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spk01: Good morning, ladies and gentlemen, and welcome to the first Interstate Bank System Inc. Q2 2023 earnings conference call. At this time, all lines are in a listen-only mode. Following 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 for the operator. This call is being recorded on Thursday, July 27, 2023. I will now turn the conference over to Andrea Walton. Please go ahead.
spk02: 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. I'd 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 in 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 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 Marcy Mutch, our Chief Financial Officer, along with other members of our management team. At this time, I'll turn the call over to Kevin.
spk07: Thanks, Andrea. Good morning, and thanks again to all of you for joining us on our call today. Again, this quarter, along with our 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 relations website, and if you haven't 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 Marcie to provide more details on our financials. We performed well in a difficult environment during the second quarter, reflecting the strength of a franchise we've built, while we've seen pressure on deposit costs, 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. Our capital is strong. And importantly, we are beginning to see some stabilization in our net interest margin, which has remained flat around 3% for May, June, and July. Though 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 in net income, or 65 cents per share, in the second quarter, which includes one cent 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 meaningful disruption in customer behavior following the bank failures in March during the second quarter it was very much business as usual in 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 in the agricultural industries where clients are performing well and 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, which bodes well for our ad 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. 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 1.6%, which is partially a result of our success in new client acquisition. It is 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 for 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, On prior calls, we continue to be thoughtful in regards to new loan production, maintaining strong underwrite 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 funding in the second quarter was up about 80 basis points from the prior quarter to 7.1%. Asset quality also remains strong. Although we saw modest increase in non-performing and criticized loans this quarter, those balance make up 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. Outside of this one credit, losses were negligible. With that, I'd like to turn the call over to Marcie to provide some additional details around the second quarter results. Go ahead, Marcie.
spk03: 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 costs, short-term borrowings, and interest-bearing deposit accounts. Purchase accounting accretion was also $600,000 lower quarter over quarter. Our reported net interest margin decreased 24 basis points from the prior quarter to 3.12%. Excluding purchase accounting accretion, our adjusted net interest margin also decreased by 24 basis points to 3.05% 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 trend in our deposit costs, we are now expecting our interest bearing deposit data 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 remain 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. 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 non-interest expense, we saw a continued decline as we remained 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, 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 flow that is not being reinvested. We would expect the 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, non-performing assets increased $8.5 million and criticized 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 for $11.4 million are 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 1.23% of total loans held for investment. Lastly, while AOCI offset the growth in retained earnings this quarter, which resulted in modest reductions to book value and tangible book value, our regulatory capital ratio is 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?
spk07: Thanks, Marcie. Now I'll wrap up with a few comments. Given 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. One of 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 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 mechanism 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 MLO positions, which contribute to the severance expenses quarter that Marcy mentioned earlier. Going forward, we will look to leverage our network of more than 300 retail branches to generate referrals for our digital mortgage loan origination platform. And we will incent our retail staff for leads they generate. We have just launched this program but the initial results are encouraging, and we are 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 through the investment in two solar projects, one in Iowa and one in Oregon. The electricity generated by these two projects will offset a good portion of the Scope 2 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 the Board has approved a 47-cent dividend for the third quarter. Given the strength of our balance sheet, the prospective earnings power of the company, and our 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 deliver to our shareholders. So with that, we'll open the call up for questions.
spk01: Thank you. Ladies and gentlemen, should you have a question, please press the star followed by the one on your touch-tone phone. If you'd like to withdraw your question, please press the star followed by the two. If you're using a speakerphone, please lift the headset before pressing any keys. One moment, please, for your first question. Your first question comes from Jared Shaw from Wells Fargo. Please go ahead.
spk05: Hey, good morning, everybody.
spk00: Can you hear me? Hello? Hello?
spk05: Hello? Can you hear us? Hello?
spk02: Can you hear us?
spk05: I can hear you. Okay. Okay. So 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 DDA here? Or is there – you know, still more pressure on sort of the dollars of DDA.
spk07: Is that interest-bearing you're talking about, Jared? Yes. Well, we've seen some stabilization in that, but we're still projecting that there'll be some deterioration as we move through the remainder of the year, but we are seeing some stabilization in that.
spk03: And so, Jared, by the end of the year, we're thinking, you know, non-interest-bearing should be about 25% of total deposits.
spk05: Okay, 25% with the overall balance of deposits still following those trends in June, still seeing an upward bias as we go through the year?
spk03: Yeah, flat deposits through the balance of the year.
spk05: Okay. And then on the loan yields, thanks to the caller on loan yields ex-construction, what's the balance of remaining deposits? construction loans that could be funded and should we be, what's the timing of the funding of those loans?
spk03: So there's still about a billion one to be funded. They spend around $75 million a month.
spk04: Chair, it's John. So the yield is just over 5.3%. So as we roll forward, that yield drag that we were referencing, that will lessen as the year goes on. But it's about $75 million a month, as Marcy mentioned, but the funding kind of picks up as the year progresses.
spk05: 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 FHLB and FDLB? As we move forward, should we assume that securities are smaller as a percentage of assets and that wholesale funding goes lower?
spk07: Yes.
spk05: I use it for loan growth. We'll be paying down our funding.
spk03: Yeah. And we expect loan growth to be pretty modest into the back half of the year.
spk05: Okay. Thanks. And I guess just finally for me, when you look at the rollout of cards that you're talking about, How is the proposed legislation, the proposed urban legislation on interchange, does that impact your timing or your enthusiasm for that product? No. So if for some reason that went through, that wouldn't change the economics of rolling that out?
