Oct 22, 2013
Executives
Ed Garding - Chief Executive Officer Kevin Riley - Chief Financial Officer Marcy Mutch - Investor Relations
Analysts
Jeff Rulis - D.A. Davidson Brad Milsaps - Sandler O'Neill Jacque Chimera - KBW Brett Rabatin - Sterne Agee
Operator
Good morning and welcome to the First Interstate, third quarter 2013 conference call. All participants will be in listen-only mode.
(Operator Instructions). Please note this event is being recorded.
I would now like to turn the conference over to Marcy Mutch. Please go ahead.
Marcy Mutch
Thank you, Marine. Good morning.
Thank you for joining us for our third quarter earnings conference call. As we begin, I’d like to direct all listeners to the cautionary note regarding forward-looking statements and factors that could affect future results and our most recently filed Form’s 10-Q and 10-K.
Relevant factors that would cause those actual results to differ materially from any forward-looking statements are listed in the earnings release and in our SEC filings. The company does not intend to correct or update any of the forward-looking statements made today.
Joining us from management this morning are Ed Garding, our Chief Executive Officer and Kevin Riley, our Chief Financial Officer, along with other members of our management team. At this time I’ll turn the call over to Ed Garding, Ed.
Ed Garding
Thanks Marcy. Good morning and thanks again for all of you for joining us on the call.
Yesterday, we reported one of the highest quarterly earnings levels in the history of our company at $23.8 million or $0.54 per share. Our increase in quarterly earnings is reflective of the continued progress we have made in improving credit quality and reducing other real estate holdings.
During the recession we took a pretty conservative approach to identifying problem loans and value in collateral. So this has allowed us to record a $3 million reversal in loan loss provision this quarter.
While our level of non-performing assets is still higher than we are comfortable with, it continues to decline at about the pace we expected for the year. Non-performing assets, which are now 1.53% of total assets, decreased over $13 million from last quarter.
$9 million of the decrease was in non-performing loans and $4 million of the decrease was in other real estate. Breaking it down a little further, other real-estate property continues to decrease with $2 million of additions to other real estate and $6 million in sales during the quarter.
About a third of the other real estate sales were land development properties, which further indicates improvements in our local economies, as well as vacant lots get sold and developed. As we’ve seen our other real estate holdings decline over the year, we’ve also had a significant reduction in other real estate expense, which has provided an additional lift to earnings.
Our cumulative net other real estate expense for the first three quarters of this year is just under $1 million. This year-the-date amount is lower than any individual quarter last year and $4.5 million lower than the first three quarters of last year.
Non-performing loans decreased $9 million this quarter, in flow into non-performing loans was $6 million, while outflow consisted of $5 million in charge offs, $7 million in payoffs and $3 million moved back to accrual status. Moving on to loan growth, we are cautiously encouraged with our growth for the quarter.
Despite having $12 million of charged off and paid off non-performing loans, we still had $35 million of loan growth for the quarter. With the year-to-date growth of 2.6%, we are optimistic that we’ll obtain our 3% overall loan growth goal by the end of the year.
One of the main areas of growth was the consumer portfolio, which increased about 3% for the quarter. The majority of this growth was in the indirect portfolio.
Our in-direct portfolio consists of automobile and recreational equipment loans and at $477 million is 11% of our total loan portfolio. While we’ve extend the boundaries of indirect lending into Idaho and Eastern and South Dakota, the majority of the growth is coming from within our current markets.
The indirect portfolio is closely tied to consumer spending and with the positive data we see in our markets related to employment and personal income, we think this is an area of the business that should continue to experience strong growth. Turning to our revenue trends, the boom we’ve enjoyed over the last three years from refinance activity appears to have come to an end.
Total home loan production is down about 21% from the second to the third quarter. There is a bright side however, and that is that purchase production in the third quarter accounted for 72% of the current quarter’s activity.
We think we are well positioned to continue to capture additional market share of purchase activity within our market area. I’d like to touch just a little bit on the economies within our footprint.
Over Labor Day the Montana Department of Labor and Industry issued a report that indicated Montana was a leader in the nation and several different indicators during 2012, with the third fastest employment growth, the second fastest private wage growth, and the fifth fastest personal income growth in the nation. We believe we are seeing the impact of those leading indicators this year.
The Balkan activity continues to have a positive impact, particularly in Eastern Montana and is part of the reason for the growth in the indirect portfolio. Across our entire footprint, the housing industry remains strong.
