Q2 2023 First Interstate BancSystem Inc Earnings Call
Good morning, ladies and gentlemen, and welcome to the first Interstate Bank system, Inc. Q2, 'twenty three.
Earnings Conference call at this time all lines are in a listen only mode.
During the presentation, we'll conduct a question and answer session. If at any time. During this call you require immediate assistance. Please press star Zero 40. All further this call is being recorded on Thursday July 27 2023.
I will now turn the conference over to Andrea Walton. Please go ahead.
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 apart.
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 of the forward looking statements made today a copy of our earnings release, which contains non-GAAP .
What measures is available on our website.
K 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.
Thanks Andrea.
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 hasnt. Some additional disclosures that we believe will be helpful.
The presentation can be accessed on our Investor Relations website.
You haven't downloaded a copy yet.
Marriage, 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.
We performed well in a difficult environment during the second quarter, reflecting the strength of our franchise we've built.
While we have seen pressure on deposit cost balances performed as expected.
Benefiting from the strength of our markets and the diversity of our client base, we have not had to take any extraordinary measures around liquidity.
Credit continues to perform well.
Capital is strong.
Partly we are beginning to see some stabilization in our net interest margin.
Which has remained flat around 3% for May June and July .
So we expect the environment to remain challenging for the banking industry for the remainder of the year.
We are well positioned to play offense.
We generated $67 million and net income or <unk> 65 cents per share in the second quarter, which includes one set of severance expense primarily related to the strategic repositioning of our home lending business, which we will discuss later in the call.
As we indicated on our last earnings call, we did not see any meaningful disruption in customer behavior. Following the bank failures in March.
During the second quarter it was very much business as usual.
And what we would characterize as a relatively normalized operating environment.
We continue to see healthy economic conditions throughout many of our markets.
And most notably in tourism and the agricultural industries.
Our clients are performing well.
In particular, Yellowstone is having a very strong tourist season with a number of visitors to the park up 19% compared to the first six months of last year, and we've seen sufficient moisture over most of our footprint with bodes well for our clients.
While deposits declined about 2% in the second quarter. This result was very much in line with the expectations, we spoke to in April <unk>.
Importantly throughout the quarter balances expressed very normal seasonality.
We saw expected outflows in the first half of the quarter with broad seasonal strength into the end of June for the month of June total balances grew $375 million or one 6%.
Which is partially a result of our success in new client acquisition.
It's worth noting that we continue to have no broker deposits on our balance sheet.
Our noninterest bearing deposits showed resiliency and while down for the quarter balances ended June modestly higher than April .
Given the strength of our balance sheet and our reputation we have developed will providing superior level of service, we have been able to effectively capitalize on the current environment.
Given our advantageous loan to deposit ratio, we have strategically raised our rates to provide a competitive value proposition to our current clients, which we believe is the right thing to do.
At the same time, we are selectively raising rates and adding products to support new business development efforts targeting new clients, where we have the opportunity to develop deeper more profitable relationships over the long term.
As we indicated.
Prior calls we continue to be thoughtful regards to new loan production, maintaining strong underwriting criteria and discipline in our pricing.
As we expected this resulted in a lower level of loan growth in the second quarter, but with improved risk adjusted yield.
We expect both trends to continue for the balance of the year.
Excluding draws on construction lines the average yield on new loans fundings in the second quarter was up about 80 basis points from the prior quarter to seven 1%.
Asset quality also remained strong although we saw a modest increase in nonperforming and criticized loans this quarter those balance.
Makeup just 51 basis points and 350 basis points of loans held for investments respectively.
Looking forward based on our current evaluation of the loan portfolio, we anticipate a reduction in criticized balances over the remainder of the year.
Charge offs increased to $11 4 million this quarter with about 85% coming from the restructuring of a single Metro office construction property that we've discussed in the past.
With the recent restructure we expect this credit to perform going forward.
It is one credit losses were negligible.
With that I'd like to turn the call over to Marcia to provide some additional details around 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 2023 and I'll begin with our income statement.
Our net interest income decreased by $20 5 million.
Which was primarily due to an increase in our interest expense, resulting from higher rates on interest bearing deposits and a shift in our funding mix toward higher cost short term borrowings and interest bearing deposit accounts.
Purchase accounting accretion was also $600000 lower quarter over quarter.
Our reported net interest margin decreased 24 basis by turned the prior quarter to $3 one 2%.
Excluding purchase accounting accretion our adjusted net interest margin also decreased by 24 basis points to three 5% from the prior quarter as the nine basis point increase in the average yield on earning assets was more than offset by the increase in our total cost of funds.
