First Interstate BancSystem (FIBK) Q1 2022 Earnings Call Transcript

First Interstate BancSystem (FIBK 0.29%)
Q1 2022 Earnings Call
Apr 29, 2022, 11:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good morning, and thank you for attending today's First Interstate Bank System first-quarter earnings call. My name is Jason, and I'll be the moderator for your call today. [Operator instructions] I would now like to pass the conference over to Lisa Slyter-Bray.

Lisa Slyter-Bray -- Executive Assistant

Thanks, Jason. Good morning. Thank you for joining 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. 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 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 non-GAAP financial. Into robust economic activity and job creation to serve these growing communities.

This has translated into increasing levels of activity coming through our credit approval process, which should lead to higher levels of book production going forward. Our Mantia and Idaho markets were particularly strong this quarter and why only has stabilized and is no longer a headwind to loan growth than it was last year. Additionally, as we had quickly resolved many of the credit challenges related to the transaction, we have good momentum to grow in our expanded footprint. Within the legacy First Interstate loan portfolio, as a result of an increase in utilization rate on commercial lines of credit and a strong production levels, we grew our total loans held for investment by roughly 2% alive in the first quarter, excluding PPP loans, Importantly, we experienced over 5% annualized growth from our branch network, which was partially offset by the decline in our home mortgages and indirect lending portfolios.

This is a positive to -- as a seasonality, we typically see a beginning of the year of our results in flat or slightly declining loan balances during the first quarter. Compared to the fourth quarter -- we are beginning to see some sanity return to loan pricing as interest rates have increased, along with marginally less competitive environment. This quarter, the average rate on new loan production in our legacy footprint is now over 4%. Moving to Great Western.

Excluding PPP loans, reduction levels remained strong in the quarter. Since the close of the acquisition, we've been able to make formal announcement affirming continued consistent leadership in both markets, which has minimized the uncertainty created in any acquisition. The teams, many of which I have personally visited are excited about the future and I'm impressed with this talented group of bankers. With the motivation we are seeing from this team, combined with the substantial progress that we have made to work down levels of problem loans.

We are optimistic that we will see growth in these new markets faster than we anticipated. In terms of problem loan resolution, if you recall the time of the transaction analysis, we identified $1.2 billion PCT loans. When we closed the acquisition, the number was down to $722 million, and we've made progress by working down the portfolio since the close. Criticized always, but we're [Inaudible].

We're down to $655 million at quarter end and decelerate the work process. We transferred $241 million of credit to loans held for sale of the transaction, and we expect these loans will be substantially off our books by the end of the second quarter. Considering these factors, many of the headwinds that total loan growth that we initially anticipated in the first two years of the combined operation from the disposition of problem loans has been substantially reduced. We now expect great results that to be contrary to the growth of the combined companies this year.

While we are very excited about the acquisition, we haven't lost focus on expanding the digital learning capabilities that we introduced over the last couple of years. We continue to refine this small business banking loan origination platform that we launched late last year, offering lines of credit up to $100,000. We are currently focused on increasing the automation of scored products up to $250,000 and are prepared to launch this later this year. The digital capabilities and the assets the Small Business Lending Center will be rolled out into the new footprint at system conversion.

Before I turn the call over to Marcy to provide additional details about our first-quarter results, I'd like to say that I have never experienced an acquisition where there is so much enthusiasm and excitement for our new colleagues. This has been a rewarding, rewarding experience and I am excited about the possibilities going forward. And with that, I'll turn the call over to Marcy.

Marcy Mutch -- Chief Financial Officer

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 2021. Of course, the primary driver of the variances in each area will be the partial quarter impact from the Great Western merger, which closed on February 1st. I'll begin with our income statement.

On a GAAP basis, our net interest income increased by $56.2 million, while the growth in our earning assets from the acquisition was a primary driver, so too was the sequential expansion of our adjusted net interest margin as well as the increased contribution from accretion on purchased loans. Our reported net interest margin increased 11 basis points from the prior quarter to 2.8%. Excluding purchase accounting accretion and PPP income, our adjusted net interest margin increased 19 basis points from the prior quarter to 2.65%. This was driven by a favorable mix shift and an expansion in our yield on earning it's in the first quarter, up from 53% in the prior quarter.

