Good day, and welcome to the First Interstate Bank Systems Second Quarter 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'd now like to turn the conference over to Lisa Slater Vray.
Please go ahead, ma'am.
Thanks, Rocco. Good morning. Thank you for joining us for our Q2 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 and factors that could affect future results contained in our most recent annual report on Form 10 ks 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 of the forward looking statements made today. A copy of our earnings release, which contains non GAAP financial measures, is available on our Web site at fibk.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 reference.
Joining us from management this morning are Kevin Reilly, 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 Reilly. Kevin?
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 Relations website. And if you have not downloaded it, a copy yet, I encourage you to do so.
I'm going to start today by providing an overview of the major highlights for the quarter, and then I'll turn the call over to Marci, so she can provide more details on our financials. During the Q2, we generated net income of $42,500,000 or $0.69 per diluted shares, while delivering on everything we discussed last quarter. Excluding PPP loans, we generated upper single digits annualized loan growth, higher levels of net interest income and fee income on a run rate basis, well controlled expenses and excellent credit metrics. We saw an acceleration of positive trends we experienced early in the year, driven by healthy economic activity throughout our markets. This resulted in yet another quarter of strong deposit inflows, which grew by 12.4% annualized in the quarter.
Non interest bearing deposits alone grew 413,000,000 dollars or 33% on an annualized basis. We continue to utilize these strong deposit inflows to grow earning assets, both in loans and investment securities, which produced an expected increase in our net interest income, excluding the impact of PPP fees. Across our footprint, we have been able to effectively capitalize on higher loan demand we are now seeing and grew our total loan balances excluding PPP at an annualized rate of approximately 9%, which is consistent with the outlook we provided last quarter. Notably, we are seeing balanced contributions to growth across almost all of our portfolios and markets as our clients continue to look for attractive opportunities to invest into this robust economic environment in the states we serve. Our Western markets continue to produce our strongest growth rates, but we are now seeing real improvement in our Eastern markets as well.
Encouragingly, we saw our commercial portfolio, excluding PPP loans, increase at an annualized rate of approximately 3%, which is the Q1 of substantial growth we have experienced in this portfolio since the pandemic started. This growth came despite line utilization remaining relatively unchanged and still well below historic norms. Heading into the second half of the year, we are continuing to focus around speed to market, more efficient underwriting, and we are expecting the recent growth trends to continue, allowing us to come in at or above mid single digit range we originally expected for the year. Our continued deposit growth should enable us to put more liquidity to work in our investment portfolio than we initially expected, the details of which Marci will discuss later. We will do this, however, at a much shorter durations to retain our asset sensitivity position.
The health of our markets is also evident in the continued across the board improvement in our asset quality, Non performing assets, non performing loans, delinquent loans and criticized loans were all down. Net charge offs annualized at a percentage of average loans was only 4 basis points. Nevertheless, we continue to take a cautious approach and retain a healthy reserve, which remains at 1.3% of loans held for investment and is at 1.46% excluding PPP loans. As I usually do, I would like to add some additional color about our footprint. The local optimism I noted last quarter continues to be evident across our footprint.
Tourism is having a record season as we expected to see. The parks in the surrounding hotels are full and the business are seeing activity also follow. In April, I noted the positive in migration trends across our states, which was confirmed in the last census. However, just last week in the Wall Street Journal listed Billings, Montana, yes, Billings, Montana, the new number one market on the emerging housing market index, which rates the markets by low unemployment, affordability and attractiveness to the outdoor lifestyle. This continues to attract new residents from all over the country.
In fact, we serve 3 of the top 5 markets on the list: Billings, Montana, number 1 Coeur d'Alene, Idaho, number 2 and Rapid City, South Dakota, number 4. In short, the bullishness I expressed in April about our markets and the future of the company has been solidified over the last 3 months and the momentum of our business sets us up for a strong second half of the year. We are expecting solid loan growth, solid operating pre provision net revenue improvement and strong credit results to drive further improvements in our profitability metrics. And with that, I'll turn the call over to Marcy so she can provide more details on the quarter. Go ahead, Marcy.
