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spk01: Hello, everyone, and welcome to the first Interstate Bank System third quarter earnings conference call. My name is Harry, and I'll be your operator 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 Sleiter-Bray to begin. Lisa, please go ahead.
spk02: Thank you, Harry. Good morning. 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. Prevalent factors that could cause actual results to differ materially from any forward-looking statements are included in the earnings release and in our SEC filing. 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 financial measures, is available on our website at fibk.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 for management this morning are Kevin Riley, our Chief Executive Officer, and Marcie 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?
spk03: Thanks, Lisa. Good morning and thanks again to all of you for joining us on our call today. Again, this quarter, along with our early release, we have published an updated investor presentation that has some additional disclosures that we believe will be helpful. The presentation can be accessed on our investor website. And if you haven't downloaded a copy yet, I encourage you to do so. I'm going to start off today by providing an overview of the major highlights of the quarter, And now I'll turn the call over to Marcie 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 resulted in another quarter of strong financial results with added income coming in at $47.1 million, or $0.76 a share, This includes $0.08 of merger-related expense and $0.02 of expense related to settlement of legal claims. Excluding these two items, our earnings per share was $0.86 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, and expenses were flat, excluding the two items I noted earlier. All in all, it was another solid quarter for us, which reflected 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 non-interest-bearing deposits. These strong inflows have enabled us to continue growing our earning assets, and driving increases in our net interest income. 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 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 most of the major areas were up from the prior quarter, resulting in 12% growth in non-interest 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 Wyoming, our annualized loan growth was over 4% for the quarter. While our loan pipeline remains healthy, There's three key factors continue to impact both new loan fundings and draws on existing lines of credit. Supply chain disruption and very tight labor market is resulting in more projects 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. One of the highlights this quarter is that 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 are 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 off-boarded to another credit channel. In the first couple of weeks, it resulted in about $1 million of booked loans and attractive risk-adjusted yields with the average balances of around $50,000. 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 Transmitted Merger Agreement with Great Western Bancorp. Since the announcement of the merger, we've had the pleasure of hosting town halls in Sioux Falls, Des Moines, Omaha, Fort 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 to team up with this group of talented bankers. Their bankers recognize the opportunity to attract new clients and expand existing relationships with the collective resources and support of a $32 billion organization. What was evident throughout our travels is 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 rest of the results you 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 XPPP loan balances declined 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 as PCP loans in our review. They have continued working through their problem loan portfolio while booking only $4 million in charge of 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 Marcy to provide some additional details around our third quarter results. Go ahead, Marcy.
spk06: Thanks, Kevin, and good morning, everyone. As I walk through our financial results, unless otherwise noticed, 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 PPP loan income. Accretion income was $200,000 lower on a linked quarter basis. Excluding the impact of PPP income, Our net interest income increased by 1.7% from the prior quarter for 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 resulted 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 non-interest bearing deposits. Having said that, we're encouraged by the fact that yields on new loan production increased by 13 basis points length quarter to 4.11%, and that new money in the investment portfolio is now almost on top of the 127 yield we reported this quarter, but it's shorter duration. So going forward, we expect our net interest margin to be mostly dictated by the mix of earning assets. 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 laddered approach to managing our interest rate risk, the new swap has 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 3.9 years compared to four years at the end of the second quarter. Our non-interest income increased $4.4 million quarter over quarter to $39.7 million with most of our fee generating areas contributing to the increase. Payment service revenues increased by approximately $800,000 due primarily to higher business credit card volume which reflects the strong economic activity we're seeing in our markets. 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 expect non-interest income to be strong for the fourth quarter, but down roughly mid-single digits from our third quarter high. This guidance assumes no changes in our mortgage servicing rights valuation. Moving to non-interest expense, we recorded $6.6 million in acquisition expense in the third quarter, as well as $1.2 million for the settlement of legal claims. The legal claims were related to two class action lawsuits that many other financial institutions have also settled in recent years relating to the overdraft and insufficient funds fees. Excluding these two items, our non-interest expense was $98.1 million. This was approximately $1 million lower than the prior quarter, 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 loans held for investment decreased $212 million from the end of the prior quarter due to a net decline in PPP loans of approximately $265 million. Excluding PPP loans and deferred fees, total loans held for investment were up $53 million 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 CNI and consumer loans, primarily due to the supply chain and labor issues that Kevin discussed earlier. As of September 30th, we still had approximately $281 million of PPP loans on our balance sheet, net of $13.1 million of associated deferred loan fees remaining. On the liability side, our total deposits continue to increase, and we're up $442 million from the end of the prior quarter, with $201 million of the growth coming in non-interest-bearing deposits. Moving to asset quality, our portfolio continued to perform exceptionally well. We had small declines in non-performing loans and non-performing assets, and a $22 million decline in criticized loans as a result of upgrades and payoffs. Credit losses were very low with only $600,000 of net charge-offs 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 1.4% at September 30th, excluding PPP loans, our allowance represented 1.45% of loans held for investment at the end of the quarter. With that, I'll turn the call back to Kevin.
