First Interstate BancSystem Inc
NASDAQ:FIBK
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Earnings Call Analysis
Q4-2023 Analysis
First Interstate BancSystem Inc
As we head into 2024, the company is well-positioned with robust capital liquidity and a conservatively underwritten loan portfolio, poised to navigate potentially difficult economic conditions. The firm's focus on expense management, reflected in recent workforce reductions and restructuring efforts, has paid off with enhanced efficiencies. These savings and other process improvements are expected to balance out investments in technology and risk management. The impact of these initiatives is already visible in the provided expense guidance. Despite a cautious outlook from potential borrowers in the short term, the company anticipates steady loan growth, projecting total loan balances to be flat or to increase by low single digits in 2024. Efforts to bolster customer relationships, particularly through the revamping of the Treasury Solutions business and the rollout of improved credit card offerings, aim to solidify the company's market presence.
The company has seen a satisfactory margin expansion, thanks to solid loan yield growth in the previous quarter. With the spot loan yields at approximately 7.8% and the expectation to weather construction funding pressures, a mid-single-digit growth in loan yields is anticipated, continuing the upward trajectory witnessed in the fourth quarter of 2023. Meanwhile, discussions around the securities portfolio cash flows suggest a flexible approach in managing cash—whether through reinvestment or paying down borrowings—depending on market conditions, which should further stabilize the net interest income (NII). More specifically, if market interest rates drop more than the three cuts anticipated, the company could see a favorable impact on NII. However, a flat rate scenario would still yield NII growth in the latter half of the year without any cuts.
Executive discussions indicate that there's an expected—but slowing—migration from noninterest-bearing to interest-bearing deposits, with a projected incremental increase in spot beta into the second quarter. This migration is being closely monitored to manage impacts on the company's margins. The board's capital management strategy prioritizes maintaining a healthy dividend throughout the year. There appears to be no forecasted net charge-offs on agricultural loans, specifically in the dairy sector within Arizona or California, at present. The company's strategy seems broad-based, focusing on diverse industry verticals, with continued emphasis on small business initiatives and commercial and industrial growth, signaling a commitment to a comprehensive service offering across its locations.
In terms of future guidance, an expected dip in net interest margin (NIM) in the first quarter is anticipated to rebound significantly in the second half of the year, potentially surpassing the 3% mark, assuming stable deposits and the three rate cuts factored in. The company continues to refine its operating structure, optimizing its staffing and reinforcing investment in risk management and IT to uphold operational efficiency and potentially improve expense structure.
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Good morning, ladies and gentlemen, and welcome to the First Interstate BancSystem, Inc. Fourth Quarter Earnings Call. This call is being recorded on Wednesday, January 31.
I would now like to turn the conference over to Andrea Walton. Please go ahead.
Good morning. Thank you for joining us for our fourth 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. 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. Our fourth quarter performance reflected our ability to generate strong financial results in this challenging economic environment. In the fourth quarter, we generated $61.5 million in net income or $0.59 per share. There were some moving parts on both the balance sheet and the income statement that Marcy will go over in her remarks.
For the quarter, we remain disciplined in our new loan underwriting and pricing criteria. The new production rate, excluding draws on construction lines approximated about 7.8% during the quarter. This reflects our efforts to generate strong risk-adjusted returns on new production. Additionally, as with the prior quarter, we continue to see construction projects being completed and moving into the commercial real estate portfolio, while undrawn construction lines also declined. We also saw the expected seasonal declines in deposits in December and utilized our strong liquidity profile to selectively allow some high-cost time deposits to lead the balance sheet while remaining focused on retaining our relationships.
And lastly, you probably saw the 8-K we filed in December, where we were able to repurchase 1 million shares during the quarter. Even with this, capital ratios continue to increase modestly providing us with the ability to pay a healthy dividend while maintaining flexibility going forward. The challenging banking and rate environment is resulting in near-term earnings pressure but we are confident these pressures will lessen in the back half of 2024, setting us up for a strong 2025.