Our securities yield expanded 23 basis points, which was partially attributable to the repositioning we did after the Great Western investment -- after adding great Western's investment portfolio, along with higher new investment yields, which were 2.2% in the first quarter. Looking ahead, we believe we are well-positioned to see a continued expansion in our net interest margin due to a number of factors. We anticipate a continuation of the positive mix changes to our earning assets in the second quarter. Investment securities purchases continue to be accretive to book yields in the current environment, and we expect to invest additional cash in the second quarter.

Loans should begin repricing with the recent Fed rate hike. Loan accretion should be modestly higher in the second quarter with a full-quarter impact from Great Western. And at this point, we've seen nothing in deposit trends after the first rate increase to change our expectation that we will have a very low deposit beta during the initial stages of this rate hike cycle. While the expansion will vary from quarter to quarter.

We expect the general trend in our net interest margin to be higher as the Fed raises rates, which should help lead sequential improvement in the net interest income as the year progresses. Before I discuss fees and expenses, I would like to level set on one area and address the realignment of Great Western's accounting practices to our own, as you'll see referenced in the investor presentation on Page 8. Previously, Great Western netted certain expenses against noninterest income, which for accounting clarity, we don't do it first or state. This practice was most notable in our payment services business.

While the unwinding of this practice has zero impact to net income, it will result in both fees and expenses being approximately $13 million higher for the calendar year 2022 or approximately $1.8 million for the first quarter. So with that, our noninterest income increased $11.8 million quarter over quarter to $49.2 million, which included a $3.4 million recovery of mortgage servicing rights impairment and a $1.4 million gain on the repayment of Great Western sub debt. We saw strong results from our payment services business, which we expect to continue, along with nice improvement in our swap fee revenue as compared to prior periods. With higher rates reducing demand for refinancing and continued housing supply constraints impacting purchase volumes, we anticipate the environment to become more challenging in the mortgage banking business.

We expect to offset some of these headwinds as we expand our production into the new Great Western markets, particularly through our digital loan origination platform, which will be available to them at system conversion. Looking ahead, by the fourth quarter of 2022, we expect our run rate for noninterest income to be in the range of $52 million to $54 million, excluding any impact from MSR. This also takes into consideration the reduction related to the full impact of our new NSF and overdraft policies. Moving to noninterest expense.

We recorded $65.2 million in acquisitions related expenses in the first quarter. This, along with the partial quarter impact of adding Great Western's operations resulted in total noninterest expense of $207.2 million. Looking ahead, as most of the cost savings will not come out until after system conversion, the additional month of Great Western's operations will increase our adjusted operating expense by approximately $20 million in the second quarter. Additionally, we expect to incur another $60 million to $70 million in merger expenses, which should also fall mostly into the second quarter.

We are on track for the system conversion in late May, after which we'll start to realize the cost savings projected for the transaction. By the fourth quarter of 2022, we expect our quarterly run rate for total operating expenses to be approximately $160 million, which includes approximately $4 million of reclassified expenses related to the realignment of Great Western's accounting practices that I mentioned earlier. This should put us right in line with original expectations even after considering inflationary wage adjustments we expect to make later this year. Moving to the balance sheet.

Excluding the addition of Great Western, the legacy First Interstate loan portfolio increased $37 million, excluding PPP loans from the end of the prior quarter, primarily due to growth in the commercial loan portfolio. As of March 31, we had approximately $56.7 million of total PPP loans remaining on our balance sheet, net of $1.3 million of remaining associated deferred loan fees. Our investment portfolio increased by approximately $3 billion from the end of the prior quarter, largely due to the securities added from Great Western. Immediately after closing, we've repositioned part of that portfolio, selling securities that didn't meet our risk profile and moved $464 million of securities from available for sale to held to maturity.

This reduced the impact of higher interest rates on OCI and our tangible book value. At the end of the quarter, the duration of the investment portfolio was 3.8 years or 3.6 years when you include the impact of our interest rate hedges. On the liability side, our total deposits continue to increase in what is historically a flat to down quarter, and we were up 3.2% on an annualized basis from the end of the prior quarter. Moving to asset quality.

