First Interstate BancSystem, Inc. (FIBK) Q4 2015 Earnings Report, Transcript and Summary

Good day and welcome to the First Interstate Bancsystem Fourth Quarter 2015 Earnings Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Kenzie Lawson [ph]. Please go ahead.

Thanks, Chad. Good morning. Thank you for joining us for our fourth 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?

Thanks, Kenzie and good morning and thanks to all of you for joining us on our call today. We had a good quarter. Yesterday, we reported fourth quarter earnings of $23.4 million or $0.51 per share, an increase of 3% over the same period last year. Excluding acquisition-related costs of $166,000, we had core earnings of $23.5 million or $0.52 per share. Our performance was primarily driven by another quarter of solid loan growth. After a slow start to the year, we saw loan demand steadily improved as we move through 2015. But for the full year, we had organic loan growth of approximately 6.5%, which is pretty healthy considering the range of growth we have had historically. As a result of the good loan growth, we saw a higher level net interest income and a 2 basis point increase in our net interest margin for the quarter. Our loan production for the fourth quarter was well-diversified, with solid growth in all of our non-ag related portfolios. And as we have stated before, the fourth quarter is a low point in the cycle for ag, as ranchers normally pay down their lines during this time of the year. The loan production was well balanced across our footprint. We saw 4% or better growth this quarter in our Billings, Gallatin Valley, Riverton, Rapid City, Sheridan, Badlands and Jackson markets. That’s pretty widespread. Marcy will cover a little more of detail around the growth in the various loan categories. Moving to credit quality, we saw good stability in our portfolio with slight increases in non-performing loans and a $23 million decline in our criticized loans. This decline was primarily driven by several large payoffs and some upgrades. Our net charge-offs for the quarter were just 6 basis points of average outstanding loans. This quarter, we recorded a provision for loan loss of $3.3 million, which primarily reflects the growth in our loan portfolio and a sizable specific reserve of one commercial real estate customer. Our markets continue to perform well on the economic front. As of December, the unemployment rate was 2.91% in South Dakota, 4.3% in Wyoming, and 4% in Montana. Each of our markets is well below the national unemployment rate of 5%. We continue to closely monitor the trends in the oil and gas industry, the help of our borrowers directly involved in the industry and the impact to our large regional economies. Our Wyoming markets of Casper, Gillette and Riverton are the areas most directly involved in the production of oil and gas. In aggregate, these markets represent 14.6% of our total loan portfolio as of December 31 with those loans spread broadly across different industries. Our total direct exposure to the oil and gas industry is approximately $75 million in outstanding loans, with an additional $24 million in commitments. As of December 31, 36.4% of this portfolio was in criticized loan category. The composition of the $75 million in outstanding loans includes $50 million related to drilling and extraction activity and $25 million to the oil and gas service companies. We have been closely managing our exposure to the oil and gas industry. And generally speaking, we have been lowering the amount of credit lines as they come up for renewal. Additionally, during the third quarter, we included a new qualitative factor in our allowance for loan loss methodology related to the potential impact of the slowdown in the energy products to the Wyoming markets. This accounts for an additional $1.4 million being added to the reserve calculation. As we mentioned in the past, as the oil and gas industry has reduced payroll over the past year, we see no other industries like construction absorb a lot of those workers. As a result, we haven’t seen broader weaknesses in other loan types. For example, losses in our indirect portfolio in Casper market, was just 9 basis points in 2015, down from 15 basis points in 2014. Indirect losses in the Gillette market were only 7 basis points, that was down from 38 basis points from the prior year. And the indirect losses in the Riverton market were just 4 basis points as compared to net recoveries of 8 basis points in the prior year. Oil prices have been declining for more than 1.5 years now and we haven’t seen a meaningful impact on credit quality. But we are certainly at a price level that puts more stress on our borrowers and we are beginning to be very proactive in terms of addressing potential problem loans. However, given our limited exposure in general stable credit trends we have seen throughout the downturn in the oil and gas, we feel comfortable that our risk is well-managed and any continued weaknesses in the oil price won’t impede our ability to generate profitable growth in 2016. It’s now been a few months since I have taken my new position. So, I would like to spend a few minutes talking about some of the changes we have made to the management team. Bill Gottwals joined us in November as our Chief Banking Officer. Bill comes to us from U.S. Bank, where he oversaw the Montana and Northern Wyoming markets. Bill has been in Montana for 21 years. So he knows or market, our people and our customers. And it’s great to have Bill on board. Kirk Jensen is our new General Counsel and joined us at the beginning of January. Kirk relocated from Washington, D.C. where he is a partner at a major law firm. Kirk and his wife are from small towns in Utah. So, moving back to Montana is like coming back home. Kirk’s most recent focus has been around bank regulatory and compliance matters. So, he will be instrumental to our team as we approach the $10 billion mark and beyond. Lastly, Lee Groom has joined our executive team. Lee has worked in the financial service area his whole career and also grew about West. Lee has been with the bank since 2010 overseeing our payment services area. Based on excess, we watched him have there. We have passed him at overseeing our mortgage any indirect activities. We are excited about having Lee as an addition to the leadership team. I am happy to have these three talented individuals join our executive team. These changes and I am sure there will be more are intended to make us more capable and responsive to the opportunities ahead of us. We are focused on having the right people, processes and technology in place that will allow us scalability as we move forward. So with those comments, I would like to turn the call over to Marcy for a little more detail behind the numbers. Go ahead, Marcy.