Over the course of last year, we invested in areas to drive future efficiencies and profitability. As we noted previously, we standardized and streamlined our mortgage process. We also realigned operational support and line of business functions. These improvements have allowed us to provide an enhanced suite of products and services to our clients, such as our consumer credit card, which we discussed last quarter. At the same time, we delivered on our promise to evaluate the existing cost structure of the company, resulting in a reduction of workforce in December. In short, we continue to make strategic decisions to strengthen the long-term value and profitability of our franchise.
And with that, I'll turn the call over to Marcy, so she can provide some additional details around our fourth 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 to the third quarter of 2023, and I'll begin with our income statement.
Our net interest income decreased $5.9 million as the increase in our average yield on earning assets was outpaced by the increase in our total funding costs. Our reported net FTE interest margin was 3.01%, a decrease of 6 basis points from the prior quarter as we continue to see less pressure on our net interest margin than we did in the first half of 2023. Our adjusted net interest margin, excluding purchase accounting accretion, also decreased by 6 basis points from the prior quarter to 2.94% due to higher overall funding costs, which offset our loan yield expansion and a 1 basis point reduction from reinvesting cash flows back into the investment portfolio, which I'll discuss in a minute.
Looking ahead, we anticipate deposit costs moderating in the first half of the year as the majority of our time deposits have already repriced near market rates and the customer mix shift into higher cost deposits has slowed. That, along with the repricing of our adjustable rate and maturing assets, supports our confidence that both the margin and net interest income will begin to increase in the second half of 2024.
Our total noninterest income increased $2.5 million quarter-over-quarter. Our fee business performed generally in line with our expectations, with the increase driven by a net gain on the sale of fixed assets.
Moving to total noninterest expense. We had an increase of $4.9 million from the prior quarter, but there's a lot of noise in that number. Salaries and employee benefits expense was lower as a result of lower incentive accruals of $11.5 million, which was partially offset by higher severance costs of $3.6 million as a result of the reduction in workforce Kevin mentioned earlier.
Other expenses were higher and included the special FDIC assessment of $10.5 million and an increase in our credit card rewards accrual of $2.1 million as we saw higher engagement from our clients in our new rewards program. Adjusting for the items noted, our quarterly noninterest expense would approximate $161 million.
Moving to the balance sheet. Loans held for investment increased modestly by $66 million from the end of the prior quarter. As Kevin indicated, much of the growth in commercial real estate loans was driven by the movement of completed construction projects into permanent financing. Our outstanding commitments on commercial construction lines totaled just under $700 million at the end of the fourth quarter at a weighted average rate of approximately 5.7%. This represents about a $200 million decline from the previous quarter. We expect the impact on our margin from this portfolio to lessen in the back half of 2024, as those lines continue to fund up and we're seeing limited new commitments.
We had $162 million increase in the securities portfolio, which was primarily due to an increase in fair market value. We chose to reinvest approximately $135 million of cash flows back into securities, locking in a weighted average yield of 5.5% during the quarter. Going forward, we may selectively reinvest cash flows depending on the returns available in the market at the given time. I would note that the decision to reinvest some of the cash flows, along with the increased fair market values in the fourth quarter, will contribute to a roughly 4 basis point reduction in our net interest margin in the near term.
On the liability side, total deposits decreased by $356 million as we saw seasonal deposit outflows during the latter half of the fourth quarter. As Kevin pointed out, we also let some higher cost retail CDs runoff given the high level of liquidity we have on our balance sheet.
Moving to asset quality. This is a little noisy as well. While we reported an increase in criticized and nonperforming loans, we are seeing positive underlying and overall credit trends. We moved $35 million of held-for-sale loans back into the held for investment portfolio as the opportunity arose to restructure these loans for a more favorable outcome. This transfer accounted for the increase in nonperforming loans. Excluding this transfer, nonperforming loans declined $2 million. The transfer also accounted for most of the increase in criticized loans. Finally, total watch loans decreased by more than $90 million in the quarter, which was the second consecutive quarter of improvement.
