Financial Institutions Inc (FISI) 2021 Q1 法說會逐字稿

Good day, and welcome to the Financial Institutions, Inc. First Quarter 2021 Earnings Conference Call. (Operator Instructions) Please note this event is being recorded.

I would now like to turn the conference over to Shelly Doran, Director of Investor Relations. Please go ahead.

Thank you for joining us for today's call. Providing prepared comments will be President and CEO, Marty Birmingham; and CFO, Jack Plants. Chief Community Banking Officer, Justin Bigham; and Director of Financial Planning and Analysis, Mike Grover, will join us for Q&A. Today's prepared comments and Q&A will include forward-looking statements. Actual results may differ materially from forward-looking statements due to a variety of risks, uncertainties and other factors. We refer you to yesterday's earnings release and historical SEC filings available on our Investor Relations website for a safe harbor description and a detailed discussion of the risk factors relating to forward-looking statements. We will also discuss certain non-GAAP financial measures intended to supplement and not substitute for comparable GAAP measures. Reconciliations of these measures to GAAP financial measures were provided in the earnings release, which was filed as an exhibit to a Form 8-K. Please note that this call includes information that is accurate as of today's date, April 29, 2021.

I'll now turn the call over to Marty.

Thank you, Shelly. Good morning, everyone, and welcome to our first quarter 2021 earnings call. It was another compelling quarter for our company. We generated record high net income of $20.7 million or $1.27 per diluted share as compared to $13.8 million or $0.84 per share in the fourth quarter of 2020 and $1.1 million or $0.05 per share in the first quarter of 2020. Pretax pre-provision income for the quarter was also the highest in company history at $24.1 million, a $3.1 million increase from the fourth quarter of 2020 and an $8.7 million increase from the first quarter of 2020. It was a strong quarter for net interest income and noninterest income as we continue to experience cost savings from our enterprise standardization program. All these factors contributed to a significant decrease in the efficiency ratio to 52.5% for the quarter.

We started to buy back shares under our stock repurchase program during the quarter and repurchased about 238,000 shares at a cost of $24.30 per share, roughly 103% of tangible book value. No shares have been purchased since quarter end. On February 1, we completed the acquisition of Rochester based insurance brokerage firm, Landmark Group. Landmark was acquired by our SDN Insurance Agency subsidiary and their principles remain with SDN to lead our Rochester Insurance Operations. We believe this acquisition will expand our insurance business in Rochester and the Finger Lakes region. As we stated last quarter, this is a bolt-on transaction expected to negatively impact the TCE ratio by less than 2 basis points. EPS dilution is projected at only about $0.01 per share in the first year with EPS accretion generated shortly thereafter.

We also announced a new organizational structure during the quarter. One developed to meet evolving customer needs while aligning in-house talent with leadership roles that position them and our company for long-term success. Several members of management demonstrated strong leadership and contributions in 2020, which combined with their exemplary experience and industry knowledge, resulted in their promotion within the new structure. A press release issued on February 9th, available on our Investor Relations website, provides additional details. The reorganization directly impacted 2 of my teammates on the call today. Justin Bigham was named Chief Community Banking Officer, assuming leadership of the newly established Community Banking area. Community Banking is designed to advance and strengthen 5 Star's customer journey and success across all major customer-facing functions with a focus on digital experience and data and analytics. Justin's experience as our CFO and his prior experience with 2 larger banks, including retail and small business product management responsibilities, position him well for this new role.

Jack Plants was named CFO and Treasurer, and he now leads Financial Planning and Analysis, Accounting, Tax, Investor and External Relations and Treasury. Jack joined our organization in 2019 as Treasurer with more than 14 years of experience in bank finance. He was integrally involved in last year's capital market activities and balance sheet strategies, demonstrating his readiness to assume the role of CFO. With that said, I'll now turn the call over to Jack, so he can provide additional details on results and guidance.

Thank you, Marty. Good morning. I'm very pleased to be speaking with you regarding our first quarter results during my first earnings call as CFO of Financial Institutions, Inc. I'd like to begin by providing comments on several key areas with comparisons to the fourth quarter of 2020. Net interest income for the quarter was $37.9 million, an increase of $1.7 million from the linked quarter. The increase was primarily the result of PPP loan activity, which included accelerated amortization of fees on loans paid off through the forgiveness process. Total deferred fee amortization was $2.9 million in the first quarter of 2021 as compared to $1.2 million in the fourth quarter of 2020. Approximately $87 million and $17 million of PPP loans were forgiven in the first quarter of 2021 and the fourth quarter of 2020, respectively.