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 third quarter of 2015. I will begin with our income statement. Net interest income increased $2.1 million on a linked quarter basis. The increase was a result of the loan growth we saw in the quarter along with an improvement in our net interest margin. Our reported net interest margin was 3.49%, up 2 basis points from last quarter. When you exclude the impact of accretion of the interest on early pay-offs of acquired loans, along with recoveries of charged off interest, our net interest margin remained stable quarter-over-quarter. Our non-interest income was up approximately $400,000 from last quarter. We had increases in deposit service charges as a result of our continued focus on our fee initiatives. Other income also increased this quarter mainly due to higher yields on deferred compensation plan assets. This increase is fully offset in the salary and benefit line and has no net impact to our earnings. These increases in non-interest income were partially offset by a decline in wealth management revenues. This revenue declined as a result of market volatility, leading to a reduction in reoccurring fees. There was also a decline in interest – in income from the origination sale of loans. This was attributable to the typical seasonality we see in mortgage production in the fourth quarter. While mortgage production was lower than last quarter, it was 17% higher than the fourth quarter of last year, which is reflective of the overall higher level of production we have been able to achieve throughout 2015. Refinance activity as a percentage of production saw a small increase this quarter with 34% of the production related to refinance compared to 26% of our mortgage loan production in the third quarter. On the expense side, our non-interest expense was down $4.6 million for the quarter, with the difference being primarily related to the non-core expenses we recorded in the third quarter for litigation and merger-related expense. Outside of those non-core items, the most significant difference between the two quarters was $900,000 decline in salary expense due to the reversal of a portion of our incentive compensation accrual. Moving to our balance sheet, as Kevin indicated we had strong loan growth and we are up 1.3% over last quarter, with the strongest growth in our commercial real estate portfolio, which increased by $42 million. Our commercial portfolio also increased by $14 million. We saw a lower level of payoffs and pay downs than last quarter, which allowed us to resume growing this portfolio. Our consumer loans were up $12 million, with both the indirect loans and credit cards contributing to the growth. Residential real estate grew $12 million as we continued to retain some of our 10-year and under adjustable rate mortgage production. And lastly, our construction portfolio increased $11 million, primarily driven by land acquisition and development loans in the Bozeman, Kalispell and Jackson markets. These increases in loans were offset by a $13 million decrease in ag loans and a $7 million decrease in ag real estate loans. Overall, the agricultural trends in our markets have been very positive. While we have seen recent declines in cattle prices, these are coming off all-time highs and prices are now returning to more normalized levels. Our customers are seasoned operators and produce strong cash flows, even at these lower cattle prices. Moving to deposits, total deposits were up $53 million or about 1% from the end of the prior quarter. The increases came primarily in our interest-bearing demand and savings accounts, which offset a decline in time deposits. We also paid $15 million of variable rate subordinated debt at the bank level in the fourth quarter, reducing our level of long-term debt to $28 million. At the time of the pay-off, the interest rate on the sub-debt was 2.19%. So with that, I will turn it back to Kevin.