Through our normal course workout process, we will enter agreements with these borrowers to improve the quality of the underlying credits and we anticipate the associated credits will either be upgraded or exit the bank in the second half of 2024.
In summary, we believe total credit quality performed well this quarter, showing underlying improvement, and we remain confident in our near- and long-term credit outlook. We recorded a provision for credit losses of $5.4 million, which increased our allowance for credit losses by 1 basis point to 1.25% of total loans held for investment. Net charge-offs in the quarter remained low at $4.8 million or 10 basis points of average loans.
And finally, the leverage ratio was flat quarter-over-quarter with all other regulatory capital ratios modestly increasing as we continued to manage our risk-weighted asset exposure. Tangible book value increased due to a positive shift in AOCI and the earnings generated during the quarter.
Going forward, our strong capital position continues to give us the flexibility to take advantage of growth opportunities and allows us to remain dedicated to serving the needs of our customers and attracting new households to the bank.
And lastly, we declared a dividend of $0.47 per common share, which equates to a 7.2% annualized yield on the average closing price of our stock in the period.
And with that, I'll turn the call back over to Kevin. Kevin?
Thanks, Marcy. Now I'll wrap up with a few comments on our outlook and priorities for the coming year. We are entering 2024 with a high level of capital liquidity as well as a conservatively underwritten loan portfolio. This positions us well to perform this year even if economic conditions remain challenging. In 2023, one of our goals was to manage our expense levels, which we did well. This will continue to be a focus in 2024. As mentioned, in December, we completed a reduction in workforce and some organizational restructuring that will enhance our efficiencies.
The cost savings from these actions as well as leverage from our automation and process improvements will help offset our investment in technology and risk management. These efforts are reflected in our expense guidance.
In the near term, we are still seeing some reluctance from potential borrowers, but expect this to change as economic conditions and the weather improves. Given that outlook, we are expecting total loan balance to be flat or up low single digits in 2024. However, given the strength of our balance sheet, if market demands increase, we'll be able to respond quickly to additional growth opportunities.
As always, customer relationships are top of mind. Considering this, we continue to make improvements in the delivery of our products and services. We recently restructured our Treasury Solutions business, bringing in new leadership, aligning our business development efforts and expanding our offerings. We are investing in a new consumer and small business loan origination system, which will allow us to streamline our client experience and speed up our origination process. We are enhancing our business credit card offerings as we did with the consumer card in 2023. This will allow us to offer a more attractive, comprehensive suite of products to our business clients. We are also continuing our journey to automate manual processes to make us more efficient.
While the environment is tough right now, we are taking advantage of this time to capitalize on these opportunities so that we can deliver more effectively when the environment improves.
In closing, we believe that revenue growth will return in the second half of 2024. Coupled with our ongoing expense discipline, this sets us up well for a strong back half of the year with improving operating leverage and notably improved profitability run rate as we look into 2025. We believe our diverse footprint, the talent of our people and our disciplined culture positions us well to win. We remain focused on the long-term value of our franchise and are optimistic and confident in the future earnings power.
So with that, we'll open the call up for questions.
[Operator Instructions] First question comes from Andrew Terrell at Stephens.
Maybe first question on the margin. I mean the loan yield expansion we saw this quarter was good and maybe a few parts to my question here. One, do you [indiscernible] the spot loan yields at 12/31. And then can you remind us if there any lingering headwinds, kind of from the construction fund-ups. And then just kind of bigger picture and maybe holding rate moves aside, just would you expect similar upward trajectory in the loan yields throughout 2024 as the 7 basis points you saw in the fourth quarter?
Yes. So the spot loan yields were about 7.8%. Again, the construction fundings there happening at about $200 million a quarter. The weighted average yield on those of 5.7%. So there will continue to be some pressure from that portfolio in the first half of the year which should taper off as we get to the back half of the year.
What's the second part of that question. And in terms of loan yields going forward, we think there'll be -- they are a few basis points higher than the Q4 average.
Yes. And then I guess, just like going throughout 2024 on a quarterly basis, would you expect a similar kind of 7-basis-point-or-so pickup in loan yields per quarter?
