First Interstate BancSystem, Inc. (FIBK) Q3 2015 Earnings Report, Transcript and Summary

Good morning and welcome to the First Interstate Bancsystem Third Quarter 2015 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] And please note this event is being recorded. I would now like to turn the conference over to Kenzie Lawson [ph]. Please go ahead.

Thanks, Robert. Good morning. Thank you for joining us for our third quarter earnings conference call. As we begin, I’d 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 the other members of our management team. At this time, I will turn the call over to Kevin Riley. Kevin?

Thanks, Kenzie, and good morning everybody, and thanks to all of you for joining our call today. This is my first call since becoming CEO. I just wanted to take a minute to say how excited I’m to leading this incredible organization. From my perspective, I had the best job in the banking industry. First Interstate embodies all the best qualities of community banking. We have fantastic employees and a true customer centric philosophy that is engrained throughout the entire company. This is a very special place to work and I look forward to building upon the great reputation that First Interstate has developed over the past 47 years. Now on to the results for the third quarter. Yesterday, we reported earnings of $20.2 million, or $0.44 in earnings per share. The third quarter earnings were impacted by $5.6 million of expenses related to the ultimate settlement of our outstanding litigation along with core acquisition cost on the United Bank transaction. So on a core basis excluding litigation and merger related expenses, we had a strong quarter with positive trends in most areas of the company. As a result, our core pre-tax pre-provision income increased by 7% over the third quarter of last year. In July, we closed United Bank transaction and we’re able to do the sister conversion on the same week-end. So this has been a smooth integration of United Bank’s operations and we have already started to see the synergies that we projected for this acquisition. Pick up we saw on loan growth in the second quarter carried through to this quarter as well with increases across all of our major portfolio except our commercial portfolio. As I review the performance of particular portfolios, I’m going to only reference the organic growth we saw during the quarter. Our commercial real estate loans increased by $35 million. The growth being particularly strong in the Billings, Gillette and Jackson markets. Our consumer loans were up $30 million. The majority of the growth coming in our indirect portfolio. We continue to see good demand for recreational vehicles in our markets and the overall volume resulting from the expansion within our dealer network that we have been accomplished over the past few years. Our year-to-date net losses in this portfolio amount to about 11 basis points. Our construction portfolio increased by $15 million with $10 million of the growth coming from our residential construction. Our residential real estate loans grew by $16 million. Prior to now, our residential real estate portfolio has been fairly flat over the last three quarters. And at this time, we do not expect any continued real growth in this portfolio. Our ag portfolio was up $5 million as we continue to be in the seasonal strong times of the year, where our ag customers continue to increase their line utilization. You will see some paydowns on these lines over the next quarter, as our ag producers’ ramp up their season. As I said earlier, the portfolio was – our commercial portfolio was down with a decline of about $45 million. This is primarily due to a seasonal paydowns along with two customers that paid off loans after selling their businesses. Despite the decrease in our commercial portfolio, we were still able to grow our total loans by $36 million in the third quarter, allowing us to report a 6% organic loan growth over the last 12 months. Moving to credit quality, we continue to see positive trends in the portfolio with low levels of new loans flowing into our problem asset categories in a steady progress on resolving existing non-performing inventory. Our non-performing assets declined to 90 basis points of total assets, down from 101 basis points at the end of last quarter. This ratio was out by a reduction in our other real estate owned, which was down to just $8 million at the end of the quarter as we sold $4.7 million of ORE during the quarter. Given the positive trends in asset quality, our provision requirement was just $1.1 million in the third quarter, which provided for the growth we had in the portfolio. I want to mention our deposit growth. Our organic deposit growth was 2.5% for the quarter. And we believe the loan demand and the deposit growth we are seeing is reflective of the general positive economic trends throughout our footprint. As of the end of September, the unemployment rate in each of the states that we compete in are well below to national average of 5.1%. The unemployment rate was 3.5% in South Dakota, 4% in Wyoming and 4.1% in Montana. Despite the continued weakness in the price of oil, we haven’t seen it having much of an impact on unemployment rates in our footprint. In Casper, which is the market we expect lower prices – oil prices to have the biggest impact, the unemployment rate stood at 3.8%, which is slightly higher than it was at beginning of the year. As we noted before, the overall economy is performing well. Local skilled labor that was affected by layoffs in the oil and gas sector has been absorbed by growth in other industries such as construction. Increasing construction activity that we’ve seen, December supports our belief that we’ve had some pent-up demand over the last few years that’s now being realized and supported – supports our loan growth results. Our direct oil and gas exposure in the loan portfolio at the end of September was approximately $75 million with another $32 million of unfunded commitments. $75 million outstanding loans represent about 1.5% of our total loan portfolio and we continue to closely monitor the portfolio for signs of deterioration in these credits. We are pretty much through the peak of the tour season and we had a banner year with recreational visits up more than 11% through September to Yellowstone, Glacier, and Mount Rushmore and the Grand Tetons national parks. Gas prices are at the relatively low levels. National parks were popular destination point this year. In the ag industry, cattle prices have softened since the historical high as we saw last year, but are still very healthy with prices remain low for the 2015 cycle, but the crop production has been good in all of our markets. Overall, gross revenues will be lower simply due to lower prices. 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.