While our nonperforming and criticized loans increased due to the acquisition, credit trends in both portfolios continue to improve. Within the legacy First Interstate portfolio, we had just 6 basis points of net charge-offs on an annualized basis in the quarter. Outside of those charge-offs, we recorded approximately $15 million of net charge-offs on loans acquired from Great Western, most of which were specifically reserved and taken in anticipation of restructuring these loans in future quarters. We recorded $68.3 million through the loan loss provision on non-PCD loans from Great Western, which was partially offset by a release of reserves on the legacy First Interstate portfolio.

Our allowance as a percentage of loans held for investment was 1.46% at March 31, up from 1.31% at December 31. Our reserve remains strong with coverage of our nonperforming loans at over 200% post transaction. And with that, I'll turn the call back to Kevin.

Kevin Riley -- President and Chief Executive Officer

Thanks, Marcy. I'll wrap up with a few comments on our outlook. Despite the inflationary pressures and higher interest rates, loan demand remains robust, and our pipeline remains strong across all asset classes in all margins. Pricing appears to be firming, and we expect to see the usual seasonal increases at the construction lines during the second and third quarters of this year.

With the progress that we have been made in reducing Great Western's problem loans, the headwinds that we expected to have the total loan growth post closing have been meaningfully reduced. Based on our strong pipeline, we are optimistic for growth in excess of low single-digit outlook we previously gave for the combined company over the remainder of combined with cost savings that we will see. After the system conversion, we are optimistic about the level of profitability that we'll be able to generate during the second half of the year. Another benefit of resolving the product loans at a faster pace than it is expected is that we have been able to devote more time and attention to executing on potential revenue synergies.

We've been able to make more progress than we expected on putting the groundwork in place to take advantage of our larger footprint to drive growth in home loans, indirect lending, commercial and consumer credit cards and treasury management solutions. While we may see some small incremental benefits in 2022, we are setting the stage this year to see positive impacts from these efforts in 2023. And finally, we've been relatively conservative with respect to capital leading up to the closing of the merger. But we have the merger completed and more clarity around the credit quality and the acquired loan portfolio we have the ability to evaluate and consider options to optimize our capital.

So with that, I'd like to open the call up to questions.

Questions & Answers:

Operator

[Operator instructions] Our first question is from Jeff Rulis with D.A. Davidson.

Jeff Rulis -- D.A. Davidson -- Analyst

Just a question on -- assuming there are some lockups or incentives aligned with -- I guess, through the conversion in mid-May. Any preliminary thoughts on retention or departures that you might see? I guess it could be a little -- to be determined, but what's your gauge on that as we approach conversion?

Kevin Riley -- President and Chief Executive Officer

The lockups that we put into place for our producers lack that are in place for a year. So that -- we're hoping that we'll continue to lock them up as they've been locked up so far since the transaction closed.

Jeff Rulis -- D.A. Davidson -- Analyst

Got it. I guess the folks that you did stock through conversion, that departure is to be assumed, I suppose, or --

Kevin Riley -- President and Chief Executive Officer

[Inaudible] retention bonuses. Yes, when we gave retention conversion they'll get the retention bonus once the conversion is done, and they'll move on. But the producers we gave lockups for over a 12-month period.

Jeff Rulis -- D.A. Davidson -- Analyst

Fair enough. Kevin, on the -- just taking a different angle. Would a buyback be considered now with the deal closed, I guess, there was a discussion of some technical trading headwinds as you approach to close. And I just wanted to check in on capital use post? Or as we head forward and is buyback part of that discussion?

Kevin Riley -- President and Chief Executive Officer

Well, as you know, we've always talked about the different things that we use capital for and buybacks is always part of the discussion. Right now, we probably -- we have more capital than we had pre-pandemic. And as you saw around endemic it we did some special dividends. We did some share buybacks.

So everything is on the table, and we're looking at the options as we speak. So time will tell where we go.

Jeff Rulis -- D.A. Davidson -- Analyst

OK. And one last one on -- just looking forward on the maybe the credit path of NPA resolution from here, noting that the PCD balance is down and what you've moved into held for sale. But any kind of major mile posts that you see on the remaining NPAs?

Kevin Riley -- President and Chief Executive Officer

We see some upgrades as the economy is improving in some areas, and you'll see some that were we'll show the door and then we'll free right other ones. So it's just going to be normal kind of working out of where we are with regards to these classified assets. Also have built into there some inflationary wage increases. Our wage increases related to inflationary pressures.

