First Interstate BancSystem Inc
NASDAQ:FIBK
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Earnings Call Analysis
Q2-2024 Analysis
First Interstate BancSystem Inc
In the second quarter, the company reported a net income of $60 million, equating to $0.58 per share. This figure aligns with company expectations and reflects a stable operational environment. The net interest margin expanded by 7 basis points to 3%, indicating effective management of interest-earning assets. The decrease in nonperforming assets by 7.7% suggests an improvement in asset quality, positioning the company favorably as it heads into the latter part of 2024 and into 2025.
The company has emphasized expense control with total expenses coming in better than anticipated, largely due to prudent salary management and lower-than-expected medical expenses. Noninterest expenses declined by $3.3 million to $156.9 million, a reduction attributed to effective cost management and strategic hiring. Looking ahead, while the third quarter may witness a normalization in medical expenses, the guidance suggests noninterest expenses will be maintained at a rate of approximately $160 million per quarter, with slight increases expected due to inflation.
The company's treasury service income increased by mid-single digits, aided by enhancements that improved customer relationships. Overall noninterest income also saw a slight rise to $42.6 million, which is a 1.2% increase from the prior quarter. Despite challenges in the mortgage segment, the company projects net interest income to grow by 3% to 5% in the second half of the year compared to the first half, buoyed by anticipated improvements in the net interest margin.
Deposits grew by $60.7 million this quarter, although a sizable part of this increase was attributed to a single large customer deposit, suggesting a potential plateau in growth for the third quarter. The company expects overall deposit levels to remain relatively flat against quarter-end balances for the remainder of the year. The loan-deposit ratio stood at 79.7%, reflecting a stable liquidity profile amid changing economic conditions.
The company’s outlook on credit quality remains cautiously optimistic with a decrease in net charge-offs to $13.5 million. Specific reserves were adjusted concerning a nonperforming commercial and industrial loan, but overall provisions for credit losses were adequate given the improving asset quality. The allowance for credit losses increased slightly, and the company is actively managing its exposure to nonperforming loans, anticipating a resolution for at least one troubled asset later in 2024.
CEO Kevin Riley announced his upcoming retirement after 11 years, signaling a transition period that the Board plans to navigate carefully. They have engaged an executive recruiting firm to find a successor, but the current strategy remains unchanged as the Board seeks to maintain growth and possibly pursue acquisition opportunities in the future. Investors should keep an eye on how this leadership transition might influence strategic initiatives in the coming months.
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Good day, and welcome to the First Interstate BancSystem, Inc. Second Quarter Earnings. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions] I'd now like to turn the call over to Andrea Walton. Please go ahead.
Good morning. Thank you for joining us for our second 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 contained in our most recent annual report 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 most 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 of the 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 regarding our use of the non-GAAP financial measures may be found in the body of the earnings release, and a reconciliation to their most directly comparable GAAP financial measures is included at the end of the earnings release for your reference.
Joining us from management this morning is 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'll turn the call over to Kevin Riley. Kevin?
Thanks, Andrea. Good morning, and thanks again to all of you for joining us on our call today. Again, this quarter, along with our earnings release, we have published an updated investor presentation that has some additional disclosures, which we believe will be helpful.
The presentation can be accessed on our Investor Relations website. And if you have not downloaded a copy yet, I would encourage you to do so.
I'm going to start today by providing an overview of the major highlights of the quarter, and then I'll turn the call over to Marcy to provide more details on our financials. So let's get to our results.
We generated $60 million in net income in the second quarter or $0.58 per share. We continue to execute well in the second quarter, and our results were generally in line with our expectations, including a 7 basis point expansion in our net interest margin to 3%.
We were pleased to see improvements in criticized and nonperforming asset metrics. Our capital and liquidity position remains strong, and our allowance for credit losses is sufficient for our credit profile. All these factors, along with our anticipation of steady expansion in our net interest margin, reinforces our belief that we are well positioned for the remainder of 2024 and into 2025.
Expense control remains a key tenet for us, and our expenses came in better than we expected in the second quarter. This was driven primarily by the ongoing prudent management of our base salaries. Our medical expenses continued to run below expectations and as I said, our persistent focus on controllable expenses. We have managed the expense reductions while, at the same time, continuing to make internal investments into our systems and our people.