Net interest margin was 3.29%, 16 basis points higher than the linked quarter, primarily due to the impact of the PPP loan forgiveness. Excluding all impacts of these loans, NIM for the quarter was 3.15%, up 1 basis point from fourth quarter 2020 NIM at 3.14%. While NIM improved 1 basis point over the prior quarter, the overall environment continues to provide challenges. Access liquidity, coupled with the low interest rate environment has made it difficult to deploy cash and investment alternatives with attractive duration adjusted yields. We did experience a large inflow of liquidity from our public deposit portfolio late in the quarter, with balances higher than the seasonal inflows we typically experience. Since the inflows were very late in Q1, the impact on average balances was muted, which is also why our period end cash was higher than normal. One of the benefits we have is that the seasonality of this public portfolio will have predictable outflows in June. So we view the high use of liquidity as shorter-term in nature as we will be able to deploy liquidity through anticipated deposit outflows.

Provision for credit losses was a benefit of $2 million in the quarter compared to a provision of $5.5 million in the linked quarter. As was disclosed in our earnings press release, the first quarter benefit was due to continued improvement in national unemployment, which is the primary loss driver for our CECL model, coupled with positive trends and qualitative factors, resulting in a release of loan loss reserves. Charge-offs were low at $887,000 in the quarter, down from last quarter's $2.4 million. Accordingly, our allowance for credit losses decreased by $2.6 million in the quarter to $49.8 million.

As we discussed last quarter, we've analyzed the unique characteristics of our commercial customers in at-risk industries. We then identified the specific customers and industries we believe to be most at risk because of the pandemic. These customers represent a very small pool of loans, about 20, with balances of approximately $127 million. During the fourth quarter of 2020, we moved this population of loans to criticized assets and set aside a specific reserve of $4.7 million for certain assets in the pool, consistent with our CECL methodology. During the first quarter of 2021, we added $2.4 million of specific reserves on this pool. To be transparent, $1.9 million of the increase is related to one credit relationship with a payment delinquency that was subsequently resolved. We remain cautiously optimistic that these credits will normalize post-pandemic. Although we have seen improvement in performance indicators of several of these credits, we do not plan to release specific reserves until the credits return to normal paying status.

The allowance for credit losses on loans to total loans was 1.36% at quarter end, down 10 basis points from December 31. If you exclude PPP loans, the ratio increases to 1.47% as compared to 1.57% at year-end. Credit metrics remained strong with a total nonperforming loan to total loan ratio of 27 basis points at March 31, 2021, and a ratio of allowance for credit losses for loans to nonperforming loans of 514%. Noninterest income was $1.6 million higher than the fourth quarter of 2020. Key drivers were income from derivative instruments, which was up $971,000 and is based upon the number of interest rate swap transactions, combined with the impact of changes in the fair market value of borrower facing trades, which were positively impacted by the recent increases in longer-term interest rates. Income from limited partnerships was up $615,000 based on the performance of the underlying investments.

Insurance income was $518,000 higher due to the timing of contingent revenue and the February acquisition of Landmark Group. These increases were partially offset by lower gains on the sale of loans, down $519,000 due to the seasonal impact of lower residential real estate loan volume. Noninterest expense was $26.7 million, an increase of $206,000 from the linked quarter. The largest increase in expenses was professional services expense, $543,000 higher due to the timing and level of consulting fees, including improvement initiatives and audit fees, which are typically highest in the first quarter due to the timing of year-end audit procedures.

Income tax expense was $5.3 million in the quarter, representing an effective tax rate of 20.5%. Our effective tax rate was higher than we originally guided due to the significantly higher level of pretax earnings.