And between all of that, that will be the run rate announcement and you add that on an annual basis, $14 million to that. We're kind of right in line with where we thought we'd be.

Jeff Rulis -- D.A. Davidson -- Analyst

OK. And then on the fee income run rate of $52 million to $54 million by the fourth quarter. I think some of that's accounting related to, but what else is getting you from that $44.5 million this quarter on a core basis up to that $5 million to $4 million range by the fourth quarter?

Kevin Riley -- President and Chief Executive Officer

Again, I just think when you include the run rate from Western, we expect mortgage to be flattish ex MSR impact as we go into the back half of the year, we're just feeling positive about where we expect to be from a fee perspective. And again, part of that's the $14 million reclass.

Jeff Rulis -- D.A. Davidson -- Analyst

Right. And there was $1.8 million of that in this quarter. Is that right for the reclass?

Marcy Mutch -- Chief Financial Officer

Yes.

Jeff Rulis -- D.A. Davidson -- Analyst

Did I hear that correctly? OK. OK. And then on the pipeline, Kevin, you mentioned it's strong. I know the comparisons are distorted having just closed on the deal.

But I guess how would you size up that pipeline relative to the growth you might anticipate coming out of it? Where it's coming from.

Kevin Riley -- President and Chief Executive Officer

Yes, I always from what I get to my chief credit officer is that they have approved $1.6 billion of loans and wrote something that sticks to the phones. Just It doesn't mean they're all going to be booked because they could be put by some other intention. But the approval process is probably at the highest level we ever seen.

Operator

Our next question comes from Jared Shaw with Wells Fargo.

Jared Shaw -- Wells Fargo Securities -- Analyst

I guess maybe just going back to the growth, Kevin, you sound pretty optimistic about the geography and the job formation, people moving in, strong credit. You referenced competition slackening. I guess why not be more optimistic on growth. I guess you're saying we're off of the low single digits, but with the faster cleanup, what would have to happen to get you up to sort of mid-single digits or high single digits?

Kevin Riley -- President and Chief Executive Officer

Well, it's always our goal, Jared, to grow as fast as we possibly grow. But again, we're in a risk business, and we want to make sure we're taking the appropriate risk in that growth. So it's -- we're very optimistic that growth is going to be better than what we have seen maybe in the past, but the fact that matter I don't want to -- you know me, I don't want to ever get out too far ahead of people and promise too much and under deliver. So I rather hedge my bet with regards to what we think growth might be.

And it comes up better than that. you trust me I am going to turn down the business.

Marcy Mutch -- Chief Financial Officer

I think we optimistic about line usage, we're optimistic about line usage. We're seeing a slowdown in the pace of payoffs. And so both those things to make are encouraging to us.

Jared Shaw -- Wells Fargo Securities -- Analyst

OK. That's great color. And then I'm just looking at the asset quality side and you referenced the $31 million remaining loan balances that could be exited. Are those already -- I guess a couple of questions.

One, are they already marked. Is there -- is that sort of reflective of what you expect their worth? And is that included in the held-for-sale category?

Kevin Riley -- President and Chief Executive Officer

Yes.

Marcy Mutch -- Chief Financial Officer

It is -- excuse me, it is not Hold on, Michael?

Michael Lugli -- Chief Credit Officer

Yes. This is Michael. The $31 million that you're referring to relates to the TDRs that we're anticipating doing over the next couple of quarters, so we rightsized some loans in the first quarter. And so what you're seeing is that will be through we've taken the charge.

So now we just need to put together and redocument the loans so that we can upgrade the remaining balances up from classified.

Jared Shaw -- Wells Fargo Securities -- Analyst

OK. So not necessarily a charge as you take that next step, that's already been reflected in the valuation?

Michael Lugli -- Chief Credit Officer

That's correct.

Jared Shaw -- Wells Fargo Securities -- Analyst

OK. And then just finally for me, I guess, with the stronger environment purchasing securities. What -- where do you see securities potentially going as a percentage of assets? And is that something that would be phased out over the year? Or if there's good pricing, good opportunity, you potentially get there faster?

Marcy Mutch -- Chief Financial Officer

Yes. So I do think we have the opportunity to deploy some of our cash into the investment securities portfolio. we see some good opportunities there. So I would expect, as a percentage of earning assets to go up a little bit, but of course, our first hope is to deploy that into the loan portfolio.