Thanks Marcy. Nice job. As we wrap up today, I want to talk about our expectations and priorities for 2016. We are expecting 2016 to be good year for profitable growth for the company. With the softening in the Wyoming market that we discussed, there is likelihood we will be able to repeat the loan growth we had last year. We are expecting loan growth to be closer to the mid single-digit levels that has been the norm for the bank. We think we are well-positioned to drive growth in all of our major fee generating areas. Our income from the sale of residential loans production this year was up 25% in 2015, partially due to the additional several new producers we added throughout the year that expanded our penetration in the various markets. We have a full year contribution from these folks, which should help us produce another good year of growth in this area, although they probably won’t be as robust as we saw last year. We think our net interest margin will remain relatively stable or perhaps increase a bit. Given the current trends in loan pricing, we are bringing on new loans at approximately the same interest rate as what’s rolled off. So, we feel pretty comfortable at the very least that we won’t see any compression in the margin this year. We also believe we might see a little bit of a benefit from the bump in Fed funds rates that occurred in December. We expect provisioning to probably run a little closer to 20 basis points of total loans this year, which should allow us to cover projected growth and provisioning for seasoned acquired loans. Our operating expenses should be relatively flat compared to 2015 as we continue to implement cost rationalization plans in certain areas in order to allocate more resources towards deploying new systems, which will allow us to become more scalable along with building up our digital banking platform. As I mentioned earlier, during 2016 we are addressing people, processes and technology. While our core system is fine, we are in the process of implementing a new general ledger system and financial reporting system. We also identified a new human resource system. These changes will beef up our infrastructure, increase our efficiency and provide us with a more robust analytics and allow us to be more scalable into the future. I talked about upgrading our digital platform. We have signed an agreement with a service provider that will allow us to enhance our customer experience with a more robust set of digital banking products and services. Digital banking in our markets footprint has lagged behind what is now being offered in larger markets. But we intend to be a leader in this area. We believe the rural markets have an even greater need for mobile services, just based on the vast geography we cover and the industries we serve. Investing in our mobile and online banking capabilities will enhance our overall customer experience, improve our ability to attract new customers to the bank and ultimately help drive value. We are excited about rolling out our digital strategy. We think it will be another key differentiator for the bank in our markets. And it will contribute to the growth in the years ahead. So with that, I would like to open the call up to questions.

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Jared Shaw with Wells Fargo Securities. Please go ahead.

Hi, good morning.

Good morning Jared.

Good morning.

If we can start with the provisioning, you said the $3.3 million in provision was for growth and primarily one CRE credit, was that credit already non-performing or what’s the status of that loan?

I will have Bob Cerkovnik answer that question for you.

Yes. Jared, this credit was a commercial real estate that relates our restaurant operation that the borrower was providing us fraudulent financial information right up to the point to where he dropped the keys off on the desk to us. So once we got the valuations on the real estate involved, we said to – it resulted in us having to put specific reserves on that particular credit.

Was that already a non-performer before you moved the specific reserves?

No, it was actually current.

Okay. So right from current to non-performing with – and did you charge-off any of that or not yet?

Not yet. We are still evaluating that credit, but we took a comfortable specific reserve on it.

Okay. And then could you remind us or illustrate on what the specific reserve on the $75 million of energy-related loans are and how that breaks out between the E&P and the services?

Yes. Bob will answer that question again. And again it’s really only one credit and we have talked about the same credit in the past quarters. So Bob is just going to give you an update on that one credit.

Yes. That’s the credit done for Casper office. It’s an oil and gas production credit that we had to increase the allowance on that specific reserve because of the decline in prices and looking at the production. And going forward we thought we need additional reserves on that. Just primarily because of the collateral base that we have setup with the borrowing base that we have setup and resulted in that decline.

What about the reserve though on the overall energy book, not necessarily that specific loan?

