Q4 2023 First Interstate Bancsystem Inc Earnings Call
Participants
Andrea Walton; Administrative Officer; First Interstate BancSystem, Inc.
Kevin Riley; President & CEO; First Interstate BancSystem, Inc.
Marcy Mutch; EVP & CFO; First Interstate BancSystem, Inc.
Andrew Terrell; Analyst; Stephens Inc.
Brody Preston; Analyst; UBS Equities
Jeff Rulis; Analyst; D.A. Davidson & Co.
Adam Butler; Analyst; Piper Sandler & Co.
Timur Braziler; Analyst; Wells Fargo
Presentation
Operator
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.
Andrea Walton
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 and 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 in 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. dot 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 and 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?
Kevin Riley
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 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 loans, approximated about 7.8% during the quarter. This reflects our efforts to generate strong risk-adjusted returns and 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 utilize 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 areas to drive future efficiencies and profitability. As we noted previously, we standardized and streamline 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.
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 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 six basis points from the prior quarter as we continued 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 six basis points from the prior quarter to 2.94% due to higher overall funding costs, which offset our loan yield expansion and a one 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 a 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, with 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 a $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 four 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 lead from higher cost retail CDs runoff given the high level of liquidity we have on our balance sheet.
Moving to asset quality. This was a little noise 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 non-performing loans, eExcluding 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 one 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?
Kevin Riley
Thanks, Marcy. Now I 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 our outlook, we are expecting total loan balances 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 to 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 that will open call it for questions.
Question and Answer Session
Operator
(Operator Instructions) Andrew Terrell, Stephens.
Andrew Terrell
Hi, my first question on the margin. I mean the logical expansion we saw this quarter was it was good. And maybe a few parts of my question here on one deal -- the spot loan yields that [fall 31]. And then can you remind us if there are any lingering headwinds from the construction fund, 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 seven basis points you saw in the fourth quarter?
Marcy Mutch
Yeah. So the spot loan yields were about 7.8%. Again, the construction fundings. They're happening at about $200 million a quarter. You know, the weighted average yield on those are [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. That's a part of that question.
In terms of loan yields going forward, we think it will be there a few basis points higher than the Q4 average.
Andrew Terrell
And then I guess just like going going throughout 2024 on a quarterly basis, would you expect a similar kind of seven basis point or so pickup in loan yields per quarter?
Marcy Mutch
Yeah, it should be it's kind of mid-single digits, right in there somewhere.
Andrew Terrell
(multiple speakers) 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?
Kevin Riley
I think, Andrew, we're going to 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 to and reinvest in, we might take that route. But if it's if the market has shifted dramatically, then we'll probably just pay down borrowings and also deposit. The thing is where how seasonally that deposits are in the first quarter two also. So there's a couple of moving factors. There's no -- I know it's going to be hard for you to project it, but we're kind of we looked at it does it materially move the numbers either way that much.
Marcy Mutch
NII.
Kevin Riley
NII.
Andrew Terrell
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 three rate cuts are to that 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 the NII guide? And how could we see the guide change based on the sharing assumptions.
Marcy Mutch
So if there's more than three rate cuts, you know, that's going to be a benefit to us. You know, 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 pop in a 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 if those deposits will set potentially a little bit slower than then the rate cut that comes from the Fed, but push through.
Kevin Riley
So I'll do nothing in a flat rate environment, we still see NII growing in the back half without any rate cuts at all. So as requested increase, you'll see more benefit with regards to NI. So but we have run the numbers with no rate increase at all. And I should I should grow in the back half of 2024.
Andrew Terrell
That's helpful. I appreciate it. And just if I can sneak one last one. And Marcy, it sounds like within your expense guidance, we should be using kind of $161 million or so of the run rate for operating expenses, I presume kind of grow as they work throughout 2024. Is that fair?
Marcy Mutch
That's right.
Kevin Riley
That's good.
Operator
Chris McGratty, KBW.
This is Andrew Listern on for Chris Mcgratty. On that mid single digit decline guidance for 2024, what are you assuming for your noninterest-bearing deposit mix and your beta expectations?
Kevin Riley
NII deposit expectations and --?
NII expectation and your beta expecatations that go into the NII.
Marcy Mutch
So in the fourth quarter, our beta was 33%. And then with a 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 --
Kevin Riley
But that's slowing.
Marcy Mutch
Yes, it is slowing, but we assume that's going to move a couple of basis points higher into the second quarter.
Okay. Thank you. nd then just on capital, you had a $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?
Kevin Riley
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 that's our first priority with capital and then to use capital for organic growth will be the second priority. I would say that And unless things really go really well, I would say share repurchases at this time has been shelved. So those are prior our biggest priorities at this point.
Operator
Brody Preston, UBS.
Brody Preston
Hey, Marcy, within the net interest income guidance, did you give the down beta that you're assuming from the comps that you have in the back half of '23.
Marcy Mutch
So we didn't give a down beta in the back half under our assumptions. We're assuming some lag where we actually think there's if rates come down, we think there's some potential to do better on than that. Then we're assuming in our guidance. And 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.
Brody Preston
Okay. The NII guide itself, is that GAAP or is that FTE? I just wanted to clarify.
Marcy Mutch
That is GAPP. Well, it's ex purchase accounting.
Brody Preston
Ex-PAA, okay. The expense guidance, I just wanted to --
Marcy Mutch
The guide, Brody, just to be clear is GAAP which includes purchase accounting.
Brody Preston
Okay. Thanks for the clarification. And then on the expense, I just wanted to clarify on 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 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 by [65.8%, 65.9%] in expenses for next year, kind of like the midpoint of 1% to 3% up. Is that like am I thinking about that correctly?
