer term, we could see some additional impact, but we are closely monitoring our loan portfolios in the markets that could be most heavily influenced by the Bakken activity.

With that, I would like to turn this over to Kevin for a little more detail behind the numbers. Go ahead, Kevin.

Thanks, Ed, and good morning, everyone. We are pleased with our strong fourth-quarter results. We reported earnings of $0.53 per share, absent acquisition costs. GAAP earnings for the quarter were $0.49 per share. Acquisition expenses reported in the quarter were $2.4 million, and this should be the end of costs related to the acquisition of Mountain West. Excluding acquisition expense, our pre-tax, pre-provision income increased $3.2 million over the prior quarter, or 9.3%.

Let's start with the balance sheet. For the quarter, as Ed mentioned, loans grew about 1% organically, or $43 million. Year-over-year organic loan growth was 4.4%, or 12.7% including the Mountain West acquisition. This quarter our investments increased $117 million, or 5%, over the prior quarter to $2.3 billion and currently represents 27% of our assets. The duration of the portfolio declined slightly this quarter to 2.98 years, down from 3.1 years last quarter.

We continue to stay steady with our strategy to keep the duration short in our investment portfolio in order to enhance our asset sensitivity. If and when rates rise, we will be in a good position. Our organic growth in deposits this quarter was also at about 1%, or $47 million. Year over year, our organic growth was 5.8%. Our mix of deposits continue to shift away from higher-cost deposits into non-interest-bearing deposits, which grew 9% this quarter.

Now to the income statement. Despite increase in our net interest income of $456,000, our net interest margin decreased 17 basis points for the quarter to 3.38%. Exclusive of the impact of purchase loan discounts related to early payoffs of acquired loans and a recovery of charged-off interest quarter over quarter, the margin declined 14 basis points.

Frankly, average deposits for the quarter increased at such a rapid pace that we ended up carrying large balances in overnight funds for the quarter, earning us only 27 basis points. This cost us about 10 basis points in our net interest margin calculation this quarter. The additional 4-basis-point decline was due to lower yields in our outstanding loans.

Going forward, our cash balances have already returned to a more normalized level and we don't anticipate our loan yields to continue to decline at this pace. We believe the margin should move back up as asset liquidity leaves the bank or is put into higher yielding assets. With the continued improvement in credit quality we saw this quarter, we had a modest provision of $118,000. Our provision pretty much covered our net charge-off for the quarter of $149,000. Our fourth-quarter non-interest income was 32% of total revenue.

There was some noise in our non-interest income this year. Our seasonal decline in mortgage revenue was offset by gains on the sale of bank buildings, death benefit proceeds and a car payment network bonus. Our origination and sale of mortgage loans declined by 24% last quarter. We started the quarter out strong, but things quickly tapered off. Going forward, we still see this as an area of growth.

Our wealth management revenue and our card business continues to be an area of strength. I will talk more about our initiatives in regards to non-interest income in just a few minutes. Our core non-interest expense held steady over the third quarter and we summed up changes fairly well in our earnings release. Seasonal increases in normal operating costs were offset by decreases in incentive accruals and group health care costs.

Now, I would like to take a moment to talk about our strategies for 2015. First in regards to interest income, we expect to see a steady year-over-year loan growth in the mid-single-digit range. We intend to be disciplined in our pricing and so we expect to see corresponding increases in net interest income. With the large influx of deposit over the last half of 2014, our deposit growth goals are in the low-single digits, anticipating that we might experience some level of runoff during the first quarter. With our continued asset quality improvements, we expect our provision to approximate net charge-offs next year.

We set strategies to increase non-interest income revenue. These initiatives are based on increasing mortgage production, increasing a number of products for customers, and generating additional business credit card usage. We also have some opportunities around what I call leakage. We are evaluating how we are collecting the fees due to us from our customers and where there could be some potential to collect more fees. We know we have given up some fee revenue and we are focused on plugging those holes.