Yes, it should be kind of mid-single digits right in there somewhere.
Okay, then Marcy on the...
In the first half, assuming, but -- yes. Go ahead.
Yes. Okay. Plan for the securities portfolio cash flow in the first quarter. I mean, obviously, a bigger amount of cash flow coming off the bond book in 1Q. Is the plan to use that to pay down borrowings? Or is there a preference to kind of build liquidity or reinvest back into the bond book right now?
I think, Andrew, we're going to see what the market will give us during that period of time, and we'll make decisions accordingly. But if the market gives us good rates doing reinvesting, we might take that route. But if it's -- if the market has shifted dramatically, then we'll probably just pay down borrowings. And it also -- the thing is how seasonally the deposits are in the first quarter also. So there's a couple of moving factors. There's no -- I know it's going to be hard for you to project that, but we're kind of -- we looked at -- it doesn't materially move the numbers either way that much.
NII, right?
NII.
Right. Okay. And then maybe last on the margin. I'm just trying to understand the NII guide. I'm just trying to understand how influential the 3 rate cuts are to that forward guidance. And I know you guys are slightly asset or -- slightly liability-sensitive as we sit here. But if we were to flex that and kind of assume the full forward curve or assume conversely kind of no rate cuts, I guess how big of a driver is that C&I guidance? How could we see the guide change based on those varying assumptions?
So if there's more than 3 rate cuts, that's going to be a benefit to us. We have over 50% of our CD book matures in the first half of the year and 90% by the end of the year. We have our 17% of our deposits that are in the index money market product. So that's going to reprice. And then we'll see the benefit in some of our borrowing costs. I think there's going to be a bit of a lag on our deposit -- on the deposit side, most likely. So those deposits will set potentially a little bit slower than the rate cut that comes through on -- that the Fed would push through.
So -- nothing. In a flat rate environment, we still see NII growing in the back half without any rate cuts at all. So as the rate cuts increase, you'll see more benefit with regards to NII. So -- but we have run the numbers with no rate increase at all and NII should grow in the back half of 2024.
Okay. That's helpful. I appreciate it. And then just if I can sneak one last one. Marcy, it sounds like within your expense guidance, we should be using kind of $161 million or so as the run rate for operating expenses that I presume kind of grow as we work throughout 2024. Is that fair?
That's fair.
That's fair.
The next question comes from Chris McGratty at KBW.
This is Andrew Liesch on for Chris McGratty. On that mid-single-digit NII decline guidance for 2024, what are you assuming for your noninterest-bearing deposit mix and your beta expectations?
NII deposit expectations and?
Yes, your NII deposit expectations and your beta expectations that go into the NII guidance?
So in the fourth quarter, our beta was 33% and then with the spot beta at the end of the year at 34%. We continue to believe that we'll see some migration out of noninterest-bearing into higher cost deposits as we go through the rest of the year.
But that's slowing.
Yes, it is slowing, but we assume that's going to move a couple of basis points higher into the second quarter.
Okay. And then just on capital, you had that $32 million share repurchase from the estate of a single stockholder. How should we think about your capital priorities for 2024? And can you just remind us if you have any specific capital targets?
We have some internal things that we don't publish or talk about our internal capital levels or what we strive to have. But I will tell you that our priority is to maintain a healthy dividend throughout the year and into the future. So that's our first priority with capital. And then to use capital for organic growth would be the second priority. I would say that unless things really go really well, I would say, share repurchase at this time has been shelved. So those are probably our biggest priorities at this point.
The next question comes from Brody Preston at UBS.
Marcy, within the net interest income guidance, did you give the down beta that you're assuming with the cuts that you have in the back half of '23?
So we didn't give the down beta in the back half, under our assumptions, we're assuming some lag. We actually think there's -- if rates come down, we think there's some potential to do better than we're assuming in our guidance. So we assume it will go up modestly from the 34% that it is in December, which if rates come down, we could see some benefit there.
Okay. The NII guide itself, is that GAAP or is that FTE? I just wanted to clarify.
