Q3 2021 First Interstate BancSystem Inc Earnings Call
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Hello, everyone and welcome to the first Interstate Bank systems third quarter earnings Conference call. My name is Harry and I'll be your oil prices are today.
If you wish to ask a question during the Q&A session. You may do so by pressing star followed by one on your telephone keypad.
I will now hand, the call over to Lisa Slyter Bray to begin Lisa. Please go ahead.
Thanks Harry.
Thank you for joining us for our third quarter earnings Conference call.
As we begin please note that the information provided during this call will contain forward looking statements.
Actual results or outcomes may differ materially from those expressed by those statements.
I'd like to direct all listeners to read the cautionary note regarding forward looking statements and factors that could affect future results contained in our most recent annual report on Form 10-K filed with the SEC and in our earnings release as well as the risk factors identified in the annual report and our more recent periodic reports filed with the SEC.
C C.
Factors that could cause.
Actual results to differ materially from any forward looking statements are included in the earnings release and in our SEC filings. The company does not undertake to update any of the forward looking statements made today.
You have our earnings release, which contains non-GAAP financial measures is available on our website I, if I BK dot com.
Information regarding our use of the non-GAAP financial measures may be found in the body of the earnings release and a reconciliation to their most directly comparable GAAP financial measures is included at the end of the earnings release for your reference.
Joining us from management. This morning are Kevin Riley, our Chief Executive Officer, and Marcy Mutch, Our Chief Financial Officer, along with other members of our management team at this time I'll turn the call over to Kevin Riley Kevin.
Thanks, Lisa good morning, and thanks again to all of you for joining us on our call today.
This quarter along with every release, we have published an updated investor presentation that has some additional disclosures.
We believe it would be helpful.
The presentation can be accessed on our investor website.
And if you haven't downloaded a copy yet.
Encourage you to do so.
I'm going to start off today by providing an overview of the major highlights of the quarter and then I'll turn the call over to Marcy. So she can provide more detail on our financials.
During the third quarter, we saw a continuation of positive trends, we have experienced this year.
Most notably quality balance sheet growth higher revenue and disciplined expense management. This.
This resulted in another quarter of strong financial results with net income coming in at $47 1 million or <unk> 76, a share.
This includes eight cents of merger related expense and <unk> <unk> of expense related to settlement of legal claims.
Excluding these two items our earnings per share was 86.
Or 25% higher than the prior quarter.
While the quarter had less robust loan growth than we anticipated we were still able to generate the growth in our operating pre provision net revenue that we were expecting.
Net interest income excluding PPP increased at a similar pace as the second quarter.
Fee income showed strong sequential increases in expenses were flat excluding the two items I noted earlier.
All in all.
It was another solid quarter for us, which reflective of the underlying strength of our diverse business model.
Despite the supply chain and labor challenges economic activity in our market remains very healthy which continues to drive strong inflows of core deposits.
Our third quarter is typically our strongest quarter for deposit growth and this quarter did not disappoint total deposits increased $442 million and close to half of the growth came in noninterest bearing deposits.
These strong inflows have enabled us to continue growing our earning assets.
And driving increases in our net interest income as.
As we told you earlier to expect in July.
Our net interest income excluding PPP was up for the third quarter and we expect another core good quarter to finish out the year.
The healthy economic activity in our market is also having a positive impact on our fee generating businesses as.
As most of the major areas were up from the prior quarter, resulting in 12% growth in noninterest income.
We were able to deliver strong performance despite loan growth coming in below our expectations across the organization. We are seeing strong demand and good production with the exception of Wyoming excluding.
Excluding Wyoming, our annualized loan growth was over 4% for the quarter while.
Our loan pipeline remains healthy there's three key factors continued to impactful of new loan fundings and draws on existing lines of credit.
Supply chain disruption in very tight labor market is resulting in more project and planned investments among our commercial clients taking longer to complete or being delayed.
The underlying financial strength of our customers and markets, which you see reflected in our stellar credit metrics is resulting in very little line usage or higher levels of loan payoffs.
Competition remains challenging and we are declining opportunities to extend loan portfolio duration at unprofitable yields.
What are the highlights this quarter is it the investments we've made in technology over the past few years are coming to fruition.
We've hit an inflection point in the growth of our digital mortgage application portal, while currently available across the footprint in a couple of months, we've rolled out training in the last couple of months, we've rolled out training to the frontline staff on how to assist clients with this process.
Rather than channeling all mortgage activity coming into our branches to our mortgage loan originators.
As a result, the digital channel is now accounting for roughly 5% of our total mortgage application volume and it is growing rapidly once the training is fully rolled out it should have an even greater impact on volumes and the overall profitability of our mortgage business.
