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Good day. And welcome to the First Interstate BancSystem First Quarter 2021 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 today’s event is being recorded. I would now like to turn the conference over to Lisa Slyter-Bray. Please go ahead, ma’am.
Thanks, Rocco. Good morning. Thank you for joining us for our first quarter earnings conference call. As we begin, please note that the information provided during this call will contain forward-looking statements. Actual results or outcomes may differ materially from those expressed by those statements.
I’d like to direct all listeners to read the cautionary note regarding forward-looking statements and factors that could affect future results contained in our most recent annual report and on Form 10-K filed with the SEC and in our earnings release, as well as the risk factors identified in the annual report and our more recent periodic reports filed with the SEC.
Relevant factors that could cause actual results to differ materially from any forward-looking statements are included in the earnings release and in our SEC filings. The company does not undertake to update any forward-looking statements made today.
A copy of our earnings release, which contains non-GAAP financial measures is available on our website at fibk.com. Information guarding our use of the non-GAAP financial measures may be found in the body of the earnings release and the reconciliation to their most directly comparable GAAP financial measure is included at the end of the earnings release for your reference.
Joining us from management this morning are Kevin Riley, our Chief Executive Officer; and Marcy Mutch, our Chief Financial Officer, along with other members from our management team.
At this time, I’ll turn the call over to Kevin Riley. Kevin?
Thanks, Lisa. Good morning and thanks again to all of you for joining us on the call today. Again this quarter along with our earnings release we have published an updated investor presentation that has some additional disclosures that we believe will be helpful. The presentation can be accessed on our investor website and if you haven’t downloaded a copy yet, I would encourage you to do so.
I’m going to start off today by providing an overview or the major highlights of the quarter and then I’ll turn the call over to Marcy to provide more detail on our financials.
The first quarter came in largely consistent with our expectations. We continue to see healthy economic activity throughout our markets, which resulted in strong deposit inflows, a positive impact on our fee generating businesses and further reduction in all of our problem loan categories.
We executed well on our near-term strategy to support our net interest income by utilizing some of our excess liquidity to retain more of our residential mortgage production and increased purchases of securities in our investment portfolio.
The additional revenue generated through this strategy combined with the stable expense level helped us to deliver another strong quarter of earnings for our shareholders. With a quarter we generated a net income of $51.4 million or $0.83 per share.
Loan balances were essentially flat to year-end whereas most years we’ve seen declines in balances during the first quarter. We believe this reflects the health of our markets and increasing confidence that our clients have and the strength and sustainability of the broader economic recovery.
Across our footprint, our clients are looking to invest in projects and put money to work that will help them capitalize on the improving economic environment. We will continue to see this most notably impacting our commercial construction loan bounces, along with modest growth in commercial loans, excluding PPP loans and growth in our residential real estate portfolio.
Heading into the second quarter, we are already seeing promising growth and we are focused on ensuring our speed to the final credit decision allows us to get deals done. We have adjusted to become more efficient in our underwriting and approval process, and are winning deals without compromising on price or quality.
We are also pleased with the execution of another successful round of PPP loan originations in the first quarter. The automated process we utilized is the first round continues to provide a very efficient access to this funding for existing and new clients, and we funded an additional $437 million in loans throughout the end of -- through the end of March.
We continue to be surprised at the pace of our deposit growth, which was over 25% on annualized basis in the period where we typically see balances decline. While some of this growth can be attributed to PPP loans and stimulus payments, we believe this continuous historical high level growth reflects the health of our clients.
While we’re able to put a substantial amount of liquidity to work in the first quarter, strong deposit inflows continues to leave us with high cash balances. Consistent with our approach in the first quarter we expect to retain more of our residential mortgage production in the second quarter and we’ll continue to add to the investment portfolio although at a much more modest pace.
The health of our markets is also reflected in our asset quality. Across the Board, we saw improvement in all of our problem loan categories, non-performing assets, non-performing loans, criticized loans and delinquent loans were all down from the end of the prior quarter.