That is GAAP. Well, it's ex-purchase accounting. Yes.
Okay. Ex-PAA. Okay. the expense guidance, I just want to...
The guide, Brody, just to be clear, is GAAP.
Which includes...
Yes, which includes purchase accounting.
On the expense, I just wanted to clarify, it says excluding the $10 million -- the $10.5 million FDIC, you're expecting a low single-digit increase, but that includes -- I'm assuming that, that means that you're including the severance charges and stuff that you had last year. So if I kind of just took the $10.5 million out, it kind of implies that you're looking more towards like [658, 659] in expenses for next year, kind of like the midpoint of 1% to 3% up? Is that -- am I thinking about that correctly?
That's a fair way to think about it, yes.
You're right on it.
The next question comes from Jeff Rulis from D.A. Davidson.
On that credit side. I wanted to get into that ag loan kind of group. I guess, first, just safe to assume those were legacy -- Great Western credits. Is that fair?
Are you talking about the ones that moved into nonperforming?
Correct.
Okay. Yes, they were -- yes, legacy Great Western credits. But the thing is that we believe that's temporary because we're restructuring those loans. And what we need is a payment performance for like 6 months on account rows before we can move them out of nonperforming into performing. So we believe those loans will move out of nonperforming into the third quarter of this year.
Yes, I heard it in the prepared. I appreciate it. I was going to follow up is just -- it seems like moving that to held for investment that allows you to sort of move those through. Is that the messaging of the move? more or less?
Yes. And it's also the messaging is that we kind of were able to restructure these into performing loans. So I think that's more of the message that they're kind of getting cleaned up.
What is the type of -- if maybe they're pretty granular in mix, but is there a type of ag that, that represents? And what type of geography did that come from?
It's dairy and it's Arizona or California, down in that area.
All right. And on your guide of net charge-offs of 15 to 20 basis points, is that broad-based? Or is that including likely some of that those ag loans to contribute to the bulk of that?
Well, we're not looking at any kind of charge-offs on those loans at this juncture, but we're talking -- that's just broad based.
Okay. So no particular segment. Just you think that's where you are in the cycle of 15 to 20 basis points for '24?
Yes, I guess the thing s we haven't hit that, but we're forecasting that.
Got it. Okay. And within the loan growth expectations kind of flat or low single digit, I guess within segment, would you -- got the discussion on the construction commitments. But trying to peg what segments of growth do you see in '24 versus some areas that may be flat or maybe running off within that overall guide on growth?
I would say the way our franchise is, we're kind of -- we have -- we're in every different industry and verticals. So it's hard to say at this point, we think that's pretty much going to be growth that's going to be brought across all different verticals.
I think we'll continue to focus on our small business initiatives. We'll continue to focus on C&I growth. All of those things, of course, but to Kevin's point, it's going to be pretty broad-based and spread across the 14-state footprint.
Okay. So the commercial real estate growth largely from construction completion, that's a bit timing of Q4, but the balance of '24 again, kind of pointing to a pretty mixed contribution, albeit modest for the full year?
That's correct.
The next question comes from Adam Butler from Piper Sandler.
This is Adam on for Matthew Clark. First, I was just wondering if you could provide some commentary around the staffing reductions that were completed in December. I was curious if it was more surrounded by efficiency improvements in the back office or maybe lower producing -- lower revenue producing producers?
It's kind of broad with regards to that. I would say that we looked at the levels of staff that we needed in various areas based on the workload that people were doing, and we made reductions in order to bring efficiencies to the levels they should be at. I would say that, with that reduction, we also plan on adding, as we said in our remarks, putting more expense into, I would say, risk management as well as IT, so that bounce up. But we just really went through the company and looked at where we might have some excesses and took those out.
Okay. I appreciate the color there. And then second, I appreciate the guidance on the NIM and NII down in the first quarter relative to the fourth quarter. Do you guys happen to have either the spot rate on interest-bearing deposits or the NIM in the month of December or at the end of December?
I'm sure we have that. Go ahead, Marcy.
