First Interstate Bancsystem's (FIBK) CEO Kevin Riley on Q1 2016 Results - Earnings Call Transcript

| About: First Interstate (FIBK)

First Interstate Bancsystem Inc. (NASDAQ:FIBK)

Q1 2016 Earnings Conference Call

April 26, 2016 11:00 ET

Executives

Kenzie Lawson - Investor Relations

Kevin Riley - Chief Executive Officer

Marcy Mutch - Chief Financial Officer

Analysts

Jackie Chimera - Keefe, Bruyette & Woods, Inc.

Matthew Forgotson - Sandler O'Neill & Partners, L.P.

Timothy Coffey - FIG Partners

Matt Yamamoto - D.A. Davidson & Co.

Operator

Good morning and welcome to the First Interstate Bancsystem First Quarter 2016 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation there will be an opportunity to ask questions. [Operator Instructions] Please note, that this event is being recorded.

I would now like to turn the conference over to Kenzie Lawson. Please go ahead.

Kenzie Lawson

Thanks, Ed. Good morning. Thank you for joining us for our first quarter earnings conference call. As we begin, I would like to direct all listeners to the cautionary note regarding forward-looking statements and factors that could affect future results in our most recently filed Form 10-K.

Relevant factors that would cause actual results to differ materially from any forward-looking statements are listed in the earnings release and in our SEC filings. The Company does not intend to correct or update any of the forward-looking statements made today.

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?

Kevin Riley

Thanks, [Kenzie]. Good morning and thank you all for joining us on our call. Yesterday we reported $20.1 million or $0.45 per diluted shares for the first quarter. This compared with $21 million or $0.46 per share for the same period last year. The lower earnings was mainly attributed to higher provision expense, which I would discuss in a few minutes.

Outside of our provision expense, on a year-over-year basis we saw positive trends in virtually all of our key metrics, including both our spread and fee-based income, our net interest margin and our efficiency ratio. As a result of these positive trends our core, pre-tax, pre-provision net income increased 5.4% over the first quarter of 2015.

Overall, our first quarter results were generally in line with our expectations and are reflected to the seasonally slow revenue generation we see at the start of the year, particularly in our fee generating areas. Loan and deposit trends were fairly typical for what we see in the first quarter. And as a result there is not much change in the balance sheet from that at the end of the year.

Let's talk about credit quality. Since that is on the top your mind, with all the focus these days on energy sector and we live in that part of the country. We saw general improvements across most areas of the portfolio and our net charge-offs continue to be very low. We continue to closely monitor the trends in the energy sector. The health of our borrowers directly involved in the industry, and the impact to our larger regional economies.

The $4 million provision expense for the first quarter was primarily the result of the continued challenges in the energy market. We are actively managing down our exposure to the energy market and our total outstanding loans to customers directly involved in the oil and gas industry declined to $69 million at March 31, down from $75 million at the end of the prior quarter.

As a percentage of our total loan portfolio oil and gas declined to just 1.3%, down from 1.4% at the end of 2015. We had a slight increase in criticized loans in this portfolio which totaled $40 million at March 31, as compared to $36.4 million at the end of last quarter. However, credit migration trends in the rest of the portfolio asset categories were relatively stable with no new oil and gas credits downgraded to non-performing status in the quarter.

As we previously discussed, we updated the collateral valuations underlying the oil and gas credits using the prevailing pricing within the energy market. Our first quarter valuations were estimated using oil price forecasts based on what was happening in industry in late January or early February. And as you would expect the outlook at that time was very grim.

So this resulted in a very conservative assumptions used in our impairment analysis and drove the majority of the elevated provision expense we recorded in the first quarter. Since that time the actual price per barrel has increased about $10 and we expect this increase will partially reflected in our May pricing forecasts. So for our customers involved directly in production this small bump in oil prices allows wells to become more economically viable.

We have about 14% of our portfolio in Gillette, Riverton, and the Casper markets, which are those markets most heavily impacted by the energy sector. And 27% of our total loan portfolio is in Wyoming. So we are closely monitoring the entire region for softening considering the impact not only from the oil and gas, but from the most recent announcements for the coal companies in this region.

That said, at this time, we are not seeing any significant changes in delinquencies in these markets. As we indicated on our last call, we have added a new qualitative factor in our allowance methodology related to the potential impact of the slowdown in the energy products on Wyoming market.

