Q2 2022 First Interstate BancSystem Inc Earnings Call
Hello, and welcome to the best in State Bank system incorporated second quarter earnings Conference call My.
My name is Harry and I'll be coordinating the call today.
If you'd like to ask a question during the question and answer session would you sacrifice your staff by one on your telephone keypad.
I would now like to hand, you over to also speak at least as much fried chicken Lisa. Please go ahead.
Thanks, Terry Good morning, Thank you for joining us for our second 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.
Like to direct all listeners to read the cautionary note regarding forward looking statements 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.
Relevant 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 forward looking statements made today a copy of our earnings release, which contains non-GAAP financial measures is available on our website.
<unk> Dot com information regarding our use of 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 will 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.
Again this quarter along with our earnings release, we have published an updated investor presentation that has additional disclosures that we believe will be helpful.
Presentation can be accessed on our Investor Relations website, and if you have not downloaded a copy yet I encourage you to do so.
I'm going to start today by providing an overview of the major highlights of the quarter.
And then I'll turn the call over to Marcy to provide more details on our financials.
I'm very pleased with our performance this quarter.
We had good contribution from the entire team across our footprint.
<unk> accelerated loan growth significant expansion in our net interest margin.
And further improvement in asset quality.
In addition to successfully executing on the great Western core system conversion.
All of this resulted in a substantial increase in our profitability as we generated 92 cents in earnings per share excluding acquisition related expenses and some other items.
We are starting to see the benefits of our increased scale following the merger.
Particularly given our strong revenue growth as our adjusted efficiency ratio improved to 58% from 62, 2% from the prior quarter.
Underlying our strong performance alright, healthy economic conditions throughout our markets.
Which contributed to six 4% annualized loan growth excluding PPP loans.
The second quarter our.
Our loan production was 30% higher than the prior period.
With growth accelerating as the quarter progressed, ending with 10% annualized growth in the month of June .
Our well balanced production resulted in increases in most of the major portfolios.
And even into the third quarter, we are capitalizing on this momentum and.
And we have a strong pipeline going into the second half of the year.
We are particularly pleased with a higher level of growth. We are seeing the legacy first interstate footprint with every market contributing positively, including Wyoming, which as you know was a headwind last year.
Overall, the legacy first Interstate branch network has an annualized loan growth rate of 15% in the second quarter with Montana, Idaho, Eastern Washington markets, leading the charge.
As always we are maintaining discipline in our pricing and as a result, our new production reflected the impact of higher interest rates.
The average rate on new loan production in the second quarter was 25 basis points higher than it was in the first quarter.
As we discussed last quarter, we intended to deploy more of our excess liquidity into higher yielding assets, earning assets both in loans and the investment portfolio.
This has allowed us to benefit from higher interest rates, resulting in a 45 basis points increase in our net interest margin more poorly our core net interest margin expanded 36 basis points to 3.0% to 1%.
We saw significant increase in our yield on earning assets, while keeping our core our cost of funds flat with the prior quarter.
While deposits declined a little bit more than we originally anticipated in the quarter. We were encouraged by the stickiness of our noninterest bearing in our interest bearing demand deposits and the performance of the legacy F N b footprint overall during.
During the quarter, a large portion of the attrition was discretionary R&R R&R part as we chose not to retain expensive non relationship acquired balances. Additionally, we are taking a proactive and strategic approach to product and pricing in this environment to drive incremental client growth.
From here.
With our strong financial performance and capital position, we were able to increase our return of capital to our shareholders. During the second quarter with the resumption of our share repurchase activity.
During the second quarter, we repurchased one 7 million shares of our common stock at a weighted average price of $37.38.
Paid a dividend yielding four 6% on an annualized basis.
And with that I will turn the call over to Marcy to provide some additional details in the second 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 first quarter of 2022 of course, a significant portion of the variance will be the full quarter impact from the great Western merger.
Through My review I will just focus on any other notable items and I'll start with the income statement.
Net interest income increased by $59 $9 million as we saw improved yields along with an increase in average earning assets are.
