Q1 2022 First Interstate BancSystem Inc Earnings Call
Our branch network, which was partially offset by the decline in our home mortgages and indirect lending portfolios.
This is a positive outcome as the seasonality we typically see at the beginning of the year offered results been flat or slightly declining declining loan balances during the first quarter.
Compared to the fourth quarter, we are beginning to see some synergy returned to loan pricing as interest rates have increased along with marginally less competitive environment.
This quarter the average rate on new loan production in our legacy footprint is now over 4%.
Moving to Greg electric excluding PPP loans production levels remained strong in the quarter since the close of the acquisition, we've been able to make a formal announcement of affirming continue consistent leadership in both markets, which has minimized the uncertainty created in any acquisition.
The teams many of which I have personally visited.
We are excited about the future and how many.
Breast with this talented group of bankers.
With a motivation we are seeing from this team combined with the substantial progress that we have made to work down levels of problem loans.
We're optimistic that we will see growth in these new markets faster than we anticipated.
In terms of problem loan resolution.
If you recall at the time of the transaction announcements, we identified $1 $2 billion in PCI loans. When we closed the acquisition that number was down to $722 million.
And we've made more.
Progress on working down our problem loans since the close.
Criticized loans for great Western we're down to $655 million at quarter end.
And if you accelerate the workout process, we transferred $241 million of credits to loans held for sale at the close of the transaction.
We expect these loans will be substantially all of our books by the end of the second quarter.
Considering these factors many of the headwinds to total loan growth that we initially anticipated in the first two years of the combined operation from the disposition of problem loans has been substantially reduced we now expect great restaurants footprint can be a contributor to the growth of the combined company this year.
Sure.
While we are very excited about the acquisition, we haven't lost focus on expanding the digital lending capability that we introduced over the last couple of years, we continue to refine our digital business banking loan origination platform that we launched late last year operating lines of credit of up to $100000.
Currently we focus on increasing the automation of score products up to $250000 and are prepared to launch. This later this year.
Actual capability.
Access to small business lending center will be rolled out into the new footprint at system conversion.
Before I turn the call over to Marcia to provide additional details around our first quarter results.
Like to say that have never experienced an acquisition whether it has been so much <unk>.
And excitement for our new colleagues. This has been rewarding a rewarding experience and I am excited about the possibilities going forward.
That I will turn the call over to Marcy.
Thanks, Kevin and good morning, everyone.
Walk through our financial results unless otherwise noted all of the prior period comparisons will be with the fourth quarter of 2021.
The primary driver of the variances in each area will be the partial quarter impact from the great Western merger, which closed on February 1st I'll begin with our income statement.
On a GAAP basis, our net interest income increased by $56 $2 million.
While the growth in our earning assets from the acquisition was the primary driver so too with the sequential expansion of our adjusted net interest margin as well as the increased contribution from accretion on purchase.
Our reported net interest margin increased 11 basis points from the prior quarter to two 8%.
Excluding purchase accounting accretion and Pvp related income our adjusted net interest margin increased 19 basis points from the prior quarter to $2 six 5%.
This was driven by a favorable mix shift and an expansion in our yield on earning assets primarily in our investment securities portfolio.
On an average basis loans increased to 56% of earning assets in the first quarter up from 53% in the prior quarter.
Our securities yield expanded 23 basis points, which was partially attributable to the repositioning we did after the right western investment after adding great Western's investment portfolio, along with higher new investment yields which were two 2% in the first quarter.
Looking ahead, we believe we are well positioned to see a continued expansion in our net interest margin due to a number of factors.
We anticipate a continuation of the positive mix changes to our earning assets in the second quarter.
Investment Securities purchases continue to be accretive to book yields in the current environment and we expect to invest additional cash in the second quarter.
Loan should begin repricing with the recent fed rate hike.
Loan accretion should be modestly higher in the second quarter with a full quarter impact from great Western and at this point, we've seen nothing in deposit trends. After the first rate increase to change our expectation that we will have a very low deposit beta during the initial stages of this rate hike cycle.