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 Q1 of 20 21, and I'll begin with our income statement. As previously stated, our priority in the current operating environment is to utilize our strong deposit inflows to grow earning assets and support net interest income. Excluding PPP impacts, our 2nd quarter results reflect our execution on this strategy, which generated the growth in net interest income we told you to expect last quarter. Our net interest income decreased by $1,900,000 as a result of lower PPP fee income, which declined by $4,500,000 from last quarter.
Accretion income was just $200,000 higher on a linked quarter basis. Excluding the impact of PPP, our net interest income increased by 2.4% or 9.5% annualized. The increase was attributable to growth in both average loans and investment securities during the quarter. Looking ahead on an operating basis, excluding PPP income, we would expect to see even more improvement in net interest income heading into the second half of the year. With the continued robust growth in deposits, the net interest margin continues to be a challenge.
On a reported basis, our net interest margin decreased 22 basis points to 2.82% in the 2nd quarter. This was primarily due to less income derived from our PPP loans, which was about half of the decline and a mixed shift toward investment securities at lower rates. The lower rates on the investment securities reflect a full quarter impact of investments made in the Q1 at an average yield of 1.19% and then new securities added during the Q2 at an average yield of 93 basis points. At 4.26%, our average loan yields, excluding PPP impacts, were essentially unchanged from the Q1. Although the spread between our book yield and new production continues to narrow, we did benefit this quarter from an adjustment to our indirect auto dealer reserve, which added a few basis points to our average yield that's not expected to carry forward.
With the continued inflow of noninterest bearing deposits, our total cost of funds declined by 1 basis point to 11 basis points in the 2nd quarter. As you can see on Page 27 of the investor presentation, the duration of the securities portfolio was shortened to 4 years from 4.3 years at the end of the Q1. With the increase we've had in the size of the investment portfolio, we've taken a few actions designed to minimize the potential impact to our capital ratios and increase the earnings power of our cash position, which puts the effective duration at the end of the second quarter at 3.75 years. In early June, we moved securities of approximately $670,000,000 to the held to maturity portfolio. This has the effect of eliminating a significant portion of our estimated downside risk to tangible book value should rates begin to rise.
Additionally, in mid June, we purchased $500,000,000 of a 5 year treasury bond yielding 87 basis points and then simultaneously initiated a $500,000,000 2 year forward starting 3 year pay fixed swap at 1.19%. We'll begin receiving effective funds in addition to our original yield when the swap goes live on June 30, 2023. As a result of these actions, we've been able to execute our excess liquidity deployment strategy while protecting our capital and maintaining our targeted level of asset sensitivity. Our noninterest income decreased by $2,800,000 quarter over quarter to $35,300,000 This was due to the $5,900,000 mortgage servicing rights impairment recovery that we recorded last quarter. Excluding the recovery, our quarter over quarter operating noninterest income increased primarily due to higher production related revenue in the mortgage banking business as our retention program came to an end and the percentage of production sold increased.
You can see this on Page 36 of the investor deck. In addition, payment services revenue continues to outperform our expectations as a result of the increased economic activity and higher business credit card volume. Consistent with last quarter's guide, we continue to look for a strong second half of the year and expect our total full year GAAP non interest income to be down low to mid single digits year over year, excluding any additional impact to the fair value of our mortgage servicing rights. Moving to total non interest expense. We had an increase of approximately $600,000 from the prior quarter.
Of note, during the quarter, we did experience about $1,000,000 of expenses that we do not anticipate carrying forward into the run rate for the second half of the year. Despite those added expenses this quarter, we still expect our GAAP expenses for the full year to be approximately 1% higher than last year. Moving to the balance sheet. Our loans held for investment decreased $29,000,000 from the end of the prior quarter due to a net decline in PPP loans of approximately $230,000,000 Excluding PPP loans and deferred fees, total loans held for investment were up about $200,000,000 from the end of the prior quarter or 9% annualized. Most of the growth came in commercial real estate, construction, residential real estate and in some non PPP related commercial loans.
