First Interstate Bancsystem Inc Q1 FY2021 Earnings Call

Good day. And welcome to the First Interstate BancSystem First Quarter 2021 Earnings Conference Call. All participants will be in listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note today’s event is being recorded. I would now like to turn the conference over to Lisa Slyter-Bray. Please go ahead, ma’am.

Thanks, Rocco. Good morning. Thank you for joining us for our first 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.

Thanks, Lisa. Good morning and thanks again to all of you for joining us on the call today. Again, this quarter along with our earnings release, we have published an updated investor presentation that has some additional disclosures that we believe will be helpful. The presentation can be accessed on our investor website, and if you haven’t downloaded a copy yet, I would encourage you to do so. I’m going to start off 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 detail on our financials. The first quarter came in largely consistent with our expectations. We continue to see healthy economic activity throughout our markets, which resulted in strong deposit inflows, a positive impact on our fee-generating businesses and further reduction in all of our problem loan categories. We executed well on our near-term strategy to support our net interest income by utilizing some of our excess liquidity to retain more of our residential mortgage production and increased purchases of securities in our investment portfolio. The additional revenue generated through this strategy combined with the stable expense level helped us to deliver another strong quarter of earnings for our shareholders. With the quarter, we generated a net income of $51.4 million or $0.83 per share.

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 fourth quarter of 2020, and I’ll begin with our income statement.

Thanks, Marcy. Nice job. I’m going to wrap up with a few comments about the remainder of 2021 and how it’s shaping up. Our near-term focus will be continuing to support our net interest income by retaining mortgages and increasing our security portfolio. But we are becoming increasingly confident that we will see stronger loan growth for the remainder of the year, which will give us more opportunity to increase net interest income and further improve profitability. Credit line utilization is at historic low levels. We will see construction lines fund throughout the rest of the year, and we expect both consumer and commercial lines of credit to return to a more normalized level, which will reduce the excess lines about 9%. If this materializes, this will result in about $200 million in increased outstanding balances. Our loan pipeline is steady and signs are pointing to higher demand in the coming months. We are seeing good opportunities across a variety of asset classes both in the West and Mountain division. We believe commercial construction will be an area of strength. We’re also seeing opportunities in residential construction as homebuilders look to satisfy the strong demand for housing resulting from the population growth in our markets. This also extends to multifamily lending, which is benefiting from the same in-migration trends. The outlook for commercial real estate lending looks positive. We don’t have much exposure to the office market that has some people concerned about the long-term impact of working from home. And we’re seeing good opportunities across other property types that continue to perform well. We fully expect a very strong tourism season this year given the pent-up demand. It’s very difficult to book a room at many tourist destinations in our markets right now. This only bodes well for the fee income we generate from increased economic activity in our markets, but also for loan demand from a larger ecosystem of small businesses that serve the tourist market. In May, we are launching our small business digital lending platform, which will improve our ability to serve small businesses and efficiently originate loans in this area. This is just one of the technology rollouts this year. We just completed the installation of our integrated teller platform in our branches, and later this year we will upgrade our debit card processing system and implement a new commercial loan origination system. All of these technology enhancements are driving improved efficiencies, providing more opportunity for revenue generation and improving our client experience. This is a continuation of our efforts to consistently enhance our people, processes, and technology, and do it without having a material impact on expense levels. On the people front, we had John Stewart join the team as Deputy CFO and Head of IR. We know many of you know John, and we’re excited that he has chosen to cross over to the bright side of the business. So you will see him around as he’ll be joining Marcy and me in many of the upcoming investor events. The investments we have made in prior years in processes and technology to build a robust scalable technology platform are enabling us to consistently add new features and tools that will improve our operation without much incremental expense. We believe this positions us very well to realize more operating leverage as we continue to grow the company both organically and through additional acquisitions. Before I wrap up today, I want to note that we recently published our 2021 Community Responsibility Report, which is available on our website, and I encourage anyone who is interested in understanding our company better from an ESG perspective to download a copy. We’ve been publishing a similar report for several years, and a commitment to corporate social responsibility is just something that is in our DNA. Being a good corporate citizen and a valued partner to our communities has been a core value of First Interstate for decades, and taking care of our employees, clients, and neighbors will continue to be an integral part of the success and growth of our future. So, with that, I’ll open the call up to questions.

Thank you, sir. Today’s first question comes from Jared Shaw at Wells Fargo Securities. Please go ahead.

Hey. Good morning, everybody.

Good morning, Jared.

Good morning, Jared.