Moving on to the balance sheet. Growth in total loans was $59 million or 1.6% from year-end 2020. Commercial business increased 2.9%, commercial mortgage was up 1.8%, residential loans increased 0.3%, and consumer indirect was up 2.1%. PPP loans are included in the commercial business loans. Excluding these loans, commercial business loans increased 2.8% from December 31, 2020. Total deposits at March 31, 2021, were $438 million higher than at December 31, 2020, due to a seasonal increase in public deposits combined with growth in nonpublic and reciprocal deposit portfolios. Our excess liquidity position continues to pressure the net interest margin through both our excess federal reserve balance and additions to the securities portfolio. During the first quarter, we increased our investment portfolio balance by approximately $110 million in an effort to grow interest income by deploying excess liquidity into investment classes that have a risk-adjusted yield profile that exceeds the interest on excess reserves. However, investment yields remain low, reflective of the current market conditions.

We also observed a notable increase in our federal reserve balance, which increased $253 million as compared to year-end. The increase largely occurred during the latter half of March due to the aforementioned seasonal inflows of public deposits. Moving on to the equity portion of our balance sheet. We did experience a couple of events in the first quarter that mitigated organic growth in common equity due to our strong earnings. First was the impact of approximately $6 million of share repurchases. Second was the impact of accumulated other comprehensive losses of about $13 million primarily due to the impact of an increase in longer-term interest rates on our available for sale securities portfolio.

We also experienced a decline in our TCE ratio during the quarter to 7.13% from 7.8% at year-end. The decline was primarily driven by growth in total assets, given the excess liquidity previously described. Our overnight cash and investment securities position increased approximately $360 million in the first quarter, explaining most of the increase in tangible assets, while tangible equity was down slightly compared to year-end, as I just mentioned. We remain very comfortable with our capital position, given that much of the asset growth we've experienced in the past year is shorter term, when you consider PPP loans and excess liquidity due to the current economic and interest rate environments. It is also important to note that our asset growth has been concentrated in very low risk-weighted assets, so our regulatory capital ratios have remained comfortably above the well-capitalized regulatory minimums.

I'd now like to spend the next few minutes updating our outlook for 2021 in key areas. Although we were encouraged by better-than-expected loan growth in the first quarter of 2021 in C&I and small business, despite the recent round of PPP, we continue to expect mid-single-digit growth in our total loan portfolio, excluding the impact of PPP loans. All loan categories are expected to contribute to the increase. Our original PPP assumptions included approximately $125 million to $175 million of 2021 originations and we now expect to be at the lower end of that range. We originated approximately $96 million of loans in the first quarter and continue to process applications remaining in the pipeline.

We experienced approximately $17 million and $87 million of forgiveness of these loans in Q4 2020 and Q1 2021, respectively. We continue to estimate 90% of the first wave of loans will be forgiven in 2021 with a heavier weighting of forgiveness in the first half of the year. We have not included any forgiveness on the second wave of loans in our assumptions as we believe that most of this forgiveness will occur very late in 2021 and into 2022.

We are reducing our expectations for nonpublic deposit growth to mid-single digits. While deposit balances remain elevated in the low interest rate environment, we have seen growth moderate in the first quarter, largely due to a change in the deposit behavior of PPP customers. This guidance includes the previously announced 2 new 5 Star Bank branches that we expect to open in Buffalo midyear 2021. We experienced stronger-than-expected growth in the first quarter for both reciprocal and public deposits and are now projecting double-digit growth in these categories for the year. We maintain our full year NIM guidance of 310 to 315 basis points, excluding the impacts of PPP. We continue to expect compression from excess liquidity, carrying higher balances in investment securities, and earning lower yields on earning assets as loans and securities reprice, which will be partly offset by lower deposit funding costs.

There will be noise in our NIM relative to PPP forgiveness and new originations throughout the year, so we are guiding them excluding the impact of this activity. As a reminder, our NIM fluctuates from quarter-to-quarter due to the seasonality of public deposits and its impact on both our earning asset and funding mix. In quarters where our average public deposit balances are higher due to seasonal inflows, the second and fourth quarters, our earning asset yields are lower, given the short-term duration of the deposits and limited opportunities to invest the funds. Our NIM guidance remains highly dependent on the overall rate environment. We had a strong first quarter for noninterest income and are increasing our full year guidance to mid-single-digit growth, excluding gains on investment securities.