Consumer loans continue to lag due to ongoing inventory shortages and higher than normal levels of payoffs impacting our indirect portfolio. As of June 30, we had approximately $572,000,000 of PPP loans on our balance sheet with $26,500,000 of associated deferred loan fees. On the liability side, our total deposits increased $472,000,000 from the end of the prior quarter with $413,000,000 of growth coming in noninterest bearing deposits. And moving to asset quality, again, we saw decreases in all of our problem asset categories. Relative to the end of the Q1, our non performing loans declined $5,800,000 our non performing assets declined $6,000,000 and our criticized loans declined $38,000,000 as a result of several upgrades in the ag and commercial real estate portfolios as well as payoffs on other criticized loans.
Our credit losses continue to be very low with $1,100,000 of net charge offs, representing just 4 basis points annualized of average loans in the quarter. And then following the significant build in our reserves during 2020, the improving economic forecast, improved asset quality and low levels of losses in the portfolio offset the provision requirement attributable to growth in the loan portfolio this quarter. As a result, we did not record any provision expense in the quarter. This kept our allowance as a percentage of loans held for investment at 1.38 percent at June 30, unchanged from the end of the prior quarter. When PPP loans are excluded, our allowance represented 1.46% at June 30.
With that, I'll turn the call back over to Kevin.
Thanks, Marcy. Nice job. I'll wrap up with a few comments about our outlook. So far, the year has unfolded pretty much as we expected, if not a little bit more favorable, particularly in terms of loan growth. As we look at the second half of the year, we expect a continuation of many positive trends.
Businesses in our markets are performing well, in particular in light of the strong tourist season. They are generating strong cash flow and growing their deposit balances, which gives us the opportunity to continue to grow earning assets and to generate higher net interest income. We are seeing good loan growth opportunities in almost all of our markets, and we feel good, if not better, about the outlook for loan growth that we did 3 months ago. Real estate related lending continues to see strong the strongest demand, but commercial loan demand is starting to pick up as well. Excluding PPP loans, we think our full year loan growth will exceed our original expectations with less growth from our in the second half of the year coming from our residential real estate portfolio.
In terms of fee income, as our guidance would suggest, we expect to have a good second half of the year. Residential mortgage demand remains strong, and we were getting back to selling more of our production, and then we expect to see a lift in our mortgage banking revenue. Meanwhile, payment services and wealth management continues to deliver strong results. Expenses remain well controlled, which should result in a nice improvement in our efficiency ratio in the second half of the year and credit should continue to be very strong. Collectively, we believe these trends should position us well to see solid earnings growth and a notable increase in pre provision net revenue in the back half of the year.
And with the foundation of the company being extremely strong from a capital, liquidity and credit perspective, we remain well positioned to execute on any attractive M and A transaction that we believe can further enhance the value of our franchise. And so with that, I will open it up for the call for questions.
Thank you. We'll now begin the question and answer session. Today's first question comes from Jared Shaw of Wells Fargo Securities. Please go ahead.
Hey, good morning, everybody.
Good morning, Jared.
Maybe starting with on the loan outlook side, with mortgages, I hear that you're going to retain less, sell more. Should we be thinking about residential mortgages staying flat as a percentage of the total portfolio from here or more from a dollar balance? And then when you look at the overall mortgage market expectation, I guess just maybe comment on the strength of the purchase market and inventory and things like that in your market?
Well, we on a dollar sense, the balances should remain relatively flat for the rest of the year. With regards to the actual volume of purchase stuff, I mean, inventories are low, but as a house comes on the market, it is sold and the purchase volume actually is increasing as the refinance volume is going down. So it's pretty robust, Jared.
Okay. And then, Marci, maybe can you just comment on what the expectation is for sort of the pace of PPP fee, these 100 point going forward?
