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Good morning and welcome to First Interstate BancSystem's Fourth Quarter 2017 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please also note today's event is being recorded.
I would like to turn the conference over to Margie Morse. Please go ahead ma'am.
Thanks, Rocco. Good morning. Thank you for joining us for our fourth quarter earnings conference call. As we begin, it is worth noting 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 address 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 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 are Kevin Riley, our Chief Executive Officer and Marcy Mutch, our Chief Financial Officer; along with other members of the management team.
At this time, I'll turn the call over to Kevin Riley. Kevin?
Thanks, Margie. Good morning and thanks again, to all of you for joining us on the call today. I'm going to provide an overview of the major highlights of the quarter, and then have Marcy provide more detail on our financials. Marcy and I are traveling for an investor conference and members of our teams are calling from around the country. So please be patient if we suffer any technical difficulties. We're not expecting any but we could have some.
In the fourth quarter we saw a continuation of the positive trends in our earning power. Most notably we saw solid loan growth, stable deposit cost and improved asset quality. On a reported basis, we had earnings per share $0.61 this quarter, with merger-related expenses having about $0.04 negative impact. I'm most pleased with the improvement that we had in organic loan growth and which is typically in a seasonally slow quarter for us. In the fourth quarter, we grew loan by $62 million or 3.3% in our annualized basis as compared to the fourth quarter 2016, when loans declined $52 million.
The two strongest areas of growth were commercial loans, which were up 2.5% for the quarter and commercial real estate loans which were up 2.3%. From a geography perspective both our Mountain and West division made meaningful contributions to our loan growth this quarter. The improved loan production reflects our renewed focus on business development including increasing our calling efforts and doing a better job of capturing high quality lending opportunities at our markets. Our pipeline is strong which gives us great optimism for 2018.
Turning to liability side of the balance sheet, deposits remain stable and we had another very good quarter in terms of [indiscernible] our deposit cost. Our total cost of funds was flat for the quarter at 29 basis points. We have been able to keep our deposit cost stable over the second half of 2017, while still paying a very competitive rate within our markets. This has been a key factor in the margin expansion we saw in the second half of the year. We certainly expect to see more pricing pressure as rates continue to rise in the future. But we anticipate our deposit beta will remain at a lower level than what we had beginning of this tightening cycle.
I'm also excited about the restructuring we've done within our executive leadership team. As you may have seen last week, we announced some significant changes including Jodi Delahunt Hubbell, who'll now serve as our Chief Operating Officer with the former responsibilities of overseeing our company's operational functions. Renee Newman who has been appointed our Chief Banking Officer with formal responsibilities for managing all of our client facing channels. Bill Gottwals will have an expanded role as Director of Banking with responsibility of overseeing our greatest network across our entire footprint allowing us to provide clarity and consistency across the company.
One of the encouraging things about this realignment is that it started from the ground up, with the executive team discussing how we can make this company better. We believe this new structure provides additional clarity around rules and responsibilities and captures on individual strengths of team members; enables us to align and focus of our two divisions and improve our business development capabilities. I'm incredibly optimistic about this team and our future. I'm confident we have the right people in the right roles focused on the right priorities. Throughout our organization we have some of the best people in banking and we're starting off the year strong.
Lastly before I turn the call over to Marcy I want to talk about the recent tax reform and the commentary you've been seeing about how banks and other companies are spending some of their benefits from tax reform because we've always invested in these areas. We played on tax benefit to increase earnings. Let me spend a couple minutes on my soapbox. We operate the company based on the value of putting people first. This is exemplified by the value chain and which we believe that engaged employees make happy customers which create a healthy community off which ultimately our shareholders will benefit.
We believe our employees are the most important asset we have, we have always provided them with great benefits. For instance, all of our employees participate and receive incentive compensation. All of our employees participate in profit sharing. All of our employees participate in robust 401(k) plan in which the company matches 1.25% for employees contribution up to 4%. All of our employees get up $300 in fitness membership reimbursement annually. In addition we provide great healthcare benefits to both not only our employees but their whole family at a reasonable cost. We contribute up to $1,500 per child up to a maximum $5,000 per family for child care for working parents who earn under $60,000. We provide 100% short-term disability for new moms for the first six weeks and up to 80% for the next six weeks.