Our reported net interest margin increased 45 basis points from the prior quarter to $3 two 5%.
Excluding purchase accounting accretion and PPP related income alright, adjusted net interest margin increased 36 basis points to three 1% from the prior quarter driven by a favorable shift in our mix and increase yields on our earning assets, while our cost of funds was unchanged at 10 basis points.
With the continued redeployment of our excess liquidity on an average basis loans increased to 58, 1% of earning assets in the second quarter up from 55, 6% in the prior 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.
We anticipate a continuation of the positive earning asset mix changes into the third quarter.
Investment security purchases continue to be accretive to current book yield.
New loan production is coming on the books at higher rates and is currently at or above the roll off yield.
And variable and adjustable rate loans and securities will continue to benefit from the recent fed rate increases.
All of this will more than offset some anticipated increases to funding costs.
We are beginning to raise our deposit pricing as we head into the third quarter as we believe based on what we're seeing in our local markets. This can provide us a competitive advantage to attract new clients.
As a result, you should expect to see a higher cost of deposits into the next quarter that said, we still expect to see a relatively low deposit beta over this cycle and that the increase in our yield on earning assets should exceed any increases to our funding costs in the coming quarters.
Our noninterest income increased $1 $8 million quarter over quarter to $51 million. We saw continued strong results from our payment services businesses as well as the full quarter impact of adding great Western <unk> wealth management business.
Adding great Western wealth business allowed us to offset the negative impact to total assets under management from the market pullback.
Excluding the $3 4 million dollar recovery of market servicing rights impairment, we had last quarter, our mortgage banking revenues were flat.
Going forward, we expect them to remain relatively stable as we head into the back half of the year as the increased production volumes, we should see from our new markets will help us offset the lower overall demand, resulting from higher mortgage rates.
When compared with last quarter's outlook, given the incremental interest rate and market driven headwinds on mortgage wealth management and swap fee income we have made a slight reduction to the run rate for non interest income that we expect by the fourth quarter of 2022, adjusting that run rate to be approximately $50 million.
Down from the prior range of $52 million to $54 million.
Moving to total noninterest expense.
Exclusive of acquisition related expenses, our noninterest expense increased $22 $5 million from the prior quarter, which was primarily attributable to the additional one month of great Western operations and consistent with what we told you to expect last quarter.
With the completion of the core system conversion in late May we will now start to realize more of the cost savings projected for the transaction by the fourth quarter of 2022, we still expect our quarterly run rate for total operating expenses to be approximately $160 million.
Moving to the balance sheet.
Our loans held for investment increased $262 million, excluding PPP loans from the end of the prior quarter with growth in all of our major portfolios with the exception of egg.
As of June 30, we had approximately $12 $1 million in PPP loans remaining on our balance sheet net of $300000 of remaining associated deferred loan fees.
Our investment portfolio increased by approximately $1 $4 billion from the end of the prior quarter as we continued to take advantage of higher rates.
We also terminated a 5 million dollar forward starting.
$500 million excuse me.
Forward, starting pay fixed swap on June 1st this resulted in a $23 $3 million gain that will be accreted into income through may 2026.
At the end of the quarter the duration of the investment portfolio was three nine years. Our three eight years. When you include the impact of our remaining 200 million dollar interest rate hedge.
On the liability side.
Our total deposits decreased $1 2 billion, which primarily came from outflows in our savings and jumbo CD balances.
<unk> portion of the decline was attributable to the intentional runoff of higher cost non relationship deposits carried over from great Western.
Within our legacy footprint, we saw a decline of one 7%, but remain in line with our year to date expectations given the unseasonal growth we saw in that deposit base in the first quarter.
Given our strong liquidity position headed into this quarter, we funded the runoff out of our cash balances.
In aggregate, our balances of noninterest bearing and interest bearing demand deposits were just about flat during the quarter, which reflects the stability that we typically see in our core deposit base.
Moving to asset quality, we saw positive trends across the portfolio with declines in nonperforming assets and criticized and classified loans.
The decline in criticized loans was largely driven by our continued progress in working through the problem loans added in the great Western acquisition.
