Good day, and welcome to the First Interstate BancSystem first quarter 2021 earnings confer ence call. All participants will be in listen only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on a touchtone phone. To withdraw your question, please press star then two. Please note, today's event is being recorded. I would now like to turn the conference over to Lisa Slyter-Bray. Please go ahead, ma'am.
Thanks, Rocco. Good morning. Thank you for joining us for our first quarter earnings conference call. As we begin, please note that the information provided during this call will contain forward-looking statements. Actual results or outcomes may differ materially from those expressed by those statements. 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 and 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 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 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. Joining us for 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?
Thanks, Lisa. Good morning, and thanks again to all of you for joining us on the call today. Again, this quarter, along with our earnings release, we have published an updated investor presentation that has some additional disclosures that we believe will be helpful. The presentation can be accessed on our investor website, and if you haven't downloaded a copy yet, I would encourage you to do so. I'm going to start off today by providing an overview of the major highlights of the quarter, and then I'll turn the call over to Marcy to provide more detail on our financials. The first quarter came in largely consistent with our expectations. We continue to see healthy economic activity throughout our markets, which resulted in strong deposit inflows, a positive impact on our fee-generating businesses, and further reduction in all of our problem loan categories.
We executed well on our near-term strategy to support our net interest income by utilizing some of our excess liquidity to retain more of our residential mortgage production and increase purchases of securities in our investment portfolio. The additional revenue generated through this strategy, combined with the stable expense level, helped us to deliver another strong quarter of earnings for our shareholders. For the quarter, we generated net income of $51.4 million or $0.83 per share. Loan balances were essentially flat to year end, whereas most years we've seen declines in balances during the first quarter. We believe this reflects the health of our markets and the increasing confidence that our clients have in the strength and sustainability of the broader economic recovery. Across our footprint, our clients are looking to invest in projects and put money to work that will help them capitalize on the improving economic environment.
We will continue to see this most notably impacting our commercial construction loan balances, along with modest growth in commercial loans, excluding PPP loans, and growth in our residential real estate portfolio. Heading into the second quarter, we're already seeing promising growth, and we are focused on ensuring our speed to the final credit decision allows us to get deals done. We have adjusted to become more efficient in our underwriting and approval process and are winning deals without compromising on price or quality. We are also pleased with the execution of another successful round of PPP loan originations in the first quarter. The automatic process we utilized in the first round continues to provide a very efficient access to this funding for existing and new clients, and we funded an additional $437 million in loans through the end of March.
We continue to be surprised at the pace of our deposit growth, which was over 25% on an annualized basis in the period where we typically see balances decline. While some of this growth can be attributable to PPP loans and stimulus payments, we believe this continuous historical high level of growth reflects the health of our clients. While we were able to put a substantial amount of liquidity to work in the first quarter, strong deposit inflows continues to leave us with high cash balances. Consistent with our approach in the first quarter, we expect to retain more of our residential mortgage production in the second quarter and will continue to add to the investment portfolio, although at a much more modest pace. The health of our markets is also reflected in our asset quality. Across the board, we saw improvements in all of our problem loan categories.
Non-performing assets, non-performing loans, criticized loans, and delinquent loans were all down from the end of the prior quarter. Improved economic forecast, along with positive trends in asset quality, resulted in a negative provision for credit losses in the quarter and a small reserve release. Although with an allowance of 1.38% of total loans or 1.51% when PPP loans are excluded, we still have a very high level of reserves that should enable us to keep our provision expense relatively low as we add to our loan balances in the future. I'd like to add a little color about our footprint. Over the last few weeks, I've had the opportunity to once again get out and visit some of our communities and our employees. What I've seen is that there's an overall optimism about the local economies, and that the outlook for continued recovery throughout the summer.
