Financial Institutions Q3 2024 Earnings Call Transcript

Quartr
Provided by Quartr
October 25, 2024

There are 7 speakers on the call.

Operator

Thank you for standing by, ladies and gentlemen. Welcome to the Financial Institutions Incorporated Third Quarter 2024 Earnings Call. My name is Candice, and I will be your event coordinator today. All lines have been placed on mute during the presentation portion of the call with an opportunity for question and answer at the end. Would now like to turn the conference call over to Kate Graf, Head of Investor Relations.

Operator

Please go ahead.

Speaker 1

Thank you for joining us for today's call. Providing prepared comments will be President and CEO, Marty Birmingham and CFO, Jeff Plant. They will be joined by additional members of the company's leadership team during the question and answer session. Today's prepared comments and Q and A will include forward looking statements. Actual results may differ materially from forward looking statements due to a variety of risks, uncertainties and other factors.

Speaker 1

We refer you to yesterday's earnings release and investor presentation as well as historical SEC filings, which are available on our Investor Relations website or our Safe Harbor description and a detailed discussion of the risk factors relating to forward looking statements. We'll also discuss certain non GAAP financial measures intended to supplement and not substitute for comparable GAAP measures. Reconciliations of these measures to GAAP financial measures were provided in the earnings release filed as an exhibit to Form 8 ks or in our latest investor presentation available on our IR website, www.fisi investors.com. Please note that this call includes information that may only be accurate as of today's date, October 25, 2024. I'll now turn the call over to President and CEO, Marty Birmingham.

Speaker 2

Thank you, Kate. Good morning, everyone, and thank you for joining us today. Our Q3 results were highlighted by strong deposit growth, incremental net interest margin expansion, solid expense management and continued build in our regulatory and tangible capital ratios. 3rd quarter 2024 income available to common shareholders was 13,100,000 dollars or $0.84 per diluted share compared to $25,300,000 or $1.62 per diluted share in the linked quarter, which benefited from a $13,500,000 pre tax gain on the sale of our insurance business. 3rd quarter return on average assets was 89 basis points and our efficiency ratio was 65%.

Speaker 2

Year to date ROAA of 90 basis points and efficiency ratio of 72% were impacted by our previously disclosed fraud event and the sale of our insurance subsidiary. Excluding these items, adjusted ROAA through the 1st 9 months of the year was 100 basis points and efficiency ratio was 65%, reflecting the strength of our core business. Before discussing our Q3 results in greater detail, I would like to provide an update on the wind down of our banking as a service offering announced last month after a careful review undertaken in conjunction with our annual strategic planning process. In considering balance sheet allocation, only about 2% of the bank's total deposits are BaaS related and they're primarily associated with 4 live partnerships. These deposits amounted to $103,000,000 on September 30 and they averaged $109,000,000 in the 3rd quarter with a cost of 3.84%.

Speaker 2

Our initial BaaS partner engagement focused on core funding capabilities, a modest amount of credit extension and transaction related fees. As we continue to evaluate the financial results associated with this offering, management determined that the business unit economics were not contributing to the company's franchise value as anticipated. Furthermore, it was evident that an exit from the line of business would not have a material impact on the company's future financial performance. Since launching our BaaS offering in 2021, our investments have largely been focused on building a scalable technological interface to engage with our BaaS partners. This interface also enables smooth integration with other software and tools we rely on, including our customer relationship management solution that supports all business lines.

Speaker 2

We intend to redeploy our investments of time and talent, including headcount to support the significant opportunities we have at 5 Star Bank's community banking franchise. As we work with our customers to wind down their respective relationships, we intend to take the same measured approach that we have since our entry in the past in order to support orderly transitions for our partner firms and their customers. We're having productive and regular discussions with live partners about orderly wind downs and completion remains targeted for some time in 2025. We currently expect to see the outflow of BaaS deposits begin more notably in the Q1. In our core community banking business, we see good opportunities for deposit gathering along our existing markets and within our consumer, commercial and municipal customer bases as experienced in the Q3.