And in 2017, we redesigned and enhanced our healthcare benefits, the new plan which went into effect January improves the offerings, reduces employees out of pocket healthcare cost and prefunds HSA accounts $500 per individual and $,1000 per family. We take care of our employees. Respected the community for years. We've been committed to giving back at least 2% of our pretax earnings to our communities with last year's contributions being 2.1%. In addition we match employees contribution dollar for dollar up to $5,000 per year. We also support our employees [volunteerism] [ph] by matching hours worked at $10 an hour to any charitable agency.
Now let's talk about investing in our company. As we've discussed in the past we've been replacing systems. We have invested in our digital platform with more investment being planned for this year. All to say, our commitment to putting all of our stakeholders first has been how we do business and these costs have already been baked into our normal operating expenses regardless of and well before the tax reform announcement. As a result, we will be able to use the tax savings to build up our capital levels and flow benefits through to our shareholders. Accordingly we announced a 70% increase in our quarterly dividend in yesterday's earnings release.
So with those comments, I'd like to turn the call over to Marcy for more details behind the numbers. Go ahead, Marcy.
Thanks Kevin and good morning, everyone. As I walked through our financial results unless otherwise noted all of the prior period comparisons will be with the third quarter of 2017. I'll begin with our income statement and our net interest margin. On a reported basis, our net interest margin remain consistent at 3.71% in the fourth quarter. Excluding the impact of charged off interest and loan accretion income our operating net interest margin increased three basis points to 3.52%. The expansion in our margin is attributable to the stability in our deposit cost and improvement in our yield on our investment portfolio.
Total accretion income on the acquired portfolio was $3.8 million this quarter which was $200,000 less than the third quarter an early pay off contributed $2 million to accretion income this quarter about $100,000 less than last quarter. While the predictability of early pay offs will continue to cause volatility in our accretion income. We anticipate that scheduled accretion will contribute an average of $1.6 million per quarter in 2018.
Looking forward given the success we're having in managing our deposit costs we would anticipate seeing a stable to improving operating net interest margin if the Fed continues to raise rates.
Moving to non-interest income we saw decline of about $1 million quarter-over-quarter to $37.2 million. Most of our major fee generating areas were relatively consistent with the prior quarter with the exception of mortgage banking. Our mortgage banking revenues declined about $1.8 million which along with rate pressures reflects with seasonal decline we typically see in mortgage loan demand in the fourth quarter. This was partially offset by smaller securities losses an increase in other income.
Our non-interest income to total revenue ratio remains high at 27% for the quarter. For modeling purposes I'll give my annual reminder that headed into 2018. We expect to see a lighter first quarter for non-interest income as many of our fee generating areas are impacted by seasonality and this revenue stream is typically 10% to 12% in the first quarter. And just a reminder, the Durbin amendment will negatively impact us by approximately $6 million in the second half of the year.
Moving to non-interest expense we had a decline of $9.6 million from the prior quarter as a result of lower acquisition related expenses. Outside of acquisition related expense to most significant variance was $2.3 million increase in the other expense category, as we made the decision to be more aggressive with our initial advertising campaign and increase promotional expenses in our west division to support our branding in that new footprint.
Additionally we incur professional fees related to our client experience initiatives that will not be repeated in 2018. Backing out our acquisition expenses, our normal operating efficiency ratio this quarter was 57.89%. As we start 2018, we would expect our quarterly expense run rate to increase to $80 million to $81 million per quarter with the increase primarily driven by upward pressure on salary and wage expense.
Kevin mentioned the restructuring of our leadership team earlier and we'd also restructured a couple of our holding company departments as of the beginning of 2018. The departmental restructure will resolve in higher compensation expense in the first quarter due to severance cost of about $1 million which we will recoup as we go throughout the remainder of the year.
Lastly as a result of tax reform we recorded $2.2 million benefit in our income tax expense. Going forward, we'd expect our effective tax rate to be between 23% and 23.5%. Looking at the balance sheet, Kevin already discussed our loan growth in the quarter. So I'll start with our deposits. Our total deposits were essentially unchanged from into the prior quarter. Another deposit metric that we keep our eye on is our mix of deposits between consumer and business, which remains steady at 53% and 47% respectively. Our loan to deposit ratio remains strong at 76.64%.
