First Interstate BancSystem, Inc. Reports Fourth Quarter Earnings Transcript (Summary)

Note: Call starts abruptly and with technical difficulty.

Kevin Riley: Thanks, [Lisa]. 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 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 for the quarter. And then, I'll turn the call over to Marcy to provide more details on our financials.

 

We delivered another strong quarter as healthy economic conditions across our markets resulted in strong deposit inflows, a strong level of new loan production and further improvement in asset quality. Combined with our disciplined expense management, this produced a strong quarter of earnings with net income coming in at $51.2 million or $0.83 per diluted shares. Excluding $0.06 per share of merger related expenses, our earnings per share was $0.03 higher than the operating earnings per share in the prior quarter.

 

While we're disappointed with our net loan growth in the quarter, the highlight was exceptional levels of loan production that we had. Although, we are still seeing some impact from supply chains disruption and labor shortages causing projects and investments to be delayed, we had a strong level of new loan production with all of our markets making strong contributions. We are particularly pleased with the positive trends we are seeing in the [Mount] division as Montana [led] all of the markets. This is indicative of both, increasing demand and our improved business development efforts.

 

While we had extremely productive quarter of new business development, this was offset by an unusually high level of loan payoffs, which impacted our total loan growth. Some of the payoffs were result of sales of [companies] prior to year-end, while others were related to both, banks and non-banks offering low long-term fixed rate pricing, where we made a balance sheet management decision not to compete.

 

As always, we balanced growth with risk management. In this case, we are not going to take on unnecessary interest rate risks just to show loan growth, particularly ahead of potential [arising] interest rates. This long-term approach has enabled us to grow the company while maintaining exceptional asset quality and our target level of interest rate sensitivity, producing results that consistently created long-term value for our shareholders.

 

As a result of the elevated payoffs and the continued strong deposit growth, our cash position grew by nearly $600 million on average during the quarter to $2.3 billion or approximately 13% of earning assets. This leaves us a lot of room to optimize our balance sheet mix over time.

 

As we announced earlier this month, we have received all regulatory and shareholder approvals for the merger with Great Western Bancorp, which is expected to be completed on or about February 1st. We are very pleased that we are on track to complete this merger, just four-and-a-half months after announcement. This is a testament to our acquisition experience, efficiencies and strong regulatory standings. Over that time, we have made great progress in our integration planning and continue to feel good about our ability to meet our announced financial targets for the merger. The system conversion is scheduled for the weekend of May 20^th, with Great Western branches to open under the First Interstate brand on May 23^rd. We expect full realization of our cost synergies shortly thereafter.

 

As you may have seen, Great Western announced its fourth quarter results last night as well, showing tremendous progress working through its problem loan portfolio. Non-performing assets declined [30%], while criticized loans declined by nearly $150 million, excluding the loans held for sale. On that point, the team did a great job reaching an agreement to sell $75 million of mostly criticized hotel loans at a 12% discount, which is below the mark we disclosed on hospitality loans designated as PCD in our initial due diligence.

 

Great Western [has consistently resolved in] problem loans inside of our original estimate for PCD low marks, which may lead to a lower level of loan marks assumed in the transaction than initially projected. Great Western also had a good quarter of loan production, with total loans increasing over $100 million, adjusted for $122 million impact on PPP loans, and $36 million related to the disposition of non-performing loans.

 

With a strong progress Great Western has made on working through its problem loans, the front-line has been able to shift its focus back to business development and capitalizing on the strong growth in many of its markets, which is a trend we expect to continue. And, lastly, we hope you saw that earlier this week, we announced significant changes in our consumer overdraft practices, including the elimination of NSF fees, and a significant reduction in overdraft fees.

 

We're also introducing a checkless account that has no ability to be overdrawn, and includes debit and online banking access that will allow us to expand our product set and better serve the underbanked in our community. As a regional bank, it is important for us to be setting the example in our market on this front. It is the right thing to do and we hope other local market participants will follow our lead.

 

With an effective date of April 1^st, we estimate this change will reduce First Interstate’s and NSF an OD fees by around $5 million in 2022. Helping your neighbor and being a good corporate citizen, those are the core values that First Interstate was founded on and they will not change as we grow. They will only get stronger.

 

And with that, I'll turn the call over to, Marcy, so she can provide some additional details on our fourth quarter results. Go ahead, Marcy.

 

Marcy Mutch: 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 third quarter of 2021, and I'll begin with our income statement.

 

On a GAAP basis, our net interest income decreased by $5.1 million, which was primarily due to $4.5 million decrease in PPP loan income. Accretion income was also $400,000 lower on a linked-quarter basis.

 

Excluding the impact of PPP and accretion income, our net interest income was relatively flat compared with the prior quarter. Our net interest margin declined 22 basis points from the prior quarter to 2.69%, partially attributable to the lower level of PPP income. Excluding PPP from both periods, our net interest margin decreased by 15 basis points, primarily due to a shift in the mix of our earning assets toward investment securities and cash, along with modestly lower loan yields. This offset a 1-basis point decline in our cost of funds.

 

Yields on new loan production were about 20 basis points lower than the prior quarter, but still in the very high 3% range. This decline is attributable to an intentional shift in the mix of new production towards variable rate loans, which were about 54% of the total production in the quarter.