Kevin, can you start by discussing some of the technology investments, particularly the small business lending portal? How do you see that impacting business growth? Will it allow you to attract leads from the PPP, possibly from customers of other banks, and do you believe it will help convert them into full-service customers more quickly than before?

Yeah. There are two things that we see benefit, Jared. One is that people can go online and apply for a loan themselves and be immediately approved and funded, because it has an automatic scoring process. So it’s a fast and efficient way for them to do it themselves. Or we’re also training our Financial Service Representatives, which are not commercial lenders, to walk customers through this digital application within some of the locations that might not have commercial lenders to quickly get loans approved and funded.

Okay, great. And then on the mortgage side, are you retaining everything that you’re producing at this point, or are you trying to keep shorter? You’re not looking at 15-year; are you holding on to 30-year as well? And I guess how will that impact mortgage banking revenue going forward in terms of volume retained versus sold?

Marcy is going to answer that question.

Yeah. So, Jared, in the first quarter, we retained about 58% of our production in the portfolio, and some of that did include the 30-year mortgage product. Going forward, we will begin to phase out of that, headed into the end of the second quarter. So, again, we had a certain amount that we were going to retain around $400 million throughout this whole process since we started retaining mortgages in the fourth quarter, and we’re about at that threshold. So we’ll begin to sell more of our production as we head into the end of the second quarter.

Okay. And then just finally coming on credit, I guess, are two things. One, should we expect that the negative provision this quarter sort of got you to where the current economic environment is reflective of? And any reduction of the allowance for credit losses will be more a function of loan growth at this point, or could there be another negative provision? And then just sort of tying into slide 21 in your slide deck, there is a construction loan that you highlight as management attention. It doesn’t look like there was a reserve against that. Can you just give a little color on that?

So I’m going to let Michael Lugli answer that last question. But I’m hoping that we grow into the reserve balance where it is right now with loan growth. And I’m not anticipating any substantial change in our economic outlook unless we continue to see things markedly improve from here. And then does that answer that question, Jared?

Yeah. Thanks.

Okay. And then Michael?

Michael.

Michael.

Hi, Jared. It’s Mike Lugli. What you're referring to is the commercial institutional building construction and the need for management attention. This is mainly due to a couple of hospitality loans we are working on. It's not related to the actual project but stems from the guarantor having weaknesses linked to other assets they own, which is impacting their liquidity. That's why it was shifted to management attention given the uncertainty. Does that clarify things for you?

Yeah.

Management attention is about as late as we get criticized. So, no, there is not. We feel very good about the project. It is really just looking, and we’re looking at that hospitality book and office book closely. It’s just looking at that guarantor that, out of caution, abundance of caution, we moved that to special mention.

Great. Thank you.

And our next question today comes from Levi Posen with D.A. Davidson. Please go ahead.

Kevin, Marcy, good morning. This is Levi on for Jeff Rulis.

Good morning, Levi.

Good morning, Levi.

If I can just start with a housekeeping question on the tax rate, is it fair to assume that the seasonality we’ve seen in the past couple of years repeats this year and we land towards the 23% for the full year?

Yeah. I think we’ll be between 22.5% and 23%. We always have some benefit that we see in the first quarter from the tax benefit associated with option exercises, and so that’s what happens in the first quarter to drive that rate down a little bit.

Got it. Okay. Thank you. And then I apologize if I missed it earlier, but was there an expense run rate going forward?

1% increase year-over-year.

Great. Thank you. And then last one for me on the capital side of things, you guys have been active with buybacks and the dividends. What are your thoughts on M&A coming up here?

We are always in discussions about potential acquisitions, and those conversations are ongoing. However, we are being quite selective, as we have been in the past. There are more opportunities available right now, and we are being approached, but we are not rushing into any decisions. We have specific acquisitions in mind that we believe will enhance the value of our franchise, and we feel that being patient is the best approach at this time.

Understood. Okay. Thank you. I’ll step back now.

And our next question today comes from Matthew Clark with Piper Sandler. Please go ahead.

Hi. Good morning.

Good morning, Matt.

Good morning, Matt.

Marcy, do you have the weighted average rate on new loans this quarter for PPP?

It was 4.25%.

Okay. Okay. And I guess what I’m getting at is kind of the incremental core margin based on new business, new securities at 119, new loans at 4.25. Maybe some additional security from here might be a little bit lower in that 119. Assuming kind of a similar mix of assets, do you feel like we’re kind of near the bottom here on the core NIM?

