First Interstate Bancsystem Inc (FIBK) 2015 Q2 法說會逐字稿

Good morning and welcome to the First Interstate BancSystem second-quarter 2015 earnings conference call.

(Operator Instructions)

I would now like to turn conference over to Marcy Mutch, Investor Relations Officer. Please go ahead.

Good morning. Thank you for joining us for our second-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.

Thanks, Marcy. Good morning and thanks again to all of you for joining us on the call. Yesterday we were pleased to report second quarter earnings of $22 million or $0.49 per share, a 6% increase over last quarter. We had a great second quarter with strong growth in both loans and total revenue. Let's start with loan growth.

Total organic loan growth was $177 million for the quarter. This equates to a 3.6% increase quarter over quarter and a 5.3% increase year over year. Growth in the loan portfolio extended over every major loan category with the exception of construction real estate. The largest increase in total dollars was in the commercial portfolio, which grew $65 million or 8.6% over last quarter. This is encouraging and supports the economic stability we are seeing in most of the small communities across our footprint.

Ag loans grew $25 million, or 21.3% for the quarter. As we mentioned on the last call this portfolio fluctuates seasonally and generally increases significantly in the second quarter as our farmers and ranchers draw down on their operating lines. Commercial real estate grew $33 million, or 2% quarter over quarter, with a good share of this growth occurring in the Livingston and Billings, Montana markets.

The indirect portfolio remains a steady source of loan growth. Indirect loans grew 4.1% for the quarter and currently comprise $589 million of the consumer portfolio. Just to remind you our indirect portfolio is comprised predominantly of auto and RV loans. The majority of our lending is done within our markets but we do have a few dealers in the neighboring states of Idaho, Nebraska, and North Dakota. On a combined basis the activity in those three states makes up approximately 5% of our total indirect volume. The lower tier of this portfolio, which are those consumers with a FICO score under 660, makes up approximately 11% of the total portfolio.

Moving to credit quality, our non-performing assets are back down to 1.01% this quarter. We are making significant progress in disposing of our other real estate and have already disposed of an additional significant piece of other real estate in the third quarter. In case you're wondering what a significant piece of other real estate is, I'll give you a hint that we no longer own any golf courses, especially in Missoula.

Now for the revenue side. Total revenues were up $5 million or 5.4% over last quarter and $10.8 million or 12.5% over the second quarter of last year. I'm not going to go into this in much detail because Kevin will do that, but there are two highlights I'd like to mention; mortgage revenue and fee income. Mortgage revenue was the largest contributor to our increase in total revenue and was up $3 million or 49% quarter over quarter. 65% of the mortgage activity was purchases and 35% was refinancing. Because of our strong economies, we continue to have a strong pipeline headed into the third quarter.

Debit and credit card fee income was up $914,000 from last quarter, or a 14% increase. This increase was driven by transaction volume which is a result of a continual shift in customer behavior as consumers appear to prefer electronic payments over writing checks, along with our initiative to increase our business credit card usage. Economics across our footprint continue to be strong. As of the end of May, unemployment was 3.8% in South Dakota, 3.9% in Montana, and 4.1% in Wyoming. We've now had several months to observe the impact of lower oil prices on our markets and it's clear that it has not had much impact on employment across our footprint.

Crude prices were up for the quarter but have since been flat or down. Economic concerns coming out of Europe, the uncertainty in China, and further pressure felt as a result of the strong dollar leads to volatility in oil prices. Our oil and gas exposure at the end of June was $72 million in direct loans and an additional $42 million committed for total exposure of $114 million.

Last quarter we said we expected the tourism season to go well and I'm pleased to let you know that it's living up to our expectations. You might remember that I warned you that lodging was already full in Yellowstone Park and if you did want to visit Yellowstone you're welcome to stay at my cabin which is on the highway to Yellowstone. I would report that the cabin has been full of analysts since the first part of June and they make wonderful house guests with the exception that no matter what you give them they want more.