Let me give you an example. We automatically opt out our customers under Regulation E. Consequently, only 2% of them have opted in and allow us to take their bank accounts to a negative balance when using their debit card. We will become more proactive in informing our customers to the benefit of opting in under Regulation E and so we can increase that 2% customer base to a higher level.

In terms of non-interest expense, the majority of cost saves from Mountain West have been realized, so we anticipate our non-interest expense to be about $60 million a quarter for 2015. Our goals around efficiency will include the continued rationalization of our facilities and our staffing levels. Savings in these areas will allow us to invest in new technology that will benefit our customers.

Lastly, I would like to wrap up, talk about capital. Capital remains strong and we will continually actively manage capital in an effort to reach our 12% return on equity goal by the end of 2016. Our [depoment] priorities remain unchanged. Being first, organic growth; second, strategic acquisitions; third, the repurchase of stock; and lastly, dividends back to our shareholders. Along those lines, the Board has just approved a new share repurchase program that authorizes us to repurchase up to 1 million shares. We will take advantage of that opportunity as the markets allows.

We also just announced a 25% increase in our dividend to $0.20 per share. We know our shareholders will like that. We're optimistic about loan growth this year and, as always, we are on the hunt for a good bank acquisition. With those initiatives and strategies in place, our job this year is to execute on them. With that, I would like to turn the call back over to Ed.

Thanks, Kevin. As Kevin indicated, we are focusing on growing the bank. Part of that involves looking at how we approach the $10 billion mark. We have already started to plan for this and have acquired systems that will help us with our DFAST stress testing and other compliance issues.

We also recently hired a new Head of our Compliance Department to replace our longtime compliance officer, who is retiring. Our new hire comes to us from Bank of America and, prior to that, from JPMorgan. She comes with some big bank experience which will help us through the transition of going over $10 billion. We are excited about 2015 and all that might bring. With that, we will open up for questions.

(Operator Instructions)

Matthew Clark, Sterne, Agee.

First on loan yields, can you just talk about what rates you are getting on new originations in the quarter? I think previously your yields have held up very well. I'm curious as to what those new rates are and what has changed here.

(multiple speakers) I am going to refer that one to Bob Cerkovnik, our Chief Credit Officer.

This is Bob. Matthew, thank you for your question.

We -- for the fourth quarter we are showing about a weighted average rate of about 4.75%.

Okay.

On the whole portfolio.

Okay. Because as you look out, you talked about the -- I assume part of that is from the curve and what the curve has done more recently, but just can you talk to why you think loan yields might hold up as we look out throughout this year?

I think that the statement about how they hold up through the year is really based upon that we are going to continue to be very cautious in how we are pricing our loans and that we're not going to be the lowest cost provider in the market. We will continue to because we add value to our customers over a long term and we think we can command higher prices across our footprint.

Okay. I guess maybe I should rephrase that. It sounded like you guys were talking about the rate of change would be a lot less going forward, but maybe the trend is still lower?

No.

(multiple speakers) In terms of the portfolio yield.

We think it will stable out; and, again, it is just how we are trying to do business and the fact that we're going to be disciplined in our loan pricing going forward.

Okay. And then back to the direct exposure to the Bakken, or just oil and gas direct exposure of $75 million or so, maybe $110 million with commitments -- I think you also mentioned direct exposure to the Bakken of $16 million. Can you talk, through, the ancillary exposure that you might have? Maybe not necessarily right to the Bakken, but to industries providing services to the Bakken?

I can. First off, I would explain that the $16 million that we mentioned is the piece of our indirect portfolio. That will be automobile loans that we have identified that are in Western North Dakota. Again, so far we haven't seen any movement in regards to delinquencies there.

Secondly, yes, we have a lot of customers that provide services, from trucking to welding to electrical, over in that oil field; and we feel pretty good about where they are at from the standpoint of, they have been reasonably prudent and they have been profitable to the point to where they can withstand a slowdown.