Improved economic forecast along with positive trends in asset quality resulted in a negative provision for credit losses in the quarter and a small reserve release. Although, with an allowance of 1.38% of total loans or 1.51% when PPP loans are excluded, we still have a very high level of reserves that should enable us to keep our provision expense relatively low as we add to our loan balances in the future.
I’d like to add a little color about our footprint. Over the last few weeks I’ve had the opportunity to once again get out and visit some of our communities and our employees. What I’ve seen is that there is an overall optimism about the local economies and that the outlook for continued recovery throughout the summer.
Notably, the expectation of record tourism across our footprint continues to point toward increased revenues for sectors that were hit hard by the pandemic. Unemployment in the northwest continues to be below national averages and average wages show signs of growth.
Our states continue to benefit from positive in migration with some of our mid-sized markets like Rapid City showing hot residential housing trends with notable -- noticeable increases in building permits to address growing inventory shortages.
Building -- Billings, Coeur d’Alene and Spokane, all made the national news as they were in the top five metro market areas for homebuyers. Montana saw its population grow by 9.6% and picked up a house sheet based on the recent census data. Oregon picked up the seat as well. In fact based on the results of last census all of our states saw positive growth with Idaho reporting the strongest increase of over 18%. They are also showing 6% annualized growth so far in 2021.
The near-term future for the agriculture industry always -- also looks positive. Federal programs provide substantial relief from the effects of the pandemic and have allowed farmers and ranchers to weather the effects of commodity prices and export tariffs. Higher income levels have resulted in increased liquidity and capacity to pay down existing lines.
Lastly, our state and local governments have not experienced a severe shortfall in revenue that were predicted at the height of the pandemic and are in some cases seeing benefits from increase in gross sales and additional tax revenues.
In summary, the strength of our markets and the momentum of our core business trends set us up well for accelerating core pre-provision net revenue growth for the rest of the year. Now, I’m going to go off script for a second, because I just wanted to say that, I am more bullish about the future of the bank than I ever have been since I joined the company.
And with that, I’m going to turn the call over to Marcy to provide some additional detail on our financial results. 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 fourth quarter of 2020 and I’ll begin with our income statement.
Our strong deposit inflows continue to generate excess liquidity that impacted our net interest margin. However, the increase retention of mortgage production and the growth in our investment portfolio helped us keep our net interest income, excluding PPP and accretion income relatively consistent quarter-over-quarter.
On a GAAP basis, our net interest income decreased by $7.7 million all of which can be attributed to lower PPP fee income, lower accretion income on acquired loans and to fewer days in the quarter. Relative to last quarter, PPP income was $4.4 million lower, accretion income was $800,000 lower and two fewer days in the quarter equated to $2.4 million on an operating basis.
Looking ahead on an operating basis, excluding PPP income, we believe this quarter was the low watermark for net interest income and we should see sequential improvement from here for the rest of the year.
On a reported basis, our net interest margin decreased 21 basis points to 3.04% in the first quarter, primarily due to less income derived from our PPP loans and a mix shift from loans to bonds invested at lower rates, exacerbated by the significant increase in earning assets as a result of our rapid deposit growth.
Taking all the noise from both accretion and the all-in impact of the PPP loans, the yield on loans went down by approximately 10 basis points, which was partially offset by a 2 basis point drop in our average cost of funds.
The weighted average rate of new purchases in the investment portfolio was 1.19% in the first quarter. While the securities we have purchased in the first quarter have pushed our duration to slightly over four years as of the end of the quarter, we have a bias toward higher rates going forward and so incremental purchases in the investment portfolio will be made with the goal of keeping our overall duration under four years.
Our non-interest income increased $4.2 million quarter-over-quarter to $38.1 million. This was primarily due to a $5.9 million mortgage servicing rights impairment recovery. Excluding this recovery, non-interest income was down from the prior quarter due to the typical seasonality we see in payment services revenue, lower service charges on deposit accounts with distributable to fee waivers and healthy account balances and lower gains on the sale of mortgage loans as a result of our decision to retain more of our production, which you can see very clearly on page 45 of the investor presentation.