Notably, the expectation of record tourism across our footprint continues to point toward increased revenues for sectors that were hit hard by the pandemic. Unemployment in the Northwest continues to be below national averages, and average wages show signs of growth. Our states continue to benefit from positive in-migration with some of our mid-sized markets like Rapid City showing hot residential housing trends with noticeable increases in building permits to address growing inventory shortages. Billings, Coeur d'Alene, and Spokane all made the national news as they were in the top five metro market areas for home buyers. Montana saw its population grow by 9.6% and picked up a House seat based on the recent census data. Oregon picked up a seat as well. In fact, based on the results of last census, all of our states saw positive growth, with Idaho reporting the strongest increase of over 18%.
They are also showing 6% annualized growth so far in 2021. The near-term future for the agriculture industry also looks positive. Several programs provide substantial relief from the effects of the pandemic and have allowed farmers and ranchers to weather the effects of commodity prices and export tariffs. Higher income levels have resulted in increased liquidity and capacity to pay down existing lines. Lastly, our state and local governments have not experienced the severe shortfall in revenue that were predicted at the height of the pandemic and are, in some cases, seeing benefits from increase in gross sales and additional tax revenues. In summary, the strength of our markets and the momentum of our core business trends set us up well for accelerating core pre-provision net revenue growth for the rest of the year.
Now, I'm going to go off script for a second because I just wanted to say that I am more bullish about the future of the bank than I ever have been since I joined the company. With that, I'm going to turn the call over to Marcy to provide some additional detail on our financial results. Marcy?
Thanks, Kevin. Good morning, everyone. As I walk through our financial results, unless otherwise noted, all of the prior period comparisons will be with the fourth quarter of 2020. I'll begin with our income statement. Our strong deposit inflows continued to generate excess liquidity that impacted our net interest margin. However, the increased retention of mortgage production and the growth in our investment portfolio helped us keep the net interest income, excluding PPP and accretion income, relatively consistent quarter-over-quarter. On a GAAP basis, our net interest income decreased by $7.7 million, all of which can be attributed to lower PPP fee income, lower accretion income on acquired loans, and two fewer days in the quarter. Relative to last quarter, PPP income was $4.4 million lower, accretion income was $800,000 lower, and two fewer days in the quarter equated to $2.4 million on an operating basis.
Looking ahead, on an operating basis, excluding PPP income, we believe this quarter was the low water mark for net interest income, and we should see sequential improvement from here for the rest of the year. On a reported basis, our net interest margin decreased 21 basis points to 3.04% in the first quarter, primarily due to less income derived from our PPP loans and a mix shift from loans to bonds invested at lower rates, exacerbated by the significant increase in earning assets as a result of our rapid deposit growth. Taking out all the noise from both accretion and the all-in impact of the PPP loans, the yield on loans went down by approximately 10 basis points, which was partially offset by a two basis point drop in our average cost of funds.
The weighted average rates of new purchases in the investment portfolio was 1.19% in the first quarter. While the securities we have purchased in the first quarter have pushed our duration to slightly over four years as of the end of the quarter, we have a bias towards higher rates going forward, incremental purchases in the investment portfolio will be made with the goal of keeping our overall duration under four years. Our non-interest income increased $4.2 million quarter-over-quarter to $38.1 million. This was primarily due to a $5.9 million mortgage servicing rights impairment recovery.
Excluding this recovery, non-interest income was down from the prior quarter due to the typical seasonality we see in payment services revenue, lower service charges on deposit accounts attributable to fee waivers and healthy account balances, and lower gains on the sale of mortgage loans as a result of our decision to retain more of our production, which you can see very clearly on page 45 of the investor presentation. At the beginning of the year, we indicated that we expected our total GAAP non-interest income to be at or modestly down from 2020, which assumed a modest MSR impairment recapture over the course of the year. As a result of the decisions we made in the first quarter around fee waivers and home loan sales, we now expect our total full year GAAP non-interest income to be down low to mid-single digits year-over-year.