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 second quarter of 2015, so I’ll begin with our income statement. Net interest income increased $1 million on a linked quarter basis. The increase was a result of loan growth we saw in the quarter, a favorable shift in our mix of earning assets and one extra day of accrual. Our net interest margin was 3.47% and was unchanged from last quarter. However, when you exclude the impact of accretion on the interest of early pay-offs of acquired loans and recoveries of charged-off interest, our net interest margin increased 2 basis points from the prior quarter. This improvement in our core margin was attributable to the favorable shift in our mix of earning assets. Although we continue to see a decline in the overall yield on the loan portfolio, we are seeing a stabilization of pricing on our new loan production. The average rate on new loan organizations was 4.88% in the third quarter, which compares to 4.92% in the second quarter and 4.81% in the first quarter of this year. Our non-interest income was down $1.3 million, or 4.1% from last quarter. If you remember, last quarter we had two one-time items that positively impacted our non-interest income. First, there was $863,000 gain on the sale of land that was included in other income; and second was $410,000 gain on the sale of a season loan portfolio that was included in our income from the origination and sale of loans. If you exclude these two items, our non-interest income was essentially flat with last quarter. We saw a bit of drop-off in our gain on sales from mortgage loans due to 11.7% decrease in mortgage loan production this quarter compared to the prior quarter. However, this is a really tough comparison, since the second quarter of 2015 was the largest quarter in terms of production that we had seen since back in 2012 when most of the activity was related to refinancing. Year-over-year our mortgage production in the third quarter of 2015 was up 10%, so the longer-term trends in this business are still very productive. Demand for mortgages [indiscernible] continued to be strong, but there was lower demand for refinancing this quarter. Refinancing accounted for 26% of our mortgage loan production in the third quarter compared to 35% in the second quarter. The decline in gain on the sale of mortgage loans was partially offset by an increase in deposit service changes and wealth management revenues. Service charge revenues increased in part due to the initiatives in place to maintain greater discipline in capturing fees for the services we provide to our customers. The increase in wealth management revenues was due to continued growth in our customer base. And as of September 30th, our assets under management stood at $4.5 billion. Non-interest expense was up $3.5 million or 5.7% from the prior quarter. This increase was entirely attributable to two non-recurring items: the $5 million litigation settlement expense that Kevin mentioned earlier, and $566,000 of United Bank merger related expenses. Excluding these items, we saw a decline in all of our major expense areas even with the addition of United Banks personnel and operation. This allowed our core efficiency ratio for the quarter to dip to 61.12%. Total salaries were down 2.4% primarily due to lower short-term initiative compensation accruals, employee benefits decreased 9.4%, primarily due to lower earnings on assets held under deferred comp plans, and a seasonal decline in payroll taxes. As Kevin mentioned earlier, we sold $4.7 million of other real estate. These properties were sold at net gains with the impact to our earnings being about the same as last quarter. Other expenses decreased 4.2% primarily due to lower advertising expense and lower fraud loses. We did have one unusual item that impacted our other expense this quarter. We took $806,000 valuation write down on two buildings, previously occupied by branches that we consolidated. One of the buildings was sold and closed in October, and the other is currently held for sale. Now let’s move to our balance sheet. Kevin discussed our loan portfolio, so I will start with the investment portfolio. Our investment portfolio declined this quarter by approximately $72 million. With loan demand fairly strong, we’ve been redeploying the runoff in the investment portfolio into higher yielding loans. Given the pick-up in loan demand, we’ve also allowed our cash balances to increase rather than investing the funds into the securities portfolio, so that we have sufficient liquidity to capitalize on the loan production opportunities. As a result of the runoff in the investment portfolio, our duration has come down to 2.66 years. Our strong liquidity and low duration should put us in a good position to benefit should interest rates rise in the next few months. Total deposits increased 3.4% this quarter. This follows a seasonal pattern for the bank where we see a pick-up in deposits during the third quarter after a weaker period during the second quarter. We saw a nice growth in both the non-interest bearing and interest bearing deposit categories. Our total cost of funds remained at a low 24 basis points and was unchanged from last quarter. And with that I’ll turn it back to Kevin.

