Financial Institutions Inc
NASDAQ:FISI
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Financial Institutions Inc
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Hello, everyone, and welcome to the Financial Institutions, Inc. First Quarter 2024 Earnings Call. My name is Harry, and I'll be your operator. [Operator Instructions] I will now hand over to Kate Croft to begin. Please go ahead.
Thank you for joining us for today's call. Providing prepared comments will be President and CEO, Marty Birmingham; and CFO, Jack Plants. He will be joined by additional numbers of the company's financial leadership during a question-and-answer session.
Today's prepared comments and Q&A will include forward-looking statements. Actual results may differ materially from forward-looking statements due to a variety of risks, uncertainties and other factors. We refer you to yesterday's earnings release and investor presentation as well as historical SEC filings, which are available on our Investor Relations website for a safe harbor description and a detailed discussion of the risk factors relating to forward-looking statements.
We'll also discuss certain non-GAAP financial measures intended to supplement and not substitute for comparable GAAP measures. Reconciliations of these measures to GAAP financial measures were provided in the earnings release filed with an exhibit to Form 8-K or in our Investor Relations presentation available on our IR website, www.fisi-investors.com. Please note that this call includes information that may only be accurate as of today's date, April 26, 2024. I'll now turn the call over to President and CEO, Marty Birmingham.
Thank you, Kate. Good morning, everyone, and thank you for joining us today. Heading into 2024, we knew that the challenging operating environment would persist. In the fourth quarter, you'll recall we took steps to optimize the configuration of our balance sheet and completed a strategic reorganization to enhance the earnings potential of the company while positioning us for sustained incremental performance in the future.
Given the fraud event we experienced, we never could have imagined the intensity of the challenges we have faced and vigorously managed in the last several weeks. As previously disclosed, in early March 2024, we discovered fraudulent activity conducted by in-market deposit only Five Star Bank business customer that resulted in $18.4 million deposit-related charge-off in the first quarter. This has been broken out in our income statements from other expenses.
The charge is modestly lower than the $18.9 million potential exposure we originally estimated, reflecting funds recouped in late March. We are actively pursuing all legal recourse available to us to recover additional funds from the customer and minimize this loss. This event certainly had a significant impact on our otherwise solid first quarter 2024 financial results with the associated pretax fraud loss and elevated legal and consulting expenses totaling approximately $19 million.
As we recognize this loss in the first quarter, net income available to common shareholders was $1.7 million or $0.11 per diluted share compared to $9.4 million or $0.61 per share in the late fourth quarter and $11.7 million or $0.76 per share in the first quarter of 2023. We reported an annualized return on average assets of 13 basis points and an efficiency ratio of approximately 106%.
Excluding the impact of expenses related to this fraud event, the company would have reported $0.12 of earnings per diluted share, ROA of 1.14% and an efficiency ratio of approximately 69%. Even as we navigated this matter, we remain focused on strategic actions to enhance liquidity, capital and earnings.
On April 1, we announced and closed the sale of the assets of our insurance subsidiary, SDN Insurance Agency to NFP Property & Casualty Services, a leading property and casualty broker and benefits consultant. In addition to having a meaningful contribution to overall net income, the sale occurred at an opportune time when this line of business was generating what we believe was a peak EBITDA margin.
The $27 million all-cash transaction represents 4x 2023 insurance revenue and approximately 10x earnings. This transaction allowed us to capture strong value premium in this business, generating a gain of approximately $11.2 million on an after-tax basis, prior to selling costs, while also eliminating $11.3 million of goodwill and other intangible assets.
Importantly, the transaction provides at least 40 basis points of incremental regulatory capital that positively impacts our TCE ratio by more than 30 basis points, which will be reflected in the second quarter results. We were pleased to have the opportunity to source capital at a time when it is needed in such an efficient and shareholder-friendly manner.
In the 10 years since we acquired SDN and supported revenue diversification and allowed us to expand the capabilities and services we provide our customers, we enhanced our former insurance subsidiary through bolt-on acquisitions in the Buffalo and Rochester markets and helped it grow into a leading insurance agency serving Western New York and clients nationally.