While the expansion.
It will vary from quarter to quarter, we expect the general trend in our net interest margin to be higher if the fed raises rates, which should help lead sequential improvement in the net interest income as the year progresses.
Before I discuss fees and expenses I would like to level set on one area and address the realignment of great Western accounting practices to our own as you'll see referenced in the investor presentation on page eight.
Previously great Western netted certain expenses against noninterest income, which for accounting clarity, we don't do at first Interstate.
This practice was most notable in our payment services business.
While the unwinding of this practice has zero impact to net income. It will result in both fees and expenses being approximately $13 million higher for the calendar year 2022, or approximately $1 8 million.
For the first quarter.
So with that our non interest income increased $11 $8 million quarter over quarter to $49 2 million.
Which included a $3 4 million dollar recovery of mortgage servicing rights impairment.
The $1 $4 million gain on the repayment of great Western sub debt.
We saw strong results from our payment services business, which we expect to continue along with nice improvement in our swap fee revenue as compared to prior periods.
With higher rates, reducing demand for refinancing and continued housing supply constraints impacting purchase volume, we anticipate the environment to become more challenging in the mortgage banking business.
We expect to offset some of these headwinds as we expand our production into the new great Western markets, particularly through our digital loan origination platform, which will be available to them at system conversion.
Looking ahead.
By the fourth quarter of 2022, we expect our run rate for noninterest income to be in the range of $52 million to $54 million, excluding any impact from MSR.
This also takes into consideration the reduction related to the full impact of our new NSF and overdraft policies.
Moving to noninterest.
Noninterest expense, we recorded $65 2 million in acquisition related expenses in the first quarter.
This along with the partial quarter impact of adding great Western operations resulted in total noninterest expense of $207 2 million.
Looking ahead as most of the cost savings will not come out until after system conversion. The additional months of great Western operations will increase our adjusted operating expenses by approximately $20 million in the second quarter.
Additionally, we expect to incur another 60% to $70 million in merger expenses, which should also fall mostly into the second quarter.
We are on track for the system conversion in late May after which we'll start to realize the cost savings projected for the transaction.
By the fourth quarter of 2022, we expect our quarterly run rate for total operating expenses to be approximately $160 million, which includes approximately $4 million of reclassified expenses related to the realignment of great Western accounting practices that I mentioned earlier.
This should put us right in line with original expectations, even after considering inflationary wage adjustments, we expect to make later this year.
Moving to the balance sheet. Excluding the addition of great Western the legacy first Interstate loan portfolio increased $37 million, excluding PPP loans from the end of the prior quarter, primarily due to growth in the commercial loan portfolio.
As of March 31, we had approximately $56 7 million.
Of total PPP loans remaining on our balance sheet net of $1 3 million of remaining associated deferred loan fees.
Excuse me.
Our investment portfolio increased by approximately $3 billion from the end of the prior quarter largely due to the securities added from great Western.
Immediately after closing, we repositioned part of that portfolio selling securities that didn't meet our risk profile and moved $464 million of securities from available for sale to held to maturity.
This reduced the impact of higher interest rates on OCI and our tangible book value at.
At the end of the quarter the duration of the investment portfolio was three eight years or three six years. When you include the impact of our interest rate hedges.
On the liability side, our total deposits continued to increase and what is historically a flat to down quarter and we were up three 2% on an annualized basis from the end of the prior quarter.
Moving to asset quality, while our nonperforming and criticized loans increased due to the acquisition credit trends in both portfolios continued to improve within the legacy first Interstate portfolio. We had just six basis points of net charge offs on an annualized basis in the quarter.
Outside of those charge offs, we recorded approximately $15 million of net charge offs on loans acquired from great Western most of which were specifically reserved and taken in anticipation of restructuring these loans in future quarters.
We recorded $68 $3 million through the loan loss provision on non PCI loans from great Western which was partially offset by a release of reserves on the legacy first Interstate portfolio.