In terms of asset quality we saw an improvement across the portfolio with decreases in non-performing assets, non-performing loans, past due loans and criticized loans. For the quarter, we had net charge offs of $6 million are 31 basis points on an annualized basis of average loan. This is similar to the fourth quarter of last year, as there is a concentrated effort to clean up lingering issues at the end of each year. Our charge offs this quarter were comprised of several loans for which $3.1 million of specific reserves have been established in prior quarters.
With the improvement in overall credit quality and because most of the charge offs came out of specific reserves the higher level of charge offs this quarter didn't drive a commensurate increase in our provision expense which $3.5 million for the quarter.
And with that I'll turn the call back over to Kevin. Kevin?
Thanks, Marcy. Nice job as always. I'm going to wrap up with few comments about our outlook. We anticipate that 2018 will be a very positive year for First Interstate driven by the continued benefits of the bank of the Cascade acquisition and the higher levels organic balance sheet growth than we have experienced in recent years. One of our key opportunities this year is to capitalize on the cross selling opportunities we have on the merger. In particular we're focused on expanding our indirect auto lending and commercial credit card business into the west division.
We plan to add people to help build out these areas in the west, which is one of the reason we'll see a modest growth in our operating expenses. We also continue to invest in our digital platform to remain competitive and offer our clients a more convenient way to engage with the bank. In 2018, we plan to begin offering online application for both residential mortgage loans and small business loans. As well as introducing a global [ph] wealth management product which should provide us with greater efficiencies in long run.
With the increase earning power resulting from the bank of the Cascade acquisition and lower rate of our effective tax, we have more capital available for deployment. Additionally, we intend to continue to use this capital support organic growth of the company as well as to fund additional acquisitions that can further enhance the value of our franchise. So with that, we'd like to open the call up for questions.
[Operator Instructions] today's first question comes from Jeff Rulis of D.A. Davidson. Please go ahead.
Just a question on the core expenses. I think in the Q3 call you talked about core expenses for Q4 being in the $78 million range; just wanted to kind of see what - was it sort of growth of the bank or other initiatives as you'd kind of touched on that’s leading to a little higher run rate.
Most of it, Jeff was other initiatives. We made the decision proactively to increase our advertising promotional expenses in the west and that with a little bit over $1 million and then we had a consultant in that was helping us with some of our client experience initiative and that was about $500,000 as well.
We're done with that.
Yes, we're done with that. That won't continue onto 2018. So we just had extra, some kind of extra one off things this quarter.
And really Jeff also the 2018 run rate that we're talking about increased a lot of it just merit increases going forward.
And if I caught you right with that, you started to kind of 81-ish level and maybe that can trend lower as that the comp piece falls off over the balance.
Yes, that's correct.
And then any thoughts on the provisioning level. You talked about a lot of those charge offs were allocated reserves and just trying to get a sense for also you do a lot of year end clean up in the portfolio. How does that balance for the provision for 2018 in your view?
We look at about 20 basis points of average loans. This is what we'd expect.
And then I just, the last one just to confirm the Durbin impact, so that's a $12 million annualized impact and it's a true caught - $6 million in the back half or does it sort of feather in Q3 where it's not a full impact or?
No it's a full impact for Q3 and Q4.
Okay, fair enough. That's it for me. Thanks.
And our next question comes from Jared Shaw of Wells Fargo Securities. Please go ahead.
Looking at the loan growth and optimism, you're hearing there, is that more utilization driven. Are you seeing your customers be more optimistic and looking to do more or is it really starting to get the benefit of the expanded footprint and last quarter you were talking about best practices moving from market-to-market. Are we seeing more I guess business efficiency on the part of the bank or is it more optimism in the part of customers and potential customers?
I will say it's probably we're doing better banking, we have stronger sales practice; we talked about instituting that last quarter and I think they really started taking hold actually. It's interesting we had more growth on a percentage basis in the Mountain legacy portfolio than we did in the new portfolio, so or to new markets. So we're pretty excited about that. We have weekly sales meetings where the sales people get together talk about loan prospects and we're having credit actually going to those sales meetings so they're working together as a team to make sure that, we know the credit issue is upfront and they're just doing a better job hitting the road, trying to get business.