As we have stated before, 2020 was a unique year from a fee income perspective. We waived service charges for a portion of the year as part of our COVID-19 relief package, but that was more than offset by strong results for derivative instruments or interest rate swaps and mortgage banking activity. We are not expecting to waive fees and expect fees from both interest rate swaps and mortgage banking to moderate in 2021, even though the first quarter was a strong quarter in both areas. We continue to anticipate an increase in noninterest expense in the low to mid-single-digit range for 2021. Noninterest expense is expected to range from $27 million to $29 million per quarter. We are maintaining our 2021 efficiency ratio guidance of 57% to 58% for the full year. But when considering the first quarter results, we have a bias towards the lower end of the range.

With better-than-expected earnings performance in Q1, we now expect that the effective tax rate for 2021 will be within a range of 20% to 21%, which includes the impact of the amortization of tax credit investments placed in service in recent years. We will continue to evaluate tax credit opportunities, and our effective tax rate would be positively impacted by taking advantage of further investment opportunities. Given our low level of net charge-offs in Q1, we are revising full year guidance to a range of 30 to 40 basis points, which is a 5-basis point reduction to the low end of the range previously provided.

As we said in January, our overall focus is improved profitability and operating leverage. We believe that achieving results in line with the guidance provided will drive these outcomes. That concludes my prepared comments.

I'll now turn the call back to Marty for closing remarks.

Thank you, Jack. The company's 2020 Annual Report is now available on our Investor Relations website. Within this report, we document our many accomplishments of 2020 and provide significant discussion about our commitment to corporate responsibility and sustainability. Through corporate citizenship, our commitment to a strong corporate culture, advancing inclusion and diversity, a strong culture of ethical behavior, supporting our communities, environmental sustainability, strategy and enterprise risk management and strong corporate governance. I encourage you to take a few minutes to review this important update on our companies.

Today, infection rates are declining in our footprint, vaccination rates are increasing, and we are seeing signs of an expanded reopening of the economy. The pace for us is not slowing, and we are active on many fronts. We remain focused on helping customers obtain forgiveness of existing PPP loans as well as new PPP loans funded in 2021. We are in the process of bringing a portion of staffing back to corporate offices and developing long-term plans, department by department, for working in the office, working from home and a hybrid work approach. Progress continues toward completion of 2 new 5 Star Bank branches in the city of Buffalo. These branches were initially expected to open by February of 2021, but were delayed due to the pandemic. We currently expect them both to open early this summer. These new branches at 2222 Seneca Street and 451 Elmwood Avenue will help us expand in the important Buffalo growth market and make us more accessible to existing and new consumer and commercial customers. They are located in vibrant commercial corridors and will extend the reach of our distribution system while reinforcing strong commitment and community engagement.

We are starting to experience fewer restrictions on events in our footprint, which is very encouraging, and we were able to renew an important community sponsorship, the Rochester Lilac Festival. This is the largest free festival of its kind in North America and an important event for our local and regional community, perhaps more important than ever this year after a year of isolation due to the pandemic. Through this modest action, we are reinforcing a commitment to a return to normalcy by providing an opportunity for folks to get outside and get together. Especially at this point in time, this event personifies the economic vitality, resilience and quality of life of the communities we serve. The rate of change for the financial services industry was accelerated by the pandemic. We experienced this firsthand with a very strong positive response to our digital banking launch in 2020. The effective use of technology and data is essential for our success, and it remains a critical focus for our organization. While many uncertainties remain, I believe that we are stronger than ever and remain well positioned to take care of our customers and communities.

Operator, this concludes our prepared comments, and we are ready to open the call for questions.

(Operator Instructions) The first question comes from Alex Twerdahl with Piper Sandler.

First off, just wanted to follow-up on your commentary on loan growth outlook for 2021. I think you said mid-single digits, all categories. I was hoping maybe you could sort of comment on the state of the pipelines as you look at them today. Do you think that that growth is going to kind of come evenly across the year and the pipelines kind of need to rebuild in the back half of the year as some of the dynamics around PPP and whatnot play through the economy?

So we've continued, Alex, through the pandemic, to continue to try to maintain as much discipline as we can around customer engagement as well as managing and driving a pipeline process. So our performance in this quarter represented a pipeline that converted, a significant pipeline that converted, that existed at the end of the year. And I think for the remainder of this year, it will continue to experience a smooth conversion as we move out into the next 3 quarters.