The strong performance of our loan portfolio. It's also reflected in the very low level of net charge offs, which were just $300000 or one basis point of average loans in the quarter.
Given the positive trends and the low level of loss in the portfolio. We recorded a negative provision of $1 7 million for the quarter.
Bias toward a more negative economic outlook was offset by the positive trends in our portfolio.
Relative to last quarter, the allowance declined $26 8 million.
As part of a reevaluation of the acquired loan portfolio. There was a release of $24 $8 million of specific reserves on certain PCT loans, which was booked as an adjustment to the acquired balance sheet and resulted in a net reduction to goodwill.
This brought our allowance as a percentage of loans held for investment to $1 two 8%, while our coverage of nonperforming loans remained relatively unchanged at 201%.
As further noted on slide four of the Investor presentation. In addition to the PCB along as I. Just mentioned we also adjusted the initial credit marks on our acquired held for sale portfolio.
On a combined basis the after tax impact of these adjustments resulted in a decrease to goodwill of $37 $8 million and had a corresponding increase to regulatory and tangible capital and with that I'll turn the call back over to Kevin.
Thanks, Thanks Marcy.
Wrap up with a few comments on our outlook.
Our market has remained resilient.
And we have not yet seen higher rates or inflationary pressures, having a material impact on economic activity loan demand or asset quality.
Loan production remained strong and we see many catalysts, we're continuing our positive trend in loan growth as I mentioned early earlier, our legacy first Interstate markets are performing very well and we are seeing better than expected trends already from the acquired footprint and we continue to work with.
Our colleagues, who joined us from great Western to accelerate business development efforts in our new markets. This includes Omaha, and Lincoln area, where we have put new leadership in place in Colorado, and Arizona, where we believe we can more effectively capitalize on the strong economic activity in these markets.
<unk>.
As rates move higher is likely we will see a decline in pay offs, which are less than one of the headwinds to loan growth.
Given these catalysts and the trends we are seeing we are optimistic that we can achieve the mid single digit annualized loan growth over the second half of the year, which is an improvement from our outlook a quarter ago.
While our growth outlook has improved it should be noted that through our proactive management practices. We continue to resolve acquired credit challenges well inside of our initial loss assumptions. We told you on the onset of the acquisition that the credit marks where capital that belong.
To the shareholders.
We take that responsibility seriously and we are very proud that we've been able to recoup some of those marks for the benefit of all constituents.
As Mark mentioned, we expect to continue seeing an expansion in our net interest margin and with a core system conversion now behind US we will see some more synergies that we projected for the great Western merger. The combination of continued loan growth margin expansion and the realization of more cost.
Savings from the merger should lead to continued improvement in our levels of profitability and finally, even after this quarter's repurchase activity. We continue to run capital levels in excess of our internal targets, while our markets continue to perform well we are mindful of the broader macro economic.
Burns and the potential recessionary environment, given the strength of our franchise. We believe we are well positioned to perform well in whatever type of economic environment materializes in the future.
I want to end my prepared remarks to reiterate how proud we are of the entire team for what has been a very successful conversion at the end of May.
We have noted the stimuli areas of our two organization from the onset and now that we're one organization we are experiencing the synergies of our cultures coming together as one the result of our recent published Gallup poll survey are a positive sign we are heading in the right direction.
Lastly, as part of it.
Of the $21 million donation to our foundation related to this acquisition.
We have agreed to donate 1 million across our footprint through our belief in local grant campaign.
It has encouraged our colleagues from across the footprint in support of local employee sponsored not for profits in all 14 states I could not be happier with the supportive for this effort we are truly moving together as one cohesive company.
So with that we'll open the call up for comments.
<unk>.
Yes.
Yeah.
Thank you Kevin as a reminder, if you would like to ask a question. Please press star followed by one on your telephone keypad now.
And our first question is from the line of Jared Shaw Wells Fargo.
Jared Your line is now open if you'd like to pursue.
Hey, good morning, Thank you.
Good morning, good morning Gerry.