Okay, great. Lastly, if I may, just on deposits. A big surge here this quarter. Sounds like some of that may have already left the bank, but just wanted to get a sense for how many relationships really drove that increase and what might still be at the bank.

Kevin, would you take that one?

Sure. It was interesting because really, the deposit growth was across all our footprint. It wasn't really a surge of new accounts as much as just increasing balances in the accounts that we already had. Some of that has dissipated. We really can't point to a single reason why it all came in. It's kind of seasonal and it has dissipated a little bit already in the first quarter.

Okay. Thanks, guys.

Jeff Rulis, D.A. Davidson

Good morning. Ed, thanks for the oil dialogue. I thought that was very thorough, so very helpful.

Question on the -- I guess trying to quantify again on the margin, then. You talked about loan yields and perhaps a benefit on the -- as you deploy that recent funding and lowering cash balances. What is again the outlook on margin for 2015? If you could just clarify where you think the direction is there.

Kevin, would you take that?

Sure. As we saw in 2014, it did come down a little bit as compared to 2015. I think you are going to see, if we stay in this zero rate environment, we could see some of the margin continually to move down a basis point or two a quarter. We believe that the increase in actual balance sheet growth will more than offset margin erosion. We will have some marginally, but we believe the growth will more than offset that. Net interest income, we believe, going into 2015 will continue to increase.

Part of the margin erosion a little bit, if you look at, it was kind of a loan mix change. Some of the things, as we mentioned earlier, the mix from higher growth and indirect loans and some mortgages versus some of the ag loans being paid down. Some of that might stable out in the short run.

Okay, thanks. Maybe one for Ed on capital usage.

You sort of outlined the strategy of where you would prioritize capital use; and I guess with the repurchase announcement and dividends, does that shed any light on M&A opportunities, as in, that is any lighter that has been? Maybe you could talk about dialogue you are having on M&A and the opportunity in 2015.

First, I would say that we don't have any one silver bullet, so to speak, for capital. We are trying to approach it in a variety of ways -- as you mentioned, with the dividend, some amount of stock repurchase, and, of course, we would look at the right fit for an acquisition; probably not go out and do something huge. A little bit of everything.

Okay. And that particular, on the M&A side, those are discussions that are ongoing? It has not increased or decreased?

No. I would say it has been fairly steady and it's -- as you know, how the industry is going, we do have a lot of visits with what I would call very small community banks that are expressing an interest to sell, retire, so on. We continue to have those talks but we will probably pick our locations and targets pretty carefully.

Okay. Thanks. That's it for me.

Matthew Ferguson, [Ceremonial]

Just a quick clarification here. Kevin, when you said that the margin may decline a basis point or two, is that off of the 3.38% level?

No. That is off of the normalized margin that we articulated with regards to adding back the 10 basis points. We are going to have some interest recovery. We stripped out interest recoveries and we stripped out the aspect of some advanced amortization on loans that will prepay with regards to Mountain West acquisition. You are always going have some of that every quarter. And if you look at all of those things put in place, the margin came down four basis points once you start normalizing some of that stuff. We try to strip it out to a core margin absent of any of that stuff. You got to add back some of that when you look at it. It is going to be far greater than the 3.38%.

Okay. You mentioned in the release that you are booking some more residential products. Can you talk to us a bit about your interest rate sensitivity position and how much room you have to extend duration in the loan portfolio?

Well, we look at our interest sensitivity very conservatively. That is why you can see our investment portfolio has a very short life. Normally we target about $500 million overnight in funds that can float. We try to monitor asset sensitivity when looking at what fixed-rate loans are going on the books. We try to offset any kind of duration risk on the loan side of the house by keeping our investments and our other funds short. That is how we balance it out.

Okay.

Pardon me, I would add to that, that you probably noticed that the yield on our investment portfolio is below peer. That is by design. We use that investment portfolio as a hedge for changes and we recognize that liquidity is not free, but we want to have a nice cushion of liquidity.

