FIRST INTERSTATE BANCSYSTEM INC Q3 FY2024 earnings call

Key Highlights - Kevin Riley: Recorded $55.5 million in net income in Q3, or $0.54 per share. Net interest margin ex purchase accounting increased by 5 basis points to 2.97%, expected to exceed 3% in Q4. Noninterest expenses better than expected with one-time costs related to CEO transition. Modest growth in fee business, excluding branch sale, noninterest income up ~3%. Credit quality: criticized and classified loans declined, but metro-office portfolio had charge-off noise, now addressing challenges. Deposits essentially flat, excluding temporary outflow, up ~1%. - Marcy Mutch: Net interest income increased $3.8 million. Yield on interest-earning assets up 3 basis points. Cost of interest-bearing liabilities declined with average borrowings reduced. Fully tax equivalent net interest margin increased 4 basis points to 3.04%. Noninterest income up, noninterest expense increased but one-time CEO transition cost accounts for it. Asset负债表: loan balances changed, noninterest-bearing deposits stable. Credit: criticized and classified loans declined, total provision expense $19.8 million, ACL coverage 1.25% of total loans. Metro-office portfolio had charge-offs, exposure now <$90 million. Capital: common equity Tier 1 capital ratio increased.

Net interest income in the third quarter was $205.5 million, an increase of $3.8 million. The net interest margin, excluding purchase accounting accretion, increased by 5 basis points to 2.97%. Noninterest income increased to $46.4 million in the third quarter, excluding a $2.6 million gain on the sale of a branch, noninterest income increased by approximately 3%. Loan balances decreased by $207.9 million in the third quarter, with commercial real estate loans increasing by $164.8 million and construction loans decreasing by $212 million. Deposits ended essentially flat in the third quarter, but excluding the effect of a temporary outflow, deposits increased approximately 1%. Criticized and classified loans both declined in the third quarter. The common equity Tier 1 capital ratio increased 30 basis points to 11.83%.

Guidance - Anticipate sequential increase in net interest margin in Q4 and 2025. Net interest income expected to continue to increase sequentially in Q4, margin increase to offset modestly declining interest-earning assets. 2025 margin expansion coupled with expense discipline to improve profitability. Fourth quarter expects two more 25 basis point rate cuts by Fed, not materially impacting Q4 earnings. 2025 Q1 will have $1.7 billion of borrowings repriced. Net charge-off guidance 20-25 basis points excluding large C&I credit. Anticipate resolution of agricultural credit in Q4, specific commercial loan communication ongoing with borrower, expects clarity in Q4.

Risks - Metro-office portfolio had charge-off noise with specific loans, although exposure now <$90 million. Uncertainty around agricultural credit resolution and specific commercial loan outcome. Interest rate变动 could impact cost of interest-bearing liabilities.

Q: Just remind us the specific reserves you have set aside for that C&I relationship that’s expected to get resolved by year-end.

A: We don’t specifically highlight with a specific reserve on a credit. But at this point, it’s very adequate to what we think could be the realizable value.

Q: Did you have reserves previously set aside on the charge-offs on these two metro office credits? And if so, how much?

A: While there was no specific reserves set aside on that, the characteristics of those loans were considered in our overall allowance. In the larger of those two loans, it was paying into the fourth quarter, but we anticipated there may be a problem. And so we ordered an appraisal and then wrote it down based on that appraisal.

Q: The spot rate on deposits at the end of September and the average margin in the month of September.

A: The spot rate on deposits was 2% and 3.03% was the margin in September on core basis ex-purchase accounting.

Q: On the ag credit that you guys discussed, can you just remind us the side out loan? And I'm assuming the commentary around the expectation for some kind of resolution. Is that probably what's influencing the 20 to 25 basis point charge-off guidance for the fourth quarter?

A: The ag loan was around $20 million. And yes, we feel comfortable with the 20 to 25 basis point guide on net charge-offs, excluding again the large C&I credit. We don't really anticipate taking really a loss on that ag credit specifically.

Q: Around the $1.7 billion of borrowings that are fixed currently but start to reprice earlier in the first quarter. Can you just talk through maybe some of your expectations or how we should be thinking about that?

A: We have about $1 billion of that that's going to reset in January. We have ultimate flexibility with regard to how we kind of stage that out going forward. Any rate cuts will be accretive to us as to where they're priced right now. We'll evaluate that as the time comes.

Q: Could you just walk through maybe some of the dynamics there with the swaps? Did that positively contribute any level of interest income in the quarter?

A: We use those swaps as a tool to manage our balance sheet sensitivity. We terminated that $550 million of swap because they were in a favorable position to do so, and that’s just going to reduce our exposure going forward into 2025. A tiny bit positively contributed to interest income in the quarter.