Yes, Alex, this is Jack. I'll just add that we had a very good quarter for originations on the commercial side. We noticed that there are some headwinds from supply chain challenges, both in indirect and on commercial that we're facing and our customers are facing. But as we've stated before, excluding PPP, we continue to expect mid-single-digit growth for the total loan portfolio for the remainder of the year.

Awesome. And then as you think about the uses of liquidity, you bought some securities during the first quarter. Could you comment a little bit on the strategy for deploying more liquidity into the securities portfolio? Are you kind of done at this point? Or is there more liquidity that you think you'll put to work just in securities in the next couple of quarters?

Sure, Alex. This is Jack. As we noted on the call, we added about $110 million of the securities portfolio during the first quarter. However, purchases started to slow towards the latter half of March as spreads really tightened on mortgage-backed securities. And we're really mindful of the duration adjusted risk -- or sorry, the duration and risk-adjusted return we're getting on liquidity deployment. So at this point in time, I think we've got an appropriate balance between invested cash and what we have deployed in the securities portfolio, particularly when considering the anticipated deposit outflows we'll see in the public portfolio as we approach the end of the quarter.

Okay. And then it sounded to me like when the NIM guide, which is down a little bit to the end of the year, which makes sense, coupled with the balance sheet, kind of only growing from here, obviously, with some seasonality around deposits, should imply that excluding PPP, that NII could be flat to slightly higher over the coming quarters. Does that logic make sense?

Yes. I think that we'll see a little bit of growth in NII as the balance sheet grows throughout the year. But as you mentioned before, the NIM guidance at the 310 to 315-basis point range, which is in line with what we guided during the January call, it includes a bit of margin compression just as loans reprice.

Got it. And then just final question for me on the buyback. You had some opportunities early in the year. Glad to see you took advantage of those. With the stock trading a little bit higher today relative to book value and just looking at your TCE ratio, do the buybacks make less sense at this point? Or do you think that will be a continuous part of the strategy over the course of the year?

It's something we want to keep in the forefront of our thought process and discussion with our Board. We want to remain disciplined around the investment of capital. It was very straightforward, obviously, where our stock price was versus where it is today, but we are mindful of making those investments that ultimately drive acceptable dilution accretion and earn back period for us.

The next question comes from Bryce Rowe with Hovde.

Let's see, let's start -- I wanted to start with the allowance, if that's okay. You've provided some good information in the slide deck around the breakout of the allowance specific to the criticized and classified and appreciate the commentary you gave earlier in the prepared remarks about the classified piece. So Jack, maybe you could help me understand. I'm not sure I saw the specifics around the criticized specific reserves for last quarter, so if you could comment on how that might have changed quarter-over-quarter, that would be helpful.

Sure. So on the criticized pool, the total pool increased by $2.3 million for the specific. And that was just based on a specific reserve that was aligned to that pool. So we didn't move any additional loans into the total pool itself, but we did take an additional reserve of $1.9 million on one credit, which drove the majority of that increase. And it was really due to a credit that was experiencing a 30-day payment delinquency that since came current, but it was due to a capital injection, which we deemed to not be the primary source of repayment. So we thought it was prudent on our part to take us specific there as we move forward.

Okay. And so has that -- with that, I guess, payment status having been -- having come current, does that kind of mean we'll see a reserve release tied to that specific $1.9 million? Or no, given that I guess the capital infusion not being counted as a primary source?

We remain cautiously optimistic about the stability of the credits in that pool. We really aren't planning to release reserves there until they come off their COVID deferral status and return to a normal payment status. So at this point in time, again, we're cautiously optimistic.

Okay. And then any commentary around the deferrals and what you think in terms of timing around when those credits come off of deferrals? I mean I know a lot of it is tied to sensitive areas or COVID sensitive areas. Maybe some commentary around kind of early signs in terms of how those industries look or how those borrowers look as we approach spring and as limitations are coming off.

So Bryce, I think as Jack used the phrase, cautious optimism, we're optimistic. I think the economic data out today relative to GDP is showing very strong indications of recovery. And we are seeing bright spots of that as well in the COVID impacted credit exposures that we have. For example, the flagged branded hotel portfolio, lower service portfolio of hotels, are seeing, I think, a pickup in their activity in terms of occupancy and utilization. We've also heard from these borrowers, as an example, that through the COVID pandemic, they've learned some ways to be much more aggressive in managing their labor and their mix of labor while still driving a satisfactory customer experience.