Speaker 2

3rd quarter balance sheet results were highlighted by total deposit growth of $173,300,000 or 3.4 percent from June 30. As public and non public deposit increases more than offset a decrease in reciprocal balances. In addition to seasonality typical of our public deposits, this portfolio maintained higher comp balances during typical outflow cycles, while also growing deposits with new and existing municipalities. This was complemented by solid growth in non public deposits during the quarter. Total deposits were relatively flat year over year as both public and non public deposit growth enabled us to reduce reliance on broker deposits, which were down just over $313,000,000 from September 30, 2023.

Speaker 2

Total loans were down slightly from June 30, 2024 as increases in commercial mortgage and stability in residential loans lines were offset by declines in commercial business and consumer indirect loans. Competition for capable commercial operators and high quality CRE sponsors continues to be very high and we, like many other banks, are seeing business owners utilize excess cash rather than credit in the higher interest rate environment. That said, we continue to see excellent opportunities in our geographic markets to drive credit disciplined loan growth. Our commercial pipelines are in a rebuilding phase and we would expect demand to pick up with additional rate cuts. Overall, we remain confident in the health of our portfolios.

Speaker 2

We did see an increase in non performing loans in the 3rd quarter as a result of a $15,500,000 commercial relationship that was moved to non accrual. We were pleased to report 0 commercial net charge offs again in the Q3. The $31,400,000 in non performing commercial loans at September 30, 2024 largely relates to 2 separate commercial relationships in upstate New York, which are experiencing issues that are specific to these particular borrowers. We believe we are appropriately reserved for each and are working closely with all parties involved toward resolution. Given the nature of the projects, we do expect that this will take some time.

Speaker 2

Credit quality remains strong within our Mid Atlantic portfolio where our clients operate largely in suburban communities outside Baltimore and Washington DC. Our Mid Atlantic team as intended has brought relationships with very strong and experienced developers and provides us with geographic and asset class diversity. Loans in this market totaled $338,000,000 at September 30, 2024. We're also seeing intense competition in the residential lending space as housing inventory remains low in our upstate New York markets. As a result, residential loans in line were relatively flat on a linked quarter basis at 724,400,000 dollars Credit metrics remained favorable and we reported 0 basis points of residential net charge offs in the 3rd quarter and a stable level

Speaker 3

of non performers.

Speaker 2

Consumer indirect loans totaled 874,700,000 dollars at September 30, 2024, down $19,900,000 or 2.2 percent from June 30. While indirect net charge offs increased from the linked quarter, they remain about half the level we experienced in the 1st and 4th quarters. We've intentionally reduced our indirect portfolio over time, being thoughtful in considering its percentage of our overall loan portfolio and refocusing on our core upstate New York markets by exiting the Pennsylvania auto market. At the same time, we've improved the profitability of this line of business and continue to see healthy spreads and favorable credit mix and new production. Indirect lending remains a core lending competency and is a useful balance sheet management tool given the short duration, associated cash flow and higher yields.

Speaker 2

We will continue to maintain this portfolio given the demand and practicality in our core markets where public transportation is fairly limited. For the last 20 years, in positive and negative economic cycles, this loan category has performed consistently in a narrow range of acceptable credit metrics and risk adjusted returns. Our balance sheet remains healthy overall and we look forward to continue to build relationships with depositors and borrowers throughout our upstate New York and Mid Atlantic markets. I'd now like to turn the call over to Jack for additional details on financial results and our 2024 guidance.

Speaker 3

Thank you, Marty. Good morning, everyone. We reported net interest margin on a fully taxable equivalent basis of 289 basis points for the Q3 of 2024, up two basis points from the linked Q2.