Last quarter, we said one of our focal points for internal investment is treasury solutions, and we are seeing early success in that area. Our treasury service income, which is a component of our service charges on our deposit accounts, increased by mid-single digits in the second quarter, which helped us meet our expectations for our fee businesses overall.
Within this line of business, our enhancements are helping us better serve our customers and improve our relationship banking model. We remain optimistic about future successes in this area.
We recorded $42.6 million in noninterest income in the second quarter, which is an increase of 1.2% from the prior quarter. Our asset quality improved in the second quarter. Criticized, classified and nonperforming loans all declined in the period, and nonperforming assets declined by 7.7%. In the previous 2 quarters, we discussed 2 large nonperforming loans. And Marcy will give you an update on those in a moment.
Now on to deposits. Our deposits increased by $60.7 million in the second quarter. I want to note that this end-of-period figure did include one customer deposit that was larger than normal at period end, which will partially impact our seasonality and mute our third quarter growth. This impact is incorporated in both our deposit and NII guidance.
Asset repricing is the driver of our forward margin projections, and we are not assuming any immediate material decrease in our deposit cost. Our liquidity remains stable and healthy with our loan-deposit ratio of 79.7% at quarter end.
Before I turn the call over to Marcy, I want to take the opportunity to announce that we have just added 2 strong talents to our risk management team. The first is Matt Koukas, who will succeed Michael Lugli as our Chief Credit Officer when Mike retires in September. Matt has over 25 years of experience in this field, most recently as the Chief Credit Officer of Transaction Banking at Goldman Sachs.
We have also hired a new Director of Fraud Risk Management, who brings many years of experience in this area, most recently in creating fraud programs for 2 fintech start-ups. Both of these very accomplished individuals are a great fit for our team.
And now I'd like to turn the call over to Marcy for some details on our financials.
Thank you, Kevin. And as I walk through our financials, unless otherwise noted, all of the prior period comparisons will be with the first quarter of 2024, and I'll begin with our income statement. Our net interest income was $201.7 million in the second quarter, an increase of $1.6 million. Our yields on interest-earning assets increased 6 basis points quarter-over-quarter driven by an increase in loan yields, an improving mix shift and a reduction in investment securities. Our total cost of funding declined by 1 basis point, fueled by a lower average borrowing mix.
The net interest margin inflected as we were anticipating for the second quarter. As Kevin mentioned, our net FTE interest margin is 7 basis points to 3%. Excluding purchase accounting accretion, our net interest margin was 2.92%, an increase of 8 basis points from the prior quarter. We continue to expect increases in our net interest margin of approximately the same magnitude sequentially in the third and fourth quarter, which is incorporated in our guidance.
Again, this quarter, we anticipate that loans for the full year will be relatively flat, and we intend to use the runoff from our investment portfolio to reduce borrowings. This suggests that our interest-earning assets will decline slightly through the remainder of the year.
When we consider this, alongside the trajectory we foresee in our margin, we believe net interest income will increase 3% to 5% in the second half of the year over the first half of the year. You should note that we have revised our rate forecast a [ 1 25 basis point ] rate cut in the fourth quarter. We view our balance sheet as relatively neutral, moving toward a more liability-sensitive position in 2025 as our term borrowings begin to mature. This gives us strong flexibility in light of current rate expectations.
For the last several quarters, we have discussed the impact of our undrawn commercial construction line and, in particular, our belief that the negative impact on our margin will subside further in the second half of the year. This quarter reinforced that view.
Total unfunded lines at the end of the quarter were just over $400 million at a weighted average rate of approximately 6%. We do not anticipate the unfunded balance will move materially lower from this point forward as ongoing production will keep us right around this level. As new production continues to occur at market rates, the weighted average rate will continue to normalize.
Noninterest income was $42.6 million in the second quarter, an increase of 1.2% over the previous quarter. Improvements in our fee businesses remain a priority for us.
So as Kevin said, we're pleased with the early positive movement in treasury solutions. However, mortgage remains a challenge, and we're still experiencing minimal volume in our mortgage business. We expect this to continue through 2024, and that view is incorporated into our guidance.
Moving to expenses. Noninterest expense, as Kevin also mentioned, declined in the second quarter by $3.3 million to $156.9 million. Our medical insurance expense has remained consistently below our expectations so far this year, contributing to the lower reported level in the quarter. We anticipate this will normalize in the third quarter, which is also incorporated into our guidance.