Okay. I know we may need to wait for the K for this, but Kevin, would you happen to have either your one-year static GAAP or your NII sensitivity, say, to a 100 basis-point incremental move in the curve?

You'll see that in the kit. I have it, but it is very minimal. Right now, again, it all depends on your modeling with regards to the betas you use on your deposit repricing, which we are very aggressive on our beta. But right now, our GAAP 100 basis points, 200 basis points, I think it's a little over 1%; 100 basis points, a little over 2% net interest income over 200 basis points. We're pretty much, I'd say, neutral; but you also have got to look how aggressive we are when we look at our deposit pricing.

We believe a little bit different than other institutions out there that, one, deposits aren't as sticky as everybody thinks they are; and two, that rates will need to be raised on your deposits quite quickly or your deposits are going to find another place to put their money. I think you're going to get competition from the larger institutions, which have liquidity needs, so they're going to price up. I think there's going to be some good competition on deposit pricing when rates start to rise. That is why we are really being prepared to increase our deposit rates when that time comes.

Okay. And then, lastly, could you give us, if you have it there, the dollar balance of your pipeline and just remind us how this compared to the September 30 level?

You are talking about the loan pipeline?

Yes, I am.

Bob, would you address that?

We feel it is still pretty strong going forward. I can't give you exact number about where we are going, but we feel with our economies that are surrounding us right now that we feel our loan pipeline is doing well. As I said, we expect our loan growth to continue, as Kevin articulated early in the conversation.

Thank you.

Jared Shaw, Wells Fargo Securities.

Could you just -- going back to the excess cash and the -- how long do you think it will take to really reinvest that cash and get that deployed where that is down to more of a normalized level?

Well, as we mentioned in the notes, Jared, that the cash has kind of came back down. I think we averaged close to $900 million overnight on average for the fourth quarter. We are down back into the $500 million range, so a lot of that excess has already left.

Okay.

It is already gone.

Okay. When we look at the growth in the construction portfolio, can you break that out by land, residential, and commercial for us, where the emphasis was?

Want me to answer that, Ed?

Yes.

Part of that, Jared, was a reclass of loans that we acquired from Mountain West. It wasn't a growth, really, in the sense it was -- the way they accounted for in their systems, and we consolidated for the third quarter after we did the systemic version, those kind of just reset out of commercial real estate into construction. It's not just a bunch of new construction lending.

Okay, that's helpful. Thanks.

And then, as you look at the indirect portfolio, how have the recent production loan to values and cycles held up compared to historic, or the rest of the portfolio? Have you changed any of the reserve ratio on indirect auto in light of the oil prices?

Bob, do you want to take that?

Yes, Jared, this is Bob.

As far as the portfolio holding up on rate and quality, it has been very good. We -- historically, we have very conservative underwriting in that area. Our manager of that area has done an outstanding job. Even when markets have gone down in past history, we have weathered the storm very well and have exceeded peer, as far as our quality.

When you talk about reserves, on your other question, we haven't adjusted anything in our reserve. We feel that we have more than adequate reserves for that area.

Okay, great. Thank you.

Like I said, our historical charge-offs numbers in that portfolio have been very good, even in the great recession.

I would add, in 2014 we actually had net recovery versus net charge-offs in the indirect portfolio.

(Operator Instructions)

Jacque Chimera, KBW.

Good morning.

The TruPS that were sold in the quarter for Mountain West -- was there any corresponding gain or loss associated with that?

What was the question? I missed the question, Jackie.

The Mountain West TruPS that were sold in the quarter -- was there any gain or loss that you booked on that?

We did not sell TruPS. We redeemed TruPS. We paid them off. They are TruPS that we acquired and we just paid them off and there was no gain or loss on the sale.

Okay. And then, most of the cost savings -- I know that on the last call you'd indicated the conversion was going to be on October 18. Is it fair to say that most of the cost savings were realized by the end of October?

Yes.