Speaker 2

NIM was negatively impacted by

Speaker 3

the commercial relationship placed on non accrual during the quarter that Marty discussed, which reduced margin by 3 basis points. Net interest income of $40,700,000 was down $512,000 from the linked quarter with the majority of that variance attributable to the reversal of interest income for the single commercial relationship. Interest earning asset yields increased 3 basis points, modestly outpacing our overall cost of funds, which increased 2 basis points. While the average yield on interest bearing liabilities increased from the 2nd quarter as a result of growth in higher cost time deposits, we were pleased to see a slowing of disintermediation from non interest bearing accounts, where average balances of about $1,000,000,000 were stable quarter over quarter. Average total deposits were down about 2% on a linked quarter basis, largely due to the timing of seasonal public deposit inflows, in addition to a decrease in reciprocal deposits, which offset an increase in average non public deposits.

Speaker 3

We continue to be proactive in managing funding costs where we can and further reduced short term borrowings in the 3rd quarter. Since year end 2023, we've reduced total borrowings and broker deposits by about $307,000,000 or 54%. In looking at our total deposit portfolio, relative to the magnitude of FOMC rate increases that occurred in 20222023 and the recent 50 basis point decrease, we experienced a cycle to date beta of 53%. Excluding the cost of time deposits, the non maturity deposit portfolio had a beta of 32%. Year to date NIM of 2.85% is at the low end of the 2.85% to 2.95% range we guided in January.

Speaker 3

At this time, we're narrowing our expected range for full year 2024 NIM to 2.85% to 2.9%. As a reminder, this guidance was and continues to be based on a spot rate forecast that does not factor in potential future rate cuts. Given quarter end balances and the continued lending competition that Marty discussed, we now expect 2024 annual loan growth to come in at the low end of our guided range 1% to 3%. While year to date cash flows have been lighter than originally modeled at the outset of the year, we do expect the anticipated rate cuts will be accompanied by increased demand from commercial borrowers. We're currently projecting more than $1,100,000,000 in total cash flow over the next 12 months off the loan and securities portfolios combined.

Speaker 3

Non interest income totaled $9,400,000 in the 3rd quarter compared to $24,000,000 in the 2nd quarter when we recorded $13,500,000 in pre tax gains on the sale of our insurance business. We had a small additional gain of $138,000 related to this transaction in the Q3 of 2024. Also contributing to the linked quarter variance was a net loss of $170,000 on tax credit investments in the Q3. This compares to a net gain of $406,000 in the 2nd quarter related to a historic tax credit investment with a New York State refundable component placed into service in that period. Limited partnership income of $400,000 in the recent quarter was about half the level we recorded in the second quarter and swap fee income was down $165,000 due to a lower level of back to back swap activity in the 3rd quarter as compared to the linked quarter.

Speaker 3

Recurring non interest income, which we typically provide guidance on of $9,100,000 was down modestly from $9,300,000 in the linked quarter. This excludes gains and losses on investment securities, investment tax credits and other assets as well as limited partnership and insurance income. Investment advisory income, which comes primarily from career capital totaled $2,800,000 relatively flat with the 2nd quarter. Our wealth management subsidiary had $3,200,000,000 in assets under management as of September 30, 2024 with year to date AUM growth of approximately $319,000,000 or 10% coming from a combination of market appreciation and positive net inflows of $44,000,000 as a result of business development efforts. Non interest expense was $32,500,000 in the Q3 of 2024, down modestly from $33,000,000 in the second quarter.

Speaker 3

This was primarily due to a lower FDIC assessment in part due to improvement in our leverage ratio and lower other expenses, including other bank charges and timing of director compensation and donations. We recorded a provision for credit losses of $3,100,000 in the Q3 of 2024 compared to $2,000,000 in the Q2. 3rd quarter 2024 provision was driven by a combination of factors, including a slight increase in the national unemployment forecast and higher qualitative factors overall, partially offset by lower loan balances. Income tax expense was $1,100,000 in the quarter, representing an effective tax rate of 7.4%. Our year to date effective tax rate is 12.6% and within our guided range for the full year of 11% to 13%.