Marcy Mutch
That's a fair way to think about it.
Kevin Riley
You're right on it.
Brody Preston
I just wanted to make sure that I was that I was understanding it. That's really all I had guys. I appreciate it.
Operator
Jeff Rulis, D.A. Davidson.
Jeff Rulis
On the credit side, I'm wondering, get into that ag loan of the kind of group, I guess first, just it safe to assume those were legacy GREG Western credits. Is that fair?
Kevin Riley
Are you talking about the ones that moved into nonperforming?
Jeff Rulis
Correct.
Kevin Riley
Okay. They were, yes, legacy freight, Western credits, but the thing is, we believe is temporary because we're restructuring those loans. And what we need is a payment performance for like six months on a kind of rules before we can move them out of out of nonperforming into performing. So we believe those loans will move out of nonperforming into the third quarter of this year.
Jeff Rulis
Yes, I heard it in the prepared. I appreciate I. That 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?
Kevin Riley
Well, yes, and there's also the messaging is that we kind of were able to restructure these into performing loans. So I think that's more the message that they're kind of getting cleaned up.
Jeff Rulis
What is the type of it? Maybe they're pretty granular and mix, but is there a type of bag that that represents? And what type of geography did that come from?
Kevin Riley
It's dairy and its Arizona or is it Arizona, California down that area.
Jeff Rulis
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 the bulk of that?
Kevin Riley
We're not looking at any kind of churn charge-offs on those those loans at this juncture, but we're talking that's just broad-based.
Jeff Rulis
Okay. So no particular segment, just as you think that's where you are in the cycle of 15 to 20 basis points for '24?
Kevin Riley
I know yes, I guess it seems we haven't hit that, but were we're forecasting that.
Jeff Rulis
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 you see in '24 versus some areas that may be flatter or maybe running off within that overall guide on growth?
Kevin Riley
You know, I would say the way our franchises were kind of we have a we're in every different industry and vertical. So it's hard to say at this point, we think that's pretty much going to be growth. It's going to be broad across all different verticals.
Marcy Mutch
You know, I think we'll continue to focus on our small business initiative. We'll continue to focus on C&I growth, all of those things, of course up. But to Kevin's point, it's going to be pretty broad-based and spread across 14 state footprint.
Jeff Rulis
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?
Kevin Riley
That's correct.
Operator
Adam Butler, Piper Sandler.
Adam Butler
Hey, good morning, everybody. 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?
Kevin Riley
It's kind of broad with regards to that. I would say that we looked at the levels of staff that we need in various areas based on the workload that people were on we're doing and we made reductions in order to bring efficiencies to the levels they should be at. I would say that though, with that reduction, we also plan on adding as we said in our remarks and putting more expense into, I would say, risk management as well as UM PTIT. so that the you know, the bounce up but we just really went through the Company and looked at where we might add some excesses and took those out.
Adam Butler
Okay. Appreciate the color there. And then second, I appreciate the guidance on the NIM and NII down and first quarter relative to the fourth quarter, do you guys happen to have either the spot rate on interest-bearing deposits or the NIN in the month of December or at the end of December?
Kevin Riley
I'm sure we have that. Go ahead, Marce.
Marcy Mutch
Our net interest margin in December was 2.86%, and that 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 result in a couple of basis point decline in November and December and then lower non-interest 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 Q4 average and more in line with that mid 2.80s number.
Kevin Riley
I just want to clarify that, that the that was excluding purchase accounting, the NIM guidance.
Operator
Timur Braziler, Wells Fargo.
Timur Braziler
Maybe looking at some of the in-migration into your geographies during COVID on 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 geography stand now and just some of the population migration maybe and 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?
Kevin Riley
I would say I think the migration has probably slowed a bit, but there's a 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 on. And there's a need for housing so that 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 it was flocking to some of the big cities like Portland and Seattle. But besides that, I think that the rest of our areas are I've been in pretty good shape.
Timur Braziler
Okay, thanks. And Marcy, I guess those are the four 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 are remixing the bond portfolio that's driving incremental margin for maybe could you share?
Marcy Mutch
I think the biggest thing is that the earning asset balance is bigger because first of all the fair market value adds more to earning assets would really not anymore earnings NII. And then what our forecast before we were looking at bringing down the investment portfolio and reducing the earning asset balances, it really does affect NII. But would you reinvest you're not getting that same net interest margin, but NII improved, but the overall margin is impact by the greater denominator.
Timur Braziler
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 rear view 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?
Kevin Riley
It's a great question, Timur. I would tell you that as we pay apart 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 will that we believe would make our franchise better. And we have been in touch with these banks for many, many years. It's up to the seller sell. 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 want to partner with us, then then we'll probably put something together, but we are we're hoping to do something, but we're not going to just do something for the sake of doing something.
Operator
Brody Preston, UBS.
Brody Preston
Hey, guys. Thanks for taking a follow up. I just had a couple of other ones on.
I guess if I take the guidance on loans and kind of looking at what you said about the security of 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.
Marcy Mutch
Yep.
Kevin Riley
That's exactly how we look at it, Brody.
Brody Preston
And so if we're at in the mid [2.80] ex-PAA on the 1Q margin on the kind of 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 OpEx PA margin gets to by the fourth quarter?
Marcy Mutch
You know, 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 three rate cuts that we've discussed.
Operator
Thank you. There are no further questions. I will turn the call back over for closing comments.
Kevin Riley
Thank you for your questions. As always, we welcome calls from our investors and analysts. Please reach out to us to have any follow-up -- if you have any follow-up questions and thanks for turning to tuning in today. Bye-bye.
Operator
Ladies and gentlemen, this concludes your conference call for today. We thank you for participating, and we ask that you please disconnect your lines.