Hotel, occupancy and average daily rates are up and National Park visits remain high. The floating rates in Montana and South Dakota are less than 1% and Wyoming has lowest foreclosure rate in the country of 0.6%.
Unemployment levels in all three states continue to be some of the lowest in the nation. That wraps-up my comments.
At this time I would like to introduce Kevin Riley. I’m sure most of you read the press release in July, so I won’t go into his background again.
Kevin’s been with us a couple of months now, so he’s had a little time to get his feet on the ground. We are sure pleased to have him join us.
So Kevin, I’ll let you take it from here.
Kevin Riley
Thanks Ed. I’ll start by saying its great to be part of the First Interstate Banking team.
I still feel like I’m drinking from a fire hose, but this is a well run company and I’m excited about our future. As Ed indicated, we had a strong quarter with earnings of $23.8 million and $0.54 in earnings per share.
Even if you backup the $0.04 per share impact attributed to the $3 million reversal of our loan loss provision, we have maintained a strong level of core earnings with pre-tax, pre-provision earnings increasing each quarter this year. Lets look at our income.
Out net interest income was pretty much stable quarter-over-quarter. The net interest margin did however decline four basis points from the second quarter.
Although we had a larger base of earnings assets, our average yield declined six basis points with most of the impact coming from the decrease in our loan yields. This decline was partially offset by a two basis point drop in our funding costs.
While it seems like we are seeing some stabilization in our loan pricing, it’s hard to predict the impact the economy is going to have on our interest rates going forward. Since our cost of funds can’t go much lower, we anticipate our net interest margin could decline a few more basis points over the next quarter.
Net interest income remained strong during the quarter at 32% of total revenues. As anticipated, our income from the origination, the sale of loans did decline and it was 21% down from the prior quarter or $8 million.
However as Ed indicated, we are encouraged by the strong purchase of home activity this quarter, which was 72% of our volume. With this level of purchase activity, we anticipate the fourth quarter mortgage origination revenue to remain fairly flat compared to this quarter.
Debit and credit card revenue remains steady this quarter at about $6 million in revenues. Our wealth management assets under management and the related revenue continue to grow.
Our wealth management team is doing a great job in bringing the new clients and so for 2013 we anticipate wealth management revenue to be between 15% to 20% above the 2012 levels. Non-interest expense for the third quarter was down $2.4 million or 4% from the second quarter.
Salary expense, the largest non-interest expense was also down from the second quarter, and as we look forward, we think a good run rate for salary expense should be around $23 million per quarter. Decreases in FDIC insurance, legal expenses and fraud losses have all been part of the decline in our other expense category.
All other non-interest expenses should remain within their current spending events. Now I’d like to talk a little bit about balance sheet sensitivity.
We continue to keep our investment portfolio short, with the current average life of the portfolio being about 3.6 years. And this does not include approximately $400 million we have in overnight funds.
The shortness of our investment portfolio will allow us the ability to re-price about a third of it over the next 12 months. With 80% of our deposits now being in non-contractual products, we are mindful of the shift we have seen over the last two years out of CDs.
As I said, we are already begun to make strategic changes to correct this trend. Once interest rates begin to rise, we believe our customers will be starved for return on their money and we intend to be positioned to meet their expectations.
So although we are slightly liability sensitive, we are focused on eliminating the risk associated with the rising rate environment. Capital.
Our capital levels remain strong and with the improvement in asset quality that we’ve seen over the last year, it is important for us to consider how those deploy our excess levels of capital. So besides the payment of dividend that we announced with our earnings release, I’ll talk a little bit about M&A, which I know you are all curious about.
With a couple of transactions we’ve seen on the west coast, we think our area of the country is heating up a little. And as Ed has indicated many times, this company has always been opened to doing an acquisition and that position hasn’t changed, but as you all know, unless it is done right, its not worth doing.
So we will continue to look for the right fit, at the right price that results in the overall growth of our franchise and a great return for our shareholder. Once again I want to state what a pleasure it is to have joined the First Interstate team.
And with that, I’ll turn the call back over to Ed.
Ed Garding
Thanks Kevin. I’ll wrap-up by saying that we are pleased with the positive trends we have experienced in asset quality and the declines in our criticized loans.
While commercial and commercial real estate growth still remain a challenge, we are doing a good job in managing our expense in order to maintain solid levels of profitability. So on that note, lets open it up for questions.
Operator
Thank you. (Operator Instructions).
Our first question is Jeff Rulis from D.A. Davidson.
Please go ahead.
Jeff Rulis - D.A. Davidson
Thanks, good morning guys.