Speaker 3

Our accumulated other comprehensive loss was $102,000,000 at September 30, 2024, an improvement of $23,700,000 from June 30. We reported a TCE ratio at September 30 of 6.93 percent, intangible common book value per share of $27.28 Excluding the AOCI impact, the TCE ratio and tangible common book value per share would have been 8.38% and $33.02 respectively. We continue to expect these metrics to return to more normalized levels over time given the high credit quality and cash flow nature of our investment portfolio. Our core financial performance through the 1st 9 months of the year has been strong and generally in line with our expectations. As mentioned, we've lowered the expected high end range of full year margin to 2.9% and expect 2024 full year loan growth to come in at the low end of our guided range of 1% to 3%.

Speaker 3

Additionally, we now expect full year net charge offs to fall within a range of between 20 to 30 basis points of average loans, down from the 30 to 40 basis points we originally guided. There are no other changes to our previously published guidance, which you'll find outlined in our latest investor presentation. That concludes my prepared remarks. I'll now turn the call back to Marty.

Speaker 2

Thanks, Jack. Amid a continued challenging operating environment, our company has remained intently focused on liquidity, capital and earnings. The actions we've taken over the course of this year have allowed us to expand capital ratios meaningfully, including a common equity Tier 1 ratio of 10.28 percent, up 85 basis points from 9.43% at year end 2023. Many of the strategic actions we've taken from the sale of our insurance business to adjustments within our indirect business to our decision to wind down our banking as a service offering have also been focused around supporting our core community banking franchise in our existing footprint. We remain very focused on driving sustainable growth across each of our retail banking, commercial banking and wealth management business lines and by extension driving value into the company for the benefit of our shareholders, customers, associates and communities.

Speaker 2

That concludes our prepared remarks. Operator, please open the call for questions.

Speaker 4

Our first question comes from Damon DelMonte from KBW.

Speaker 5

Just wanted to start off with a question on margin. I appreciate the updated guidance here for the Q4. Jack, just kind of want to get your thoughts though, if we have a couple more rate cuts here in 'twenty four and we have a more steady flow of 25 basis point cuts in 'twenty five, Can you just give us a little perspective on how you're thinking about the margin kind of given the cash flow expectations and what you're seeing for loan growth?

Speaker 3

Sure. So I'll just reconfirm that a little over 30% of our loan portfolio is priced off of sulfur or prime. And on the commercial side, that adjusts with on the prime side with rate cuts and then sulfur adjusts monthly. On the consumer side, the prime adjustments generally adjust on a monthly basis. And when we provided our margin guidance at the beginning of the year, it was based upon a flat environment.

Speaker 3

We did some modeling around the impact to NII for rate cuts. And we modeled out that we were fairly neutral for the first 50 basis points of cuts. The expectation on that side was that there was going to be a longer lag for deposit repricing. We've actually seen our competitors be a little bit more aggressive in adjusting their rates on a posted basis. And as such, we've reacted a little bit more faster than we would have anticipated.

Speaker 3

So we've already started to price down segments of the consumer, commercial, municipal and reciprocal portfolios. And our expectation is that we continue that with additional rate cuts. So we'll provide full year guidance on our Q4 earnings call for 2025. My expectation is that we kind of remain in that neutral band in the near term.

Speaker 5

Got you. Okay. That's helpful. And then with regards to the outlook for loan growth, I think Marty, you made a comment that the commercial pipeline seems to be to rebuilding right now. So does that give you better confidence for kind of maybe mid single digit growth as we go through 2025?

Speaker 2

It does, Damon. Thanks for the question and participating this morning. It certainly does. As I also commented, last 18 months, we've been focused on liquidity capital earnings and in light of the operating environment, in light of commentary around concerns over credit, etcetera. So we've been selective during this period.

Speaker 2

And we have been signaling to our lending teams and to our customers of our interest to start to rebuild the pipeline and to build momentum in support of growth in the range you just talked about for 2025.

Speaker 5

Got it. Okay, that's great. And then maybe just one more quick one here for Jack on expenses. It came in lower than what we were looking for this quarter and down a little bit from last quarter. I guess, how do you think about when you kind of reset the button and going into 25, do you think you can kind of maintain a modest like low single digit type growth outlook here?

Speaker 5

Or do you have any anticipated expenditures that you're aware of or you can disclose?

