First Interstate BancSystem Inc
NASDAQ:FIBK
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Earnings Call Analysis
Q3-2023 Analysis
First Interstate BancSystem Inc
In the latest quarter, the company has exhibited a level of stability, with net income rising to $72.7 million, up 8.5% from the previous quarter. This growth comes despite headwinds such as a decrease in net interest income by $4.7 million due to cost of funds outpacing yield on assets, compounded with a 5 basis point decline in net interest margin to 3.07%. Ambient caution lingers, as the margin is anticipated to remain stable or modestly decline, which is likely to result in a corresponding decrease in net interest income for the next quarter.
The company has navigated through various market pressures, seeing a $2.1 million reduction in noninterest income. However, they've managed to reduce reported expenses by $2.8 million from the prior quarter. Looking ahead, both noninterest income and expenses are expected to hover around the same levels experienced in the third quarter.
The balance sheet reflects prudent adjustments in the face of a dynamic environment. While loans held for investment shrank by $50 million, deposit growth increased by $100 million, and regulatory capital ratios improved. The decisive management actions support the announced dividend per share of $0.47, which appears secure without immediate threats prompting a reduction.
As the company enters budgeting for 2024, the emphasis on controlling expenses while recognizing the current challenges in revenue growth is paramount. They plan a meticulous review of all expenses and the introduction of complementary products like the new suite of credit cards. In terms of lending, a sluggish market leads to the expectation of loan volumes remaining flat, with a careful balance between growth and credit selectivity highlighting a commitment to asset quality.
The company has seen a fair recovery in credit quality, as highlighted by a $3.2 million recovery from a legacy deal. While substandard loans increased by $28 million, it is attributed to normal credit migration with no significant leading indicators of deterioration. Going forward, credit quality is predicted to be stable or improve slightly, in line with the management's conservative approach to credit risk.
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Good morning, ladies and gentlemen, and welcome to the First Interstate BancSystem, Inc. Third Quarter Earnings Call. [Operator Instructions] This call is being recorded on Thursday, October 26, 2023.
I would now like to turn the conference over to Andrea Walton. Please go ahead.
Thank you. Good morning. Thank you for joining us for our third 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 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 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 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'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.
In this challenging banking environment, First Interstate draws strength from our franchise value and from the robust flexible balance sheet we have carefully built. We have seen stabilization on both sides of the balance sheet over the past quarter, and we continue to carry no broker deposits. We have reduced noninterest expense. We have increased spreads on new loans. We have paid down borrowings. In short, we have controlled the things that are in our power to control and position the bank to respond to appropriate opportunities when they arise.
In the third quarter, we generated $72.7 million in net income or $0.70 per share. This is an increase of 8.5% from the previous quarter. We achieved modest deposit growth in the period and continue to see improved risk-adjusted spreads on new loan production. The new loan production rate, excluding draws on construction lines, increased roughly 40 basis points from the previous quarter to around 7.5%. We have achieved stability in our net interest margin and generated improvements in both asset quality and capital ratios.
With that, I'll turn the call over to Marcy to provide some additional details around our third quarter results. Go ahead, Marcy.
Thanks, Kevin, and good morning, everyone. As I walk through our financial results, unless otherwise noted, all of the prior period comparisons will be with the second quarter of 2023. I'll begin with our income statement. Our net interest income decreased by $4.7 million as the increase in our average yield on earning assets was outpaced by the increase in our total cost of funds. This was partially offset by a $600,000 increase in purchase accounting accretion quarter-over-quarter. Our reported net interest margin was 3.07%, a decrease of 5 basis points from the prior quarter. This is significantly less than the 24 basis point decrease we saw in the second quarter.
Our adjusted net interest margin excluding purchase accounting accretion, also decreased by 5 basis points from the prior quarter to 3%. This is stable to our exit rate last quarter as we expected. From here, the margin is expected to remain relatively stable to modestly lower in the fourth quarter with earning assets also slightly lower than in our third quarter reported results. We expect this, in turn, to lead to a modest decline in net interest income in the fourth quarter.
Our total noninterest income decreased $2.1 million quarter-over-quarter as we face pressure in the mortgage and payment service businesses. We expect noninterest income to be similar to third quarter levels in the fourth quarter, generally reflecting our core fee run rate. While we expect continued pressure in the mortgage origination environment, our newly restructured mortgage business allows us to process volume more efficiently and with improved profitability. So while demand remains minimal in the near term, as the environment improves, we can now respond to increasing demand more profitably.
Moving to total noninterest expense. Reported expenses declined $2.8 million from the prior quarter as salaries and wages declined in the period. This was generally due to the severance expense we noted in the prior quarter, lower expenses from the mortgage business and a lower incentive accrual. We anticipate a similar level of expenses in the fourth quarter.
Moving to the balance sheet. Loans held for investment decreased by $50 million from the end of the prior quarter. Our outstanding commercial construction lines totaled just under $900 million at the end of the third quarter at a weighted average rate of approximately 5.5%. This represents about a $200 million decline from the prior quarter. The securities portfolio declined by $288 million in the quarter due to normal amortization with a modest impact from higher unrealized losses.