At the beginning of the year, we indicated that we expected our total GAAP non-interest income to be at or modestly down from 2020, which just seemed a modest MSR impairment recapture over the course of the year. As a result of the decisions we made in the first quarter around fee waivers and home loan sales, we now expect our total full year GAAP non-interest income to be down low-to-mid single digits year-over-year.
Going forward, we’re seeing strong momentum in payments and wealth businesses, both of which should now outperform our original expectations. We also expect to return to more normal levels of mortgage production sold toward the end of the second quarter, which should generate a nice lift in mortgage banking revenue from first quarter levels.
As such, the first quarter should be the low point for fee income and we’re still anticipating our total fee income for the remainder of the year to be consistent with our initial forecast in January. Notably, this revised outlook assumes no further MSR recovery for the balance of the year.
Moving to non-interest expense, we had an increase of $1 million from the prior quarter. This was primarily due to higher employee benefits expenses resulting from the seasonal impact of higher payroll taxes. This was partially offset by lower salaries and wages expense due to lower commission expenses and short-term incentive accrual.
While we had a large volume of PPP originations in the quarter, we allocate a very small amount of loan origination cost per loan in this program. The impact of the deferred loan costs related to PPP loans on our first quarter expenses was immaterial. For the full year, we continue to expect our initial guidance to hold true and for total non-interest expense to be approximately 1% higher than last year.
Moving to the balance sheet, our loans held for investment increased $56 million from the end of the prior quarter. We had $372 million of PPP loans forgiven and funded $437 million of PPP loans in the quarter, with the remaining loans held for investment essentially flat quarter-over-quarter.
Growth in our residential real estate, construction and commercial portfolios was partially offset by declines in our commercial real estate and consumer portfolios. The decline in the indirect consumer portfolio continues to reflect elevated levels of payoffs and pay downs related to stimulus payments, and new production has been dampened by inventory shortages at dealers.
The demand for autos, RVs and other recreational vehicles is definitely strong and when inventory shortages are resolved, the large dealer network we’ve built should turn this area into another source of growth in the portfolio. As of March 31st, we had approximately $804 million of PPP loans on our balance sheet, with $29 million of associated deferred loan fees.
On the liability side, our total deposits increased $877 million from the end of the prior quarter, with most of the growth coming in non-interest-bearing commercial deposits, interest-bearing demand deposits and savings deposits.
Moving to asset quality, as Kevin mentioned, we saw decreases in all of our problem loan asset categories. Relative to the end of the fourth quarter, our non-performing loans declined $6.6 million, our non-performing assets declined $6.9 million and our criticized loans declined $30.7 million. Our remaining loan deferrals are de minimus.
Our credit losses continue to be very low with $2.9 million of net charge-offs, representing just 12 basis points of average loans on an annualized basis. Following the significant build in our reserve strength 2020, the improving economic forecast, improved asset quality and the low level of losses in the portfolio resulted in a reversal of provision expense of $5.1 million. This brought our allowance as a percentage of loans held for investment to 1.38% as of March 31st or 1.51% when PPP loans are excluded.
Now I’ll turn the call back over to Kevin.
Thanks, Marcy. Nice job. I’m going to wrap-up with a few comments about the remainder of 2021 and how it’s shaping up. Our near-term focus will be continuing to support our net interest income by retaining mortgages and increasing our security portfolio.
But we are becoming increasingly confident that we will see stronger loan growth for the remainder of the year, which will give us more opportunity to increase net interest income and further improve profitability.
Credit line utilization is at historic low levels. We will see construction lines fund throughout the rest of the year, and we expect both consumer and commercial lines of credit to return to a more normalized level, which will reduce the -- that reduce the excess lines about 9%. If this materialized, this result about $200 million in increased outstanding balances.
Our loan pipeline is steady and signs are pointing to higher demand in the coming months. We are seeing good opportunities across a variety of asset classes both in the West and Mount division.
We believe commercial construction will be an area of strength. We’re also seeing opportunities in residential construction as homebuilders look to satisfy the strong demand for housing resulting from the population growth in our markets. This also extends the multifamily lending, which is benefiting from the same in migration trends.