Thanks, Marcy. Good job. I want to spend a few minutes on our capital deployment. We continue to implement our stock repurchase program during the third quarter and repurchased 200,000 shares. Our Board of Directors also reloaded the stock repurchase plan back up to a million shares of our common stock. We also continue to explore acquisition opportunities both within and adjacent to our current markets. And right now, there seems to be a quite few opportunities out there both in small banks and banks between $500 and $1 billion. We feel good about the outlooks going into the fourth quarter. We’ve gotten off to a good start with loan production in October. So depending on the impact of any unexpected large paydown, we should continue to see loan growth in the fourth quarter, which is typically pretty flat for us. Our net interest margin and expense level should be fairly consistent with what we saw in the third quarter. The one area that we would likely see some decline this quarter is in mortgage production. We’ve had our mild fall, but when the weather turns colder, people are less inclined to go out looking for a new home. Taking all this into account, we expect our fourth quarter results will looks fairly similar to our third quarter, excluding non-core items. So with that we’ll open up for questions.

Thank you. We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Matthew Clark of Piper Jaffray. Please go ahead.

Hi, good morning.

Good morning, Matthew.

Good morning, Matthew.

Can you just quantify, I guess, the two credits that paydown could sold their business, I was just curious how large that was?

I bet both were fairly large, one was $4 million deal and another one was about $6 million decline, pay-off.

Okay. And can you may be quantify your pipeline going into the fourth quarter, I think, we know it’s seasonally slower one for you. I’m just curious how the pipeline looks going in the fourth relative to last quarter in general?

It looks good. As we said – as Kevin said, it does look good for us going into it. This quarter is usually, fairly flat quarter for us, and so – but positive signs are there.

Yes the market – the regional market presence is still pretty good about what we are seeing out there. So that’s going to be not going to cover up the ball, but it should be some steady growth.

Okay. And then just on the fee outlook, looks like you’re making some progress on deposit service chargers. Mortgage is what it is, but I know you guys are focused on that piece too. Just any – how should we think about fee income going forward? Assume you guys will grow faster than the rate at which you grow your customer base. Is that fair?

Yes, we’ve been focusing a lot on non-interest income. And so yes, we have initiatives around mortgage production. We believe that even though it will be down, it should be up year-over-year. With regards to the service charge revenue, we have an initiative. And again it’s not just increasing fees, it’s really collecting fees that are due to us for providing the service. So that should continue to increase. Wealth managements continue doing well. And we also have initiative around moving people to using business credit cards for interchange fee revenue. So that continues to be a real growth area. So most areas in our non-interest income area will continue to grow.