We have maintained focus on managing our staffing levels while selectively making strategic hires. And we have reduced controllable expenses while investing in our businesses where needed.
We also had a onetime expense reduction in the second quarter in the form of a tax credit reclassification, which is the result of a change in accounting guidance. This reduced expenses by approximately $1 million over the prior quarter, which had a net 0 effect on net income as the reclassification moved dollar per dollar from the expense line to the tax line. On a go-forward basis, this reduces noninterest expense and increases taxes by about $500,000 per quarter versus prior expectations.
Our tax rate, which we are projecting to be 23.5% to 24% incorporates this treatment moving forward. In summary, net income increased by 2.7% over the prior quarter to $60 million.
Moving to our balance sheet. Loans and deposits increased modestly in the second quarter. Loan balances increased by $32.2 million. Construction loans declined as several loans moved to permanent financing, but that was offset by an increase in $130.7 million in our commercial and industrial balances. This reflects our emphasis on smaller C&I and owner-occupied customers, where we see the most potential to garner full customer relationships, along with a seasonal increase in line draws.
Deposits increased by $60.7 million in the quarter. As Kevin noted, this did include one larger-than-usual customer deposit in our ending balances. We anticipate overall deposits to be relatively flat from quarter-end balances through the end of the year.
Moving to credit. Net charge-offs for the quarter were $13.5 million. About half of that amount was due to one specific metro office property credit for which we were fully reserved. Total provision expense for the quarter was $9 million, and our ACL coverage increased 3 basis points in the quarter to 1.28% of total loans.
Now for an update on the 2 nonperforming loans Kevin mentioned. We disclosed in the first quarter that we had moved the C&I credit to nonperforming loans. Based on the third-party valuation, we further increased the specific reserve for this credit in the second quarter. We are still working closely with management of this entity to resolve the situation.
The other nonperforming loan that Kevin mentioned is an agricultural relationship that we discussed during our fourth quarter 2023 earnings call. This quarter, we received a partial paydown on this relationship and completed a restructure on the balance of the loan. This has supported our optimism about a positive resolution of this credit later in 2024.
I also want to touch briefly on our metro office exposure, which we define as nonowner-occupied and construction office loans located within major cities. Our exposure to this category is about 65 basis points of total loans, having declined modestly from our prior disclosure at the end of the third quarter of 2023. During that same period, our total commercial real estate general office exposure, which we define as both nonowner-occupied and construction general office properties, declined to under 4% of total loans.
Moving to capital. We saw continued improvement in our ratios in the second quarter with our common equity Tier 1 capital increasing 16 basis points to 11.53%. Tangible common equity was slightly higher at 6.95%. And we declared a dividend of $0.47 per share or a yield of 7.1% for the second quarter of 2024.
And finally, I did want to comment briefly on the material weakness that was included in our 10-K. We are glad to report positive progress in this area, and we'll include additional detail when we file our 10-Q next week.
And with that, I'll turn it back to Kevin. Kevin?
Thanks, Marcy. Our quarter was characterized by stability, and we are pleased that the results were in line with our expectations. We are positioned to manage rate movements well. We are optimistic about our ability to generate improved returns from this point forward.
The combination of our ongoing margin inflection, expense discipline, stability in our core asset quality and the balance of our allowance for credit losses provides us with confidence in our ability to generate improving return metrics over the coming quarters, positioning us well as we move into 2025.
I would like to wrap up with the recent news about my intention to retire. I am deeply proud of what we have achieved during my 11 years at this great company, but I'm ready to start a new chapter of my life. The Board has retained a leading global executive recruiting firm to conduct a thorough and comprehensive search for the next CEO, and we will provide updates as appropriate. Under this transition plan, I will continue to serve as President and CEO until a successor is appointed and then be available as an adviser as requested.
And now I would like to open the call up for questions.
[Operator Instructions] We'll take our first question from Andrew Terrell with Stephens.
Maybe just to start on the noninterest-bearing deposits, I'm just trying to get a sense -- I appreciate the commentary that maybe the end of period was inflated a little bit. I'm just trying to get a sense for what you view as maybe like the starting point for the third quarter. Like how much would you characterize as being outsized in the balances we can see in this period?
So overall, for the year, Andrew, we think noninterest-bearing deposits on average are going to just run in that 26% range, excluding the lumpiness from that deposit.
Okay. Got it. So just model [indiscernible] at 26%.
Yes.