spk03: 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. While 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 to deliver strong financial results without compromising our pricing and underwriting criteria. We also continue to make progress on our integration planning for the Great Western merger, again, As you have probably seen with Great Western's early release, they continue to make progress working through the disposition of loans that we expected to run off after the closing. While that impact their overall loan balances this quarter, this is just a difference in expected timing and the progress they are making prior to closing. This is very encouraging to us. To wrap it up, our house is 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 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.
spk01: 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 Rudis from DA Davidson. Jeff, your line is now open if you'd like to proceed.
spk05: Thanks. Good morning. Kevin, just wanted to follow up on the Great Western results. Again, you know, further credit progress in the most recent quarter. And I just wanted to, you know, to the degree that that expected runoff is occurring or what you had anticipated following the close, if that's continues to clean up, I guess I just wanted to circle back to your expectations. I think you mentioned that those haven't 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 to complete and then kind of the flip to growth, which they saw a little bit in September. Just an update on that conservative outlook, if you wanted to kind of further discuss that, Kevin, it'd be helpful.
spk03: 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 in the years to come. If they're able to clean up a lot of that earlier, then we probably will have earlier organic loan growth upon the completion of the acquisition.
spk05: And just to kind of re- engage with that milepost. I think the standard growth rates were sort of low to mid-single-digit for the first year following conversion. Could you just kind of update us back to what those mileposts were?
spk03: Yeah, they were mid-single-digits with the offset being taking care of some of their criticized assets. So if that is you know, taken care of prior to the closing, which I don't think all of it's going to be done. I think they're doing a great job and that their management team should actually be commended for the efforts that they're putting forth. But, yeah, it would have less of an impact on that mid-single-digit growth number.
spk05: The last question related to the Great Western, the timing of that close, are you getting any more visibility in terms of the first quarter? Is that early, middle, late, too early to tell.
spk03: Well, it's kind of too early, but I'll tell you, there appears to be a little bit of delay on some of these acquisitions being approved. I think you saw one 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 many decisions right now or approving transactions until there's a decision on on the leadership changes that might occur in the Fed. So I think once that is cleared up, that logjam will be also cleared up. So it might delay us, but again, the sooner that announcement happens, the quicker this could be approved and 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.
spk05: And last one is, you know, jumping to the income line items. Your thoughts on gain on sale and the payment services showed a little life in the quarter and granted some seasonality there. But if we wanted to kind of extend that into 22 high-level expectations for those line items?
spk06: You know... We're kind of in that process right now of doing our budget jobs, 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 supply chain issues or labor issues. If people have the ability to spend more because the goods and services they want are actually out there, I think we'll see some increases in those line items.
spk05: Okay. And Marcy, while I have you, the non-interest expense guy, the 1% growth is off of the 98.1 core. What was that again?
spk06: It's off of last year's numbers, but I would expect our expenses to come in fairly consistent with this quarter's operating run rate. Got it.
spk05: Okay. Thank you.
spk01: Thank you, Jeff. And our next question comes from Jared Shaw from Wells Fargo Securities. Jared, your line is now open, so please proceed.
spk04: Thanks. Good morning, everybody. Good morning, Jared. I guess, hey, just looking at the liquidity here, you're continuing to see really good deposit growth. You're growing cash balances even as you're growing the securities book. How should we be thinking about cash going into the deal Do you have a target for cash as a percentage of assets coming out of the deal if we're still in this similar rate environment?
spk03: Every time we think we're making progress on putting our cash to work, more rolls in. We're going to continue working that down as we move in toward the deal. you know, we're not going to rush into it, but we're slowly going to make, you know, points because, again, I never like to pick the market of when you want to invest cash. So we're going to continue working that down. You know, it's there and some people say you got a lot of it, but, you know, deposits keep on flowing in and PPP loans keep on getting forgiven and cash keeps rolling in. So we're trying to put the work in a very prudent manner and we'll continue to work that down. So, you know, Do I like to see $2 billion of cash on the balance sheet? Not really. So we're going to continue working that down in the most prudent manner possible.
spk04: Okay, thanks. And then, you know, looking at loans this quarter, saw some good growth in average balances. You know, I know that there's, you know, sort of the impact of paydowns and payoffs that could potentially happen at the end of the quarter. But as we look forward into fourth quarter, Should we be expecting growth in average loans ex-PPP? Yes. Okay, that's good. And then finally for me, just on the allowance ratio, what's sort of the thinking about the timing of being able to approach day one levels and does the timing of the deal impact your thoughts around allowance and qualitative reserves at all?
spk06: So the timing of the deals does not impact our thoughts on that. But now that we're seeing some consistency in unemployment rates nationally, and they're aligning with our markets, and we're seeing improvement in our economies, 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, yeah, it's something that's on our radar, and, you know, I think you'll begin to see that start to come down toward day one levels as we go forward.
spk04: Great. Thanks for the answers, and we'll talk to you soon. All right, Jared, thank you.
spk06: Thank you.
spk01: Thank you, Jared. And as a final reminder, if you would like to ask a question, please press star followed by one on your telephone keypad now. And I'll just leave a moment for any questions to be registered. And it appears we have no further questions, so I'll hand back to Kevin.
spk03: Thanks, Harry. Thank you all for, again, all your questions and joining us on a 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.
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