Financial Institutions, Inc. (FISI) Q1 2019 Earnings Report, Transcript and Summary

Hello, and welcome to Financial Institutions, Inc. First Quarter 2019 Earnings 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, this event is being recorded. Now let’s turn the conference over to your host today, Shelly Doran, Director of Investors and External Relations. Please go ahead ma'am.

Thank you for joining us for today's call. Providing prepared comments will be; President and Chief Executive Officer, Marty Birmingham; and Chief Financial Officer, Justin Bigham. During the question-and-answer portion of the call, they will be joined by Chief Banking and Revenue Officer, Bill Kreienberg; and Chief Accounting Officer, Mike Grover. Today's prepared comments and Q&A will include forward-looking statements. Actual results may differ materially from forward-looking statements due to a variety of risks, uncertainties and other factors. We refer you to this morning's earnings release and our historical SEC filings, which are available on our website for a Safe Harbor description and a detailed discussion of the risk factors relating to forward-looking statements. We will also discuss certain non-GAAP financial measures intended to supplement and not substitute for comparable GAAP measures. Reconciliation for these non-GAAP financial measures to GAAP financial measures were provided in the earnings release, which was filed as an exhibit to our Form 8-K. Please note that this call includes information that is accurate only as of today's date April 30, 2019. I'll now turn the call over to Marty.

Thank you very much, Shelly. Good afternoon, and welcome to our first quarter earnings call. I am very pleased with our results as we generated net income of $11.5 million, up from $9.3 million in the first quarter of 2018. On a per share basis, we reported diluted earnings per share of $0.70, a 25% increase compared to the first quarter of 2018. Pre-tax pre-provision income was $15.7 million, 8.5% higher than the first quarter of 2018 and the highest quarterly pre-tax pre-provision income in our company's history. During the quarter, we continued to execute our long-term strategy to achieve sustainable earnings growth while continuing to optimize the configuration of our balance sheet. Growth was sound in our relationship-based lending categories of commercial and residential real estate. We grew deposits, charge-offs were low, net interest margin improved and we demonstrated expense discipline. In my experience as a local commercial banker, the first quarter is often the lightest period for commercial loan growth. We were not surprised that first quarter growth was lower than the previous two quarters. Our CRE and C&I commercial pipelines remain full, and we expect commercial loan growth to accelerate throughout the remainder of the year. In contrast, our Consumer Indirect loan portfolio decreased during the quarter, as we are focused on pricing in this lending category. We are not sacrificing yield for volume. The indirect portfolio at quarter end represented 29% of our total loan portfolio down from 29.8% at December 31, 2018 reflecting the impact of our pricing tactics and sustained growth in commercial and residential loans. Total deposits at quarter end were $142 million higher than year-end largely due to public deposit seasonality and $129 million higher year-over-year primarily, as a result of business development efforts including the gathering of deposits from commercial loan customers and consumer CDs. Our net interest margin increased by three basis points compared with fourth quarter of 2018 driven by a balance sheet strategy to redeploy investment securities into loans. The increase compared to the first quarter of 2018 was 6 basis points. Non-interest expense moderated in the quarter as illustrated by our improved efficiency ratio of 60.99% for the first quarter of 2019, compared to 61.85% in the year earlier quarter. I'll now turn our call over to our CFO, Justin Bigham who will provide more details on results as well as our current outlook and key areas for the remainder of 2019. Justin?