Hi, everybody, maybe just starting on the on the credit side and the provision how much of the provision reversal I guess it was most of that provision reversal, great Western and just the better performance there and how should we be thinking about.
The allowance ratio here at <unk>.
We have about 129 next GPP and migrating towards that day, one level with the with the combined bank.
So Jared.
Provision were first of all at $1 $7 million was really reflective of the credit quality of the entire portfolio that was slightly offset by kind of a negative bias so higher qualitative factor for macroeconomic.
Factors in terms of going back to day, one again, we were around $1 20 as of seasonal de 128 now.
We continue to see credit.
Improvement, which we expect to do it will be slightly offset by probably a more negative bias toward.
Negative economic outlook. So it's hard to say, yes, it's only eight basis points. How quickly we will go back to the day one.
I would expect it to stay kind of stable from here with not any big shift one way or another unless we see something turning in <unk>.
Economic conditions more negatively than we are today I think I'll, just add a little bit Jerry today, where I think the.
The thing is is that we believe asset quality will continue to prove right now in the short run even though the macroeconomic factors might get a little bit worse. They might we're looking at they could offset each other improvement in asset quality macroeconomics. So they offset so we think our allowance should be pretty much stable from this point until something dramatic drastic.
We change it.
Okay, and then in terms of like the remaining.
The loans that you are trying to to resolve from great western any any change in sort of the.
The pace of that either the appetite for them.
Sales or or.
Helping to work that out or how should we be thinking about that continuing resolution I think thing is I think you should look at Jared is that we're working through the pace of getting rid of is going just the way we expect it is going very well.
And it's not going to be any kind of wholesale selling of the loans. So.
Yes, we will work through the criticize but just in the normal course of business in the held for sale will most likely come up by the end of the year.
Okay. Thanks, Glenn on the funding side.
You've been able to keep data extremely low which is great.
As we go forward here, how should we be thinking about you know.
What youll do to defend deposits at this level in terms of data and how does.
The deposit mix look with that with the potential for DDA growth or stability from here.
Yes, I think that is.
Yes.
Last rate cycle, we were pretty aggressive with our deposit pricing because we could afford it because we're very asset sensitive and so.
We're not going to see the beta that we saw last time was that it was about 27%.
We are going to increase some of our pricing in the deposit area to give our employees.
Our product to be able to defend our position within the market and also I think as you know we have the ability to take market share due to the fact that.
Some other banks or are unwilling or.
Unable to increase deposit cost so we're going to get we're going to do some deposit price raise.
Raising in specific areas to defend and possibly grow market share.
But it will not be at the beta that we saw in the past rate Heights.
And it's and it's not going to go.
Is that going to eat into our earnings projections.
The future either.
Okay, great. Thanks, I was just finally for me any update on you're still seeing Ah.
Similar trends in terms of migration into our into the markets.
From a from some of the coastal areas or has that started to slow down at all.
No it's continuous it's pretty robust.
So.
Like I said in my remarks.
Economic activity is strong pretty much wider footprint and we have not seen that kind of.
<unk> come down much yet.
Great. Thanks.
Thank you and our next question is from the line of Jeff <unk> of D. A Davidson Jeff.
Jeff Your line is now open if you'd like to continue with your question.
Thanks, Good morning.
Good morning, Jeff This.
This is.
This is actually Andrew <unk> on for Jeff <unk>.
I just had a question on.
Specifically relating to deal conversion and the closing of the deal now.
Now that we're through both of those just wondering how net personnel for what's gone are you guys seeing departures a new edition.
Yeah.
And can you can you can you clarify that question again.
Now that we're through the closing and conversion.
Of GWB just wondering about.
Just personnel employee flow.
Guys seeing additions to your team our departures.
Well the thing is if youre talking about unexpected departures and employees of great Western is that what youre talking about.
In that area.
Right.
Okay.
No quite frankly.
I mean, it's typical in banking, you're going to lose a banker here and there we're not seeing anything outside of normal.
Swapping of some people back and forth from other banks. So no we do not see any major departure of employees.
We.
Really wanted to stay on.
Okay. Thank you and.