Ed Garding
Good morning Jeff.
Jeff Rulis - D.A. Davidson
Question on the – its sort of a follow-up on the operating cost and I understand that you suggest that maybe the comp expense goes up a bit next quarter. But I guess overall cost, I mean absent the OREO expense, which is a little lumpy, is this a sustainable kind of run rate I guess going forward.
Do you see any significant additions over the next year?
Kevin Riley
We don’t see any significant growth in that. It should be in this area, maybe a slight tick-up from here, but not much.
Jeff Rulis - D.A. Davidson
In the release from you comment on, there was some timing issues, is that just the comp expenses was just a bit lower based on timing.
Kevin Riley
No, that’s more down the other expense category.
Jeff Rulis - D.A. Davidson
Okay.
Marcy Mutch
Jeff, I think when Kevin was talking about the $22 million of the run rate, that’s for total, that’s the total salary and wage line.
Jeff Rulis - D.A. Davidson
Got it, yes. Okay, thank you.
And then on the wealth management side, is this a process of a pretty good growth year-over-year expectations. Is this just a more aggressive roll out to addition locations within the footprint or what is the focus or what’s driving that growth?
Ed Garding
We haven’t expanded the footprint. I think we are just doing a better job of penetration of our own customers and new customers within our footprint and as you can see, adding assets under management at a nice rate credit the wealth management people for their reputation and salesmanship for that.
Jeff Rulis - D.A. Davidson
Okay and then maybe one last one on the – just on the provision, the reverse provision was rather large. Do you view that as sort of a one-time catch-up or any sort of thoughts on future provision levels?
Ed Garding
I think it’s a one-time catch-up, but with all that said, while I was unsure of loan recoveries and actually rehabilitation, its hard to predict exactly when that happens. But its unusual obviously to have a $3 million reversal and also if we start ramping up loan growth a little more, that will be one more reason why we have to add to the reserves versus reverse out.
Jeff Rulis - D.A. Davidson
Okay, thanks.
Ed Garding
Thank you, Jeff.
Operator
Our next question is Brad Milsaps, Sandler O'Neill. Please go ahead.
Brad Milsaps - Sandler O'Neill
Hey, good morning.
Ed Garding
Good morning Brad.
Brad Milsaps - Sandler O'Neill
Just want to follow-up on some of Kevin’s comments about trying to position the balance sheet a little bit more asset sensitive. I noticed you guys had another strong growth of deposits.
It certainly created quite a bit of liquidity on the balance sheet since you average cash was maybe down a bit. But on a period in basis you are up close to $200 million just in fed funds and cash equivalents.
Kind of curious, does some of that revere out over the next couple of quarters or do you plan to hold on to more cash in hopes of putting that when run rates do rise, putting that to use at higher levels, because it seems holding that much excess cash would create maybe more margin compression than maybe you guys sort of guided to in terms of the couple of dips over the next few quarters.
Ed Garding
Yes, we tried to put that cash to work, but we’ll also, what we’re trying to do is spend some time in trying to restructure the liability side. So as we lock up some more in the liability side of the balance sheet, Morgan is going to free up us to put more of that cash to work.
So it’s a kind of balancing act. We don’t just want to chase margin and put the company at risk with regards to sensitivity in the balance sheet.
Brad Milsaps - Sandler O'Neill
Got it. But in the near term that couple of hundred million you’ve got Kevin in excess, are there municipal deposits there that kind of run out or is this kind of the new run rate level of cash that you got, that you’re sort of faced with putting somewhere or are the margins going to come in maybe more.
Kevin Riley
Brad I think it’s a new level, it’s a level that we’re going to be operating on and if you look at year end actually the deposits are slightly down from year end levels. So I think this is going back towards our year-end levels that we had in deposits.
So I think its kind of the level that the bank’s been operating under in prior courses. Just deposits were down in the first and second quarter.
These really are not municipal deposits. These are more or less corporate deposits and personal.
Brad Milsaps - Sandler O'Neill
Okay, okay great. And then just on the loan growth, I appreciate your color on this consumer driven piece of it.
I mean, do you think that commercial borrowing will follow. I’m just kind of curious what your guys thoughts are there on maybe ramping up from this kind of 3% growth rate your looking for in 2013.
Ed Garding
Brad, right now I don’t want to predict much more than that 3% level that we’ve been talking about. We are seeing some construction activity, both in commercial and residential, but we’re also continuing to get a very good payment stream and so all the good news is that our customers are paying.