During the first quarter, we increased the allocation to this qualitative factor, which totaled $1.5 million at the end of the quarter. The additional reserve built this quarter brought our allowance for loan losses to 11.7% of the oil and gas portfolio up from 7.8% at the end of last quarter.

Given this significant reserve, the conservative assumptions we have used in our collateral evaluation, and our relatively low overall exposure to the oil and gas industry, we believe that this portfolio will have limited impact on our future financial performance. As I mentioned in our last call, we have been able to successfully recruit several highly experienced bankers to strengthen our senior management team over the past few months.

And our most recent addition is Steve Yose, as our new Chief Credit Officer. Steve has more than 30 years of banking experience and comes to us from KeyBanc, where he served as an Executive Vice President and Credit Executive. Steve's responsibility include overseeing credit administration, credit approval, underwriting, portfolio management, and credit quality for the Rocky Mountain and Pacific regions, along with overseeing the Native American and agro business lending for the entire key franchise.

Steve is a native of Wyoming and we are glad he has chosen to come back to this area of the country and work with us at First Interstate, as we continue to grow our loan portfolio and strengthen our credit administration.

So with those comments, I'd like to turn the call over to Marcy for a little more detail behind the numbers. Go ahead, Marcy.

Marcy Mutch

Thanks, Kevin. Good morning, everyone. As I walk through our financial results, unless otherwise noted, all of the prior period comparisons will be with the fourth quarter of 2015. And I will begin with our income statement.

Net interest income decreased $480,000 on a linked quarter basis. The decrease was mainly due to a decline in previously charged-off interest recoveries. We had $1 million in interest recoveries in the fourth quarter compared with just $265,000 in the first quarter.

Our reported net interest margin was 3.54%, up five basis points from last quarter. Although, when you exclude the impact of the accretion of interest on the early pay-offs of acquired loans, and recoveries of charged off interest, our core net interest margin increased 11 basis points from the prior quarter. This improvement in our core margin was primarily attributable to an increase in the yield on our investment securities and a decline in our funding costs.

Our non-interest income decreased $3.7 million from the fourth quarter due to seasonal declines in most of our fee-based revenues and in particular the mortgage banking business. Changes in the valuation of the deferred compensation plan always creates a little noise in total non-interest income, but this is fully offset within employee benefit and has zero impact to our financial statements.

On a year-over-year basis, our fee-based revenues increased 4.6%, which is consistent with the overall growth of the bank over the past year. Mortgage revenue was relatively stable compared to the first quarter of 2015. Payment service revenues and service charges on deposit accounts are always lower in the first quarter as consumers recuperate from the holidays. And so we are encouraged to see on the continued growth in those two lines of revenue on a year-over-year basis.

Wealth management revenues declined from last quarter and from last year mainly due to the volatility in the market and the timing of fee assessment. However, we do continue to grow assets under management, which are now at $4.6 billion. Our non-interest expense was unchanged from the level we reported last quarter. The most notable variation from the prior quarter within our occupancy and equipment expense, which is attributable to change in geography on the income statement.

Starting in 2016, we began capturing expenses related to software separately from equipment costs and reclassifying them to other expense line. This resulted in a decline in our occupancy and equipment expense and an increase in our other expense. You should also know that in the first quarter, we recorded a $1.2 million in one-time and separation and special bonus expenses a portion of which related to the retirement of our former CEO Ed Garding.

Let’s move to our balance sheet. Our total loans were unchanged from the end of the prior quarter. The most significant areas of growth within the portfolio or an increase of $29 million in our indirect consumer loans and an increase of $33 million in commercial loans. The decrease in commercial real estate loans was mainly due to the repayment of one large loan and an increase in loan participation. Ag loans declined $60 million, which is consistent with the seasonal pay downs in these lines of credit.

Kevin mentioned that 27% of the loan portfolio is attributable to the Wyoming market. To provide a little more transparency 54% of the portfolio is attributable to Montana and 13% to South Dakota, the remaining 6% is made up of loans throughout our footprint where we don't track the particular state of origin, such as credit cards, mortgage servicing and real estate loan held in operation.

Our total deposits were also unchanged from the end of the prior quarter. However, we did see an improvement in the deposit mix as increases in our demand and savings account offset a decline in time deposit.

Moving to asset quality, our non-performing assets declined by $800,000 and our non-accrual loans declined by $2.5 million from the end of the prior quarter. Our criticized loans increased by $27 million primarily due to the downgrade of borrowers within the energy sector.