In addition, our small business digital delivery channel has now been rolled out and we're seeing the applications coming in across our entire footprint. In this initial phase we are seeing about 27% approval rate with another 19% of the applications being on boarded to another credit channel.
In the first couple of weeks it resulted in about $1 million booked loans at attractive risk adjusted yields with the average balances of around $50000.
As we get larger this channel will ensure our ability to continue servicing our small business clients across our footprint.
We're excited about the combination of our digital channels in mortgage credit card and now small business and expect these capabilities to enable higher levels of productivity out of our retail sales force.
Of course, the biggest development in the third quarter was the signing of the translated merger agreement with great Western Bancorp.
Since the announcement of the merger we have had the pleasure of hosting town halls in Sioux Falls des Moines.
We're Collins and Denver and have had the opportunity to meet about 70% of the great. Western employees. The response has been overwhelmingly positive and we are excited team up with this group of talented bankers.
Their bankers recognize the opportunity to attract new clients and expand existing relationship with the collective resources in support of a $32 billion organization what was evident throughout our travelers how vibrant these markets really are which gives us increased confidence in our conservative growth assumptions for the next.
Few years from the great western footprint longer term, we are confident that our exposure to these attractive markets is going to lead to higher levels of organic growth than we have historically generated.
Overall, we've gotten off to a good start in our integration planning our senior leadership teams are collaborating very well and creating a smooth transition process for employees and customers.
As well as developing plans to effectively leverage the collective strength of each organization to provide a superior banking experience and enhance our business development efforts.
Before I turn the call over to Marcy just a few comments on the great Western results, you'll have all likely have seen by now in short we are pleased with the quarter and at this point, we see no changes in our expected financial metrics, we announced last month, while ex PPP loan balances decline.
A bit more than we anticipated much of the decline resulted from the repayment of several criticized and special asset hotel loans, we would have designated PCT loans in our review staff continue working through their problem loan portfolio, while booking only $4 million in charge offs this quarter.
Another positive note is that in September they saw net positive loan growth. So that is also encouraging.
Overall, it looks like we're off to a good start and with that I'll turn the call over to Marci to provide some additional details around our third quarter results go ahead Marcy.
Thanks, Kevin and good morning, everyone as I walk through our financial results unless otherwise noted all of the prior period comparisons will be with the second quarter of 2021, and I'll begin with our income statement on a GAAP basis. Our net interest income increased by $8 1 million, which reflects the growth in our earning assets and a $6 $4 million increase in <unk>.
Mountain income accretion income was $200000 lower on a linked quarter basis.
Excluding the impact of PPP income our net interest income increased by one 7% from the prior quarter or approximately $2 million, which was in line with what we told you to expect last quarter. The increase was primarily attributable to higher average balance of investment securities.
Looking ahead to the fourth quarter, excluding PPP income, we would expect to see continued growth in net interest income driven by increases in earning assets.
The higher level of PPP income this quarter, resulting in a nine basis point increase in our net interest margin on a reported basis when compared to the second quarter, excluding PPP from both periods. Our net interest margin decreased by 10 basis points. A couple of basis points of that decline is attributable to the adjustment to our dealer reserve we called out last.
Quarter, the balance is due to a shift in our mix of earning assets toward investment securities along with modestly lower loan and security yields. This was offset by a one basis point decline in our cost of deposits, resulting from the continued growth in noninterest bearing deposits.
Having said that we're encouraged by the fact that yields on new loan production increased by 13 basis points linked quarter to 411% and net new money in the investment portfolio is now almost on top of the 127 yields we reported this quarter that is shorter duration. So going forward, we expect our net interest margin.
Mostly dictated by the mix of earning asset give.
Given the continued growth in the investment securities portfolio, we added another interest rate swap during the third quarter designed to protect our capital and maintain our targeted level of asset sensitivity.
Using a ladder approach to managing our interest rate risk the new swap with a longer maturity than the swap added in the second quarter more details around this were included in the earnings release.
At the end of the third quarter the duration of the securities portfolio was three nine years compared to four years at the end of the second quarter.
Our noninterest income increased $4 $4 million quarter over quarter to $39 7 million with most of our fee generating areas contributing to the increase payment.
Payment service revenues increased by approximately $800000 due primarily to higher business credit card volume, which reflects the strong economic activity, we are seeing in our market.
Mortgage banking revenues increased by $2 million as we return to more historic levels of selling our mortgage production into the secondary market during the third quarter.