The outlook for commercial real estate lending looks positive. We don’t have much exposure to office -- the office market that has some people concerned about the long-term impact of work-from-home. And we’re seeing good opportunities across other property types that continue to perform well.
We fully expect a very strong tourism season this year given the pent up demand. It’s very difficult to book a room and many tourist destinations in our markets right now. This is -- this only bodes well for fee income we generate from increased economic activity in our markets, but also for loan demand from a larger ecosystem of small businesses that serve the tourist market.
And in May we are launching our small business, digital lending platform, which will improve our ability to serve small businesses and efficiently originate loans in this area. This is just one of the technology rollouts this year. We just completed the installation of our integrated teller platform in our branches and later this year we will upgrade our debit card processing system and implement a new commercial loan origination system.
All of these technologies enhancements are driving improved efficiencies, providing more opportunity for revenue generation and improving our client experience. This is a continuation of our efforts to consistently enhance our people, processes and technology, and do it without having a material impact on expense levels.
On the people front, we had John Stewart joined the team as Deputy CFO and Head of IR. We know many of you know John and we’re excited that he has chosen to crossover to the bright side of the business. So you will see him around as he’ll be joined the Marcy and me in many of the upcoming investor events.
The investments we have made in prior years and processes and technology to build a robust scalable technology platform are enabling us to consistently add new features and tools that will improve our operation without much incremental expense. We believe this positions us very well to realize more operating leverage and as we continue to grow the company both organically and through additional acquisitions.
Before I wrap up today, I want to note that we recently published our 2021 Community Responsibility Report, which is available on our website and I encourage anyone who is interested in understanding our company’s -- company better from an ESG perspective to download a copy. We’ve been publishing a similar report for several years and a commitment to corporate social responsibility is just something that is in our DNA.
Being a good corporate citizen and a valued partner to our communities has been a core value of First Interstate for decades, and taking care of our employees, clients and neighbors will continue to be an integral part to the success and the growth of our future.
So, with that, I’ll open the call up to questions.
Thank you, sir. [Operator Instructions] Today’s first question comes from Jared Shaw at Wells Fargo Securities. Please go ahead.
Hey. Good morning, everybody.
Good morning, Jared.
Good morning, Jared.
Yeah. Kevin, maybe just starting with the some of those tech investments and especially the small business lending portal is how will that be -- how do you see that helping to drive additional business into -- will that enable you I guess to take some of the leads from the PPP maybe from other banks customers and you expect to have that help develop them into a full service customers at a faster pace than before?
Yeah. There’s two things that we see benefit, Jared. One that people can go online and apply for a loan themselves and be immediately approved and funded, because it has automatic scoring process. So it’s a fast efficient way for them to do it themselves. Or we’re also training our FSRs, which are not commercial lenders, FSRs, Financial Service Reps to be able to walk customers through this digital application within some of the locations that might not have commercial lenders to quickly get loans approved and funded.
Okay. Great. And then on the mortgage side, are you retaining everything that you’re producing at this point or are you trying to keep shorter. You don’t looking at 15-year, are you holding on to 30-year as well? And I guess how will that impact mortgage banking revenue going forward in terms of volume retained versus sold?
Marcy is going to answer that question.
Yeah. So, Jared, in the first quarter we retained about 58% of our production in the portfolio and some of that did include 30 -- the 30-year mortgage product. Going forward we will begin to phase out of that headed into the end of the second quarter.
So, again, we had a certain amount that we were going to retain around $400 million throughout this whole process since we started retaining mortgages in the fourth quarter and we’re about at that threshold. So we’ll begin to sell mortgages, sell more of our production as we head into the end of the second quarter.
Okay. And then just finally coming on credit, I guess, are two things. One, should we expect that the negative provision this quarter sort of got you to where the current economic environment is reflective of and any reduction of the ACL will be more a function of loan growth at this point or could there be another negative provision? And then just sort of tying into slide 21 in your slide deck, there is a construction loan that you highlight as management attention. It doesn’t look like there was a reserve against that. Can you just give a little color on that?