All through the national parks, Yellowstone, Glacier, and Mount Rushmore are seeing double digit growth in the year-to-date recreational visits with Glacier leading the pack at over 25% increase year over year. Gasoline prices remain significantly lower than they were a year ago. This has helped encourage travel.

We continue to be optimistic about agriculture this year. Cattle prices have remained stable and close to all-time highs. We've had some drought in parts of our footprint but certainly not to the extent that we've seen occurring west of us in Washington and California. And generally our drought conditions are not located in our ag areas. Because of the unusual weather patterns however the grain harvest started early this year and will be finished in the next couple of weeks. The yields and price are both good but below last year's levels.

With those comments I'd like to turn this over to Kevin Riley for a little more detail behind the numbers. Go ahead, Kevin.

Thanks, Ed, and good morning, everyone. We had a successful second quarter with GAAP earnings of $0.49 per share, or a 6% increase over last quarter. From a pretax pre-provision perspective we were up 7.9% over the first quarter and 15.5% over the second quarter a year ago. Earnings did have some unusual one time items this quarter both on the positive and negative side and I'll lay them out as we go through the income statement. But to start off let's go over the balance sheet.

As Ed mentioned we had organic loan growth at about $177 million or approximately 4% this quarter. We're well on our way to achieving the mid-single digit growth we expected for this year. Since Ed has already reviewed the changes in our portfolio in quite a bit of detail I will not cover them any further. Our investment portfolio declined this quarter by approximately $200 million or about 9%. The decline in deposits and the increase in loans allowed our investment portfolio to dip to 25.5% of total assets.

Our strategy is unchanged and we continue to keep our duration short. With long-term interest rates rising as a result of the rumblings of a potential rate increase by the Fed the duration of the portfolio remains sure up to around three years. Again, we are well positioned should rates rise in the next few months.

Total deposits declined 2.4% this quarter similar to last quarter. The decline was disbursed across all deposit types. The mix of deposits quarter over quarter was stable and as a result our cost of funds remained at a low 24 basis points. Currently we don't see this deposit decrease as a trend but more as a seasonal adjustment.

Now let's move to the income statement. Our net interest income increased $1 million on a lean quarterly basis as a result of the increase in loans and the extra accrual date. For the quarter our net interest margin increased 4 basis points to 3.47% from 3.43% last quarter. Loan growth helped mitigate margin erosion resulting from a decline in loan yields, but adjusting for accretion related to early payoffs and charge-off [interest] coverage in each quarter, the core margin actually increased about two basis points.

Our provision expense for the quarter was $1.3 million. The increased provision was the result of loan growth and a slight increase in criticized loans. Our net charge-offs for the quarter were only $124,000, and as Ed has mentioned our non-performing assets declined from 1.11% to 1.01% of total assets. Our non-interest income was the bright spot this quarter and represented about 33% of our total revenue.

A lot of you have heard me talk about our business credit card initiative and our focus of moving business customers into paying bills with our credit card. As a result approximately one-third of this quarter's increase in our credit card fees is attributed to business credit card activity. Payment card fees were up $914,000, or 14% over last quarter. As Ed said we are seeing a steady increase in the use of payment cards as a preferred method of payment.

Income from the origination of the sale of mortgage loans was $8.8 million, up 49% over the prior quarter and 38% over the same quarter of last year. Purchase activity accounted for 65% of the production this quarter, up from 57% purchase activity last quarter. Included in our mortgage revenue was a gain of sale of $410,000 related to the sale of $10 million of some of our residential portfolio loans. While slightly down quarter over quarter, our wealth management continues to be a strong source of revenue. Assets on our managements are stable at $4.6 billion. Our other income, while down slightly from last quarter, did include an $863,000 gain from the sale of a parking lot that had been previously been a drive-up facility.

Let's move to non-interest expense. Our non-interest expense was $62 million this quarter, or approximately $2 million over our expected run rate, most of which is due to the increase in other expenses which I'll cover in just a minute. Total salaries were up due to increase in commissions resulting from the increase in mortgage revenue. Our employee expense increased about 4% this quarter due to our self-insured health insurance expense increase over last quarter as a result of some large medical expense claims. Our other expenses increased $2 million or 14%. There were a few unusual items that led to this increase. We incurred a contract termination fee of $876,000 related to the change in payment service providers when we upgraded to a better system. We had losses on property sales of $300,000, and lastly we had a spike in fraud losses of about $520,000 over last quarter.