Okay. And then in your prepared comments, it sounded like guys haven’t seen much of an impact from the slowdown in the Bakken and also just curious with the slowdown in Canada as well. Just curious again any update there, any ancillary impacts that you might be seeing?

No, I mean even in the prepared comments we’ve talked about Casper market and [indiscernible] market might be the now one that’s impacted from lower oil prices, but we’re really not seeing a real turndown in those markets. Our northern markets around the flat area are impacting a little bit toursand it was little bit down or lease visits from Canada down into that markets were little bit down, but again nothing significant that is really causing any kind of economic slowdown.

Okay. Thanks guys.

The next question comes from Jackie Chimera at KBW. Go right ahead.

Hi, good morning everyone.

Good morning Jackie.

Kevin, you did mentioned that, you expect expenses to be fairly flat in 4Q from 3Q in the past they know that they’ve ticked up a little bit on seasonality so do you not expect that in 4Q 2015?

No, the way – I mean, I’ll let Marcy go over at question since she was ready to go over it. Go ahead Marcy.

As far seasonality and the non-interest revenue.

Expenses.

Expense. Now we do think that our non-interest expense overall will be pretty flat with this quarter. There’s just no major line items that we see foresee any significant…

Changes.

Changes, yes.

Okay. That’s helpful.

In the past, I think, we’ve seen some seasonality with advertising and we’re hoping that that stays pretty flat of over the quarter.

Okay. Is there any change to strategy or is it just primarily the timing as we flow through the year in terms of the advertising expense?

I think it’s timing. I think that we kind of always are looking out into the future what the expense levels look like. And I think that regarding some of the things that moves the needle a lot in fourth quarter to pass they’re just not in existence this quarter – this time.

Okay.

Sure.

And the litigation, you mentioned in both the press release and your prepared remarks the settlement. So that is completely removed now and there shouldn’t be any forward cost on that one. Is that correct?

That is correct.

Okay. And then just a small little accounting, only from me, where there any intangibles either CDI or goodwill that booked alongside the United Bank deal?

Yes it was. Very little goodwill but a little bit of core deposit I’m looking at Marcy for that remarks.

Jackie I will get back with you on that dollar amount. Yes, it’s pretty small.

It’s small pretty small, it almost – that acquisitions we came a bargain purchase acquisition was really close so there’s very little goodwill, that was booked.

Yes, you’re right.

Okay. Yes I noticed the take up once I removed CDI with pretty small so I just wanted to, just wanted to - [indiscernible] Marcy no rush on that.

Yes. I’ll follow-up on that.

Okay. And then just one last quick one. The provision, did any of relate to any oil exposure, was it all just purely on the other operations?

Yes, portion of it was related to one particular credit in oil and gas business.

And how much of the provision was that?

About close to $1 million –no about $800,000.

Okay. So excluding that then credit was very, very clean in the quarter in terms of what you…

Yes, it was.

Okay.

Correct, Jackie.

And you have said, sorry writing something else there, you said $72 million outstanding and $35 million unfunded was the exposure there?

Correct.

Just to verify that. Okay.

Yes.

And overall this I guess, I mean obviously you’re doing a little bit of provisioning for that, but and given the small exposure, do you expect continued provisions may come up from that or things doing fairly well since you’re seeing people that are – overall seems like there is other absorption for the weakness?

Yes, we are watching the portfolio very closely and as things change, obviously credit quality changes. We will make additional provisions as we see Fed we are very focused on making sure that these oil and gas credits continue to perform with – along with quarterly monitoring in borrowing base monitoring.

Okay. And the impacted loans are they pretty open to talking with you, and workout for necessary. Is any are necessary at this point?

Yes.

Okay, so you’re not having anybody, that’s being unrealistic.