So I know it is difficult to say, so just based on where we ended the quarter and then with the expectation that we’re going into our stronger season where we could see some additional modest deposit growth. I think that we could possibly see a little bit more pressure on our core NIM, just resulting from that mix shift. So, again, if we see folks spending money and deposits don’t grow and we see higher loan growth, that could change that. But I, just on a core basis, think we could see a little bit more pressure; not substantial, but a little bit.

Okay. Okay. And then can you quantify the gain in other income? I’m assuming it’s about $2 million, but just want to double-check the other fee income?

Say that again, Matt, I’m sorry.

Just looking to quantify the gain in other non-interest income this quarter; I think it was around…

Oh! So, the only non-core gain that I’d seen there, we had about a $750,000 gain on the deposit premium when we sold that Lynnwood branch. Other than that, it’s just the normal ins and outs of what we usually see in that line item.

Okay. And then just on the service charges and the fee waivers, I guess, I would have thought we kind of come to the end of that at this point, but any change in strategy or rationale on waiving fees?

So, again, when we had stimulus payments come into those accounts, we waived fees again this quarter, but we’re no longer doing that. So going into the second quarter, we should see that return to more normalized levels.

Okay. And then just lastly on the Round 2 of PPP, are we using a five-year amortization life or something shorter?

Yeah.

Okay. Thanks.

Yeah.

Our next question today comes from Jackie Bohlen with KBW. Please go ahead.

Hi. Good morning.

Hi. Good morning, Jackie.

Good morning. I wanted to follow up on Matthew’s question regarding service charges. Considering the strong tourism season last year and the expectation that this year is equally strong, if not stronger, it’s difficult to identify trends due to the pandemic's impact on activity. I am curious about your expectations for the summer and whether we can anticipate a more normalized trend compared to last year, particularly with fee waivers ending and other factors in consideration.

It's difficult to predict, Jackie. I agree with your point because clients have increased cash in their accounts, leading to a decrease in NSF charges. I wouldn't anticipate a significant change in the trend compared to what we observed last year at this time. We will have to wait and see if spending becomes more vigorous, but I expect it to be similar to last year.

Okay. Okay. And then just in terms of the strength of your customers and how that’s driving some deposit volume. To the extent that net migration continues, I would expect economic activity to be robust. Is there anything that would stop that flow? And I know that this quarter had stimulus and everything involved too, but just thinking about it outside of that?

No. I don’t think there’s anything that would stop that. I mean we’re not trying to actively exit deposits from the bank.

No. And Jackie, we usually decline in deposits in the first part of the year, and our growth of deposits starts in, like, the mid-second quarter and continues for the remainder of the year. So we believe with the increase in economic activity, deposits should grow. The question is how fast they grow and do they grow at the pace they have been growing. But there is anticipation that deposits will continue to grow. We just don’t know how fast, because we’re entering the normalized season where deposits grow.

And then we don’t know how fast spending will pick up as well. So it’s just kind of a new environment.

Yeah. No. I get it, and I myself am just trying to wrap my arms around it. So your thoughts on that are helpful. So thank you. Everything else I had was already covered.

Thanks, Jackie.

Thanks, Jackie.

And our next question comes from Tim Coffey with Janney. Please go ahead.

Thank you. Good morning, everybody.

Good morning, Tim.

Good morning. Kevin, I want to follow up on your comments regarding loan growth. You seem to have a more optimistic outlook moving forward. How do you think that will affect loan growth for the remainder of this year?

We believe that we will meet the mid-single-digit level, and we are now moving toward expectations of potentially upper single digits in our growth for this year.

Okay. Can you provide any details on the MSR recovery for the quarter? Do you expect this to be a one-time event or is it a result of previous impairments?

Well, I think the thing is, is that we had previous impairments of last year due to the speed of prepayments, and we had a write-down our MSR. We did give highlights that this year we’d probably see a recovery of that, so that’s just part of writing it up and writing it down. So the thing is that we don’t see any more really large recoveries of impairments for the remainder of the year. But it’s just an accounting thing you have to go through where you write them down, you write them back up. So it’s just puts noise in our numbers, which we don’t like.

Yeah. So, on our prepared comments, we didn’t factor any additional recovery into the run rate of non-interest income going forward.

Yeah. Great. I just want to clear that up. Thanks a lot. Those are my questions.

Yeah.

No problem, Tim.

And ladies and gentlemen, that concludes our question-and-answer session. I’d like to turn the conference back over to the management team for any final remarks.

Well, I want to thank everybody for your questions. As always, we welcome calls from our investment analysts. Please reach out to us if you have any follow-up questions. Again, thank you for tuning in today and goodbye.

Thank you, sir. This concludes today’s conference call. We thank you all for attending today’s presentation. You may now disconnect your lines and have a wonderful day.