So our net interest margin in December was 2.86% and so it was lower than the fourth quarter average. And we saw pressure there because we had the vast majority of our early cycle CDs reprice in November and December. We also -- that was impacted by the recovering fair market value on our investment portfolio and then our decision to reinvest those investment portfolio cash flows that resulted in a couple of basis point decline in NIM in December. And then lower noninterest-bearing deposits, higher borrowings were also a factor there. So that's where when we talk about our first quarter NIM, we expect it to be lower than the fourth quarter average and more in line with that mid-280s number.
[indiscernible] I appreciate the color and thanks for the time.
I just want to clarify that thing. That was excluding purchase accounting. That NIM guidance.
Next question comes from Timur Braziler from Wells Fargo.
Maybe looking at some of the in-migration into your geographies during COVID, your construction balances doubled over that period. I know that leading up to it, there had been a shortage of supply of housing along with other things, just inability to find workers. Can you maybe give us an update on where your geographies stand now and just some of the population migration, maybe how that's trending and if there are any areas within your geographies that you feel like might have been overbuilt given some of that migration over the past couple of years?
I would say I think the migration has probably slowed a bit, but there's definitely a shortage of houses in the majority of our markets. So we don't see really any markets right now having accesses. So there's a need for housing. So we don't -- we're not right now seeing anything in any one of our markets that we -- there's been any overbuilding. The only area I'd say that might not be where everybody's flock into is some of the big cities like Portland and Seattle. But besides that, I think that the rest of our areas are in pretty good shape.
Okay. And Marcy, I guess the 4 basis points of NIM pressure from bond reinvestment at 5.5% in 1Q. I guess I don't understand that. Did I hear that correctly that as you're remixing the bond portfolio that's driving incremental margin or maybe you can move slightly?
I think the biggest thing is just that the earning asset balance is bigger because first of all, the fair market value adds more to earning assets would really not any more earnings in NII. And then when our forecast before we were looking at bringing down the investment portfolio and reducing earning asset balances. It really doesn't affect NII, but as you reinvest, you're not getting that same net interest margin. But NII improves, but the overall margin is impacted by the greater denominator.
Got it. And then lastly, Kevin, would love to hear your updated thoughts on M&A with some of the headwinds of '23 more or less in the rearview, purchase accounting a little bit easier as AOCI becomes less of a headwind. Maybe just give us an update on where you stand with M&A and how that fits into the capital deployment story at First Interstate?
That's a great question, Timur. I would tell you that as you probably have heard from other institutions, I think there's a lot more conversations that are being had out there. As you always know, we're very disciplined on our M&A strategy. We have a priority list of institutions that we believe would make our franchise better and we have been in touch with these banks for many, many years. And it's up to the seller itself. So I think there are more activities out there, but we're going to stay steadfast to the institutions that we believe will make our franchise better. And if they come and wanted to partner with us, then we'll probably put something together. But we're open to do something, but we're not going to just do something for the sake of doing something.
Next question is a follow-up from Brody Preston at UBS.
I just had a couple of other ones. I guess if I take the guidance on loans and kind of looking at what you said about the security cash flow and reinvestments there in the past. It sounds like maybe average earning assets should be flattish for the year. I just wanted to clarify that.
Yes.
Yes, that's exactly how we look at it, Brody.
Okay. And so if we're in the mid-2.80s ex-PAA on the 1Q margin, kind of the guidance on NII, Marcy, kind of implies like a pretty good step up in the NIM by the time we get to 4Q? And so where are you thinking that ex-PAA margin gets to by the fourth quarter?
We believe it could be comfortably over that 3% mark in the back half of the year, assuming stable deposits, and that's assuming the 3 rate cuts that we've discussed. So...
There are no further questions. I will turn the call back over for closing comments.
Thank you all for your questions. As always, we welcome calls from our investors and analysts. Please reach out to us if you have any follow-up questions. And thanks for tuning in today. Bye-bye.
Ladies and gentlemen, this concludes your conference call for today. We thank you for participating, and we ask that you please disconnect your lines.