No…

Okay, great. Thanks for the color. I appreciate it.

Thank you.

Thanks, Jackie.

The next question comes from Jeff Rulis of DA Davidson. Go ahead.

Thanks, good morning. Question on the – I guess circling back to the non-interest expense and then you offered some guidance there, but I wanted to – I guess that United Bank deal, is that conversion complete fully?

Jeff, yes it is

Okay. And so again that wouldn’t – I guess quarter-to-quarter you’re saying flat expense, anything into 2016 there would be additional cost savings or potentially any increase in cost from that platform?

No, we have realized all the cost savings in that acquisition. So there should be nothing going forward, it’s going to really impact us.

Got it. And now do you anticipate, is there any additional legal settlement, I guess that you have to accrue for any potential loss further or is that complete?

That is totally complete. And the only thing is – there is potential for us still in the future of recovery of some of this loss.

Okay, okay. And then just one last one on the – I guess the paydowns or payoffs in total sequentially, do you have that figure, I think you rolled out some originations quarter-to-quarter, but any sense on the paydown activity in Q2 versus Q3?

Jeff, I can give this to Bob Cerkovnik. I can get back to you on that Jeff. I don’t have that detail in front of me.

Okay. Yes, I guess if you align that with originations that would be great, thanks. And I guess, well I – any comments on the tax rate I guess in Q4, but even into 2016 and that’s kind of bounce around a little bit. Any idea on what we should expect?

It’s going to stay right around that 34% rate.

Okay, thank you.

[Operator Instructions] The next question comes from Jared Shaw of Wells Fargo Securities. Please go ahead.

Hi, good morning.

Good morning, Jared.

Can you go through some of the buybacks as you look at the opportunity to buyback stocks going forward and may be looking at the shares repurchased this quarter, where those originally coming from B shares or those all open market purchases of A shares. And then what are your thoughts in terms of future buybacks lowering the number of A shares available?

They were all added market buyback A shares. And we continue to look at possible times to buy shares back we do have a price limit in which we will buy the shares back at. And so we’ll continue to be in the market when the price is right, and we’ll be add the market when the price is too high.

And what if – so when you look at the evaluation of pricing on buybacks, is that all IRR driven or is it – I guess what are your primary measures of evaluating whatever that prices for your buybacks?

Primary measure is return on intangible – tangible book value dilution. With regards to the buyback, we want to make sure that we achieve the payoff within five years or less – five years and less.

Okay. And then if we could shift to loan yields, you’re saying I think Marcy, that origination yields were 48% this quarter. This is the – I think it’s the second quarter now where origination yields have been greater than portfolio of yields overall that we suddenly seeing that stabilization of yields in the overall portfolio. Should we expect to continue to see so the trends are down in the loan yields for the overall portfolio, or we close to bottoming them out here?

I think we’re getting pretty close to just bottoming out. We’re seeing kind of what’s going off and coming on pretty close to the same.

Yes. And some of that deterioration [indiscernible] Jared was due to the fact that the accretion on early pay-off of acquired loans as well as some interest recoveries both declined this quarter from the second quarter. So a lot of that 6 basis point decline can be attributed to that.

Okay, all right, perfect. Thank you. That’s it.

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

Thank you. Good morning everybody.

Good morning, Tim.

Good morning, Tim.

Good morning. Kevin, do you have – the loans to deposit ratio has been improving and Marcy mentioned about the improving mix of interest earning assets. Do you have any kind of visibility that tells you the loans to deposit ratio can continue to improve from here?

I wish I have my crystal ball that could tell me that – and - or I could sit there and kind of have my genie come out of the bottle and kind of make a wish, but I’d like to see it increasing a little more, but I would say that this level is probably a good level to kind of do a forecast looking forward.

Okay, that was my only question. All my other questions have been answered. Thanks.

Thanks, Tim.

Thanks, Tim. This concludes our question-and-answer session. I would like to turn the conference now back over to Kevin Riley for any closing remarks.

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

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