Thank you, Marty. Good morning, everyone or good afternoon, everyone. About 6 months into my tenure here at Financial Institutions, I could not be more excited about the opportunities that we have in front of us at this company. We have an excellent finance and accounting team, which my predecessor Kevin Klotzbach put together. At the same time, Marty and Bill have assembled producers and relationship managers who are well-positioned to meaningfully grow the number and size of the company's relationships, particularly, among businesses across Western and Central New York. Turning to first quarter of 2019 results. Let me provide a few comments on items with comparison to the fourth quarter of 2018. Net interest income was $31.8 million down $237,000 from the linked quarter. Two fewer interest accrual days in the current quarter, reduced net interest income by approximately $500,000 more than offsetting growth in average loan balances and net interest margin. NIM for the quarter was 3.24% up 3 basis points from the linked quarter. Margin expansion was primarily driven by a continued improvement in our interest-earning asset mix along with higher yields on newly originated loans. Our average yield on loans was 4.77% in the first quarter up 9 basis points from the fourth quarter. The average yield on interest-earning assets was 4.77% in the first quarter, up 9 basis points from the fourth quarter. The average yield on interest-earning assets was 4.23% in the quarter, up 12 basis points from the fourth quarter. Our cost of funds was 99 basis points, below the average for similarly sized banks, though up 9 basis points from the fourth quarter. It is noteworthy that we had a seasonally lower level of average public deposits in the first quarter as compared to the fourth quarter of 2018. Loan growth was 0.7% from year end, with 3.7% growth in commercial mortgage and 2% growth in residential real estate, largely offset by a 1.9% decrease in Consumer Indirect and a 0.7% decrease in commercial business loans. As Marty mentioned, we're intensifying our focus on the profitability of new originations in the indirect portfolio. The decrease in commercial business loans reflects seasonal first quarter softness, and we believe this lending category will revert to high-single-digit growth for the remainder of the year, based on the strength of the pipeline and the team of producers we have in place today. Provision was low at $1.2 million, reflecting asset quality, lower charge-offs, and slower loan growth in the first quarter of 2019. Provision was $3.9 million in the fourth quarter of 2018, reflecting higher charge-offs related to three commercial credits combined with 3.3% loan growth in the fourth quarter. Regarding asset quality, non-performing loans continued to be at historically low levels, representing just 19 basis points of total loans at quarter end. This is the lowest quarterly level we have experienced over the past 10 years, and is down from 23 basis points to year end. Allowance for loan losses to total loans was 1.07% at quarter end, down 3 basis points from year-end. At the same time, our allowance for loan losses was 574% of non-performing loans, up from 475% at year end, and remains among the highest levels in the industry. Non-interest income was relatively flat in the quarter at $9.1 million, compared to $9.3 million in the linked quarter. Service charges and card revenues were lower than the linked quarter, reflecting lower levels of consumer activity consistent with seasonal trends. Insurance income was $366,000 higher than the fourth quarter, the result of seasonality in this line of business. Non-interest expense in the first quarter was $25.2 million, slightly less than the low end of guidance provided in our last call. Typical first quarter seasonal increases in compensation and benefits were more than offset by a decline in advertising and promotion expense. Our full year 2019 branding and marketing plans are unchanged, but the timing of when advertising and promotions expenses are incurred will vary quarter-to-quarter. Accordingly, our guidance for quarterly non-interest expense for the remainder of 2019 is unchanged. We continue to expect a range of $25.5 million to $26.5 million per quarter with variability reflecting the timing of incentive compensation, healthcare and marketing costs. Other key areas of our current outlook for 2019 remain unchanged as well. We continue to plan for mid-single-digit growth in non-public deposits. We continue to expect full year net interest margin within a range of 3.25% to 3.35%. We continue to project mid-single-digit growth in non-interest income for the full year. We continue to anticipate that our efficiency ratio will be within a range of 59% to 60% for the full year. We also continue to anticipate converting between $110 million and $160 million of securities into loans in 2019, bringing us to a level in line with our peers at 15% to 20% of total assets. And lastly, we continue to expect an effective tax rate for 2019 within a range of 20% to 21%. Our current outlook does include one adjustment from last quarter. We now expect mid to single – mid to high-single-digit growth in our loan portfolio -- total loan portfolio for the full year of 2019. This differs from our previous guidance of high-single-digit loan growth due to a reduction in the expected indirect loan production. We currently project that the Consumer Indirect portfolio will decrease to 25% to 27% of total loans by year-end, as a result of the expected strong loan growth in commercial and residential combined with lower expected Consumer Indirect loan production. We expect our provision to return to normal levels for the balance of 2019, in line with our historical experience. In the first quarter Financial Institutions delivered very healthy growth, in core operating profitability. And as strong as our balance sheet is today, we continue to see opportunities for enhancement. We expect to continue rotating interest earning assets from securities into higher-yielding, higher-quality loans. On the liability side, we intend to maintain deposit pricing discipline, by continuing our focus on durable relationships with local consumers and businesses. I'll now turn the call back over to Marty.