Looking to the balance of the year given the recent trends in our deposit costs. We're now expecting our interest bearing deposit beta to reach the low to mid 30% range by the end of the year.
This outlook assumes one additional 25 basis point rate hike in the second half of 2023.
As Kevin noted in June and July our net interest margin was around 3% under the repricing assumptions just noted and assuming deposits remained stable through the end of the year and average earning assets approximate $28 billion. We would now expect this to approximate the net interest margin for the balance of the year.
Our total non interest income increased $27 $7 million quarter over quarter, primarily due to the $23 $4 million loss on investment securities and the $1 $9 million net write down to the fair value of loans held for sale recorded during the first quarter <unk>.
Excluding these items non interest income increased about 6% from the prior quarter.
This was primarily due to higher levels of payment services revenue as we saw the impact of greater transaction volume driven by normal seasonality in our markets as well as modestly higher mortgage banking revenue and service charges on deposit accounts.
Based on the first half of the year and the trends, we're seeing we expect quarterly fee income for the balance of the year to increase low to mid single digits from the reported second quarter. This outlook is in line with the improvement in the second half of the year, we have been expecting.
Moving to total noninterest expense, we saw continued decline as we remain vigilant to control expenses with operating expenses down $1 $9 million from the prior quarter.
Results in the second quarter included $1 $9 million in severance expense, mostly related to the restructuring of the mortgage business.
Excluding this item expense.
Expenses declined 2% from the prior quarter to $162 million.
At this point, we would expect this to be a good approximation for the run rate over the rest of the year. This run rate does not include any impact from the FDIC special assessment.
Moving to the balance sheet, our loans held for investment increased $18 million from the end of the prior quarter with growth in the commercial real estate and AG portfolios offsetting slight declines in the commercial and consumer portfolios.
The securities portfolio declined about $250 million in the quarter, partly due to higher unrealized losses, but also from normal monthly cash flows that is not being reinvested.
We would expect that portfolio to continue to decline and have provided a new disclosure related to the expected quarterly cash flows on slide 18 of the investor deck.
On the liability side, our total deposits decreased $528 million, we saw declines in most categories, which were partially offset by increases in our balances of time deposits as we see more customers taking advantage of attractive CD rates.
Again as Kevin noted, we have no broker deposits on the balance sheet.
Short term borrowings also declined from the prior quarter end.
Moving to asset quality nonperforming assets increased $8 $5 million and criticize loans increased $20 million from the prior quarter, which was partially attributable to problem loans moving through the credit administration process.
Outside of these loans the remainder of the portfolio continues to perform well based on current projections, we expect to see asset quality improvement for the balance of the year.
Our net charge offs were $11 4 million or 25 basis points of average loans.
In the quarter, driven primarily by the one charge off on a metro office property that Kevin discussed earlier.
Our provision covered our net charge offs this quarter and with total loans being relatively flat our allowance for credit losses percentage remained relatively unchanged at 123% of total loans held for investment.
Yes.
Lastly, while <unk> offset the growth in retained earnings this quarter, which resulted in modest reduction to book value and tangible book value or regulatory capital ratios. All strengthened as we are proactively managing our risk weighted asset exposure, while continuing to support the strategic growth of the company.
With that I'll turn it back over to Kevin Kevin.
Thanks, Marcy now I'll wrap up with a few comments.
The relative stability in our outlook from here the strength of our balance sheet.
And the strength of our footprint. We continue to believe first Interstate is well positioned to play offense as such.
We are moving forward with several initiatives to further strengthen the franchise and improve our ability to generate long term profitable growth.
While these initiatives is a shift in our mortgage business away from a mortgage loan originator model.
We have implemented a new digital loan origination system enabled us to push the sourcing of loans across our branch network.
While the underwriting is and the fulfillment is now fully centralized.
Not only will this improve our operational efficiencies for the benefit of our people and our clients, but it's much more cost effective delivery mechanisms for the company, allowing this product to be more profitable and more scalable in the future.
As part of this restructure we have eliminated most of our envelope positions, which contribute to the severance expense this quarter Marcy you mentioned earlier.
Going forward, we will look to leverage our network of more than 300 retail branches to generate referrals for digital mortgage loan origination platform.
And we will insert a retail staff for leads they generate.
We have just launched this program, but the initial results are encouraging and we're excited about the possibilities.
In August we will be introducing our new suite of consumer credit cards, which will offer a more robust set of benefits and a more competitive and user friendly rewards program.