Going forward, we're seeing strong momentum in payments and wealth businesses, both of which should now outperform our original expectations. We also expect to return to more normal levels of mortgage production sold toward the end of the second quarter, which should generate a nice lift in mortgage banking revenue from first quarter levels. As such, the first quarter should be the low point for fee income, and we're still anticipating our total fee income for the remainder of the year to be consistent with our initial forecast in January. Notably, this revised outlook assumes no further MSR recovery for the balance of the year. Moving to non-interest expense, we had an increase of $1 million from the prior quarter. This was primarily due to higher employee benefits expenses resulting from the seasonal impact of higher payroll taxes.
This was partially offset by lower salaries and wages expense due to lower commission expenses and short-term incentive accruals. While we had a large volume of PPP originations in the quarter, we allocate a very small amount of loan origination costs per loan in this program. The impact of the deferred loan costs related to PPP loans on our first quarter expenses was immaterial. For the full year, we continue to expect our initial guidance to hold true and for total non-interest expense to be approximately 1% higher than last year. Moving to the balance sheet. Our loans held for investment increased $56 million from the end of the prior quarter. We had $372 million of PPP loans forgiven and funded $437 million of PPP loans in the quarter, with the remaining loans held for investment essentially flat quarter-over-quarter.
Growth in our residential real estate, construction, and commercial portfolios was partially offset by declines in our commercial real estate and consumer portfolios. The decline in the indirect consumer portfolio continues to reflect elevated levels of payoffs and paydowns related to stimulus payments, and new production has been dampened by inventory shortages at dealers. The demand for autos, RVs, and other recreational vehicles is definitely strong, and when inventory shortages are resolved, the large dealer network we've built should turn this area into another source of growth in the portfolio. As of March 31st, we had approximately $804 million of PPP loans on our balance sheet with $29 million of associated deferred loan fees. On the liability side, our total deposits increased $877 million from the end of the prior quarter, with most of the growth coming in non-interest-bearing commercial deposits, interest-bearing demand deposits, and savings deposits.
Moving to asset quality. As Kevin mentioned, we saw decreases in all of our problem loan asset categories. Relative to the end of the fourth quarter, our non-performing loans declined $6.6 million, our non-performing assets declined $6.9 million, and our criticized loans declined $30.7 million. Our remaining loan deferrals are de minimis. Our credit losses continue to be very low, with $2.9 million in net charge-offs, representing just 12 basis points of average loans on an annualized basis. Following the significant build in our reserves during 2020, the improving economic forecast, improved asset quality, and the low level of losses in the portfolio resulted in a reversal of provision expense of $5.1 million. This brought our allowance as a percentage of loans held for investment to 1.38% as of March 31st or 1.51% when PPP loans are excluded. Now I'll turn the call back over to Kevin.
Thanks, Marcy. Nice job. I'm going to wrap up a few comments about the remainder of 2021 and how it's shaping up. Our near-term focus will be continuing to support our net interest income by retaining mortgages and increasing our security portfolio. We are becoming increasingly confident that we will see stronger loan growth for the remainder of the year, which will give us more opportunity to increase net interest income and further improve profitability. Credit line utilization is at historic low levels. We will see construction lines fund throughout the rest of the year, and we expect both consumer and commercial lines of credit to return to a more normalized level. That would reduce the excess lines about 9%. If this materialize, this will result in about $200 million in increased outstanding balances.
Our loan pipeline is steady and signs are pointing to higher demand in the coming months. We are seeing good opportunities across a variety of asset classes, both in the West and Mountain Division. We believe commercial construction will be an area of strength. We're also seeing opportunities in residential construction as home builders look to satisfy the strong demand for housing resulting from the population growth in our markets. This also extends to multifamily lending, which is benefiting from the same in-migration trends. The outlook for commercial real estate lending looks positive. We don't have much exposure to the office market that has some people concerned about the long-term impact of work from home. We're seeing good opportunities across other property types that continue to perform well. We fully expect a very strong tourism season this year, given the pent-up demand.