Thank you, Justin. A few comments about capital, we believe that our capital levels are sufficient for the company's current operating profile, especially considering our credit discipline and solid asset quality metrics. Our regulatory ratios are well above minimum requirements, and all increased in the most recent quarter. For example, our common equity-to-assets ratio increased by 30 basis points from 8.79% to 9.09%, our tangible common equity-to-tangible-assets ratio or TCE ratio also increased by 30 basis points in the quarter. We expect continued improvement in these ratios as we generate capital through the retention of earnings. As a community bank, we understand that our responsibilities extend beyond the delivery of banking, insurance and investment solutions. We serve as an employer of choice, supportive neighbor and steward, in all the communities in which we are operating. We are continually seeking the most effective ways to constructively engage and provide support. And we believe we've identified an excellent way to do just that. Next week, we'll be kicking off an exciting new part of our community outreach effort called progress in and action, revitalizing neighborhoods, restoring hold. This is a program structured to empower residents of our neighborhoods, most in need of our support to define and implement solutions and improve their quality of life in a sustained fashion. We look forward to sharing more information about this program with its launch on May 8. I've said it before, and it warrants repeating today, we've made significant investments, in systems people and platforms over the past two years. We are seeing tangible results of these investments, and the hard work that has strengthened and transformed our company. We are producing stronger financial results, and have significant positive momentum. I'm looking forward to the remainder of 2019. At this point, Keith, we'd like to open the call up for questions.

Yes. Thank you. We will now begin the question-and-answer Session. [Operator Instructions] And the first question comes from Joe Fenech with Hovde Group.

Good afternoon.

Hi, Joe.

Hey, Joe.

Hi, Joe.

Hi, guys. Appreciate, as always, the detailed guidance and then this quarter the added detail on the specific balance sheet transition targets through year-end. My question is, I guess, if you achieved those year-end targets with the shift in investments to loans and then the lower concentration in indirect auto do you think at that point the balance sheet will be where you ultimately want it to be? Or is there potentially another phase for the transition looking beyond 2019? Just trying to think of -- trying to get a sense for kind of what things look like beyond this year if we get to the targets that you outlined?

Yeah. Joe I'll take that question. As far as the securities portfolio is concerned, the guidance that we've provided is sort of the best we can do relative to a range. I will tell you that, internally we're not forecasting any further declines, or any further rotation within that portfolio. I sense your question around indirect and the reality is we're going to be smart about that portfolio and make sure we're focused as we said on pricing. And if that means that the volume goes down a little bit we're okay with that. But that one is not quite so easy for me to give you guidance on.

Okay. Fair enough. And then, just the updated -- I know you reiterated the NIM guide from last quarter. But just can you talk about, what you think makes the difference between the lower end of that range, and the higher end of that range? Is it executing internally or is it more kind of the wideness of the range is more attributed to the uncertainty in the macro?

Yes. I mean, it's all of that, right Joe. That's the hardest number if you will to peg because of all of the moving pieces in the balance sheet and we're just one quarter end and we're talking about changes to indirect and changes to other things that have happened on the balance sheet just as we react to what's happening in the market. So it's real hard to figure that out with any certainty given the changes that can happen. If I could isolate just the interest rate environment or isolate just the balance sheet, I can probably give you more guidance, but we need to keep that range where it is just because of the uncertainties around everything else in the market.

Okay. Fair enough. And then just confirming it sounds like the lower loan growth guide is solely due to the slowdown -- to the purposeful slowdown in the indirect originations. Just confirming that you guys aren't really seeing a change in the back -- the economic backdrop or just any expectations on the commercial side?

That's correct, Joe.

Joe I just would add that that's consistent with the conversation we've been having in terms of emphasizing our relationship-based lending businesses as well.

Okay. And then just with the slowdown in the loan growth obviously purposeful with the indirect and then just the capital build at what point do or does at all share repurchase look a little more interesting to you?

So that's obviously above our pay grade Joe, and we've been thoughtfully considering our capital requirements in light of the capital advance associated with the growth that we've been driving. And we feel great about the progress we've made in terms of our capital levels and in terms of pushing them up more closely aligned with our peer group. But at the same time given the array of opportunities that we have in front of us, our focus is on executing our strategic initiatives.

Sounds good. Thank you guys.

Thanks, Joe.

Thank you. And the next question comes from Damon DelMonte with KBW.

Hey, good afternoon everyone. How you are doing today?

Hi, Damon.

Hello Damon.

Hey, Damon.

Great. Quick question on the outlook for the provision, I believe I just need a reference that I would kind of revert back to historical levels. I know historically because of the indirect portfolio or we've seen that there was a little bit higher component to the provision because of historical charge-off rates and indirect consumer lending. So could you help give us some guidance or range for the provision over the next three quarters?