We believe this new suite of cards, along with our marketing initiatives will help us achieve our goals of growing our customer base and expanding existing customer relationships, particularly in our new markets.
We are also strengthening our commitment to being a good corporate steward and reducing our carbon footprint to the investment in two solar projects, one in Iowa and one in Oregon.
Electricity generated by these two projects.
Offset a good portion of the scope two emissions from our operations in these two states.
Heading into the second half of the year, we will continue to prioritize prudent risk management and expect to deliver solid financial performance.
Expect us to remain thoughtful regarding new loan production, which will likely result in a full year loan growth being in the low single digit range.
Finally, we are pleased to announce that.
But the board has approved a 47% dividend for the third quarter.
Given the strength of our balance sheet.
The perspective earnings power of the company and are high and growing capital ratios, we are well positioned to maintain our dividend at the current level, which is an important component of the total return that we delivered to our shareholders. So with that we'll open the call up for questions.
Thank you ladies and gentlemen should you have a question. Please press the star followed by the one on your Touchtone phone. If you would like to withdraw your question. Please press the star followed by the Q.
If you're using a speaker phone please lift the handset before pressing any Keith one moment. Please for your first question.
Your first question comes from Jared Shaw from Wells Fargo. Please go ahead.
Hey, good morning, everybody.
Can you hear me.
Hello.
Hello Hello.
Hey, guys.
Hello.
Can you hear me.
I can hear you.
Okay.
Okay.
Maybe sticking with the starting with deposits.
Do you think that we're at a do you think we're at a floor for dollars of DVA here.
Or is there.
Still still more pressure on sort of the dollars of DBA.
Non interest bearing youre talking about Germany.
Yes.
We will be seeing some stabilization in that.
We're still projecting that they'll be some deterioration as we move through the remainder of year, but we are seeing some stabilization in that.
By the end of the year, we're thinking noninterest bearing should be about 25% of total deposits.
Okay, 25% with the with the overall balance of deposits still.
Following those trends in June and still seeing an upward bias as we as we go through the year.
Yes flat deposits through the balance of the year.
Okay.
And then on the loan yields it's thanks for the color on loan yields ex construction, what's the balance of remaining.
Construction loans that could be funded and should we be whats the timing of them.
The funding of those loans.
Okay.
About a 1 billion won to be funded.
And $75 million.
Yeah.
Hi, Matt.
Sure John .
Yes.
The yield is just over five 3% so as we roll forward.
Yield drag that we're referencing that will lessen as the year goes.
But it's about $75 million a month as Marty mentioned.
It kind of picks up as the year progresses.
Okay.
Okay. That's good thanks and then.
When we look at the securities cash flow slide.
Should we just assume that you use that to pay down FHA Ob and and as we as we move forward should we assume that securities are smaller as a percentage of assets in that that wholesale funding.
It goes lower.
Yes.
For loan growth will be paying down our funding yes.
Loan growth should be pretty much into the back half of the year.
Okay.
Thanks, and I guess, just finally for me you know when you look at the rollout of cards that you're talking about.
How is the.
The proposed legislation proposed durbin legislation on interchange that impact your timing or your.
Your enthusiasm for that for that product.
No.
So.
For some reason that went through.
That wouldnt change the economics of rolling that out.
Yeah.
Is that.
First of all I'll be honest.
Honestly I am fully aware of the new amendment.
You are talking about because durbin usually is on debit cards.
On credit cards, but.
If youre going toward credit card is it is going to hurt the economics.
On the product.
Okay. Yeah. He is there is a there is a.
Proposed legislation to have the interchange impact.
Credit cards as well so it feels like it's it's a.
That's a long shot but it seems like there theyre trying to sneak it in on must pass legislation. So.
Yes.
So that will have an impact on us and every other bank.
Yes.
Alright, thanks, guys.
Your next question comes from Brody Preston from UBS. Please go ahead.
Hi.
Alrighty.
My question is on the NII guidance.
Looking at that kind of implies flattish NII on the back half of the year.
I'm just curious are there any factors or any levers you could pull that would cause it to be either above or below that.
The.
The only factor you'd be really as we've said in the past is really based on our assumption on deposits right now.
Balances have been stable since.
And then basically.
So if deposits continue to perform the way, we think they're going to perform seasonal through remainder of the year.
Our growth.
It should be.
Okay.
Gotcha, and then just on the.
On that Metro office construction project I was just hoping for a little more color on that.
What metro was it in.
Any details you can give on that one plus are there any updates on the CRE.
CRE npls from last quarter.
The Metro acquisition that we've talked about today was the one that was in.