You bet. And so, we have about $26,500,000 in deferred fees at this point with about $1,100,000 remaining from the 2020 originations. So that's going to come into income before the end of the year. The balance of it, I would guess between now and the end of the year, 60% 50% to 60%. I think that's reasonable to expect that to come in, in addition to the normal amortization.
Okay, great. And then finally, Kevin, just the what have you changed any expectations around what the deposit duration could be? I know a lot of people are focusing on the strength of the growth and the really low cost that everyone's been able to generate on deposits. But what's your expectation for duration as rates start to move? I know you're clearly keeping the asset side really short duration.
Do you think that we've seen a change in what could be sort of the traditional understanding of deposit duration?
Well, yes, it's a great question, Jared. I wish I had crystal ball telling me exactly what's going to happen with deposits. Right now, our expectation, I would say, is that deposits we're in a deposit growing season right now. And so we're expecting those deposits to continue to grow. And I think some of the growth and we looked into it, it's interesting.
We grew about 3,100 new deposit relationships during the quarter. And then those new deposit relationships brought us about $110,000,000 So I don't know. I think deposits are going to from this point are going to continue to grow. I'm not sure exactly when that growth will slow down. But right now, we're in our traditional seasonal deposit growth season.
Okay, great. Thanks for the color.
And our next question today comes from Jeff Rulis with D. A. Davidson. Please go ahead.
Hi, good morning.
Good morning, Jeff.
Marci, on your guide of NII to continue to increase in the second half, I guess, I sort of begs the question on the 2 components of that margin and earning asset balances. Is the confidence more on you think you can keep earning asset balances up or growing and margin flat? I just wanted to kind of understand the components of that.
Yes. And so if you look at what we expect for loan and deposit growth, we would expect, the second quarter, the NIM to be near the bottom, excluding PPP impacts, with only a little bit of run rate impact as a result of the investments we made late in the second quarter. But we do believe we're going to see a nice lift in our net interest income going into the second half of the year, again, because earning asset balances are going to
be up and that's going
to drive net interest income growth.
All bets are off with regards to net interest margin because if deposits continue to be robust growth that we're seeing, it's still going to continue to put pressure on our net interest margin. But net interest income, we feel very strong that will increase throughout the rest of the year ex PPP.
Okay. It sounds like more of a confidence on the earning asset balance than margin is going to do what it's going to do, but okay, fair enough.
That's correct. That's correct.
Okay. I wanted to talk about just the decline in non performers, if there was anything specific to those credits or if those were kind of pandemic related or what was kind of cleaning up in the portfolio there?
Yes. I'm going
to have our Chief Credit Officer answer that question. Mike?
Yes. So this is Mike Lugli. The decline really was a result of payoffs and a large charge off of $2,200,000 associated with one loan. So that really kind of drove that number Charge offs themselves growth were relatively flat and recoveries were continued to be very robust and strong.
Okay, great. Thanks, Mike. I'll step back.
And our next question today comes from Jackie Bohlen with KBW. Please go ahead.
Hi, good morning.
Good morning, Jackie.
I wanted to start with the Mountain division because I know the West has been outpacing it and I feel like that's usually our discussion. But you sounded more optimistic on the Mountain division and then I saw the article you were referencing about billings. So I just wanted to see how you were thinking about growth and what it was last quarter?
Well, first of all, good positive growth is better than what we've seen for a period of time. So the West has been really holding us up. So it's really nice to see real positive growth. And it's kind of it's really through Montana is doing really well. And the interesting thing is Bozeman used to be
a
hot market, but it's now spreading throughout in Missoula and Helena and Billings and all the different things. So that growth is not only was which we continue to see and always saw growth in, say, the Bozeman area, it's now spreading throughout like Montana. And even in Wyoming, we're seeing some growth for the first time. South Dakota has been always kind of strong, but it's even stronger now. So that's kind of what we're talking about.
But we used to see a draw on some markets were actually contracting. So the growth was hard to off hit, but it's we don't see any real contraction of any of the markets were all kind of growing.