Second question just wondering Ken.
Again on sale expectation for 2023.
Mortgage.
You know I think that's a little bit too early for us to comment on that at this point.
I think we've talked about before.
We have a digital product that we intend to rollout across the great Western footprints that we're hoping to see.
Increased volume from from that product.
At this point I'm not going to speak to 2023 expectations.
Okay. Thank you.
Next question.
Loan growth in June was 10.
10% and now with guiding to mid single digits.
What's the growth in June due to demand getting pulled forward.
Anticipation of higher rates in the future.
No I think.
This was the growth.
When we say mid single digits I think we're going to have a good third quarter and I think the fourth quarter will be normally seasonally like we've seen in the past where growth will be a little harder in the fourth quarter due to the fact deadlines are paying off and stuff like that so you have that headwind. So that's why we're saying mid single digits.
Hopefully that one quarter will be better than the other but that's why we're targeting mid single digit yes, that's into the second half of the year, So just to be clear.
Got it thank you and last question from me.
Just wondering about buyback appetite going forward with the TCE ratio at six 6%.
The CET one ratio down linked quarter.
Well I think the thing is we have we still believe we have excess capital to to do share repurchases.
Board authorized 5 million and we bought back one 7 million and we will continue to you know.
Look at our position with regards to buyback as we move forward.
Okay. Thank you congrats on the quarter.
Thank you. Thank you.
Thank you and our next question comes from the line of Andrew Terrell Stevens.
Andrew Your line will be opened now if you would like to proceed with your question.
Okay.
From Andrey <unk> from Stephens your line of Jacobo.
Hey can you hear me.
Now I'll give you a yes go ahead.
Hey, Kevin Hey, Marci.
Sorry about that I wanted to start on the expense side.
Marci.
Reiterated the $160 million run rate by <unk> I was curious when you announced the deal you expect that adding 56 million.
Annually in cost saves.
How much of that has been realized to date and do you think there is any opportunity still to do better than the $160 million <unk> run rate or does some of the inflation, maybe continue investments limit that ability.
Yeah. So we're right in line with where we expect it to be Andrew we're not anticipating.
Any other changes based on inflation or other investments that we've seen that are going to take us above that $160 million in the fourth quarter. Yes, I think the thing is we ended up.
Put another way.
We're seeing a little bit better in somebody expenses than we anticipated, but we have inflationary expenses creep in salary and wages are putting pressure on that.
The other area. So I think where we're seeing increased costs because of inflation is being offset because we're doing better than we anticipated.
Yeah understood, Okay, and do you have how much of the total announced cost saves you've realized like a percentage today.
Yeah.
They're all my finance people kind of sitting there shaking her head.
I'd love to get back to you on that we can get back to you.
Yeah no problem. Thank you.
Andrew will be in second half of the year, So again in a conversion.
May 20th.
Okay.
Got it okay.
I wanted to move over to the deposits.
Like the runoff, mostly this quarter was from kind of a higher cost or higher beta acquired balances.
Do you anticipate any more of.
Of those to kind of move out of the bank in the back half of the year or some of the actions you're taking on pricing kind of.
Prevent that and then just overall thoughts on what you expect for deposit growth.
In the second half.
Yeah, that's a great question.
I would say that we don't anticipate any of those large amounts to go out.
We saw it in the second quarter, I think our pricing will stem the tide of other maybe outflows, but what we're looking at roundwood deposits is pretty much being flat.
From here to the remainder of the year.
Got it okay.
And last question just on.
Just the efficiency ratio the revenue trends down really solid you've got continued cost savings coming through the benefit from fed interest rates.
<unk> do you think you can work the efficiency ratio.
Proved a lot this quarter, but do you think you can get it down to like a low 50% type number.
In the back half.
Yes.
Well, we'll go lower than we were this quarter I wish it should continue to come down.
Okay.
I appreciate taking my questions I'll step back.
Alright, Thank you Sandy.
Thank you and our next question is from the line of Matthew Clark Piper Sandler Your line is now open.
Hey, good morning.
Hi, good morning, Matt.