It's very difficult to book a room at many tourist destinations in our markets right now. This only bodes well for fee income that we generate from increased economic activity in our markets, but also for loan demand from a larger ecosystem of small businesses that serve the tourist market. In May, we are launching our small business digital lending platform, which will improve our ability to serve small businesses and efficiently originate loans in this area. This is just one of the technology rollouts this year. We just completed the installation of our integrated teller platform in our branches, and later this year, we will upgrade our debit card processing system and implement a new commercial loan origination system. All these technology enhancements are driving improved efficiencies, providing more opportunity for revenue generation and improving our client experience.
This is a continuation of our efforts to consistently enhance our people, processes, and technology, and do it without having a material impact on expense levels. On a people front, we had John Stewart join the team as Deputy CFO and Head of IR. We know many of you know John, and we're excited that he has chosen to cross over to the bright side of the business. You will see him around as he will be joining Marcy and me in many of the upcoming investor events. The investments we have made in prior years in processes and technology to build a robust, scalable technology platform are enabling us to consistently add new features and tools that will improve our operation without much incremental expense.
We believe this positions us very well to realize more operating leverage as we continue to grow the company both organically and through additional acquisitions. Before I wrap up today, I want to note that we recently published our 2021 Community Responsibility Report, which is available on our website. I encourage anyone who is interested in understanding our company better from an ESG perspective to download a copy. We've been publishing a similar report for several years, and a commitment to corporate social responsibility is just something that is in our DNA. Being a good corporate citizen and a valued partner to our communities has been a core value of First Interstate for decades, and taking care of our employees, clients, and neighbors will continue to be an integral part to the success and the growth of our future. With that, I'll open the call up to questions.
Thank you, sir. We'll now begin the question and answer session. To ask a question, you may press star then one on your touchtone phone. If you're using a speakerphone, we ask that you please pick up your handset before pressing the keys. To withdraw your question, please press star then two. Today's first question comes from Jared Shaw at Wells Fargo Securities. Please go ahead.
Hey, good morning, everybody.
Morning, Jared.
Yeah, Kevin, maybe just starting with some of those tech investments and especially the small business lending portal. How do you see that helping to drive additional business? will that enable you, I guess, to take some of the leads from the PPP, maybe from other banks' customers? do you expect to have that help develop them into full service customers at a faster pace than before?
Yeah. There's two things that we see benefit, Jared. One, that people can go online and apply for a loan themselves and be immediately approved and funded because it has an automatic scoring process. It's a fast, efficient way for them to do it themselves. We're also training our FSRs, which are not commercial lenders, FSRs, financial service reps, to be able to walk customers through this digital application within some of the locations that might not have commercial lenders to quickly get loans approved and funded.
Okay, great. Then on the mortgage side, are you retaining everything that you're producing at this point, or are you trying to keep shorter, you're looking at 15-year, or are you holding on to 30-year as well? I guess how will that impact mortgage banking revenue going forward in terms of volume retained versus sold?
Marcy's going to answer that question.
Yeah. Jared, in the first quarter, we retained about 58% of our production in the portfolio, and some of that did include the 30-year mortgage product. Going forward, we'll begin to phase out of that, headed into the end of the second quarter. Again, we had a certain amount that we were going to retain around $400 million throughout this whole process since we started retaining mortgages in the fourth quarter. We're about at that threshold. We'll begin to sell mortgages, sell more of our production as we head into the end of the second quarter.
Okay. Just finally from me on credit, I guess there are two things. One, should we expect that the negative provision this quarter got you to where the current economic environment is reflective of, and any reduction of the ACL will be more a function of loan growth at this point, or could there be another negative provision? Just sort of tying into slide 21 in your slide deck, there was a construction loan that you highlight as management attention. It doesn't look like there was a reserve against that. Can you just give a little color on that?