We evaluated potential buyers for this business. NFP's offer was compelling both financially and in terms of its vision for SDN's future and continued collaboration with our Five Star Bank team. Looking forward, NFP will be the bank's insurance partner of choice ensuring our customers have continued access to exceptional insurance counsel, products and services.
We expect to deploy proceeds from the sale into our core banking business in the form of high-quality credit disciplined loan origination to drive higher yielding earning asset growth and support net interest margin expansion through the year.
We continue to expect that our full year loan growth will be driven by our commercial lending group, which operates across Western and Central New York and our Mid-Atlantic region. In the first quarter, growth in this portfolio was offset by anticipated declines in our indirect auto segment as we continue to enhance the profitability of this line of business, while benefiting from the spending cash flow it provides.
While total loan balances were relatively flat to the end of 2023, down $20 million or 50 basis points, we have solid pipelines and have closed several notable commercial deals so far in the second quarter. Credit quality remained strong and stable in the first quarter with nonperforming loans to total loans of 60 basis points at 12 March 31, 2024, and December 31, 2023. Annualized net charge-offs to average loans were 28 basis points in the current quarter, an improvement of 10 basis points from the fourth quarter. While we have seen higher charge-off rates in our indirect portfolio in the last few quarters, the trend that continued into the first quarter of 2024, we saw positive trends in overall indirect delinquencies during the quarter.
As an example, total delinquencies, including nonaccruals declined by more than $12 million during the first 3 months of the year to 1.24% at March 31, essentially half of the 2.53% we saw at December 31, 2023. Overall, we remain confident in the health of our loan portfolio and associated asset quality metrics.
Deposit growth was a highlight for our first quarter performance with balances up $183.8 million or 3.5% from year-end 2023. While seasonality of public deposits was the main driver of this increase, we experienced growth in nonpublic and reciprocal deposits as well. Banking as a Service, or BaaS-related deposits were down modestly from the end of 2023 to approximately $116 million reflecting normal fluctuation within end user accounts. We remain energized about the opportunity this line of business presents, while mindful of the challenges others in this space have experienced.
As we have stated in the past, our approach to BaaS has been measured, deliberately aligned with our organizational risk appetite statement and focused on select partners serving small and midsized businesses, affinity groups and niche markets. Our risk-adjusted process for evaluating BaaS partners, coupled with a control approach to transitioning them onto our platform has resulted in modest but sustainable growth in this line of business and a reduction in our partnership pipeline.
We deem this prudent, and are currently focused on cultivating strong and lasting, partnership. This concludes my introductory comments. It's now my pleasure to turn the call over to Jack for additional details on results and details of our 2024 guidance.
Thank you, Marty. Good morning, everyone. Net interest income of $40.1 million for the first quarter was up $196,000 for the fourth quarter of 2023. Interest-earning asset yields increased 11 basis points, in line with overall cost of funds, reflective of the impact of the continued high interest rate environment, the inward yield curve with strong competition in our markets.
Margin has stabilized, and we reported NIM on a fully taxable equivalent basis of 278 basis points for both the current and linked quarters. Margin increased incrementally on a monthly basis in the first quarter. Given our $1.1 billion in anticipated cash flow in 2024, we have ample opportunity to redeploy funds into higher-yielding earning assets.
And looking at our total deposit portfolio relative to the magnitude of FOMC rate increases that occurred in 2022 and 2023, we have experienced a cycle-to-date beta of 46%. Excluding the cost of time deposits, the non-maturity deposit portfolio had a beta of 28%. Given FOMC expectations and internal modeling, we expect the trajectory of deposit betas to slow in 2024.
Noninterest income totaled $10.9 million in the first quarter, down $4.5 million on a linked-quarter basis. This variance was largely driven by lower company-owned life insurance, or COLI income in the current quarter. As you'll recall, we reported $9.1 million of COLI income in the fourth quarter of which approximately $8 million related to a higher crediting rate on the investment of the premium into a separate account product during that period.