We talked about.
We have.
Qualified.
Going into that we took a charge off level.
It should and we need some more equity come in from the investors. So from this point forward.
We're looking at it should perform.
Well going forward, but it did cause a little bit to get it into that position.
One that we talked about last quarter.
And so it can be.
Okay.
The one in Seattle.
Understood. Thank you and then just last one from me on the expense base is there any other opportunities to rationalize that outside of the mortgage that you guys announced this quarter.
Okay.
Turning to look at that.
Staff turnover.
We continue to look at the fact.
Are they are they need it and part of the goal.
We had this year for working.
Working on.
And we don't have any kind of estimates on that.
We're looking at prices to automate manual processes in the back room.
A number of processes that are done and then we re entered into the operational groups that we're looking at what I made that so it goes flows straight through so there are some possibilities to eliminate some staff and operations as we modernize some of the processes.
Great. That's it for me thanks for taking my questions.
Thanks.
Your next question comes from Chris Mcgratty from K B W. Please go ahead.
Hi, This is Nick we topic is on for Chris Mcgratty Good morning, guys.
Good morning, Nick.
Maybe just on the on the deposits.
Just going back to the <unk>.
Primarily outflows from the on the commercial side on the Niv mix.
Sure.
Is there any catch up in the retail bank.
On a go forward basis.
Actually seasonally we're seeing.
Commercial growth.
The downward trends a little bit more on the retail side.
Seasonally that's what we're expecting and we're seeing that.
Total balances are growing.
Okay and then.
And maybe just on the Cds are the what's the duration on that.
Our portfolio now.
Relatively short.
Most of the JV.
It's like 12 months or less so the duration is pretty short.
Okay alright good.
Yes.
If the forward curve plays out.
Sorry to get cuts in 2020 forwards.
It's kind of a comment.
You take the margin react too.
Great cuts on the way down.
Well right now we would be we'd characterize yourselves as slightly liability sensitive.
We would benefit.
Downward.
Yes.
Okay.
Thanks, guys.
Thank you Nick.
Ladies and gentlemen, as a reminder, should you have a question. Please press star followed by the one your next question comes from Jeff <unk> from D. A Davidson. Please go ahead.
Thanks, Good morning.
On.
The criticized loan.
Balance increase that $20 million.
With us.
Yes.
Segments was that in.
And was that acquired or legacy credits.
For a little color.
It was it was acquired loan it was it's in Arizona commercial criticized.
Criticized loans.
Okay.
Criticized loans.
Yes.
Were acquired.
Firstly in senior housing.
Sector.
So again.
We expect those to improve over the long term because we are.
Kind of resolve the Ram first Matt right.
Sure.
We should see some improvement in those credits.
And we're forecasting.
No we are forecasting that our criticized loans should go.
Go down from here throughout the remainder of the year.
And that Kevin is that resolution.
Some of these credits or is that broad based other.
Movement that you see.
Resolution of these credits as well as other credits that.
In that portfolio.
Okay I appreciate it.
Mentioned earlier.
Elevated charge offs.
This quarter were related to the the office credit is that right.
Yes, 85%.
The charge, a pretty which was the office of credit in Seattle.
Great. Thank you.
And then.
Kevin.
Mark you touched on it as well, but Kevin mentioned the margin in June and July was was near 3% I believe in and just wanted to clarify.
Marcy you kind of in the guide as well as that.
Is that the expectation that.
You've moderated and so for the balance of the full quarter average could be down but kind of hugging the 3% at this point.
That is correct.
Okay, Great and last one for me would just be interested in the competitive on the deposit side not just your own customers sort of asking rate, but just.
The peer landscape, how aggressive do you see pricing amongst peers.
And your footprint.
Well, it's very geography, geographically, but I would tell you that.
Everybody is pretty much the same same place.
That's really where the short term so I.
I would say pretty much everybody has moved to the same position so.
It's pretty competitive yes, it is very competitive.
Really good credit unions as much as anything.
Okay.
Yes.
From deposits.
Okay I appreciate it thanks.
And Sir there are no further questions at this time. Please proceed with your closing remarks.
Again, 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 thank you for tuning in today.
Goodbye.
Ladies and gentlemen, this concludes your conference call for today, we thank you for joining and you may now disconnect your lines.
Okay.
Yes.
[music].
Okay.
Okay.
Thanks.
Okay.
Okay.
Okay.
Sure.
Yes.
Okay.
Yes.
Yes.
Okay.
Okay.
[music].
Sure.
Okay.
Okay.
Thank you.
Yeah.
[music].