 

Our non-interest income decreased $2.3 million quarter-over-quarter to $37.4 million, primarily due to lower mortgage banking revenues, which was partially offset by higher wealth management and swaps revenues.

 

Moving to total non-interest expense, we recorded $5 million in acquisition related expense in the fourth quarter. Excluding acquisition related expense in both periods and the litigation accrual last quarter, we were pleased with our expense management in the quarter with non-interest expense declining by $900,000.

 

Moving to the balance sheet, our loans held for investment decreased $291 million from the end of the prior quarter, which included a net decline in PPP loans of approximately $190 million. Excluding PPP loans and deferred fees, total loans held for investment declined by approximately $107 million from the end of the [third] quarter, primarily due to declines in the construction and consumer loan portfolios. This was partially offset by an increase in our commercial real estate portfolio.

 

The commercial portfolio was essentially unchanged from the prior quarter, excluding the PPP loan impact. As of December 31^st, we had approximately $96 million of PPP loans on our balance sheet, net of $3.8 million of remaining associated deferred loan fees. On the liability side, our deposits continued to increase, and were up $262 million from the end of the prior quarter, with most of the growth coming in interest-bearing demand deposits.

 

Moving to asset quality, our portfolio continued to perform exceptionally well. Non-performing assets declined by 16% in the quarter and criticized loans declined by another 14% due to upgrades [and] pay-downs.

 

Our credit losses continued to be low, with $2.7 million of net charge-offs, which on an annualized basis, represented only 11 basis points of average loans in the quarter. Given the improvement in asset quality and a strong macroeconomic backdrop, we had a negative provision for credit losses of $9.5 million. This reduced our allowance as a percentage of loans held for investments to 1.31% at December 31^st, while our coverage of non-accrual loans increased to 491%. Excluding the $96 million of remaining PPP loans, our allowance represented 1.32% of loans held for investment at the end of the quarter.

 

I'll wrap up with a few comments about our outlook for 2022, which at this point are for First Interstate on a standalone basis. We will provide additional color on the combined company once we have a clear understanding of the purchase accounting impacts at the end of the first quarter.

 

Our outlook assumes 325 basis points [Fed hike] at the beginning of April, August and November. Excluding PPP, we expect mid-single digit loan growth, and for deposit balances to be relatively flat for the year. Excluding PPP income, we expect mid-single digit net interest income growth. We would expect the net interest margin to be relatively flat in the first quarter, again, excluding PPP. And for the first quarter to be the low point of the year.

 

Excluding the MSR impairment recoveries and securities gains we saw in 2021, we expect total fee income to be down mid-single digits, which includes a conservative outlook for our mortgage banking revenue and fully considers the roughly $5 million impact we discussed earlier related to consumer, NSF and overdraft fees. This also assumes no MSR impact in 2022.

 

Excluding the merger charges and litigation accruals that were incurred in 2021, we expect our operating non-interest expense growth to be in the low-single digits. This is a great result considering the inflationary pressures in the market today. And is a result of the scale of efficiencies, we have worked so hard to put in place over the last few years.

 

Of course, we know we won't be operating on a standalone basis, but we thought it was important to provide a sense for the positive trends we expect in our historical business. In regard to the acquisition, there's still a lot of moving pieces. But at this point, we feel good about our ability to deliver the earnings and performance metrics we projected at the time of deal announcement.

 

So with that, I'll turn it back to Kevin. Kevin?

 

Kevin Riley: Nice job, Marcy. On top of our priority list this year is executing a smooth and efficient integration of Great Western’s operation. After the system conversion is completed in May, we should realize most of the cost savings projected for the transaction starting in the third quarter.

 

As our franchise grows to more than [$32 billion] in assets with more than 300 branches across 14 states, we believe it is important that we continue to maintain the culture that has led to a long track record of success. That culture includes a strong commitment to making our communities that we live and work positive. We are excited to support the effort of the $20 million contribution to the First Interstate foundation that we announced with the deal. These funds will allow us to continue to make impact in our legacy communities, and immediately provide support across our expanded footprint.

 

As I mentioned earlier, we’re already seeing Great Western’s commercial banking teams shift its focus back toward business development, which we expect to continue after the merger. With the progress that Great Western has made working down its problem loans prior to the closing, we should have fewer headwinds to our total loan growth than we [expected] at the time we announced the deal.

 

Combined with strong levels of loan production that we are currently seeing at both, First Interstate and Great Western, we believe our original pro forma growth expectations may prove conservative.

 

As we look ahead to the year, we're excited by a number of catalysts that we have in place to deliver strong performance, economic conditions in our markets are fundamentally healthy. We are seeing increasing loan demand. [And we’ll] increase our exposure to faster growing markets following the closure of the merger. Both, First Interstate and Great Western, have good momentum and business development that should only accelerate as we leverage the combined strength of each organization. We’ll start seeing the accretive benefits of the transaction in a more meaningful way during the second half of the year following the system conversion.

 

Our balance sheet is very well positioned to benefit from rising interest rates. And we have the technology and the products to stay relevant in this highly competitive marketplace.

 

So, with that, I'll open the call up for questions.

 

Q&A

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