On the liability side, 3 developments underscore the stability of our balance sheet, a reduction in short-term borrowings of $522 million, an increase of $100 million in total deposits and a moderation of our mix shift out of noninterest-bearing deposits. Let me reiterate that we have no broker deposits on the balance sheet.
Moving to asset quality. Nonperforming assets decreased by $11 million and criticized loans decreased by $8.7 million from the prior quarter. This is in keeping with our principle of addressing credit matters as they arise as you've seen us do in the past. We continue to have limited exposure in metro office commercial real estate and the remaining portfolio is performing well. As a note, we have de minimis exposure to syndicated national credits and by de minimis, I mean 2 credits for a total of $6 million, and we do not participate in that market. While our allowance for credit losses was up 1 basis point to 1.24% of total loans held for investment, our total provision expense was essentially 0. Net charge-offs in the quarter were minimal at just $1.1 million or 2 basis points of average loans. Our coverage rate of nonaccrual loans increased to 268% in this period.
Finally, all regulatory capital ratios strengthened in the third quarter as we continue to manage our risk-weighted asset exposure, and we were pleased to announce our $0.47 dividend per share. Tangible book value declined slightly as the AOCI position expanded and offset retained earnings. Going forward, our strong capital position gives us the flexibility to take advantage of market opportunities and to remain dedicated to serving the needs of our customers and attracting new households to the bank.
Now with that, I'll turn it back over to Kevin. Kevin?
Thanks, Marcy. Now I'll wrap up with a few comments on our outlook. We expect our fourth quarter results to continue to display the stability we have achieved. As we complete our 2024 budgeting process, we understand the operating environment that we're heading into. With revenue growth being a challenge, we know the importance of expense control. We are taking a hard look at this, and we'll be able to provide more detail in this regards on our next call.
Given the strength of our franchise and flexible balance sheet, we are well positioned to continue to protect shareholder value during these challenging times. Going forward, we will remain devoted to serving our existing customers with complementary products and services, such as the new suite of credit cards we just launched in August. We will continue to capitalize on the strength of our markets to grow our client base. In all our efforts, we will continue to enhance the strength of our high quality, resilient franchise.
So with that, we'll open up the call for questions.
[Operator Instructions] And your first question comes from Matthew Clark from Piper Sandler.
First one for me is around your deposit beta outlook. I think in the release or in the deck, you guys talk about your expectations to be in the low to mid 30s in 4Q. How do you think about you're through the cycle in interest rate deposit data, assuming the Fed is done, I mean, do you settle out in the mid-30s, do you feel like there's some lag effect there?
Yes. That's kind of what we're seeing, yes.
Yes. I think low to mid-30s by the end of the year. And depending on the mix shift, it could go slightly higher into next year.
Yes, to the mid-30s as the time moves.
And then just the NII outlook. As we look into 1Q, you have a big slug of securities coming due and just your thoughts around how the margin might benefit there? Look, it seems like we would have an uptick in the NIM there and maybe NII could trough or even maybe stabilize? Is that a fair way thinking about it?
I think, Matt, it's a fair way of thinking about it. I think that you'll see a little bit slight come down in the fourth quarter and then probably a stabilization in the first. So we see it growing in the back half of 2024.
And then just the -- your net charge-offs, it's great to see them come down a lot. Can you speak to the recoveries you had there? Just trying to get a sense for normalized expectations going forward.
We'll have Michael, our Chief Credit Officer, to answer that question, Matt.
Good morning, Matt. the recovery was centered on legacy Great Western Bank hospitality deal. The total recovery was $3.2 million. So that helped offset. And if you remember in the prior quarter, our charge-offs were elevated, but that was primarily due to one credit. So I think hopefully, that answers your question.
Your next question comes from Chris McGratty from KBW.
Kevin, you alluded to a close eye on the costs. What exactly are you looking at? I assume it's broad, but branches businesses, repositioning of the balance sheet. What -- how should we be thinking about this?
Well, it's not really reposition and balance sheet as much. We're just looking at exactly what you said. We're looking at branches. We're looking at business units. We're looking at...
All expenses.
All expenses are on the table. I will tell you we're going to go into a very in-depth look at every one of these expenses to see if they are a must have or can we do something with it.
And would the goal for that be manage expenses, the growth rate off of this year to a lower level or just outright declines from...
Absolutely. That's exactly what our goal is.
So limit the growth versus absolute decline. Is that right?
Right.
Okay. And then maybe on the balance sheet, Marcy. The securities cash flows kind of pick up early next year. At what point are we thinking -- are you thinking about -- because you do have a loan-to-deposit ratio flexibility. When do you think about reinvesting bonds, cash flows in the bond book?
You know what we're looking at potentially doing small incremental reinvestments at this point. We're just kind of evaluating our options and where we can get potentially yields over our cost of funds.