Our loans past due 30 to 89 days declined by $18 million or 42% during the quarter. This significant decline was attributable to concerted effort to complete loan renewals within 30 days and prevent current loans from falling into the past due category during the renewal process.

Our net loan charge-offs remain low at an annualized rate of seven basis point of total loans. We recorded a $4 million provision expense, which increased our allowance for loan losses to 1.52% of total loans and increased our coverage of non-performing assets to more than 100%.

And finally, we repurchased 948,000 shares of our common stock during the first quarter at a weighted average price of $26.15 per share. We have 10b5-1 plan in place to administer the stock repurchase program and it became more attractive to buyback shares during the weakness in the stock market in the early part of the year.

And with that, I'll turn it back to Kevin Riley.

Kevin Riley

Thanks Marcy, nice job. As we look to the remainder of 2016, our new business pipeline we feel comfortable that we will see greater balance sheet growth and increasing revenue as we entered the seasonally strong period of the year. Despite the well-publicized challenges in the energy industry, we continue to see generally healthy economic conditions throughout our footprint.

Given the diversity of our markets, we certainly have stronger markets such as Bozeman, Montana where we will probably see double-digit loan growth this year, which balances out some of the weaker markets like Casper, Wyoming that are impacted by the slowdown in oil production.

As we near to $9 billion in total assets, we continue to think and act like a larger financial institution that we are destined to become. We continue to invest in people, processes, and technology systems that will enable us to effectively manage our growth. We are implementing a new general ledger and financial reporting system which will improve our scalability.

We are adding resources required to prepare for the eventual stress testing will be subject to once we cross the $10 billion threshold. And we continue to move forward, with our new digital banking platform which is on track for the fourth quarter release. We have an intense focus throughout the organization on enhancing efficiencies as we make these investments in our infrastructure.

In many cases, we are able to retire older systems as we adopt newer more robust technology which minimizes the impact to our overall cost structure. Accordingly, we believe that we can continue to enhance our infrastructure while maintaining a consistent efficiency ratio.

Gaining scale is certainly a key factor in this effort and we are pleased to take another step in our M&A strategy with the announcement of our acquisition of Flathead Bank. This is the type of smaller easy digestible in market acquisition that typically proves to be an excellent use of capital.

Flathead has a good cultural fit, provide synergy as we deepen our penetration of the Gallatin and Flathead markets. We expect the acquisition to be immediately accretive and to be a nice incremental source of earnings going forward. We are looking forward to welcome Flathead’s customers and employees to the First Interstate Bank later this year.

With this acquisition we continue to focus on deploying capital in line with our four legs of our strategy. Organic growth, M&A, stock repurchases and dividends to our shareholders. We believe we’ll begin to see organic growth in the second quarter. Marcy already mentioned the 948,000 shares we were able to repurchase in the first quarter and recently announced a second quarter dividend at $0.22 per share.

So in summary we feel good about where we are. We continue to have top line revenue growth on a seasonal basis and that is building. We have adequate reserves against our loan book and we are maintaining our expenses levels while we're building our infrastructure for the future.

So with that we will open the call to questions.

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Jackie Chimera of KBW. Please go ahead.

Jackie Chimera

Hi, good morning, everyone.

Kevin Riley

Good morning, Jackie.

Jackie Chimera

Just looking at Wyoming a little bit more. How does looking at the economy compared now versus where it was a quarter ago? Are you seeing any meaningful changes or is it just kind of the same caution you had on last quarter’s call?

Kevin Riley

We see the unemployment rate increasing slightly since the last call due to the effect of some of the layoffs in the oil - I mean the coal industry. So we're starting to see a little bit increase in unemployment, but still not to a level of major concern.

Jackie Chimera

Okay. And are there other areas I know in the past billings was in desperate need maybe not desperate need, but a need for builders and other people just to help develop infrastructure and everything that's going on there. And that some - there could be people that could move into jobs over there, is that the same case in Wyoming or is a…

Kevin Riley

No, because part of the construction, part of the unemployment in the growth aspect is slowing down in Wyoming. So I don't think they're going to be able to be put back to work.

Jackie Chimera

Okay. Looking to the CRE loan payoffs in the quarter does that have anything to do with energy? Was it an intentional payoff?

Kevin Riley

No.