As expected, incremental income associated with cash to undervalue those policies and stable value component has stabilized and is reflected in our first quarter of 2024 results. In the linked fourth quarter, we also reported a $3.6 million loss on investment securities related to the repositioning we completed in October, which, along with seasonally higher insurance income in the quarter, partially offset the COLI income variance between periods.
Investment advisory income, largely driven by Courier Capital, our RIA subsidiary serving mass affluent and high net worth individuals and families, institutional clients and 401(k) plan sponsors was down about $87,000 from the linked quarter. As of March 31, 2024, Courier Capital had assets under management of approximately $3 billion.
As Marty noted, increased noninterest expense was primarily attributable to the fraud event we experienced in March 2024, including $18.4 million deposit-related fraud charge-off, approximately $660,000 in related legal and consulting expenses. Excluding these 2 items, noninterest expense would have been flat with the linked fourth quarter.
We recorded a benefit for credit losses this quarter as a decrease in qualitative factors, coupled with an improvement in forecasted loan losses and a decrease in consumer and direct loans resulted in a reserve release. We've provided additional details on Slide 19 of our investor presentation, but I'd like to touch on a couple of the contributing factors here. The primary driver of the improved qualitative factor in our model was the lower level of consumer indirect delinquencies relative to year-end 2023.
This qualitative factor for trends in delinquencies is purely quantitative in nature and corresponds to the range of the delinquencies in the portfolio over a look-back period since 2006. We also saw improved commercial delinquencies and observed favorable trends in our commercial credit review and administration functions.
Income tax expense was $356,000 in the quarter representing an effective tax rate of 14.7%. Our accumulated other comprehensive loss was $126.3 million at March 31, 2024, compared to $119.9 million at December 31, 2023. We reported a TCE ratio at March 31 of 5.72% and tangible common book value per share of $23.06.
Excluding the AOCI impact, the TCE ratio and tangible common book value per share would have been 7.53% and $30.37 respectively. We continue to expect these metrics to return to more normalized levels over time given the high credit quality and cash flow nature of our investment portfolio.
I would now like to provide an update on our outlook for the remainder of 2024 in key areas. Following our April 1, 2024, insurance transaction, we now expect recurring noninterest income between $8.5 million and $9 million per quarter or $36.5 million to $38 million for the full year.
This guidance excludes income related to investment tax credits, limited partnerships, and gains or losses on investment securities and assets, including the SDN sale. We are now projecting noninterest expense of $33 million to $34 million per quarter for the remainder of 2024, again, reflecting the sale of SDN.
This translates to full year noninterest expense of $135 million to $136 million, excluding the $19 million of expense related to the fraud event recognized in the first quarter. We now expect the 2024 effective tax rate to fall in the range of 13% to 15%, including the impact of the fraud event in the first quarter, the SDN sale in the second quarter and the amortization of tax credit investments placed in service in recent years.
We will continue to evaluate tax credit opportunities and the positive impact of these investments would have on our effective tax rate. Our previous guidance on loan to deposit growth of between 1% to 3%, net interest margin of between 285 to 295 basis points and full year net charge-offs within our annual historical range of 30 to 40 basis points remain unchanged.
Overall, our company remains in a strong financial position. We continue to be well capitalized to maintain a steady level of regulatory capital during the first quarter despite the challenges we faced, reporting a common equity Tier 1 ratio of 9.43% consistent with year-end 2023. Our liquidity position is among the strongest we've seen, approaching $1.5 billion, and our 12-month anticipated cash flow continues to exceed $1 billion putting us in a strong position to continue to support our customers and communities.
That concludes my prepared remarks and updated guidance. I'll now turn the call back to Marty.
Thank you, Jack. As challenging as the first quarter was, I'm very proud of our team for not allowing adversity to distract us from our focus of running the business, delivering on our objectives and executing on longer-term initiatives.
The second quarter is off to a strong start with a successful divestiture of our insurance subsidiary, supporting our capital ratios and earnings potential. Our pipelines are healthy, and we remain focused on our core banking business and on nurturing strong customer relationships in order to sustain and grow our deposit base.
Credit disciplined loan growth has been and continues to be a fundamental focus of our retail, commercial, credit delivery and risk associates.