Your next question comes from Andrew Terrell from Stephens.
First one to start on credit quality. I mean everything look good this quarter. The one thing I did want to ask about was the substandard loan bucket was up about $28 million or so this quarter. Any color on what drove the build in substandard?
I think is just a migration from watch to substandard. But the good news is that the leading indicator watch didn't go up that much. So it's just a normal migration sometimes.
Yes, there was nothing unusual. Kind of a few upgrades, a few downgrades, nothing unusual in the quarter.
Okay. Got it. And then just looking through the presentation, it looks like the slide on loan portfolio repricing was removed this quarter. I know it was in the last quarter presentation. It feels like the repricing kind of opportunity for you guys over the next year or so has been a big part of the narrative recently. Any reason specifically for removing that slide from the presentation? And can you just remind us how much in either adjustable or fixed rate credit you've got that reprices or matures over the next 12 months and what the yield pickup could look like?
So Andrew, we were really seeing that, that slide was creating a lot of noise. When we looked at the variance in where folks had our NII we believe that was attributed to that. So we are just going back to saying, here's what we expect earning assets to be. Here's where we expect NIM to be. Here's what we think deposits are going to do. So that was the reason for that because we think it was creating a lot of confusion and noise. In terms of variable, it's just over 20% of the loan portfolio and fixed is about 60%.
Okay. Totally appreciate that. Then last question for Kevin, just on the guidance for loans to be flattish in the coming quarter. Just wanted to get a sense of how much of that is a result of kind of slower growth across the industry right now versus you maybe being a bit more selective on the incremental credit you're willing to put on the balance sheet?
Well, we've always been selective when we refer the balance sheet. But I will tell you that the main reason why it's flattish is just due to the fact that we believe that there's not a lot of robust activity taking place right now in our markets, things are slowing down. So it's just a sluggish environment right now.
Your next question comes from Zach Westerlind from UBS.
It's Zach on for Brody. I just had a quick one for you. Are you able to share the amount -- the dollar amount of loans that are going to reprice over the next 12 months and any yield pickup associated with that?
So Zach, as Andrew just noted, we did take that out of our presentation. I really think that we're going to give earning asset guidance and NIM guidance and let you guys sort that out.
Your next question comes from Jeff Rulis from D.A. Davidson.
Just wanted to go back to credit for a minute. I just wanted to -- obviously, the jump-off point from 2Q on the nonperformer increase pretty firm that you'd see some improvement. Just wanted to see if that's largely complete or we talk about from 3Q to the [indiscernible] Potentially further NPA or criticized balance declines? Or was that largely cleaned up from the second quarter?
I would say that we see things really stable to maybe a slight improvement going into the fourth quarter. We do not see where it should deteriorate. So I would say stable to slight improvement.
And then kind of doubling back to expenses. Was there anything onetime in there? I mean, I know that you mentioned Q2 was a falloff in comp that was expected. But -- and I guess, you're pointing to a similar level in Q4 as you had in Q3. But anything kind of on the lower ebbing that might come back up?
The thing is, I think, in Marcy's remarks, I think she talked about it pretty good. I mean there was a onetime item last quarter of severance. We also then had the reduction of the mortgage staff that was going to be in the run rate. And then there is a little bit of incentive accrual reduction or reduced, but I would say most of it is the run rate stuff versus any kind of one-timer.
It sounds like seasonality trends will fluctuate, but a pretty managed expense message is what we're taking. Last one would be on the dividend outlook, I mean you're close to 70% of earnings payout this quarter with 0 provision. Just interested in the conversations you have with the Board in terms of that payout as you look at future earnings expectations?
We look at the dividends, there's no catalyst at this point that would make us look at cutting our dividend at this juncture.
[Operator Instructions] And we have a follow-up question from Chris McGratty from KBW. Chris?
Just on credit, a couple of housekeeping items and an opinion, I guess. Do you have Marcy, what's left on the acquired loans, the mark on the acquired loans?
You know, no. I mean, I'm not sure exactly what you're talking about. If you're talking about the remaining accretion, is that what you're asking about?
Well, just the mark -- the day one mark and how much has been accreted out, yes, I guess, is what I'm asking?
The credit mark.
I'll take whatever you have at your fingers.
So just to be clear, the credit mark just both -- it now is in the normal provision. And so we don't -- that's not tracked anymore. But the purchase accounting accretion, it actually is in the deck, the remaining purchase accounting accretion, on Page 12.
Okay, I will grab that. And then more broadly, how should we think about -- there's a lot of questions this quarter about just normalizing credit for the industry. Maybe an opinion on how you view or you would see as like a normalized range for charge-offs for the company?
We've typically seen between 20 and 25 basis points on a normalized range. We haven't experienced that recently, but that would be normalized.
There are no further questions at this time. I'll turn it back to Andrea for closing remarks.
Thank you for your questions. And as always, we welcome calls from our investors and analysts. Please reach out to us if you have any follow-up questions. Thanks for turning -- tunning into the call today. Thanks. Bye.
Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.