I guess, what I'll do for you Damon is talk to you little bit about the way I think about it. So internally we look at provision on a historical basis to calculate our estimates. And if you look back at the last couple of years, you'll see that we're averaging about $2.5 million of net charge-offs per quarter. And the way we think about provisioning internally is to cover net charge-offs and then provide for our portfolio growth. Obviously, our ratio of allowance to total loans has been coming down each quarter, while our coverage ratio has been increasing. So that's consistent with our credit profile and performance. Predicting with what's going to -- predicting what's going to happen with that ratio is very complicated so that involves a whole lot of moving parts within the model. But internally, we're not forecasting any further declines in the allowance to loans ratio. So, I guess that's how I would think about it is providing for growth and covering net charge-offs and looking at net charge-offs on a -- for the last couple of years that average is $2.5 million per quarter.

Got it. Okay. That makes sense. It's great color. Thank you. And I guess, kind of just a broader question type Marty. Just -- how are you looking at the ongoing disruption just from like the key first Niagara deal and -- I mean, Key maybe being preoccupied with other things other than certain areas of Upstate New York. Could you just give a little update on your outlook as to how those opportunities are continuing to shape up for you guys?

So how you just described it is the way it is. And I would say that we remain very positive and bullish on the opportunities that we have described over the last couple of years disrupted marketplace. But the fact that matters is that in Upstate New York larger banks delivered locally is just more awkward than dealing with a company like ours, whether you are talking about consumer or personal solutions or commercial solutions or in our case wealth and insurance. So I remain very positive and bullish on the opportunities we have and continue to drive performance forward by meeting the needs of the market place.

Okay. Great. And thanks for the detailed guidance on the expectations coming up. Appreciate it.

Thank you. And the next question comes from Matthew Breese of Piper Jaffray.

Good afternoon.

Hi Matt.

Hey Matt.

Just wanted to dive into the loan growth outlook a little bit. Could you share with us the size and the pipeline at quarter end versus a year-end? Or if you can't divulge that what the -- maybe the percentage change in the overall size of pipeline?

Hi Matt, it's Bill Kreienberg. I can answer that question. While we won't provide specific numbers around the pipeline, we had a very active fourth quarter. The first quarter in terms of closing was a little softer, but that is something we've seen historically. So like C&I and CRE teams, the pipelines remain robust. And we're focused as Marty and Justin said on the relationship aspects of our commercial transaction. And we're focusing on maintaining our pricing in the market. And we remain getting a look at all the deals we want to get a look at. So the leadership we've put together has remained very effective in the marketplace and we're -- our pipeline is full.

Understood. Okay. And then just understanding the NIM dynamics a little bit better, could you share with us what the blended origination yield was this quarter? And maybe compare that to the blended cost of deposits coming in. And can you give us a sense for whether or not the core spread is expanding or contracting excluding what the mix shift is going to do? Just wanted to get a sense for that.

Yes. Matt we don't have quite that level of detail at our disposal. But -- I mean I can tell you that the primary driver of our NIM expansion is from the rotation that we're doing out of securities and into loans. And that is driving the expansion. The rest of the moving pieces, if you think about our indirect book for example it's got about a two-year life. So over the course of a two-year period, if you look back two years at the rate environment and how that's looked in that last two years, you'll able to see kind of how the new originations are coming on at a higher yield than some of the originations that are rolling off. That's driving up asset yields that's not inconsistent with the way it's working on the rest of the asset side of the balance sheet. And then on the liability side of the balance sheet, if you think back a year ago or two years ago CDs were going on the books at a lower rate than they're going on now. And so it's really that trade -- those two trades one might be slightly better than the other. And that's why the rotation is really the driver of our NIM expansion.

Understood. If you think about -- if you look at across your footprint what areas are showing the most promising growth? And what areas do you look at as potential opportunities to expand into organically or through M&A?

So are you talking about business activity?

Yes. Geographically, where you're seeing the most business activity and are there geographies you feel like you're missing and want to expand into?

Again, you think about conversations we've had. We have a very terrific historical presence in and around Rochester and Buffalo and other parts of the Southern Tier of New York. And we've been taking advantage of that base and going to markets where our penetration is much lower from the overall market opportunity. So that's been Rochester and Buffalo. That has not changed. In the last quarter, we shared with the market investors on this call that we did expand some leadership to move East and have a market executive that is driving our activities on the commercial side in Central New York.

Understood. All right. That’s all I had. Thanks for taking my questions.

Thank you, Matt.

Thank you. [Operator Instructions] All right. As there is nothing else at the present time, this does conclude the question-and-answer session as well as the conference itself. Thank you for attending today's presentation. You may now disconnect your lines.