Do you think that loan growth rate could accelerate as we go through 2018 as you start getting the traction, operational traction plus the sentiment?
Yes, we're feeling better about the upper single-digit kind of loan growth for the year then the past because it seems like we've got the Mountain division’s engine starting to run a little bit smoother.
Great. Thanks. On M&A what's the opportunity for timing there. I mean that's you have this deal close now, are you back in the market looking at opportunities or is there anything that you're waiting for to happen first?
No, we're always in the market looking - we continue to talk to management teams about how do you see the future lined up themselves. We're just taking our time to make sure that when we do something it's going to be well thought out and something really good for our franchise.
Thanks and then just finally for me, on the indirect space we're seeing other banks step back from that just talking about tighter spreads and it seems like a less attractive opportunity. What are you seeing I guess that gives you optimism that this is something you still want to grow?
Well we're being cautious, as you saw in this quarter, our indirect portfolio actually shrank a little bit. So we're being very cautious on how we're pricing the stuff and we're picking spots where we believe we can make profitable loans in areas that the loan volume is not profitable, we're stepping away from that ourselves or we're being far more thoughtful exactly what type of product we're putting on the books.
Thank you.
And ladies and gentlemen, our next question comes from Matthew Clark with Piper Jaffray. Please go ahead.
You touched on kind of your loan growth outlook, little more optimistic maybe getting to the high single digits from the mid. Where you also talked about strong balance sheet growth this year in general. I guess how should we think about the pace of growth in the securities portfolio relative to loans and assuming you'll continue to have some remix out of securities and the loans I just want to get a good sense for pace of growth in securities as well.
We use securities as really kind of balancing factor, so we're going to focus on the growth of loans and hopefully we'll get the growth of deposits so that hopefully the investment portfolio will stay similar, but if the growth deposit doesn't stay in lock step with loan growth then probably some of that remix will occur, but we're focused on loan growth and really the investment portfolio is kind of balancing factor.
Okay and then just switching to fee revenue. Curious what your thoughts on are as to whether or not you think you can outperform the broader industry and mortgage this year given I think somewhat still somewhat an underpenetrated footprint and then as you think about the other products that you intend to kind of overlay with Cascade whether it be commercial credit card SBA. I guess how do you think about the overall fee revenue contribution relative to the total coming off 27% in the fourth quarter and how that might look in 2018 given all the puts and takes.
Well, I'll give you kind of run down. Mortgage, we believe that will be slightly up in 2018 over 2017 with the expanded footprint and some with the headwinds with regards to rate. With regards to card business or payments, we believe that will continue to increase as we've seen in the past years, continuing basis. Maybe pick up a little business we have a new expanded market out in the west. With regards to wealth management, I think we're going to get some growth in wealth management fees due to better just pricing and managing of accounts. We've gone through a lot of restructuring in our wealth management group to become more efficient and to make sure that we're getting the right fees that are due to us. So well other areas [service rec revenue] [ph] should be probably the same, the interesting thing about [service rec] [ph] revenue I think it was the whole age of technology and digital. We're seeing kind of overdraft income coming down a little bit and part of it is, I think people are more opportune with what they have in their accounts, so they're more cautious in overdrawing their account. So I think today’s technology has put a little pressure on that, but I think service charge would kind of hang in there flattish, year-over-year, so that's kind of my outlook. Marcy, do you want to add?
Yes, I think the mix will stay pretty similar. I would expect that it will have 27%, 28% ratio going into next year as well.
And I guess where does the SBA stand at this stage.
SBA we're not really looking, we put SBA, we put on the books more just hold onto them, we don't have the practice of turn around and selling them for a fee like the Bank of Cascades and so we're - we do SBA lending, we're actually trying to push it onto our balance sheet.
Okay and then just last one from me. Just on the efficiency ratio. Wondering what your goal might for the year on an operating basis.
Lower is better. We're going to continue to try to rationalize all of our expenses and so pushing it down. We like to get down closer to 55%, so we're going to continue to focus on growing revenues and control expenses.
Yes, I don't know if we'll get to 55% this year, but I think we'll be around 57% this year.
Okay, thank you.