Okay. I know the compensation line had some seasonal noise in it. Just in terms of the incentive bonuses, accruals, things like that -- how much of that do you think will repeat in the first quarter? Or was it all just fourth-quarter true-up items?

They were fourth-quarter true-up items. Again, with the healthcare cost, if you read our second-quarter earnings release, we also reduced our healthcare cost by $500,000 in the second quarter. We true that up more than just annually; so it's, periodically we look at our healthcare expenses and true up that cost.

So it's fair to say, then, that compensation would go up next quarter and return to a more normalized level?

That is correct.

Okay. And then just lastly, given the decline in production that you saw in the quarter, was any of that weather-related? Sorry, in mortgage banking?

In mortgage banking?

Yes.

I would not say it's really weather-related. I think it was just slowdown because of the season, more than weather-related. We're not having storms like the East Coast is having right now. It's been, actually, the weather has been pretty decent in Montana this year as compared to last year.

Okay. Is that expected -- obviously, weather changes -- but is that expected to continue over the next couple of months? Or do you think you are in for some of the big storms you had last year?

You know, I don't know. I read the Farmer's Almanac. It says, supposed to be a bad year, but I don't know how the weather is going to change. But it has been actually pretty good this year.

Okay. Was it just a quarter's decision based on the volume that came in? Or are you more changing your strategy to put more of what you're booking through mortgage banking into the portfolio?

What we put in the portfolio is, again, being sensitive over the asset sensitivity of the institution. Most of the stuff that's being book in the mortgage portfolio are ARMs. We have 5-, 7-, 10-year ARMs, and some 15, but we try to have more variable-rate loans going there. And then some other jumbo loans that we can't sell in the secondary market. That is kind of what we put in there. Most of the traditional production is sold to the secondary market.

Is it just a higher volume of those types of loans in 4Q, then? I ask because the press release indicated that part of the decline was due to adding more to the portfolio than usual.

Well, we added more, but I think is it's not that we decided, it was more like the products more than a decision, conscious decision not to sell more to the street. It was more or less the people who are buying the products are buying those types of products right now.

Okay. That is what I was looking for. Great.

I would add, Jackie, I would add to that, that when we make a mortgage loan and sell to the secondary market, the fee income, of course, is much greater than if we make a mortgage loan and hold. That did have an effect on that fee income; and I don't want you to be frightened about what we are holding, though. In many cases what is happening and what does happen in our region is that we have appraisal issues that don't match up with the secondary market, meaning that the secondary market likes to see comparable appraisals, say, within a 1.5 mile of the subject property.

A lot of times we are lending to someone who has a home on acreage or something like that and out here 1.5 mile just isn't very far. It doesn't mean there is a problem with the borrower or the qualifications of the borrower. We feel good about the value of the home in spite of the remoteness, so to speak. Out here, if you live within 150 miles we call you a neighbor. So we think that the ones that we do book are pretty good loans; and as Kevin said, the lion's share of them are adjustable rate so that we are not taking rate risk.

Okay. Great. Thanks for the additional color. That's really helpful. That was all I had.

(Operator Instructions)

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

Thank you.

As always, we welcome calls and even visits from investors and analysts. I would mention another thing about that oil price -- just that we did mention that if it stays down, the offset to that would be that we would expect it to help tourism because of the price of gassing up your car. Last year we actually had record visits in both Yellowstone and Glacier and I think near-record over in the Mount Rushmore and Black Hills area. We are pretty optimistic about that business holding up.

In regard to our loan portfolio, when that oil field was really going and blowing, we were showing things like 2.5% and 3% loan growth during those years, meaning that we weren't riding that wave by lending into that area. Consequently, we won't ride the wave down real hard, either.

I would finish by saying the weather has been very nice for the last couple of weeks. They are predicting snowstorms over the weekend, so it would be a great time for you to come out and combine a visit to us with a ski trip. Thank you and goodbye.

This conference is now concluded. Thank you for attending today's presentation. You may now disconnect.