spk07: Well, the thing is that, first of all, I'll be honest with you, I am not fully aware of the new amendment or law that you're talking about because Durbin usually is on debit cards. It wasn't on credit cards, but if they're going toward credit cards, it is going to hurt the economics of the product.
spk05: Okay, yeah, there's a proposed legislation to have the interchange impact credit cards as well. So it feels like it's a long shot, but it seems like they're trying to sneak it in on must pass legislation.
spk07: That will have an impact on us and every other bank.
spk05: Yeah. Okay.
spk07: All right.
spk05: Thanks, guys.
spk01: Your next question comes from Brody Preston from UBS. Please go ahead.
spk09: Hi. My question is on the NII guidance. So I'm looking at that kind of implies flattish NII in the back half of the year. I was just curious if there are any factors or any levers you could pull that would cause it to be either above or below that.
spk07: The only factors would be, as we've talked about in the past, it's really based on our assumption on deposits. Right now, deposits balances have been stable since the end of April to date. So if deposits continue to perform the way we think they're going to perform seasonally through the remainder of the year or grow, that should be stable.
spk09: Gotcha. And then just on that Metro office construction project, I was just hoping for a little more color on that. What Metro was it in and any details you can give on that one? Plus, are there any updates on the two CRE MPLs from last quarter?
spk07: So the Metro office that we talked about today was the one that was in Seattle that we talked about. And we have a qualified new tenant going into that. We took a charge off. wrote it down to the level, and it should, and we get some more equity coming from the investors. So from this point forward, we're looking at that one should perform well going forward, but it did cost us a little bit to get it into that position.
spk03: So that was the one that we talked about last quarter, and so it should be resolved, the one in Seattle.
spk09: Understood. Thank you. And then just the 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?
spk07: We continue to look at that as their staff turn over. We continue to look at the fact, you know, are they needed? And part of the goal we had this year at First Interstate we're working on, and we don't have any kind of estimates on that, is that We're looking at a process to automate some manual processes in the back room. There's a number of processes that are done and then re-entered into the operational group. So we're looking to automate that so it flows straight through. So there are some possibilities to eliminate some staff and operations as we modernize some of the processes.
spk09: Great. That's it for me. Thanks for taking my questions.
spk06: thanks your next question comes from chris mcgrady from kbw please go ahead hi this is uh nick mcconaughey is on for chris mcgrady good morning guys good morning nick maybe just on the on the deposits um just going back to the nibs are you seeing primarily outflows from the from the commercial side on the NIV mix, and is there any catch-up in the retail, do you think, on a go-forward basis?
spk07: Actually, seasonally, we're seeing commercial grow, and the downward trend is a little bit more on the retail side. So seasonally, that's what we're expecting, and we are seeing that our commercial balances are growing.
spk06: Okay. And then... And maybe just on the CDs, what's the duration on that portfolio now? Is it relatively short?
spk07: Well, most of the CDs that we're putting out is like 12 months or less, so the duration is pretty short.
spk06: Okay. Just trying to get a sense, you know, if the forward curve plays out and we start to get cuts in 2024, just kind of make a comment on how – you think the margin reacts to rate cuts on the way down?
spk07: Well, right now we would characterize ourselves as slightly liability sensitive and that we would benefit on a downward rate cuts. Okay. Thank you, Nick.
spk01: Ladies and gentlemen, as a reminder, should you have a question, please press the star followed by the one. Your next question comes from Jeff Rulis from D.A. Davidson. Please go ahead.
spk08: Thanks. Good morning. Question on the credit-sized loan balance increase, that $20 million. What segments was that in, and was that acquired or legacy credits? Looking for a little color.
spk07: It was an acquired loan. It's in Arizona. It's a commercial.
spk03: Criticized loans.
spk07: Oh, criticized. I thought I was talking about performing.
spk03: So criticized loans, those were acquired and largely in the senior housing sector. expect those to improve over the long term just because we're you know as the states kind of resolve the reimbursement rate issues um you know we can see some improvement in those credits and we're forecasting just so you know we're forecasting that our criticized loans should go down from here throughout the remainder of the year and that kevin is that resolution of
spk08: some of these credits or is that broad-based other improvement that you see?
spk07: It's the resolution of these credits as well as other credits that are in that portfolio.
spk08: Okay, I appreciate it. And you mentioned the elevated charge-offs this quarter were related to the office credit, is that right?
spk07: Yeah, 85% of the charge, which was the office credit in Seattle.
spk08: Great. Thank you. And then, Kevin and Marcy, you touched on it as well, but Kevin mentioned the margin in June and July was near 3%, I believe, and just wanted to clarify, Marcy, you're kind of in the guide as well. Is that the expectation that you've moderated and and so for the balance of the full quarter average could be down but kind of hugging the three percent at this point that is correct okay great and last one for me would just be interested in the in the competitive you know on the deposit side not not just your own customers sort of asking rate but just seeing the peer landscape you know how aggressive do you see pricing amongst ears in your footprint?
spk07: Well, it varies geographically, but I would tell you that everybody's pretty much at the same place, and that's really where the short-term rates are. So I would say pretty much everybody's moving to the same position. It's pretty competitive.
spk03: Yeah, it is very competitive, and really to credit unions as much as anything that, you know, kind of tend to price up some deposits.
spk08: Okay. I appreciate it. Thanks.
spk01: Resenters, there are no further questions at this time. Please proceed with your closing remarks.
spk07: 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.
spk01: Ladies and gentlemen, this concludes your conference call for today. We thank you for joining, and you may now disconnect your lines.
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