Operator

From Chris McGratty from KBW.

Chris McGratty -- Keefe, Bruyette and Woods -- Analyst

I guess a question on the balance sheet, understanding the excess cash position and the ability to remix. How should we be thinking about just growth in balance sheet? Maybe a comment on what you're assuming for deposit growth over the balance of the year?

Kevin Riley -- President and Chief Executive Officer

That's a good question, Chris. Go ahead. Go ahead, Marcy. Go ahead.

Marcy Mutch -- Chief Financial Officer

So deposit growth generally goes up as we go through the next couple of quarters. We have seen a little bit higher pace of outflows for tax payments this quarter than normal. But overall through the second and the third quarter, we'd expect deposits to grow modestly and then kind of flatten out as we go into the end of the year or potentially slightly decline.

Chris McGratty -- Keefe, Bruyette and Woods -- Analyst

OK. And then is there a targeted mix that you're looking to get for the cash position? And if so, what do you think you can get there?

Kevin Riley -- President and Chief Executive Officer

So there's not a targeted mix, but it's definitely down from where it is now. So I think we have a lot of flexibility to put that to work either in the loan portfolio or the investment portfolio to increase overall net interest income.

Chris McGratty -- Keefe, Bruyette and Woods -- Analyst

OK. And then maybe a final one. You provided the guidance on the fourth quarter where fees and expenses were going to exit. One of the questions we're getting a lot on this quarter is exit run rate of net interest income for this year.

And so I'm interested in your thoughts if the forward curve would play out, how should we think about putting all the pieces together and kind of an exit run rate for spread income?

Marcy Mutch -- Chief Financial Officer

So Chris side isn't really something that we've disclosed in the past. I think if you look at -- I think we said we had three interest rate hikes in our budget most likely It could be More than that. I mean I think we've given you all the pieces to be able to do the math there. in terms of what our variable rate loans are immediately repriced there like 27% of the loan portfolio.

Investment portfolio is 13%. The investment portfolio immediately. We expect the PA betas to be low. So I mean you can make some assumptions and kind of get there on your own based on what you think rates are going to do.

Your crystal ball is probably as clear as ours.

Operator

Our next question is from Andrew Dorell with Stephens Bank.

Unknown speaker

So most of might have been asked and answered at this point. But just from a kind of bigger picture, Kevin, when -- we announced this transaction back in September. I know one of the slides in the presentation gave us kind of a rundown of the pro forma P&L and paid kind of operating earnings in 2023 at $365 million I know there were some kind of conservative assumptions already and a lot has changed since then. But do you feel more comfortable in achieving that $3.65 pro forma EPS in 2023 to date compared to when you announced the transaction?

Kevin Riley -- President and Chief Executive Officer

I would say I would be very disappointed if we don't do better than the $365 million.

Unknown speaker

OK. And then just on the -- back on the capital management piece, can you just remind us how much you have, if any, in back authorization right now -- that would be helpful.

Kevin Riley -- President and Chief Executive Officer

Go ahead, Marcy.

Marcy Mutch -- Chief Financial Officer

Yes. I think we have 1.9 million shares left under our current authorization.

Operator

Our next question comes from Todd McKellen from RBC Wealth Management.

Unknown speaker

My questions have been answered.

Kevin Riley -- President and Chief Executive Officer

Thanks, Todd. Paul, if you have any other questions?

Operator

There are no more questions waiting at this time.

Kevin Riley -- President and Chief Executive Officer

Well, I'd like to thank everybody for your questions. And as always, we welcome calls from our investors and analysts. Please be out to us if you have any further follow-up questions, and thank you for tuning today. And have a good day.

Take care. Bye.

Operator

[Operator signoff]

Duration: 38 minutes

Call participants:

Lisa Slyter-Bray -- Executive Assistant

Marcy Mutch -- Chief Financial Officer

Kevin Riley -- President and Chief Executive Officer

Jeff Rulis -- D.A. Davidson -- Analyst

Jared Shaw -- Wells Fargo Securities -- Analyst

Michael Lugli -- Chief Credit Officer

Chris McGratty -- Keefe, Bruyette and Woods -- Analyst

Unknown speaker

More FIBK analysis

All earnings call transcripts