Yes. I am sorry, that – roughly there is $4 million related to specific reserves and then we have general reserves about $1.8 million.

Okay. Thanks. And Kevin could you give us a little update on the M&A opportunity set as you see it here and given that you do want to focus on operations this year, should we expect that M&A is more of a back burner or would we – should we think that you are still actively looking at opportunities?

Jared, you know me, so we are still looking at opportunities. But the thing is, is that even though we are focused on operations, we are laser focused. We are only doing certain projects in order to keep the capability of an acquisition integration during 2016. So we are being more focused and delivered on exactly what we are doing in the operations area not to be having too many things going on, so that limits our ability.

And how does M&A, with the stock here, how does M&A fit into the calculus of capital management with buybacks or where does buybacks fit into that with where we are here with the stock?

Our priorities are always the same. We want to use our capital through organic loan growth, good or profitable organic loan growth and then a good strategic M&A deal and then the stock buybacks closer to that and then dividends. And so we still have our same priorities. All you have to do is look at our past history on stock buybacks and make your own assumptions. And then acquisitions will play a part in the game. And we have increased our dividends as we announced 10% starting 2016.

Great. Thank you very much.

The next question comes from Matthew Clark with Piper Jaffray.

Good morning, guys.

Hey, Matt.

In terms of the new money yields, can you just give us the specific weighted average rate in the quarter? I know you said they are relatively stable, just curious if they were.

Marcy, you want to take that?

Yes. The weighted average rate was about 4.82%. Loans going on that’s what you are talking about?

Yes.

Yes.

Yes, okay. And then operating expenses is expected to remain relatively flat in 2016, just want to make sure that we are using the same basis. Is that coming off of the fourth quarter run-rate or is that the full year in ‘15 as roughly $243 million?

It should – Matt, it should run somewhere between $61 million and $62 million a quarter.

Okay, okay. And share repurchase in the quarter did you do any or no?

Not in the fourth quarter. Our stock was fairly valued.

Okay. And then I think the last question relates to – I will hop back in the queue, give me a second.

Okay.

Thank you. Our next question comes from Matthew Forgotson with Sandler O’Neill.

Hi, good morning.

Good morning, Matt.

Wondering about the purchase accounting accretion just as opposed to the margin, how much longer should you all continue to benefit from that tailwind?

It’s kind of a long tailwind. Our amortization period on the Mountain West deal was approximately 7 years on average. So Mountain West was only last year, so we still have kind of a long legacy on that one.

Okay.

That will taper off over the years, but it goes off quite a ways.

And in terms of crossing the $10 billion threshold, can you just give us a sense of kind of where that is? Where the company stands, I know you have the task force working on it do you have the ability to crossover now and your thoughts on potentially taking that next step?

We are not fully capable right now to crossover, but we are – it’s in our work plan to have the capabilities all in place by the end of 2016.

Thank you very much.

[Operator Instructions] The next question comes from Jeff Rulis with D.A. Davidson.

This is actually Matt Yamamoto covering for Jeff, but I just had a quick question. I thought that you guys had higher returns from the deferred compensation plan asset. How much did that add to fee income?

It added about yes.

$900,000.

Yes.

$900,000.

Yes. And again that fully offset it. So, it really has no impact to our net income.

Okay, thank you.

The next question is a follow-up question from Matthew Clark with Piper Jaffray.

Hey, thanks. I want to ask you about the timing of the repayment of that sub-debt and just trying to sensitize that benefit here coming into the first quarter?

Well, the sub-debt was about $15 million and there is about a little over 2%, 2.19% rate. And we paid off quite frankly, because it’s old sub-debt that was running out of capital usage. We are down to the 20% capital usage that we just prepaid, because it really had no benefit to us.

Okay, $15 million, I thought you said $50 million. Okay, thank you.

Yes, $15 million.

Right.

[Operator Instructions] This concludes our question-and-answer session. I would like to turn the conference back over to Kevin Riley for any closing remarks.

As always, we welcome calls for our investors and analysts. Please reach out to us if you have any follow-up questions. And thanks again to everybody for tuning in today. Have a good day.

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