So circling back to my comments at the beginning, there was a little noise in the quarter and we had some unusual items, both positive and negative. So let me summarize. On the revenue side we had a gain on the sale of residential mortgages of $410,000 and a gain on a piece of bank property of $863,000. This was offset on the expense side by a one time termination fee of $876,000, losses on the disposal of assets of $300,000, and a $520,000 spike in fraud losses. Net/net they pretty much offset each other.

I'll wrap up my comments by talking about our capital. Our capital ratios are strong and provide us with room for growth. We had no share repurchases as the financial metrics we use to determine if this is a good use of capital did not allow us to do so this quarter. So still we paid a healthy dividend of $0.20 per share, which resulted in about 2.9% annualized yield.

Through the first half of the year we have paid out 42% of our earnings in the form of dividends which we believe is a strong return of capital to our shareholder while still allowing us to have sufficient capital to support our organic growth and our M&A activity. The United Bank acquisition is going smoothly and we will merge and convert them onto our system at the end of business this Friday. Acquisitions costs have been kept under control and we expect employee integration will go well. Again, this is an all cash transaction which should be immediately accretive to earnings.

With that I'll turn the call back over to Ed.

Thanks, Kevin. We want to wrap up by providing a brief update related to our ongoing litigation. We are entering the mediation phase of the appeal process. Mediation will occur during the third quarter so we'll see how that process goes. If the mediation is unsuccessful the case would go on to the Montana Supreme Court.

We also want to let you know that our acquisition of Absarokee Bancorporation, parent company of United Bank, is on schedule to close this Friday. This $74 million bank will be a nice extension of our Billings footprint. As a matter of fact many of our current customers live in communities serviced by United Bank and this will allow us to offer them more convenient customer service. United Bank has a tremendous staff and a loyal customer base. We're excited to welcome them into the First Interstate family.

So with that we'll open it up to questions.

(Operator Instructions)

Jared Shaw of Wells Fargo Securities.

Good morning. Maybe if we start with looking at commercial loan growth, it was strong in second quarter. What does that growth do to the pipeline? How do you look at the pipeline now versus this time last quarter, and should those trends continue into third quarter?

I'm going to ask our Chief Credit Officer, Bob Cerkovnik to address that.

I wouldn't see -- we will continue to grow our commercial loans. We're really excited about the growth that we've had this past quarter. That trend we hope to continue throughout the rest of the year. But as we've shown in the past, the third and fourth quarter have been fairly flat.

Okay, thanks. And then when you look at share repurchases and general capital allocation, you had said that you weren't buying any shares this quarter. Is that -- is that decision based solely on share price? Or is it -- are there other elements that go into whether or not you'd be actually buying back stock?

Hi, Jared. It's Kevin. We look at it as because we buy back stock at certain prices it's a dilution to tangible equity. And we look at we want to get at least a -- under a five-year payback as we buy those shares back. With the stock price elevated we didn't believe that it was under that five-year threshold.

Okay. And then finally looking at the fraud losses that you spoke about increasing, is that just general fraud losses increasing or is that tied to -- is there a prior tail? Is that a tail to some of the prior stuff that you talked about in the past?

It's not a tail of the prior stuff and it's almost all debit card and credit card transactions where smaller merchants have been compromised, or that they've been hacked and then the customers' accounts were compromised.

Okay. Great. Thank you very much.

You're welcome.

Matthew Clark of Piper Jaffray.

Good morning, Ed.

Good morning, Matthew.

Maybe just first on the margin core up a couple basis points. Loan yields still under some pressure though. Can you just talk through the potential for additional mix change here like you had this quarter and the ability to hold that margin where it is or should -- maybe we see a basis point or two decline in the core over time here?