Yes that was.
Good question, thereby Andrew and one of them.
And then I was going to ask it does seem like if there is still a fair amount of cost saves left.
To be realized by the end of the year you run rates should come down even if you assume some.
Annual growth in comp, but we can follow up on that.
Shifting to the core NIM the core margin.
Do you happen to know that.
The average core margin was in the month of June .
I'm, just trying to get a sense for.
Whether or not we might see.
Our core NIM core NIM expansion that might be larger than what we saw here in <unk>.
So.
Matt.
Yes.
All of that information.
And so I think I'm just going to leave it at that you know again, we continue to have.
26% of our loans that are going to reprice immediately part of our investment portfolio.
Even if we do a little bit of I have a little bit higher cost of funds.
No I hear you are 36 might be a stretch basis points.
Yeah.
Yes no.
And then did you.
Happen to I guess I'm trying to hone in on kind of the deposit cost increases that we might see I know you mentioned that the beta is going to be lower this cycle no reason for it not to given your loan to deposit ratio, but any any comment.
Comments on kind of the spot rate on deposits coming out of the quarter or.
Rates on <unk>.
Promotion on some.
Promotional offerings, you might be using right now.
Well first of all our field haven't heard the promotional rates there.
So it would be a little bit premature to start talking about on earnings call, but the rates are going to come up I mean, we're not.
We're trying to look at the market, we're trying to be you know.
Protecting you have credit unions out there you have other.
Online banks are out there offer and our customers.
We're making a lot of money what a return on their money. So we're just going to be kind of.
Very strategic surgical and trying to price the deposits in areas, where we believe that we have to give our customers that return, but again, it's we're going to be very cautious we're not going to try to go to hog wild with regards to pricing, but I think we have to.
We have to our customers want increases and I think we.
Have to proactively move in that direction.
Okay. Thank you.
Okay.
Thank you and before we take our next question I'd, just like to remind everyone to register for a question. Please press star followed by one on your telephone keypad.
And our next question is from the line of Chris Mcgratty Ww, Chris. Your line is now open. Please proceed.
Great. Thanks.
Kevin and Marcy the image.
And the Remixing and comment on the balance sheet in your prepared remarks, you took cash down quite a bit in.
In the quarter. So I guess two part question, what's the what do you think is a reasonable amount of cash that you need to run and then also.
Maybe monthly or quarterly cash flows off the bond book and presumably if you're guiding to flat deposits there'll be some remix going forward. Thanks.
Yes, so the cash flow coming off the investment portfolio is about 300 million a quarter.
With regards to holding cash balances, we're going to try to hold cash balances.
I would say below $500 million mm.
And.
In regards to deposits.
What it was all part of the question was regarding.
Just on an average basis, our loans will come up quarter.
Quarter over quarter.
Expect it to continue to see the loan growth that we can find with some of that securities portfolio runoff.
Got it okay great.
And we've seen some of your peers given what the futures market is pricing for cuts reduce take steps to reduce some of the asset sensitivity or to lock it in I'm interested any thoughts there.
About.
This strategy is our swaps you might be doing to kind of lock in if we do get a cut in the next 18 months.
Yes that and Chris that leads into why we did the we got rid of the $500 million swap.
The float some of the stuff. So that's why we got rid of that to start changing the balance sheet a little bit.
To protect from a down rate environment. So that was one of the action we took and we're looking at other actions, we do have another $200 million.
Swap out there. So we are looking and taking but we don't want do it all in one interest rate cycle, just like we didn't want to invest a whole loan investment portfolio in one interest rate cycle, we're trying to be cautious of how we do that but I hear what youre, saying and we are looking at that.
Okay, great. Thank you.
Hum.
Thank you Chris we have no further questions registered at this time, so it's my pleasure to hand back to Kevin Riley for any closing remarks.
Thank you for your questions and as always we welcome calls from our investors and analysts. Please reach out to US. If you have any follow up questions and thanks for tuning into the call today Goodbye.
Thank you to everyone who has joined the call today. This concludes and you may now disconnect your lines.
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