Yes. I think last year, Jackie, we talked a lot about how we were exiting credits in the Mountain portfolio that we didn't feel were good credits to carry on our balance sheet. And so we just don't have that headwind this year. We thought we have a pretty clean book. We don't have the headwind of exiting some of those credits that we've exited the last actually couple of years in the Mountain division.
Okay.
So when I think about the interplay of the West and the Mountain and just the growth optimism, you obviously had a great quarter for growth, might see stronger growth than you even anticipated later in the year, it sounds like. Is that more a reflection of favorable trends in the Mountain division or is it favorable all across the board, meaning the West is growing faster than you would have expected as well?
Yes, I would say favorable across the board.
Yes. Okay. And then in terms of the C and I growth outside TPP, that was great to see. Is that new customer related or is there something else at play there? You mentioned line utilization was fairly flat.
New customer related.
Okay. And then just one last one and I'll step back. When I think about and I know that this is more an existential question. When I think about deposits and I understand what's going on with strong customers are bringing deposits into the bank, I guess what in your mind do you think it will take for line utilization to come up from where it's at given the trends that you're seeing with maybe customers are using some of their deposits that they're coming in as quickly as they're using them?
Yes. Sometimes you want line utilization and sometimes you don't, but some line utilization, they don't can't pay it back. But I don't know. I think they're flush with cash right now. So we're not really anticipating line utilization to pick up too fast.
We'd like to see it pick up, but I think that a lot of these customers are flush with cash and then
some of
the line utilization though is in construction lending. So we're going to see some of that increase as we move throughout the rest of the year. Yes.
And Jackie, I don't have the exact numbers in front of me, but we did look at kind of what our clients average balances trends were from 2019 into the current environment and they've gone up substantially. So I agree with what Kevin said. It's just that folks have a lot of cash on hand right now and so they're not feeling a need to borrow.
Okay. Thanks for the extra color. I appreciate it.
And our next question comes from Matthew Clark with Piper Sandler. Please go ahead.
Hey, good morning.
Good morning, Matt.
Maybe first one just on, I know it's not that significant, but the $1,000,000 of unusual expenses this quarter, what did that relate to and where did that show up in the P and L?
Yes. So about half of that amount, Matt, was in salaries and wages and then the balance was split evenly between benefits and other expenses.
Okay. And then just on the improvement in criticized loans, I know Kevin, you've been working hard at getting those numbers down since you arrived and they've come down more meaningfully this quarter. I guess, what changed this quarter? I guess, how much of that was upgrades versus moving credits out of the bank and so forth?
I'm going to have our Chief Credit Officer again answer that question. Go ahead, Michael.
Yes. So you saw on the reduction quarter over quarter about $13,800,000 was reduction in balances either line utilization coming down or just regular amortization. Also in our ag book where you saw a fair amount come down, that was just from the strong year that they had in 2020. It was an exceptional year for those folks. There was about of the $37,000,000 about $6,000,000 was upgrades and then the balance around $18,000,000 was payoffs.
Okay, got it. And then just on the reserve continues to migrate lower. I guess, can you give us your updated thoughts on where that ratio could bottom? Is day 1 still where you think it will eventually shake out? Or do you feel like based on the current mix and better macro factors, you could fall below that?
At this point, just getting back to the day 1 at around 1 point 2 or maybe a few basis points lower than that, I think that I think it will get to that point over the next year or so, and then we'll kind of see where it goes from there. A lot could change in a year as we know.
Yes. Okay. And then any material shift in your M and A conversations in the last since we last spoke in the last few weeks?
I knew I would not get off the boat answering some question around M and A. But we continue to be very selective of what we're going to do. So I mean there's a lot of banks out there looking for partners, but we're going to be picky. And if and when we do announce a transaction, you can rest assured it will be a good transaction for our shareholders, a good franchise builder and go forward. So we're being patient, which is not normally my forte, but I think it's at this time in the consolidation thing, we have to do the right deal in order for us to be a consolidated way out into the future.
Understood. Thank you.