I'm going to let Michael Lugli answer that last question. I'm hoping that we grow into the reserve balance where it is right now with loan growth and I'm not anticipating any substantial change in our economic outlook unless we were to continue to see things markedly improve from here. Does that answer that question, Jared?
Yep. Thanks.
Okay, Michael?
Mike will go.
Mike, we're with you.
Hi, Jared. It's Mike Lugli. What you're referring to is the, I believe it's commercial institutional building construction.
Yeah
The management attention piece. That's primarily driven by a couple of hospitality loans that we are doing, and it really has nothing to do with the actual project, but a weakness of the guarantor from other assets that they own, which has drained their liquidity. Given the uncertainty, that's why that was moved over to management attention. Does that make sense to you or answer your question?
Yeah. Okay. Is there a specific reserve associated with that because of that risk rating, or not necessarily?
Management attention is about as light as we get in criticized. No, there is not. We feel very good about the project. It is really just looking, and we're looking at that hospitality book and office book closely. It's just looking at that guarantor that out of caution, abundance of caution, we moved that to special mention.
Great. Thank you.
Our next question today comes from Levi Posen with D.A. Davidson. Please go ahead.
Kevin, Marcy, good morning. This is Levi on for Jeff Rulis.
Good morning, Levi.
Good morning, Levi.
If I could just start with a housekeeping question on the tax rate. Is it fair to assume that the seasonality we've seen in the past couple of years repeats this year, and we land towards the 23% for the full year?
Yeah, I think we'll be between 22.5 and 23%. We always have some benefit that we see in the first quarter from the tax benefit associated with option exercises, and so that's what happens in the first quarter to drive that rate down a little bit.
Got it. Okay. Thank you. I apologize if I missed it earlier, but was there an expense run rate going forward?
About 1% increase year-over-year.
Last one for me. On the capital side of things, you guys have been active with buybacks and the dividends. What are your thoughts on M&A coming up here?
Well, as you know in the past, we're always talking to people about doing a possible acquisition. Those conversations continue to be had, but we're being pretty picky like we have in the past. There's a lot more coming to market right now or being called on, but we're not jumping to some of those because we have certain acquisitions that we believe will enhance the franchise value. We believe just being patient is the position we're going to take at this juncture.
Understood. Okay. Thank you. I'll step back now.
Our next question today comes from Matthew Clark at Piper Sandler. Please go ahead.
Hey, good morning.
Good morning, Matt.
Morning, Matt.
Marcy, do you have the weighted average rate on new loans this quarter?
It was-
Ex-PPP?
Yeah, 425.
Okay. I guess what I'm getting at is kind of the incremental core margin based on new business, new securities at one nineteen, new loans at four and a quarter. Maybe some the additional securities from here might be a little bit lower than that one nineteen. Assuming kind of a similar mix of assets, do you feel like we're kind of near the bottom here on the core NIM? I know it's difficult to say, but-
I know. It is difficult to say. Just based on where we ended the quarter, and then with the expectation that we're going into our stronger season where we could see some additional modest deposit growth, I think that we could possibly see a little bit more pressure on our core NIM, just resulting from that mix shift. Again, if we see folks spending money and deposits don't grow, and we see higher loan growth, that could change that. Just on a core basis, I think we could see a little bit more pressure. Not substantial, but a little bit.
Okay. Can you quantify the gain in other income? I'm assuming it's about $2 million, but just want to double-check. Other fee income.
Say that again, Matt. I'm sorry.
Just looking to quantify the gain in other non-interest income this quarter. I think it was around-
Yeah. The only non-core gain that I'd see in there is we had about a $750,000 gain on the deposit premium when we sold that Linwood branch. Other than that, it's just the normal ins and outs of what we usually see in that line item.
Okay. just on the service charges and the fee waivers, I guess, I would've thought we'd kind of come to the end of that at this point. any change in strategy there, rationale on waiving fees?