[Operator Instructions] today's next question comes from Jackie Bohlen of KBW. Please go ahead.
Just want to retouch on expenses quickly to make sure I understood. So it's an $80 million to $81 million run rate in 1Q and not inclusive of roughly $1 million on severance and then seasonality of higher payroll and everything and then that will trend down through the year with, but also knowing that there will be some additional hires as you expand on some of the products offered in west division, sound a fair way to characterize it?
Yes, [indiscernible] when we talk about hires in the west division hopefully we're going to have some reductions in the other division. We keep on just reallocating staff. We add some and we subtract some, so we're not seeing that really to push too much pressure on salary expense, but it will pick up a little bit.
Okay, so outside of unforeseen items about $80 million to $81 million probably serves as a peak for the year.
Yes.
Yes.
Okay and then just a bit clarification. I can't recall you made the comment, but you'd mentioned with the additional rate hikes and the December hike that we saw that, deposit cost to increases in the quarter your expected betas [ph] to be lower than what they were earlier in rate increases, did I hear that correctly?
Yes, that's correct.
And is that just more seeing what's going on in the market rather than being a proactive one within the market.
That's correct. And we were very proactive as you know in the first part of last year, but the thing is, we still remain pretty high in the market. So the market really hasn't come up and have put much pressure on us. So we're just kind of hanging tight, so all the people putting more pressure on us.
Okay and then just last one, where did you see your new loan production at in the quarter?
We saw most of it in the legacy footprint, our legacy footprint.
In both divisions, if you have it? I'm sorry the rate on new loan production.
The rate. 4.87%.
Okay and that's for the overall.
As overall weighted average.
Okay and since most of the production was in the Mountain that was a bigger determinant of that.
Yes.
That's correct.
Okay, thanks guys.
And our next question today comes from Andrew Liesch of Sandler O'Neill. Please go ahead.
You actually covered nearly all my question, except for one. Just curious this is more of a housekeeping just the basic point of impact you expect from the lower tax rate on the margin.
It will be I think right around four or five basis points.
Great, that helped. You answered all my other questions. Thanks.
And our next question today comes from Gordon Jenkins, a Private Investor. Please go ahead.
Yes, you've covered part of this but S&P Global holds [indiscernible] recommendation on First Interstate and their reports says that that's based on weak organic growth which you've addressed some improvement on and key financial ratios versus peers and those financial ratios largely compare this favorably to peers by more than 20% on one, three and five-year timelines. So my question is, what timeline do you anticipate relative performance might justify an upgrade of the overall recommendation.
The thing is that, it depends what ratios we're looking at because sometimes when you look at ratios they're looking at.
They're looking at all of the normal what are considered common financial ratios.
But they - for the acquisition cost, add an acquisition cost, you return equity and your return assets will be dampening. So as we did a large acquisition last year that dampened our financial ratios, but if you exclude some of those acquisition costs, which is better for the shareholders. Our financial ratios are in line with peers or actually stronger than most peers.
Okay, so are you having conversations with those analysts specific to that rating?
We don't deal with those analysts, we deal with the analyst that have been answering, asking questions today on the call. Those are the analysts that we work with.
Okay.
Thank you. Our next question comes from Tim Coffey of FIG Partners. Please go ahead.
Most of my questions have been answered, but I do want to touch or ask about this. Being part of 2017, you were seeing some increased price competition from [indiscernible] in market legacy competitors and I was wondering does that abate throughout the year or has it remained?
No it pretty much abated. I think they woke up. I think they felt that doing 20 and 30-year [indiscernible] fixed rate loans was not a good business decision so [indiscernible] abated in our markets.
Okay and if I made it clear. That was mostly on the commercial real estate loans, right?
That's correct.
All right and all my other questions have been answered. Thank you.
All right, Tim. Thanks.
And ladies and gentlemen, this concludes our question-and-answer session. I'd like to turn the conference back over to Kevin Riley for any closing remarks.
Thanks. As always we're working close for our investors and analyst. Please reach out to us. If you have any follow-up questions and again thank you for tuning into our call today. Goodbye.
And thank you sir. Today's conference has now concluded and we thank you all for attending today's presentation. You may now disconnect your lines and have a wonderful day.