Okay. And then I wanted to ask on just credit. The -- if I back out that $6.8 million, you call this the construction charge-off in the quarter, still these gross charge-offs are roughly $10 million or so. What made up the rest of the gross charge-offs we saw in the quarter?
It just was really just various -- we always have about $3 million in consumer and just...
And then just some various other ones.
Yes, just various other ones, nothing large.
Okay. And then, I mean, last quarter, we talked about like comfortability with the C&I loan. Obviously, you got the third-party valuation that maybe prompted the specific reserve this quarter. I guess from your lens, has the credit deteriorated at all since we discussed last quarter?
And then as a follow-up to that, if you're -- looking at the charge-off guidance, if you're excluding it from the charge-off guidance, should we assume that means you think there's at least a chance of like kind of lumpier charge-offs here later this year?
What you said, we agree with.
Yes. I think that there's a pretty good chance that we'll end up charging off a healthy portion of that loan that we're fully reserved for.
Okay. I understand. And can you speak to anything that, specific, has changed the view of this credit?
Well, we just get -- keep on getting information. As we ultimately said from the beginning, Andrew, is that we were hoping that they would right the ship and sell the company, and that's what we're kind of still looking at same progression of selling the company.
I think what we're seeing is maybe the valuation could be a little different than we anticipated from the get-go. So that's why we're looking at probably a little bit larger maybe loss.
But the same direction is happening. It's just that we're looking at trying to be more realistic. And as we've proven in the past, we take our lumps early, we take them quick and we try to get things behind us. We don't try to kick the can down the road. So we're taking a really worst-case scenario here, and we hope it can be better, but we're making sure that we're well positioned to take care of this credit.
Understood. Okay, even with kind of a charge-off potentially later this year, you do feel like you're well reserved with the reserve for it this quarter?
That's correct.
Okay. I appreciate it. And Kevin, congrats on the retirement. I hope you have a lot of fishing trips planned.
I got to do better than the last time I was out with you.
We'll go next to Matthew Clark with Piper Sandler.
On that larger C&I nonperformer, can you just quantify how much in reserves you have set aside against it?
We're not going to disclose that, Matt.
I'm just trying to forecast the charge-off that we might see, that's all, which is going to come out of reserves.
Yes. The thing is it's not going to -- it should not affect earnings. So I think that when you're trying to look at earnings, you can just say that's not -- it shouldn't have an impact on the earnings stream.
Understood. Just trying to forecast it. Okay. And then on the core NIM, I think the guide was that the reported NIM expansion continues at a similar pace, accretion step down in the second half. But can you just speak to the core NIM and maybe the June average core NIM?
So on the core NIM, we expect the same trajectory that we would continue to see expansion there. The June NIM was 2.95%. The core NIM was 2.95%.
Okay. And then deposit cost increase was similar, at least interest-bearing, to last quarter. Do you have the spot rate on interest-bearing deposits?
At the end of the quarter -- for June, it was [ 1 97 ].
Okay. Okay. And then on the -- on M&A, I assume it's fair to assume that there's no interest in M&A at this stage given your transition, Kevin?
At this point, yes, I would say that. But I would say that we're still in contact. Hopefully, we'll get a CEO that it picks up the time and moves this company forward just as it has been moving forward. So I don't want to think that we're going to change our trajectory much. But at this point, I would say that if I was a selling company, I don't know if I want to sell into a departing CEO. So things are pretty much a little bit on hold at this time.
But the Board's made it very clear that they expect that to still be part of our strategy going forward that we would be an acquisitive company.
We'll hear next from Jared Shaw with Barclays.
Kevin, congratulations on the next step as well. Looking forward to seeing what that looks like. Maybe just a couple of follow-ups here. When you look at the deposit side, what are you expecting for CD retention and sort of what's the repricing trend there? And I know you said you're not expecting to see significantly lower deposit costs as rates move lower. Does that mean that maybe with the DDA normalization, we should expect to see time deposits return to growth?
No. I don't think you're going to see return -- pretty much flat, Jared, from this point forward.
Yes. And I think we'll see CD balances pretty stable.
Yes.
Okay. But what should we expect, I guess, for deposit beta on the way down? Maybe if we look at that first 25 basis point move and then after that, what -- how aggressive do you expect to be on being able to reprice some of that?