Again, when we had stimulus payments come into those accounts, we waived fees again this quarter, but we're no longer doing that. Going into the second quarter, we should see that return to more normalized levels.
Okay. just lastly, on the round two of PPP, are you using a five-year amortization?
We are.
Of life or something shorter? Okay.
Yeah, we're using five years.
Okay, thanks.
Yep.
As a reminder, ladies and gentlemen, if you would like to ask a question, please press star then one. Our next question today comes from Jackie Bohlen with KBW. Please go ahead.
Hi. Good morning.
Hi, good morning, Jackie.
Morning. I wanted to pick up a little bit on Matthew's question, just in terms of service charges and thinking about seasonality. I know you had a strong tourism season last year. This year, equally strong, if not more so, I would guess. It's hard to tell the trends because of the pandemic and how that influenced activity. I'm wondering what your expectations are for the pickup that we might see this summer, if it's a more normalized trajectory than what we saw last year. Understanding that your fee waivers are stopping and there's a couple of things at play in there.
I think it's really hard to say, Jackie, I agree with you, because clients have more cash in their accounts as well. NSF charges are down. I wouldn't expect the trend to be too much different than what we saw last year at this point. Time will tell if spending becomes more robust, but I would expect it to be close to what we saw last year.
Okay. Just in terms of the strength of your customers and how that's driving some deposit volume, to the extent that net migration continues, I would expect economic activity to remain robust. Is there anything that would stop that flow? I know that this quarter had stimulus and everything involved too, but just thinking about it outside of that.
I don't think there's anything that would stop that. We're not trying to actively exit deposits from the bank.
No. Jackie, we usually decline in deposits in the first part of the year, and then our growth of deposits starts in the mid-second quarter and the remainder year. We believe with the increase in economic activity, deposits should grow. The question is how fast do they grow, and do they grow at the pace they have been growing? There's all anticipation that deposits will continue to grow. We just don't know how fast, because we're entering to the normalized season where deposits grow.
We don't know how fast spending will pick up as well.
Okay.
So, you know, just kind of a new environment.
Yeah. No, I get it, and I myself am just trying to wrap my arms around it. Your thoughts on that are helpful. Thank you. Everything else I had was already covered.
Thanks, Jackie.
Thanks, Jackie.
Our next question comes from Tim Coffey with Janney. Please go ahead.
Thank you. Morning, everybody.
Morning, Tim.
Hey, Kevin, kind of follow up on your comments about the loan growth and your more bullish expectation going forward as to the outlook, what do you think that translates into, say, loan growth for the rest of this year?
Well, we believe definitely we'll meet the mid-single digit level. Depends that we're now kind of moving toward maybe upper single digits in our expectations of growth for this year.
Okay. just on the MSR recovery in the quarter. Can you provide any color with that? Is that just kind of your expectation it's a one-time thing? Is it built up from previous impairments?
Well, I think the thing is that we had previous impairments of last year due to the speed of prepayments, and we had to write down our MSR, and we did give highlights that this year that we'd probably see a recovery of that. That's just part of writing them up and writing them down. The thing is that we don't see any more really large recoveries of impairments for remainder year. It's just an accounting thing you have to go through where you write them down, you write them back up. It just puts noise in our numbers, which we don't like.
Yeah. On our prepared comments, we didn't factor any additional recovery into the run rate of non-interest income going forward.
Yep. Great. Just wanted to clear that up. Thanks a lot. Those are my questions.
Yep.
No problem, Tim.
Ladies and gentlemen, that concludes our question and answer session. I'd like to turn the conference back over to the management team for any final remarks.
Well, I want to thank everybody for your questions. As always, we welcome calls from our investors and analysts. Please reach out to us if you have any follow-up questions. Again, thank you for tuning in today, and goodbye.
Thank you, sir. This concludes today's conference call. We thank you all for attending today's presentation. You may now disconnect your lines, and have a wonderful day