Our allowance as a percentage of loans held for investment was 146% at March 31.
Up from one point.
Up from $1 three 1% at December 31, or.
Our reserve remains strong with coverage of our nonperforming loans at over 200% post transaction.
And with that I'll turn the call back to Kevin.
Sure.
Thanks Marcy.
Wrap up with some comments on our outlook.
Despite inflationary pressures and higher interest rates loan demand remains robust and our pipeline remains strong across all asset classes in all markets.
Pricing appears to be closing and we expect to see the usual seasonal increases.
<unk> during the second and third quarters of this year.
With the progress that we have.
So it may in reducing great questions, Paul the walls that headwinds that we expected.
The total global post closing have been meaningfully reduced.
Based on our strong pipeline.
We're optimistic.
Excess of low single digit outlook. We previously gave for the combined company over the remainder of 2022.
This should lead to further improvement in our earning asset mix and additional expansion of net interest margin.
With cost savings that we will see in the system.
Optimistic about the level of profitability that we will be able to generate during the second half of the year.
Another benefit of resolving the problem loans at a faster pace than initially expected.
Is that we haven't been able to devote more time and attention.
Security on potential revenue synergies.
We've been able to make more progress than we expected on putting the glad awards in place to take advantage of our larger footprint to drive growth in whole loans.
Direct lending commercial and consumer credit cards, and Treasury management solutions.
While we may see some small incremental benefits in 2022, we are setting the stage this year to see positive impacts from these efforts in 2023.
And finally, we've been relatively conservative with respect to capital leading up to the closing of the merger.
Well with the merger completed and more clarity around the credit quality in the acquired loan portfolio, we have the ability to add value.
Two options to optimize our capital.
So with that.
I'd like to open the call up to questions.
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Yeah.
Our first question is from is from Jeff <unk> with D. A Davidson. Please proceed.
Thanks, Good morning.
Good morning, John Good morning, Josh.
Just a question on.
Assuming there are some lockups or incentives aligned with.
Through the conversion in mid May and any preliminary thoughts on on the <unk>.
Tension or departures that you might see I guess it could be to be determined but whats your day John on that.
As we approach conversion.
Although the Lockups, we put into place for our producers are lockups that are in place for a year or so.
We're hoping that that will continue to lock them up is a bad locked up so far since transaction close.
Got it I guess the folks that.
SaaS through conversion.
That departure has to be assumed I suppose.
Yes.
Cash bonuses, yes. It wasn't gave you tangible as some convergence that they'll get the retention bonus once the conversion is done and then I'll move on but the producers we gave lockups for over a 12 month period.
Fair enough.
Kevin on the.
Just taking a different angle.
With a buyback.
Considered now.
Now with the deal.
Close.
Yes.
There was discussion of some technical trading headwinds.
Yes.
And then just wanted to check on.
Capital use.
Okay.
As we head forward as buyback part of that discussion.
Well as you know, we always talk about the differences.
We use capital for buybacks always part of it.
Right now, we probably have more capital than we had pre pandemic and as you saw we loved and Debbie.
Did the special dividend as we did some share buyback so everything's on the table and we're looking at the options.
As we speak so.
I will tell where we go.
Okay.
One last one on the.
Just looking forward on that maybe the credit path.
A resolution from here, noting that yet.
CD balances down and once you've moved into held for sale, but.
Okay.
Major Mileposts that you see on the remaining NPA going forward on potential resolution or is it more of that group is going to be a methodical work down from there.
Yes, I would say that from this point, it's kind of more like business as usual there was no real big pool of anything I think youll see some upgrades.
He is improving in some areas and you'll see some of that work will show.
Joe in the door and then will be by other ones. So, let's just put it would be normal.
Working out of where we are.
With regards to these these are classified asset, but no. There is no real the bucket that we are concerned.
As a bunch that we have to worry about so it was kind of just kind of working through them shortly but kind of like we've done with first interstate over the years.
Okay. So again, no super low hanging fruit that you.
<unk> resolution, it's going to be the one to 139 months, it's sort of a work down process from here.