I'll start and then I think I'll hand off to Kevin. But obviously the loans that we're putting on the books today are at a lower rate than the loans that they're replacing. But that said, if we can continue with loan growth we change the mix and obviously the margin will improve. In regards to what we're forecasting I'm going to let Kevin answer that as much as he can.

Hi, Matt. Part of the decline was that the loans that we put on last quarter had about an average yield of about 4.81%. The good news we saw this quarter is that some of the loans that we put on actually at the end of the quarter had an average yield of 4.92%. We're believing maybe that could stabilize as we move forward so that the -- it's actually higher than our current portfolio mix. So we're hoping that maybe it will stabilize at about this level.

Okay. Okay, great. And with an expenses and the growth in the mortgage platform can you give us a sense for how much of your -- how much of the mortgage expense base is variable? And if you could give us a dollar amount too that might be helpful to try to dial in seasonality.

I'm not sure I'm understanding the question. You're saying how much of the mortgage expense is variable as volume rises and falls? Is that the question?

That's it, yes.

Okay. And I can tell you that our originators are on a compensation plan that is a combination of salary and volume performance for the volume that they do. And I can't put a percent to that. I just couldn't tell you that it's going to be x percent of the total originator expense. I'd just say it's not huge because again the only ones that are on that type of a compensation plan are the originators and we have about 120 originators.

Great. Okay. And then just last one on the bump up in criticized loans. Can your just give us some additional color there whether or not that's tied to energy and related to the Bakken? And updated commentary around the Bakken too might be helpful. Thanks.

I'll start and then I'll have Bob finish. And we have seen some of the customers that drill for oil or that rely on oil as their income suffer, but not many. We have a couple in that industry that are problem loans that would have been problems regardless of the price and we have a couple of others that the price is their major problem. That said, with the whole portfolio being a little over 1% of our total portfolio, it's not going to have a huge impact. But I want to give Bob a chance to answer that too.

Yes, Matthew, you look at our criticized -- to answer your first question on the criticized loans, these numbers and percentages are well within what we consider to be an acceptable range for us. You're always going to see a little bit of movement up and down depending on what's going on with some larger credits. So again, they're within acceptable ranges for us. If you -- the Bakken, we're not seeing a huge deterioration as a result of the Bakken slowing down overall. Did I answer all your questions there, Matthew?

Yes, thanks guys.

I'll add to that because in past years we spent a lot of time saying that all of that activity in the Bakken was having a significant positive impact on the economy of eastern Montana and especially Billings. And it was because we were supplying the picks and shovels so to speak to do all of the work that was being done over there. And so then you got to wonder that that activity has literally been cut in half what's happening? And as I mentioned on the unemployment numbers we're just not seeing it. And what we are seeing is that our builders, both the commercial builders and home builders, are back to work so to speak and hiring skilled labor. Because a year ago the biggest complaint you heard around Billings and eastern Montana is we cannot find skilled labor.

And I mentioned one time that there were houses being built that might sit for six weeks because they couldn't find a roofing crew or a siding crew to come in and finish them. And that's over. The skilled labor is back and perhaps their wage scale isn't as high as it was over in the oil field, but we just haven't seen an economic impact yet.

Matthew Ferguson, Sandler O'Neill.

Good morning all.

Good morning.

So in your press release you mentioned -- you alluded to almost like a structural shift in loan demand in your market areas. Is that attributable to that influx of skilled labor coming back from the Bakken into your footprint? Is that consistent?

No. I think it's more -- I think it's more about the economy coming back. And we've mentioned before that our economy -- we were a year or a year and a half late getting into the recession and we were a year or a year and a half late getting out of it. And I think we're just seeing an awful lot of building, home building, commercial building, whether it's retail or hospitality are the two main things we're seeing in commercial. I think it's more related to that than to a demographic shift from the oil field.

Okay. Can you just speak broadly about the M&A environment, what you're seeing and chatter and your appetite for doing a transaction?

Sure. And I'll hand that off to Kevin Riley.