Jackie Chimera

Okay. And also just on that note as you're working through some of the energy exposure that you have and looking to reduce that. Do you see that as being any sort of a headwind to loan growth throughout the year?

Kevin Riley

No because I think we will be slowly working out of it in bite-size pieces. So I don't think it's really going to affect. Since a whole portfolio is only that’s less than $70 million outstanding.

Jackie Chimera

Yes, that’s true. And then just my last question. Just reconciling the criticized assets and I may have misheard that in your prepared remarks. But criticized moved from 36 to 40 in direct exposure but then you had said that total criticized assets the majority of the movement was because of oil and gas, but it was up much more than $4 million. Can you just reconcile that for me?

Kevin Riley

Hi, hello, I think – because I think this whole total criticized assets were only up $27 million in total but the oil and gas goes only up $4.

Marcy Mutch

Yes, so it's just that migration within the portfolio nothing no specific industry.

Jackie Chimera

So was the majority of the $27 million not related to oil and gas spend or to energy or they more not direct, but related to energy?

Kevin Riley

It’s not related directly to energy, no.

Jackie Chimera

Okay. Sorry I must have – I thought you had said in your prepared remarks that most of the increase in criticized was related to energy and that’s why I was confused because the dollar value was so small with the $4 million. Okay thank you for clearing that up. I will step back now.

Operator

Our next question comes from Matthew Forgotson of Sandler O'Neill & Partners. Please go ahead.

Matthew Forgotson

Hi, good morning Kevin and Marcy.

Kevin Riley

Good morning Matt.

Marcy Mutch

Good morning.

Matthew Forgotson

Just continuing on with the $27 million uptick in criticized loans, was there any specific geography any theme to that increase?

Kevin Riley

No there was really no real theme to that increase. I mean it was just a bump up there so it wasn't something that is really highlighted by anyone major event.

Matthew Forgotson

Okay. And then the provision build this quarter I guess I'm just looking at the qualitative factor associated with softening in the Wyoming market. Did you say that that reserve – that reserve allocation there is now $1.5 million at March 31?

Kevin Riley

That's correct.

Matthew Forgotson

Okay. So quarter-to-quarter you really just – it looks like a $100,000 incremental increase, is that right?

Kevin Riley

That's correct.

Matthew Forgotson

Okay. Can you – I'm sorry.

Kevin Riley

No because we added so much on individual loan basis so that's why we only increased that one about $100,000.

Matthew Forgotson

Got it. Okay. As you look at margin as we move across the year, Kevin, can you talk to us a little bit about your expectations relative to the reported 354 this quarter?

Kevin Riley

I'll take it even though the Chief Financial Officer probably should take that question, I'll take it. I think the margin is going to kind of hang around in this kind of area throughout the remainder of the year. You might see it in a quarter go up a basis point or two or go down a basis point or two, but I think it’s going to – our margin has been pretty stable and I think it's going to hang around here.

Part of that increase was due to – really the Fed increase in the fourth quarter has helped our short-term investments to yield a little more and that’s our total investment portfolio. So I think it's just going to kind of reset itself and I think it's going to kind of hang around here for the remainder of the year unless we see a real change in rates.

Matthew Forgotson

Okay. And last question. Can you remind us what the unfunded direct energy loans, what the balance was at quarter end?

Kevin Riley

One second. I think…

Marcy Mutch

I have that right here $26.5 million.

Kevin Riley

$26.5 million.

Matthew Forgotson

Thanks very much.

Operator

Our next question comes from Jared Shaw of Wells Fargo. Please go ahead.

Unidentified Analyst

Hi, good morning. This is actually [Tim Orbozillar] filling in for Jared. I guess my first question circles again to the reserve established on the energy book, any of that increase tied to any specific credits or was it all broad based?

Kevin Riley

Most of it was tied to specific credits through the pricing deck. The only reserve that wasn't tied to specific credit was that general reserve and energy book that do qualitative factor which is $1.5 million.

Unidentified Analyst

Okay. And given that much of this reserve was established when oil prices were $10 lower like you said, should we expect to see some fluctuation in this reserve level from quarter-to-quarter? Are you going to keep this more conservative reserve on for at least the next quarter or two here?

Kevin Riley

Well, the thing is it might free up some stuff, well I think it's probably going to stay, it might not require reserving in the future as much as that we saw in the first quarter. The thing is when we talked about the $10 price differential, when it was down that low some of the wells literally were valued at zero because they were not economically viable and $10 makes those wells actually have a value.