And our next question today comes from Andrew Terrell with Stephens. Please go ahead.
Hey, good morning.
Good morning, Andrew. Good morning.
So I hear you on the residential mortgage expectations, but just trying to maybe ring fence that with some of the deposit commentary. I guess if deposit growth continues coming in at just such a strong pace and above expectations, would that potentially increase the appetite into retaining more resi mortgage in the back half of the year? Or does it make more sense just to put cash to work and securities just so you can better manage the overall kind of duration?
Yes, absolutely the second comment. I think putting it into the investment portfolio where we can manage duration like you just stated, that would be our focus in the second half of the year.
Okay. Got it. Thank you. And then maybe just the in migration trends across your markets have clearly been awesome as you've noted and have picked up over the past year or so. I know that drives kind of home purchases and everything near term, but have you seen those migration trends begin to impact new business formation and commercial loan demand yet?
Or is that something that you think carries kind of a longer tail?
Well, I think we're seeing some right now, but I think it's a longer tail. I think it's going to continue to pick up as people believe these are markets that they should invest in because of the economic growth. So that's going to continue to build as the years go by.
Okay. Maybe one last one for me, Kevin. Since we last spoke, multiples kind of across the group have come in a decent amount. Can you just remind us how much you currently have outstanding under a buyback authorization? And then any update on the appetite for repurchases?
I don't want to ask.
It's about 400,000 shares remaining under well, actually, 1.9 it's 1.9 under the current current authorized buyback, dollars 1,900,000
And Andrew, as we always have stated, we're really diligent on the earned back of tangible book value dilution. So we're very cautious of when we buy back our stock so that we don't dilute tangible book and have a long earned back time line. So we continue to monitor that. When there's a good time to do it, we will. And if it's not, we won't.
So we that's just the principles that we have here.
Yes. And I think we feel really good about our organic growth opportunities and potential M and A opportunities. And so we probably choose to use our capital to do that first.
Totally understood. Thanks for the color and I appreciate you taking my questions.
Today's next question comes from Tim Coffey of Janney. Please go ahead.
Thank you. Good morning, everybody.
Good morning, Tim.
Good morning, Tim.
Hey, Kevin and Marci, I appreciate your comments on margin. I think you're spot on there. So the I guess the next derivative of that question is the growth that we saw in net interest income this quarter, core, I think, was around 2.4%. Is that repeatable?
Yes.
Is it low?
It could just pencil that maybe that area and I think it will be good.
Right. Yes, I totally understand. I think we're all conditioned to talk about margin when we should be really talking about spread income at this point. And then if you look at your deposits deposit accounts that receive PPP funds, has there been a material change in those balances in the last year?
Yes. We've seen our deposit balances increase over the last year. And I don't have the numbers in front of me, but we have seen a pretty substantial increase in deposit balance, the carrying balance in accounts.
Okay. So the PPP money is still sitting there?
Yes. So Tim, what I think would happen is that they threw a lot of money into some of our markets. And some of these businesses, they were still operating. They were still making money. They were still paying their employees, but they received excess funds.
So I think a lot of it just was excess for them. It wasn't like they really needed the money to survive and they had to utilize those funds to pay their employees. I think a lot of these we didn't shut down as hard as some of the other markets across the country. So a lot of these employers benefited from it and I think they're just holding on to that excess liquidity.
Well, which is also why we're not seeing line utilization go up.
So
Okay. Well, then it's really good to see that you've put the money to work in the investment portfolio and committed to that. And then just one last thing for me. I think Billings is a great town and totally deserving of that recognition. So I'll step back there.
Thanks, Tim. It was a bad picture to Wall Street though. They had Wells Fargo's picture there instead of us. This is our headquarters.
Thank you. And ladies and gentlemen, this concludes the question and answer session. I'd like to turn it back over to the management team for any final remarks.
I want to thank everybody for their questions. And as always, we welcome calls from our investors and analysts. Please reach out to us if you have any follow-up questions. And thanks for tuning in today. 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.