Well, first of all, Jared, about 18% of deposits are indexed to short-term rates. So they will immediately move when rates come down a quarter. I would say there's probably going to be a little bit of a lag with regards to CD repricing down even though about 90% of our CDs reprice in a 12-month period because they're shorter term. I would just say that, that's going to be a little bit more of a lag of repricing down, but the money markets will move immediately.
Again, in the way up, we didn't really change a lot of our rack rates. A lot of our customers moved over to the index money market, which by contract, it goes down when rates go down.
Okay. Okay. And then on that large deposit that you mentioned, is the expectation that, that was -- is sort of a temporary move in and that, that could move out or just that we shouldn't expect that level of growth again going forward?
It was a temporary. It moved in, and it moved out. It's a [indiscernible] then it comes and goes, and it was just a little bit larger at quarter end than normal. So it comes in and goes out periodically. And we don't control the timing of it, but it's bumpy, and the bump was at quarter end.
Okay. Okay. And then Marcy, you mentioned about you're not expecting to see a growth in the undrawn commitments on -- or I'm sorry, growth in the -- yes, the undrawn balances on construction, but pricing is going higher. Where is pricing now on new construction lines?
Yes. So on construction, on average, our loan is around 7.5%. Construction is a little bit higher than that.
Okay. Okay. And then just finally for me, I guess, what's the securities cash flow on a month that we should be thinking could be going towards paying down the wholesale?
Jared, that's in the investor deck by -- in detail. So I can't remember what page it's on but...
Slide 12. Okay. All right. I see that. Yes, yes. Okay.
Yes.
We'll turn now to Chris McGratty with KBW.
Marcy, a question for you on expenses. If I take the new guide, it roughly maps about 160 a quarter. If we go into next year, is there any reason why this isn't the right run rate to jump off and maybe put a low single-digit inflation rate on that, anything would point us either way?
Yes. So I think I would go up a little bit from 160 a quarter. I think it'll be a little slightly higher than that. But yes, then that should be a pretty good jump-off rate.
And we'll go next to Timur Braziler with Wells Fargo.
Just circling up again on that larger C&I credit as it moves to resolution, I'm just wondering if it is charged off, reserves come down. Is the anticipation that those reserves are kind of backfilled? Or is it okay to see that allowance ratio maybe trend a little bit lower as that loan is resolved?
The allowance ratio will come in a little bit lower. As you look at our actual asset quality outside is large. It's improving every quarter. Credit is down for the third straight quarter. So our asset quality continues to improve, and the allowance is reflecting that as well as the specific reserve on this larger credit.
Okay. And then the linked quarter reduction in the unfunded reserves, maybe just talk to what the driver there was.
I mean just normal funding of the -- oh, on the unfunded reserves -- oh, I'm sorry. [indiscernible] okay. Yes, it was just that we review an annual review of our methodology. And again, reserve -- unfunded reserves came down. A review of our methodology, it just kind of drove that change.
But the [indiscernible].
And then -- okay. And then just maybe lastly for me, just looking at balance sheet size. I mean there's pretty good opportunity on the bond repricing or at least the bond maturities. I know you had mentioned that's going to go towards paying down wholesale funding. I guess as you're looking at overall demand on the asset side, when do you think the balance sheet is going to stabilize here and start showing some inflection higher?
Well, I think it could change -- it would actually show a difference in mix. I think it's a balance sheet -- I think that what we're hoping for is the investment portfolio will continue to shrink, and the loan portfolio would start to expand. So that would help earnings also.
But I think the thing is in deposit growth, hopefully, deposits stabilize and start growing a little bit so we can pay down things. So I would say hopefully, in '25, there's -- interest rates come down, the economy picks up a little bit, it becomes a little bit more robust. And that starts shifting in the first part of '25, not the second part of '25.
Yes, kind of as we talk to our bankers, one of the things they feel like people are on the sidelines as far as the election, kind of see the outcome of the election, waiting for the economy to be -- the trajectory to be a little bit more clear. And so I think as kind of all of that settles out, we'll begin to see some loan growth.
And as there are no additional questions at this time, I'd like to hand the floor back over to Kevin Riley for any additional or closing comments.
Well, I'd like to thank everybody for their questions. And as always, we are welcome for calls from our investors and analysts. So please reach out to us if you have any follow-up questions, and I want to thank everybody for tuning in today. Goodbye.
Once again, ladies and gentlemen, that will conclude today's call. Thank you for your participation. You may disconnect at this time.