The bad news is that when they are very healthy in paying, it’s that much harder to get loan growth. So I am not going to step out and say it’s going to ramp up much.
Brad Milsaps - Sandler O'Neill
Okay, great. Thank you.
Ed Garding
Thank you, Brad.
Operator
Our next question is Jacque Chimera, KBW. Please go ahead.
Jacque Chimera - KBW
Hi, good morning everyone.
Ed Garding
Hi Jacque.
Jacque Chimera - KBW
Kevin, I wanted to touch back on your comment about the liability restructure. Are you looking at that from a deposit standpoint or are you looking at some of the debt you hold?
Ed Garding
Mostly on the deposit structure.
Jacque Chimera - KBW
Okay. And then just looking to the national park, the shutdown that recently happened.
I know you said that the patient has been pretty good now. Will there be any sort of a meaningful impact from that.
I know it was brief, but it does impact your areas?
Ed Garding
And the answer is that it was so brief and at this time of the year the impact would not be meaningful.
Jacque Chimera - KBW
Okay, that’s good to hear. I’m glad they are reopened.
And then lastly, the 21% decline in mortgage generation, did that refer purely to what’s held-for-sale or did that also include what you put into the portfolio as well.
Ed Garding
Both.
Jacque Chimera - KBW
Okay. So the decline then, since more of that was portfolio, then maybe in other quarters it might have been sold just based on the term of it, then the decline would have been from the held-for-sale, in essence all equal more than 21% if I look at it as to what would have been the income from gain on sale.
Ed Garding
Yes, essentially that’s right. The amount that we have held in portfolios is such a small percentage of the monthly volume.
With all that it didn’t move the bar a lot, but the total volume was down 21%, so that would include those that we sell to the secondary market and those that we held in the portfolio.
Jacque Chimera - KBW
And was that just the types of loans that you generated in the quarter or was there any sort of a change in policy in what you wanted to hold into the portfolio.
Ed Garding
No, there was no change in the policy.
Jacque Chimera - KBW
Okay. Great, those are all my questions.
Thank you.
Ed Garding
Thank you Jacque.
Operator
(Operator Instructions). Our next question is from Brett Rabatin, Sterne Agee.
Please go ahead.
Brett Rabatin - Sterne Agee
Hi, good morning.
Ed Garding
Hi Brett.
Brett Rabatin - Sterne Agee
I wanted to ask, on the loan portfolio yields you’ve been talking about generating loans that are pretty high yields, especially in CNI relative to some peers, given that you focus on smaller loans relative to maybe some of the bigger credits that some others generate. Can you talk maybe about where your seeing production and just kind of given the compression you had in the loan portfolio yield this quarter, maybe should we be thinking about a similar decline in loan yields over the next few quarters, kind of given what’s happened with rates.
Ed Garding
Well, assuming rates are going to stay where they are at, of course that’s a fair assumption. We are going to continue to see the overall yield in loan portfolio go down as we refinance existing loans into lower rates, existing loans that were made three, four and five years ago and coupled with that of course that there is a lot of competition for the quality borrowers and so if you want to keep those people, you probably have to price down a little bit too.
So I think in general we’re going to see that overall loan yield to continue to come down. Hopefully that will be offset with some modest growth.
Brett Rabatin - Sterne Agee
Well, just going back to the question on magnitude, do you think the pace of compression on yield might slow from here? Was there anything outsized that impacted this quarter more than 2Q.
Ed Garding
No, there wasn’t anything worth mentioning this quarter and going forward I think your going to see it continue at about the level we’ve seen.
Brett Rabatin - Sterne Agee
Okay. And then the other question was just a follow-up on mortgage and just thinking about kind of the – I know you got a higher percentage of purchase now, 72% I believe this quarter.
Any thoughts on production levels over the next few quarters in terms of kind of where you see the market, again assuming rates stay where they are.
Ed Garding
We think it’s going to flatten out. We don’t anticipate another 21% drop, that’s all.
I would say fourth quarter will be similar to third quarter.
Brett Rabatin - Sterne Agee
Okay then great, thanks. Those were my questions.
Ed Garding
Thank you, Brett.
Operator
Having no further questions, this concludes our question-and-answer session. I would like to turn the conference back over to Ed Garding for any closing remarks.
Ed Garding
Thanks very much for your interest in First Interstate today. As always you can contact us through Investor Relations on our website and we’ll be glad to respond to any follow-up questions.
Again, thanks for your time and good-bye.
Operator
The conference is now concluded. Thank you for attending today’s presentation.
You may now disconnect.