Looking ahead, we do expect seasonally lower mortgage banking revenues in the fourth quarter, but for the first time in a while we're beginning to see some positive momentum in our swaps business and should also continue to realize the benefits of a strong equities market in our wealth management business we.
We expect noninterest income to be strong for the fourth quarter, but down roughly mid single digits from our third quarter Hi. This guidance assumes no changes in our mortgage servicing rights valuation.
Moving to noninterest expense, we recorded $6 6 million and acquisition expense in the third quarter as well as $1 2 million for the settlement of legal claims the.
The legal claims were related to two class action lawsuits that many other financial institutions have also settled in in recent years relating to the overdraft and insufficient funds fees. Excluding these two items. Our noninterest expense was $98 $1 million. This was approximately $1 million lower than the prior quarter.
<unk>, which is right on the target we provided.
As such we continue to expect normal operating expenses to be up approximately 1% year over year.
Moving to the balance sheet, our loan held for investment decreased $212 million from the end of the prior quarter due to a net decline in PPP fees PPP loans excuse me of approximately $265 million, excluding PPP loans and deferred fees total loans held for investment were up 53.
From the end of the prior quarter most of the growth came in our commercial real estate portfolio, partially due to the transfer of construction loans into this portfolio. The increase was partially offset by declines in C&I and consumer loans, primarily due to the supply chain and labor issues that Kevin discussed earlier.
As of September 30, we still had approximately two.
$181 million of PPP loans on our balance sheet net of $13 $1 million of.
<unk> deferred loan fees remaining.
On the liability side, our total deposits continue to increase and were up $442 million from the end of the prior quarter with $201 million of the growth coming in non interest bearing deposit.
Moving to asset quality, our portfolio continued to perform exceptionally well, we had small declines in nonperforming loans and nonperforming assets and a $22 million decline in criticized loans as a result of upgrades and payoffs credit losses were very low with only $600000 of net charge off.
Representing just two basis points of annualized average loans in the quarter.
Given the stable asset quality and low level of growth in the portfolio. We did not record any provision expense again. This quarter. This kept our allowance as a percentage of loans held for investment relatively stable at one 4% at September 30, excluding PPP loans, our allowance represented 145%.
Loans held for investment at the end of the quarter.
With that I'll turn the call back to Kevin.
Thanks, Marcy nice job.
I'll wrap up the call with a few comments about our outlook.
Heading into the end of the year, we expect to deliver another strong quarter.
It's difficult at this point to say when the supply chain and labor market issues impacting loan growth might abate.
We should be able to continue generating higher levels of net interest income as a result of higher balances of earning assets.
In regards to loan growth, we are well positioned to meet the loan demand within our markets and we are confident in the ability to continue delivering strong financial results without compromising our pricing and underwriting criteria.
We also continued to make progress on our integration planning for the great Western merger again as you have probably seen with great Western jewelry release, they continue to make progress working through the disposition of loans that we expect it to run off after the closing well that impact their overall loan balance.
This quarter.
As just a difference in the expected timing and the progress they are making prior to closing.
This is very encouraging to us.
To wrap it up our houses in good order our people are engaged and excited about the future our processes and technologies are working well our balance sheet is well positioned for this environment and our capital levels are robust we.
We have a proven track record of enhancing the value of our franchise through acquisition and our shareholders have been rewarded for their support as we've executed on our strategy. We are confident they will continue to be rewarded as we realize the substantial long term benefits from the combination with great Western.
So with that I'll open the call up for questions.
Thank you Kevin as a reminder, if you'd like to ask a question. Please press star followed by one on your telephone keypad now.
And our first question comes from Jeff <unk> from D. A Davidson Jeff. Your line is now open if you'd like to proceed.
Thanks, Good morning.
Kevin I just wanted to.
A follow up on.
And the great Western results again.
Further credit progress in the most recent quarter and I just wanted to.
To the degree that that expected runoff is occurring or what you had anticipated.
Following the close if Thats continues.
Continues to clean up I guess I just wanted to circle back to your expectations. I think you mentioned that those have been altered much given the latest results but.
You did mention it's a conservative outlook in terms of the growth. So it's either the credit work you've got a complete and then the kind of the flip to growth, which they saw a little bit in September.
Just an update on that that conservative outlook. If you wanted to kind of further discuss that Kevin it would be helpful.
Well I think when we announced the transaction we talked about that we would have to kind of run off some of those maybe problem assets as we move forward and that would have a drag on maybe our organic loan growth and the <unk>.
<unk> com, if theyre able to clean up a lot of that earlier, then we probably will have earlier organic loan growth upon the completion of the acquisition.
And just to kind of re engage with that milepost I think the standard.
Growth rates were.
Sort of mid single low to mid single digits for the first.