So I’m going to let Michael Lugli ask -- answer that last question. But I’m hoping that we grow into the reserve balance where it is right now with loan growth. And I’m not anticipating any substantial change in our economic outlook until we -- unless we are to continue to see things markedly improve from here. And then does that answer that question, Jared?
Yeah. Thanks.
Okay. And then Michael?
Michael.
Michael.
Hi, Jared. It’s Mike Lugli. What you’re referring to is the -- I believe its commercial institutional building construction and the…
Yeah.
…management attention piece. That’s primarily driven by a couple of hospitality loans that we are doing. And it’s really not -- has nothing to do with the actual project but a weakness of the guarantor from other assets that they own, which is draining their liquidity. So, given the uncertainty, that’s why that was moved over to management attention. Does that make sense to you or answer your question.
Yeah. Okay. And the reserve or specific reserve associated with that because of that risk creating or not necessarily?
Management attention is about as late as we get and criticized. So, no, there is not. We feel a very good about the project. It is really just looking and we’re looking at that hospitality book and office book closely. It’s just looking at that guarantor that out of caution, abundance of caution we move that to special mentioned.
Great. Thank you.
And our next question today comes from Levi Posen with D.A. Davidson. Please go ahead.
Kevin, Marcy good morning. This is Levi on for Jeff Rulis.
Good morning, Levi.
Good morning, Levi.
If I can just start with a housekeeping question on the tax rate, is it fair to assume that the seasonality we’ve seen in the past couple of years repeats this year and we land towards the 23% for the full year?
Yeah. I think we’ll be between 22.5% and 23%. We always have some benefit that we see in the first quarter from the tax benefit associated with option exercises and so that’s what happens in the first quarter to drive that rate down a little bit.
Got it. Okay. Thank you. And then I apologize if I missed it, missed it earlier, but was there an expense run rate going forward?
1% increase year-over-year.
Great. Thank you. And then last one for me on the capital side of things, you guys have been active with buybacks and the dividends. What are your thoughts on M&A coming up here?
Well, we’re always -- as you know in the past we’re always talking to people about doing a possible acquisition. Those conversations continue to be have -- had, but we were being pretty picky like we have in the past. I mean there’s a lot more coming to market right now. We’re being called on, but we’re not jumping to somebody, because we have certain acquisitions that we believe will enhance the franchise value and we believe just being patient is the position we’re going to take it this -- at this juncture.
Understood. Okay. Thank you. I’ll step back now.
And our next question today comes from Matthew Clark with Piper Sandler. Please go ahead.
Hi. Good morning.
Good morning, Matt.
Good morning, Matt.
Marcy, do you have the weighted average rate on new loans this quarter for PPP?
It was 4 -- yeah, 425.
Okay. Okay. And I guess what I’m getting at is kind of the incremental core margin based on new business, new securities at 119, new loans at 4.25. Maybe some additional security from here might be a little bit lower in that 119. Assuming kind of a similar mix of assets, I mean, do you feel like we’re kind of near the bottom here on the core NIM…
So…
…beside, but…
I know it is difficult to say, so just based on where we ended the quarter and then with the expectation that we’re going into our stronger season where we could see some additional modest deposit growth. I think that we could possibly see a little bit more pressure on our core NIM, just resulting from that mix shift.
So, again, if we see folks spending money and deposits don’t grow and we see higher loan growth that, that could change that. But I -- just on a core basis, I think, we could see a little bit more pressure. Not substantial but a little bit.
Okay. Okay. And then can you quantify the gain in other income, I’m assuming it’s about $2 million, but just want to double check, the other fee income?
Say that again, Matt, I’m sorry.
Just looking to quantify the gain in other non-interest income…
Oh! So…
This quarter, I think, it was around...
Yeah. And so that the -- only non -- I guess, non-core gain that I’d seen there. We had about a $750 million -- I mean $750,000 gain on the deposit premium when we sold that Lynnwood branch. Other than that it’s just the normal ins and outs of what we usually see in that line item.
Okay. And then just on the service charges and the fee waivers, I guess, I would have thought we’ve kind of come to the end of that at this point, but any change in strategy their rationale on waiving fees?