Yes.
Yes.
Okay great.
Thank you.
Thank you for.
Your question.
Our next question is with Matthew Clark from Piper Sandler. Please proceed.
Hey, good morning.
Good morning, Matt.
First one on <unk>.
Expense outlook.
The fourth quarter.
Run rate expectations of $160 million I'm, a little surprised.
It will be lower than that given all the cost saves that are still yet to come in at $56 million.
On an annualized basis can you just give us a sense for what might be masking some of that.
Well again, Matt I think when you take that extra $13 million and add it to the expenses that we did at deal announcement.
Our couple of percent just increased year over year in our budget and then we.
Also have built into there are some inflationary wage increases or wage increases related to inflationary pressures and between all of that that will be the run rate and if you look at where we were last year.
At announcement and you add that on an annual basis $14 million to that.
We're kind of right in line with where we thought we'd be.
Okay, and then on the fee income run rate of $52 million to $54 million by the fourth quarter I think some of that is accounting related to but what else is getting you from that $44 5 million this quarter on a core basis.
Up to that 52% to $54 million range by the fourth quarter.
Again I just think when you include the run rate from great Western we expect mortgage to be flattish.
MSR impact as we go into the back half of the year.
We're just feeling pretty positive about but where we expect to be from a fee perspective.
And again part of that is the $14 million re class.
Alright.
And there was $1 8 million of that in this quarter is that right for the recall.
Yes. Thank you.
That's correct okay.
Okay and then.
On the pipeline.
Kevin you mentioned its strong I know the comparisons are distorted having just closed on the deal but.
How would you how would you size up that pipeline.
Relative to the growth you might anticipate coming out of it.
Okay.
Yes, all I can say from what I get my chief credit officers that.
The $1 $6 billion in loans, and we're hoping some of that speaks to the phones.
It doesn't mean, they're all going to be book, because it could be bought by some other institutions, but.
Global classes is probably at the highest level we've ever seen.
Okay, great. Thank you.
Thank you for your question.
Our next question comes from Jared Shaw with Wells Fargo. Please proceed.
Hey, good morning, everybody.
Good morning, Gerry I guess, maybe just going back to the growth.
Kevin you sound pretty optimistic about the.
Murphy and the job formation and people moving in strong credit you referenced.
Competition.
Slackening is why not be more optimistic on on growth.
I guess youre, saying, we're off of the low single digits with the faster cleanup.
What would have to happen to get you up to.
Mid single digits or high.
Single digits.
Mark.
Always our goal.
To grow as fast as we did pause you would grow but again.
We're in a risk business and we wanted to make sure we're taking the appropriate risks in that growth.
We.
We're very optimistic that growth will be better than what we have seen maybe in the past, but the fact of matter I don't want to you know me I don't want to ever get out too far ahead of people promise too much.
To deliver so I'd rather high.
Hi, Brian .
With regards to what we think what might be it comes out better than that.
Trust me, if I can turn down the business.
Okay, Yeah, I think Rob as you think about line usage mine usage, we're optimistic about line usage, we're seeing.
Slowdown in the pace of pay offs and so both of those things to make are encouraging to us.
Okay, all right that's great color, Thanks, and then.
I'm just looking at the asset quality side, and you referenced the 31 million.
The remaining loan balances that could be exited are those already I guess a couple of questions I wonder if they already March is there is sort of reflective of.
What do you expect their work and is that included in the held for sale.
Category.
Yes.
Okay.
Oh excuse me it is not that got pulled on Michael.
This is Michael Ludwig the 31.
Million that you're referring to.
<unk> to the <unk> that were anticipating doing over the next couple of quarters. So we right size.
Some loans in the first quarter.
And so what youre seeing is that will be through <unk>.
Taking the charge. So now we just need to put together.
Document alone so that we can upgrade the remaining balances up from classified.
Okay.
At this early.
As you would you take that next step that's already been reflected in the valuation.
That's correct.
Okay.
Then just finally for me I guess.