That concludes our prepared remarks. Operator, please open the call for questions.
[Operator Instructions] Our first question today is from the line of Damon DelMonte of KBW.
So just curious with regards to the provision reversal this quarter. I understand there's a combination of factors that were provided in the release that supports the reversal. But I was just wondering what would have been the harm to kind of maintain a higher loan loss reserve, especially where we are in the cycle with credit trends today.
It looks like the reserve, now at 97 basis points, is effectively kind of round trip the day 1 CECL level. So just curious as to what the harm would have been to kind of keep the reserve a little bit higher and be a little bit more conservative.
Damon, it's Marty. Thanks for the question. It's an important topic, I think, for the industry right now. There's dissidence relative to some of these reserve releases. And to your point, what we think could happen relative to the economy and other challenges to credit, et cetera.
We obviously -- all these CECL models were built at a time when interest rates were 0 to 25 basis points on a Fed funds basis. We've not -- felt the impact of the velocity of interest rate increases. Obviously, the credit events that we've been talking about in the industry and in the financial press for the last 18 months, they didn't exist.
So we are thinking about that and the model and the times that we are in today versus when it was built and adopted in the late '19 and early '20 and exploring other factors that would have acceptable statistical attribution in terms of predicting future credit losses. But Jack, you started to think about that.
Sure. So Damon, let me start by saying that a coverage ratio of 97 basis points. I'm comfortable with that given the credit performance of our portfolio. When I look back to the third and fourth quarter last year when we were building reserves, it was driven by one of the qualitative drivers of our CECL model that's quantitatively driven, and that's the delinquency on our indirect portfolio, which started to increase.
And as a result, we saw higher net charge-offs in the indirect portfolio in the fourth quarter of '23, and again, in the first quarter of this year. However, during the first quarter, we saw delinquencies at basically 50% of what they were during the fourth quarter of last year, which is the leading indicator of future charge-offs in that portfolio.
So given that performance and the quantitative factor around it, that drove the majority of our reserve release there. And with the underlying performance of that portfolio, obviously comfortable with our current coverage ratio.
Got it. Okay. And there's -- like there's no concern that if rates stay higher for longer and there's more stress on the consumer that, that indirect portfolio could experience some weakness?
We saw weakness in the portfolio through net charge-offs in the fourth and first quarter of this year. That was driven by a slug of loans that had been originated during the pandemic when consumers were flush with liquidity from government stimulus programs. We're working through that. Given the current delinquencies on the portfolio, I expect to see some improved performance in that line of business.
Okay. Great. And then just one other question here on the margin. It came in at 278 this quarter. Do you happen to have what the margin was for the month of March?
Yes, it was 280 basis points.
[Operator Instructions] Our next question is from the line of Bader Hijleh of Piper Sandler.
Just filling in for Alex today. I Just wanted to ask about the NIM guidance. You guys guided to 285 to 295 for the year. Could you just walk us through the drivers of what would have to go right for it to hit the top end of the range, 295 and vice versa to 285 throughout the year.
Sure. So a lot of what's driving that cash flow is coming off the portfolio with really tempered loan growth in that 1% to 3% range. So we're seeing the roll-on yields in our commercial book come on 8% or higher, which is exceeding the cash flows that's coming off the portfolio. So that's driving the modest expansion that we're forecasting.
We're also including modest amount of increased beta in the deposit book just given the higher rate environment. However, we think that, that's at a much lower level than what we had experienced last year. And as we indicated in the call script, we saw margin improvement each month during the first quarter at a modest level, which gets us to that guided range of what we projected for the full year.
Got it. And then just a follow-up also about the NIM. Is it fair to assume -- I mean, you just gave the NIM for March was 280. Is it fair to assume that 1Q would be the bottom for the NIM? And should we expect an inflection next quarter?
That's the expectation.
Thank you. We have no further questions in the queue at this time. So I would like to hand back to Martin Birmingham for any closing remarks.
Appreciate everyone's participation this morning and interest in the company. We look forward to continuing this conversation and updating you on our results for the second quarter in July.
This concludes today's call. Thank you all for joining. You may now disconnect your lines.