So we believe that most of the significant reserving is behind us and hopefully we won't need that need going forward. So we still believe that the 20 basis points as we gave as guidance of the overall provisioning for the year. We still feel comfortable that could be a good number.

Unidentified Analyst

Okay. That's a good color there. And then just I guess looking at capital management, you have one deal on the pipe right now slated to close later this year. Are you looking at other transactions while closing the current one? And I guess what's the appetite for these smaller deals versus maybe doing something a little bit larger to ramp up growth a bit?

Kevin Riley

There is a pipeline of deals and as you saw Glacier just not closed on a small deal there is a number of those. So we believe that there could be a small deal once a year, but the thing is we're trying to keep the pipeline open, so that if a larger deal does come around we have the bandwidth in order to do it.

So you might see us do one a year the smaller deals or skip one, but the fact the matter is that there are a lot of those little deals out there. We passed on a number of them. And so we're just – we're trying to manage our pipeline accordingly to make sure it doesn't get too filled up with small deals, which will keep us out of doing a larger deal.

Unidentified Analyst

Okay. And just one more for me. You are sitting here at $8.7 billion in assets right now. Would you be looking to do a deal of that crosses you over that $10 billion threshold, some point this year if the right deal came along or I guess another way of asking is are the systems in place right now to kind of have you cross that $10 billion threshold or is there still more work to do before you're comfortable crossing it?

Kevin Riley

If a deal comes around by the end of this year, we probably will do it because we hope to be totally prepared with our stress testing methodology by the end of this year as well as have all the systems in place. So we feel good that we'll be able to digest an acquisition that will be closing in 2017.

Unidentified Analyst

Okay, perfect. Thanks Kevin.

Operator

Our next question comes from Tim Coffey of FIG Partners. Please go ahead.

Timothy Coffey

Thanks. Good morning, everybody.

Kevin Riley

Good morning, Tim.

Timothy Coffey

Kevin, I think it was in the last conference call we talked – are you talked about lowering some of the lines of credit outstanding to the oil and gas companies – clients as they came up for renewal. What is the time line for renewing some of those loans?

Kevin Riley

I don't have a specific time, but you can see that this quarter we actually reduced that portfolio by about $5 million. So we will continue to look at that when they come up, but I don't have an actual duration schedule on me with regard to when they come and do.

Timothy Coffey

Okay. And then the criticized oil and gas funds in the quarter. Was that just more loans moving into say special mention or was it amounts outstanding on those loans increased?

Marcy Mutch

Loans moving into special mention and when we talked about kind of to circle back to Jackie’s question, the loans primarily being downgraded borrowers in the energy sector. We're really referring to kind of the Wyoming footprint. Over half of the downgrades were in the Wyoming footprint.

Timothy Coffey

Okay. That's helpful. Thanks Marcy. And then on the 27% of the portfolio that's in Wyoming, what's the kind of loan concentrations in that market?

Kevin Riley

We will have to get back [multiple speakers].

Marcy Mutch

Yes, we’ll have to get back. I don’t have that breakdown.

Timothy Coffey

Okay, no problem. And then do you have any charge-offs in the oil and gas portfolio this quarter?

Kevin Riley

No.

Marcy Mutch

No charge-off.

Timothy Coffey

Okay. Those are my questions, rest of some have been answered. Thank you.

Kevin Riley

Thank you.

Operator

Our next question comes from Jeff Rulis of D.A. Davidson. Please go ahead.

Matt Yamamoto

Hi, this is Matt Yamamoto covering for Jeff. I just had one question. In terms of loan composition, you experienced the highest level of growth in consumer and commercial loans. How do you feel about these two segments for the rest of the year?

Kevin Riley

Consumer we believe that will continue to grow because we have a major focus on that and we feel that that will continue to push for at about the same growth rates, on the commercial side I think it was a…

Marcy Mutch

Commercial just down with our customers in the business market, so we feel good about that I mean I don't think we'll see anything different next quarter than we've seen this quarter.

Matt Yamamoto

Okay. Thank you.

End of Q&A

Operator

[Operator Instructions] I'm not showing any further questions. So this concludes our question-and-answer session. I would like to turn the conference back over to Kevin Riley for any closing remarks.

Kevin Riley

Thank you. As always, we welcome calls for our investors and analysts. Please reach out to us if you have any follow-up questions. And thanks for tuning in today. Good-bye.

Operator

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.

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