With the with the stronger.
The environment for purchasing securities, what where do you see securities potentially going as a percentage of assets and.
Is that something that.
Would be spaced out over the year or if theres good pricing good opportunity.
Potentially get there faster.
Yes.
Do you think we have the opportunity to deploy some of our cash.
The investment Securities portfolio.
We see some good opportunities there so I would expect as a percentage of earning assets to go up a little bit but of course, our first.
Hope is to deploy that into the loan portfolio.
Okay. Thank you.
Thank you for your question.
Our next question comes from Chris <unk>.
<unk> from <unk>. Please proceed.
Okay.
Hey, good morning.
Good morning.
I guess a question on the balance sheet understanding that the excess cash position.
And the ability to remix how should we be thinking about just growth in the balance sheet, maybe a comment on what you're assuming for deposit growth over the balance of the year.
That's a good question.
Paul.
Go ahead go ahead Marcy go ahead.
Yes.
So deposit growth generally Chris goes up as we go through the next couple of quarters.
We have seen a little bit higher pace of outflows.
For tax payments this quarter than normal but.
Overall through the second and the third quarter, we would expect positive to grow modestly and then kind of flatten out as we go into the end of the year or potentially slightly decline.
Okay.
And then.
Is there a targeted mix that you are looking to get for the cash position and if so.
When do you think you can.
Thank you can get there.
So theres not a targeted mix, but it's definitely down from where it is now so I think we have a lot of flexibility to put that to work either in the loan portfolio or the investment portfolio.
To increase overall net interest income.
Okay, and then maybe a final one.
You provided guidance on the fourth quarter for fees and expenses were going to exit.
One of the questions, we're getting a lot of this quarter as exit run rate of net interest income for this year and so I'm interested in your thoughts if the forward curve were to play out how should we think about.
Putting all the pieces together and kind of an exit run rate for for spread income.
So Chris side isn't really something that we've disclosed in the past.
I think if you look at.
I think we said we had three interest rate hikes in our budget most likely it could be more than that I mean, I think we've given you all the pieces to be able to do the math there in terms of what our variable rate loans are.
Immediately the price they were like 27% of the loan portfolio investment portfolio of 13%.
Investment portfolio immediately re prices.
We expect deposit betas to be low. So I mean, you can you can make some assumptions and kind of get there on your own based on what you think rates are going to do.
Our crystal ball is probably as clear as ours.
Okay, great. Thank you thanks Marcy.
Mhm.
Yes.
Sure.
Thank you for your question.
Our next question is from Andrew <unk> with Stephens, Inc.
Please proceed.
Hey, good morning.
Good morning, Good morning, Andrew.
So most of mine have been asked and answered at this point, but.
Just from a kind of bigger picture, Kevin when we announced the transaction back in September .
One of the slides in the presentation gave us kind of a rundown of the pro forma P&L.
Operating earnings in 2023 and $3 65.
I know there were some kind of conservative assumptions already and a lot's changed since then but you feel more comfortable in achieving that 365 pro forma EPS in 2023 today compared to when you announced the transaction.
I would say I would be.
Very disappointed if we do better.
Yeah.
Okay and then just.
Back on the capital management piece can you just remind us how much you have.
Any on buyback authorization right now.
That'd be helpful. Thanks.
Go ahead Marcy.
One 9 million shares left under our current authorization.
Okay.
Okay. Thanks for the questions.
You bet.
Thank you for your question.
Our next question comes from Todd Mckinnon.
RBC.
Wealth management. Please proceed.
Okay.
My questions have been answered thank you.
Thanks Todd.
Well.
Core monitoring we have any other questions.
There are no more questions waiting at this time.
Well I'll just thank everybody for your questions.
Always we welcome calls from our investors and analysts please reach out to US if you have any further follow up questions.
Thank you for Attunity today and have a.
Good day take care.
That concludes the first Interstate systems first quarter earnings call. Thank you for your participation you may now disconnect your lines.
Yeah.
Okay.
Okay.