Q: Drilling into the margin trends a little bit more and how, I guess, we should be thinking about some of the moves that you just called out with the swaps and maybe on the transition of construction to CRE. What would be sort of a good place do you think that we end fourth quarter at jumping off into next year? Are some of these moves going to continue to provide some benefit as you go through the quarter?

A: Ex purchase accounting, our margin was at $303 million in September. Because we have no borrowings that are maturing this quarter, it doesn't think it will go significantly higher than that. But we do, again, expect expansion from the $297 million where we were into the fourth quarter. And by September’s rate, you can see we’re already there. That doesn’t anticipate interest accrual conversions.

Q: Is there an impact on that margin from interest accrual reversals from some of the larger non-performers?

A: That doesn’t anticipate interest accrual conversions.

Q: On the ag credit that you guys discussed, can you just remind us the side out loan? And I'm assuming the commentary around the expectation for some kind of resolution. Is that probably what's influencing the 20 to 25 basis point charge-off guidance for the fourth quarter?

A: The ag loan was around $20 million. And yes, we feel comfortable with the 20 to 25 basis point guide on net charge-offs, excluding again the large C&I credit. We don't really anticipate taking really a loss on that ag credit specifically.

Q: On the metro office portfolio, if we look at the three remaining loans that are over $5 million, any or all of them in some form of rehab and transitioning to the lease-up process?

A: There is a – we have some notes on the metro office slide. So a couple of them are already leased up have adequate debt service coverage, one recently completed and then the remainder is the one we've discussed. So there's commentary on that slide – on Slide 7. The second largest one we took a loss on that earlier in the year in Seattle. And we have an investment-grade lessor going in there. So we feel very comfortable with that one, and that one is not a concern. So we feel pretty good at what's left there.

Q: The locations of these two office charge-offs?

A: It could potentially compromise our negotiating position, and so we're not providing the locations of those. But suffice it to say, we define metro office as Portland, Seattle, Denver, Phoenix and Minneapolis, St. Paul, Kansas City. It's in one of those cities.

Q: The transition from construction to permanent finance. I'm just wondering what your appetite is to continue doing finance some of your own construction projects as the construction term comes due? And then just maybe talk us through the pricing dynamics as these loans roll from construction to permanent finance?

A: We've kind of covered that once they get finished and then they stabilize, we move them into perverse real estate. We continue to look at loans not in the metro markets, but look at loans that our customers and communities need and we look at them on an individual basis. And we're not added the construction business. We're just going to be pretty particular about what we do. So we're going to continue to stay in business, but it's just a normal transition from doing a construction loan, building this stuff up, stabilization and then move them into commercial real estate. Most of it is variable, but there is a portion that are the all-in-one construction loans that we talked about earlier and that's considered in that 6% number that we gave you earlier. Most of it is variable, but there is a portion that are the all-in-one construction loans that we talked about earlier and that's considered in that 6% number that we gave you earlier. The all among construction activity, just to refresh your memory is that we do a fixed rate during the construction period and then through the stabilization period. So that rate carries on then for a short period of time after that loan is stabilized and moving to commercial real estate.

Q: Looking at the deposit rates, I appreciate the 2% spot, I think, Marcy, you had said that some of the pressures were starting to abate in the fourth quarter. I guess you guys are starting at such a low level that maybe continued mix shift just puts additional pressure on that. But how has that 2% been working through the month of October? And are you thinking that's kind of a peak there for deposit rates? Or do you think just again starting at such a low basis, maybe there's some additional pressure there?

A: I think it will be stable to down going into the rest of the quarter.

Q: On expenses. You guys have done a nice job kind of grinding the efficiency ratio down this year, but maybe any other opportunities to work on expenses as we move into 2025.

A: I think we're doing a pretty good job on our expenses right now, I really – our efficiency ratio is more of a revenue issue than it is an expense issue. So as we see our NII build going into next year and hopefully get some traction on our fee income, we should see that efficiency ratio could continue to come down.

Q: Comment on loan demand. As move into next year, do we see that picking up? Is there a rate level where you think people are waiting to pick up activity? Or is it kind of tepid in your minds as we move into 2025.

A: I would say there's a couple of things. I think one people are looking for what's going to happen with the election happening in the next couple of weeks, and I think also rates. So I kind of stopped looking at my crystal ball because it's very cloudy because over the last few years, we haven't really picked that. So I think we're just going to have to wait and see what the rates look like. But I think there's a pent-up demand; I just don't know when that pent-up demand is going to take hold. So we're poised and we're ready and the team is ready to go. But I don't want to pick a time when that's going to pick up because I'd probably be wrong. So let's just hope it does start early going into 2025.