So, again, when we had stimulus payments come into those accounts we waived fees again this quarter, but that we’re no longer doing that. So going into the second quarter we should see that return to more normalized levels.
Okay. And then just lastly on the Round 2 of PPP, are using a five-year amortization…
Yeah.
…life or something shorter, okay.
Yeah. We’re using five.
Okay. Thanks.
Yeah.
[Operator Instructions] Our next question today comes from Jackie Bohlen with KBW. Please go ahead.
Hi. Good morning. Hi. Just a couple….
Hi. Good morning, Jackie.
Good morning, I wanted to pick up a little bit on Matthew’s question just in terms of service charges. I’m thinking about seasonality, knowing that you had a strong tourism season last year, this year equally strong if not more so I would guess. So just -- it’s hard to tell the trends because of the pandemic and how that influenced activity. So I’m wondering what your expectations are for the pick up that we might see this summer if it’s a more normalized trajectory than what we saw last year, understanding that fee waivers are stopping and there’s a couple of things at play in there?
So I think it’s really hard to say, Jackie, I agree with you, because clients have more cash in their accounts as well. And so NSF charges are down. We -- I wouldn’t expect the trend to be too much different than what we saw last year at this point. Time will tell if things, spending becomes more robust, but I would expect it to be close to what we saw last year.
Okay. Okay. And then just in terms of the strength of your customers and how that’s driving some deposit volume. To the extent that net migration continues, I would expect economic activity to be robust. Is there anything that would stop that flow and I know that this quarter had stimulus and everything involved too, but just thinking about it outside of that?
No. I don’t think there’s anything that would stop that. I mean we’re not trying to actively exit deposits from the bank.
No. And Jackie, we’re -- we usually decline in deposits in the first part of the year and our growth of deposits starts in, like, the mid-second quarter and a remainder year. So we believe with the increase in economic activity, deposit should grow.
The question is how fast do they grow and do they grow at the pace they have been growing. But there is all anticipation that deposits will continue to grow. We just don’t know how fast, because we’re entering to the normalized season where deposits grow.
And then we don’t know how fast spending will pick up as well. So it’s just kind of a new…
Okay.
…environment.
Yeah. No. I get it and I myself am just trying to wrap my arms around it. So your thoughts on that are helpful. So thank you. Everything else I had was already covered.
Thanks, Jackie.
Thanks, Jackie.
And our next question comes from Tim Coffey with Janney. Please go ahead.
Thank you. Good morning, everybody.
Good morning, Tim.
Good morning. Hey. Kevin I kind of follow up on your comments about the loan growth, I mean you’re kind of -- you’re more bullish expectations going forward as for the outlook. What do you think that translates into, say, loan growth for the rest of this year?
Well, we’re hoping that -- well, we believe definitely we will meet the mid single-digit level, depends it that we’re now kind of moving toward maybe upper single digits in our expectations of growth for this year.
Okay. Okay. And then just on the MSR recovery in the quarter, can you provide any color with that. Is that just kind of -- are you -- your expectations of a one-time thing, is it built up from previous impairments?
Well, I think, the thing is, is that we had previous impairments of last year due to the speed of prepayments and we had a write-down our MSR and we did give highlights that this year that we’d probably see a recovery of that, so that just part of writing it up and writing it down.
So the thing is that, we don’t see any more really large recoveries of impairments for the remainder of the year. But it’s just an accounting thing you have to go through where you write them down, you write them back up. So it’s just puts noise in our numbers, which we don’t like.
Yeah. So but on our prepared comments, we didn’t factor any additional recovery into the run rate of non-interest income going forward.
Yeah. Great. I just want to clear that up. Thanks a lot. Those are my questions.
Yeah.
No problem, Tim.
And ladies and gentlemen, that concludes our question-and-answer session. I’d like to turn the conference back over to management team for any final remarks.
Well, I want to thank everybody for your questions. As always, we welcome calls from our investment and analysts. Please reach out to us, if you have any follow-up questions. Again, thank you for tuning in today and good-bye.
Thank you, sir. This concludes today’s conference call. We thank you all for attending today’s presentation. You may now disconnect your lines and have a wonderful day.