Hi, Matt. I would say the M&A environment out here is pretty active. It's a little different than I'm used to. Normally you go out and kind of court potential targets. A lot of people are contacting us. Again, a lot of the banks out here are privately owned and I think as some of the Management is aging they're looking for their liquidity event so they can retire. As I mentioned probably in the past there's a bunch of smaller acquisitions like the Absarokee transaction we did and there's a lot of ones that are a little larger that are possibilities. And there's a lot of talk and I think it's probably going to be robust over the next few years.

Okay. All right. And then lastly as it relates to the $10 billion threshold, I know you have the task force working away. Any incremental learnings this quarter? And can you remind us what you're currently thinking about for the call it that day one hit once you cross over revenue at risk, et cetera?

I'll start and then I'll let Kevin finish. And I would start by saying that we've already purchased the software for the stress testing piece and that's obviously one of the major pieces of going over that threshold. We do know approximately the dollar amount for the Durbin Amendment piece and what that would cost us. And then finally I'd say that it's hard to tell when day one is because I believe that most of that goes into effect after you've had something like three quarters or two quarters, is it three quarters? Three consecutive quarters of being over the $10 billion mark. So it will be -- it sounds like it's more of a gradual change than a falling off a cliff. But Kevin, do you want to add to that?

Yes. We're calculating the Durbin Amendment to cost us about $8 million pretax in fee revenue. And the way we see it right now is that if we go over $10 billion in 2016 it will probably end up reporting in 2018. And once you start doing the reporting that's when you actually have the impact of revenue. So it's quite a ways out. We first got to get over there. And we're doing all the planning necessary to do that. But it's quite a couple years out right now.

Thank you.

Jeff Rulis, D.A. Davidson.

Hi, good morning. This is actually Mat in for Jeff.

Hi, Mat.

I know you guys have already talked quite a bit about the loan growth. Was there anything unusual in this quarter? Were there any bigger deals or production that may be shifted from Q1 or the third quarter that affected this quarter since it was so much stronger than we've previously seen?

Bob?

No, Mat. I wouldn't directly attribute it to one or two large deals.

Mat, if you look back at our second quarter of last year we did have loan growth of about 3.2% in the second quarter of 2014. So the 3.6% growth this quarter is not really unusual as compared to the seasonal trend that was set last year.

Sure.

Mat I would add that sometimes you'll see a bank our size attribute loan growth to a $75 million deal that they closed. And you just won't see us doing that because we don't do $75 million deals. We held very close to a $10 million house limit for many years. Recently raised that to $15 million and today -- and we do a lot of exceptions for what we think are very good customers. But today we have about 30 customers that are in excess of that $10 million and the very largest one is a little over $30 million. So we just wouldn't make one loan or two loans that would swing the growth.

Sure. Okay. All my other questions have been answered. Thank you.

All right.

(Operator Instructions)

Tim Coffey of FIG Partners.

Tim, you're not coming through. Are you on mute?

Hi, good morning. This is actually Carlos Velasquez in for Tim Coffey.

Good morning.

Just got a couple of questions. One on the loan growth. I saw the $177 million change. What percentage of that is actually from new clients? And what the rise from existing clients?

I'll hand that off to Bob.

It's a little bit of combination of both. Most of our existing customers have seen good economic times and are expanding.

Okay, great. You guys took a one-time charge for $876,000 for eliminating your payment service provider. Are you expecting any cost savings out of that?

Yes, and Kevin, go ahead.

We expect the actual costs of each transaction -- it's actually a payment service provider -- will go down. And we were incented also to move over to this other payment service provider that will be amortized over the life of the contract. So it will take our costs down.

Okay. And then just one last question on MPA. You brought it down to $85 million. Now as far as the market is concerned and the location -- the areas you operate in, do you see any momentum towards the MPAs are likely to get below $75 million? Or are you guys treating it as a case-by-case basis at this point.

Bob.

We're treating it as a case-by-case basis. As I said before we have to be under 1% to be a high performing bank and that's what our long-term goal is.

Okay. Great. Thanks. That's all for me.

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

As always we welcome calls from our investors and analysts. Please reach out to us if you have any follow-up questions. Thanks for tuning in and goodbye.

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