So we are seeing positive indications. But our approach, we spent a lot of time on this in our last call and trying to communicate and be as transparent as we possibly can to our key constituencies, has been to look at these credits on an individual basis, make a determination if they're sustainable post the conclusion of the pandemic and then provide them with the accommodation under the CARES Act, which we've done in most cases out through the end of 2021. So we're closely -- we continue to closely monitor it. That's why we downgraded the credits that we did at the end of the year, and we'll continue to keep the market apprised of our progress.

Okay. That's great color, Marty. Appreciate it. One more question for Jack. Jack, can you provide us with the breakdown of the unaccreted or unamortized PPP fees at this point between the 2020 originations and the 2021 originations?

As of the end of the quarter, we had $6.5 million in unamortized fees associated with PPP loans. That was largely on the first round of originations.

Yes. This is Mike Grover, Director of FP&A. I would say about 20% of that total relates to the second vintage. So it's about an 80/20 split, 80% relates to the first vintage, 20% to the second.

Okay. And you expect the second vintage kind of fee status to grow as you continue to process new loans, new PPP loans?

That's correct.

(Operator Instructions) The next question comes from Marla Backer with Sidoti.

I was hoping you could give us a little bit more color on the new management structure. You mentioned in your prepared remarks on the changes you made earlier. How do you see this fitting into your community outreach strategy? And if it does fit in, how do you see it meshing with some of the goals you have from market share gains? Thank you.

Thanks so much for the question. We're -- I'm very enthused. I think our executive team is very enthused with the alignment of our organizational structure and the execution of our plans that support community engagement like you just talked about as well as achieving the financial results, sustained financial performance that drive long-term shareholder value.

So we talked about Justin, as the leader of our community bank, we have strong leadership across all the customer-facing functions and those functions that support our customer interaction and customer experience and customer journey under a very strong and capable and experienced leader. We feel great about Jack's capabilities and experience to assume the CFO and Treasurer responsibilities and the functions that I described. We also have a leader for all of our commercial activities, and we have a Chief Administrative Officer, who's focused on -- who's been providing leadership for example in our IT technology program, our enterprise standardization program.

But in addition, is working with our team on our digital transformation and data analytics ramp. So I feel great about our ability to engage with the market. It's one of our fundamental reasons for being as a community bank and make sure we're taking care of the needs of the market. Both in terms of our products and services, but as well as the corporate citizen. And in addition, the execution against our strategic and risk plans that support long-term shareholder value.

Okay. And then with regard to the new branch openings in Buffalo, you said mid-2021, and I think sometime this summer. So is there anything that might delay that time line? Are all the permits already in place? Do you have all of the people onboard to make that happen? Can you just give us a sense of where that stands?

Thank you for the question. I'm going to ask Justin as our Chief Community Banking Officer to answer that.

Marla, thanks for the question. We don't see any delays at this point. I think literally midyear is about the timing for these. And that's our expectation. And we don't anticipate any further delays. Those projects are green. If you think about the red-yellow-green approach to project management, they're green and I have every expectation that they'll be on time.

Okay. And then my last question is to Landmark. So where are you in the process of branding Landmark? And in terms of the overall branding strategy, would there be any value to maintaining Landmark as a standalone brand, but as a subsidiary of? Thank you.

Marla, it's Justin again. We have consolidated Landmark into SDN. It is now SDN is the name of our insurance agency for our entire footprint. And honestly, based on the assessment that we did around that, from our perspective, that's what made the most sense. SDN has a very significant brand here in Buffalo and is a much, much larger agency, and it made sense to us to brand the entire thing as SDN Insurance Agency.

And Justin, I just would add that I think the principles were enthusiastic and supportive of that decision as they continue to help us execute our insurance initiatives in the Rochester Finger Lakes Region.

Thank you, Marty. Yes.

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

I want to thank everyone for their participation in the call this morning. We appreciate the opportunity to review and discuss our first quarter performance, and we look forward to doing it again later this summer for the second quarter.

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