Year. Following conversion can you just kind of update us back to what those mileposts work.
Yes, they were there they were mid single digits.
With the offset being taken care of some of their criticized assets. So.
If that is taken care of prior to the closing, which I don't think all of it is going to be done I think they're doing a great job.
Their management team Shabak should be commended for the efforts that they put forth.
But yes it.
As you would have less of an impact on that mid single digit growth number.
The last question related to the great western and the timing of that close.
Any more visibility in terms of the first quarter is that early mid or late.
Too early to tell.
Well, it's kind of too early but I would tell you there appears to be a little bit of delay on somebody's acquisitions being approved I think you saw when today, they announced a little bit of a delay.
What we're hearing and this is just anecdotal what we're hearing on the street is that.
The fed is really not making made decisions right now are proving transaction until there is a decision on.
The leadership changes that might occur in the fed so I think once that is cleared.
That logjam will be also cleared up so.
It might delay it but again.
The sooner that announcement happens quicker this could be approved to move forward. So we're still expecting the first quarter. However, if it falls at the beginning of the second quarter, it's really not going to change much of the metrics of the deal.
Got it and last one.
Jumping to the.
Fee income line items.
Thoughts on gain on sale in the payment services.
Shown little light for the quarter and granted some seasonality there, but if we wanted to kind of extend that into 'twenty two high level expectations for those line items.
We're kind of in that process right now of doing our budget, Jeff and so I would expect us to continue to grow those line items as we go into 2022, especially if we see any changes in <unk>.
Supply chain issues are late ratios as people have the ability to.
Spend more because the goods and services. They want are actually out there I think you'll see some increases in those line items.
Okay Marci.
Have you.
Non interest expense.
The 1% growth is off of the 98, one core or what was that again.
The last several years.
Yes, it's off of last year's numbers, but.
I would expect our expenses to come in fairly consistent with this quarter's run rate.
Operating run rate.
Got it okay. Thank you.
Thank you, Jeff and our next question comes from Jared Shaw from Wells Fargo Securities. George Your line is now open. Please proceed.
Thanks, Good morning, everybody.
Good morning Jared.
Hey.
Just looking at the liquidity here.
<unk> seen really good.
Deposit growth Youre growing cash balances, even as youre growing the securities book, how should we be thinking about cash going into the deal.
And then do you have a target for cash as a percentage of assets are coming out of the deal. If we're still in this similar.
A lot of rate environment.
Jeff.
We think we're making progress on putting our cash to work more roles and so we're going to continue working that down.
<unk>.
As we move in towards the deal so.
We're not going to rush into it but they are slowly going to make points, because again I never like to pick the market and when you want to invest cash. So we're going to continue working that down.
Yeah.
It's there and some people say you got a lot of it but deposits keep on flowing in and PPP loans keep on getting forgiven and cash.
Cash keeps rolling and so we're trying to put it to work.
In a very prudent manner, and we'll continue to work that down so.
Do I like to see $2 billion of cash on the balance sheet not really.
So we're going to we're going to continue working that down.
The most prudent manner possible.
Okay. Thanks, and then.
Looking at loans this quarter.
It's awesome to some good growth in average balances I know that there is there is sort.
Sure.
<unk> of Paydowns and payoffs that could potentially happen at the end of the quarter, but as we look forward into fourth quarter.
Should we still should we be expecting growth in average loans ex PPP.
Yes.
Okay. So.
Okay. That's good and then.
Finally for me just on the allowance ratio.
Sure.
What's sort of the thinking about the timing of being able to approach day one levels.
And is the the timing of the deal impacts impact your thoughts around allowance in qualitative reserves at all.
So the timing of the deal does not impact our thoughts on that but.
Now that we are seeing some consistency in unemployment rate nationally.
Aligning with our markets and we're seeing it.
<unk> our economy, we are going to need to be able to look at those qualitative factors and perhaps adjust them to begin to release.
Additional allowance if we don't see the loan growth to absorb that so.
Yes, its something thats on our radar and.
I think youll begin to see that start to come down toward.
<unk> one levels.
Okay as we go forward.
Great. Thanks, Thanks for the answers and we'll talk you soon.
Alright. Thank you. Thank you.
Thank you Jared as a final reminder, if you'd like to ask a question. Please press star followed by one on your telephone keypad now and I would just need a moment for any questions. We are interesting.
And it appears we have no further questions, so I'll hand back to Kevin.
Thanks, Terry Thank you all for again for all your questions and joining us on our call today as always we welcome calls from our investors and analysts. Please reach out to US. If you have any follow up questions. Thank you for tuning in today.
Bye.
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