Speaker 3

We're certainly focused on reinvesting in our core lines of businesses for future growth, Aimen. But our mindset over the past couple of years has been certainly focused on expense management and prudent expense management in that regard. So as far as full year expense guidance is concerned for 2025, again, we'll provide that update with the Q4 call. But I would point to our exit from BaaS and the fact that there were 14 FTEs associated with supporting that line of business that are going to be redirected towards our more mature lines of business. And in my mind, that's cost avoidance where we would have had to have gone out and hired to support growth in future periods.

Speaker 5

Got you. Makes sense. Okay.

Speaker 2

That's all that I had. I appreciate the

Speaker 5

color this morning. Have a great one. Thanks.

Speaker 2

Thanks, Damon.

Speaker 4

Our next question comes from David Mironik from Stephens.

Speaker 6

Hey, good morning. David, you're live. David, you're live.

Speaker 2

David, you're live.

Speaker 3

Hey, good morning, David.

Speaker 6

Hi, David. Can you guys hear me?

Speaker 2

Yes. Good morning.

Speaker 6

I think I kind of talked about the betas that you kind of saw on the way up. And I would love to hear your thoughts and kind of expectations around the loan and deposit betas on the way down through 2025. And if you kind of expect those figures to be fairly similar to what they were on the up cycle?

Speaker 3

Yes. This is Jack. I'll take that question. So as I mentioned earlier, when we were modeling at the beginning of the year and considering future rate cuts, we had expected to be a bit slower on the downward repricing, at least for the first couple of rate cuts in our deposit betas, so a longer lag we had experienced previously. What we have seen is that we've shortened that lag more than anticipated.

Speaker 3

The betas again are in line with what we would have anticipated. So my perspective in the near term, the impact to margin would be neutral. But as we continue to see the Fed act with additional rate cuts, I see betas catching up to where they would have been historically over time.

Speaker 5

Okay,

Speaker 6

great. And then just on Slide 23 of the presentation, it looks like in most segments loans are rolling off at a higher rate than the current rate. I don't think those loans are longer duration and we'd see some yield pickup there. So I was just wondering if you could provide some commentary around that.

Speaker 3

Yes. So that's been the story as far as our ability to expand margin throughout 2024 with that roll off yield on the loan portfolio are being reinvested at higher rates. And we've been pretty selective as far as our pricing requirements for yields that we've approved this year on the commercial side in order to preserve and expand margin. That philosophy hasn't changed, which is why we've seen a lower level of loan growth maybe than some of our peers, as we've been selective in that regard. That story continues and we continue to be focused on spread maintenance and driving towards expansion on the earning asset side.

Speaker 6

Appreciate that. And the last one for me is I'm sorry if I missed this. Just in terms of the Bass wind down, do you expect any one time costs associated with that?

Speaker 3

No material one time costs.

Speaker 6

Okay, great. I appreciate you taking my questions.

Speaker 2

Thanks, David. Thanks, David.

Speaker 4

And we currently have no further questions in the queue. I will turn the call back over to Martin Bermingham for closing remarks.

Speaker 2

Thanks very much for your help this morning, operator. Thanks to all who have participated in our call. We look forward to reporting on results with you in January.

Speaker 4

Thank you everyone for your participation. You may now disconnect from the call. Have a nice day.

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Key Takeaways

  • Q3 2024 net income available to common shareholders was $13.1 million or $0.84 per diluted share versus $25.3 million or $1.62 last quarter (which benefited from a $13.5 million pre-tax gain), with ROAA of 89 bps and an efficiency ratio of 65%.
  • The company is winding down its banking-as-a-service offering (2% of total deposits, ~$109 million at a 3.84% cost) by 2025 to redeploy resources into its core 5 Star Bank community banking franchise.
  • Total deposits grew by $173.3 million (3.4% QoQ) in Q3—driven by public and non-public inflows—while brokered deposits declined by over $313 million year-over-year.
  • Net interest margin on a fully taxable equivalent basis rose to 2.89% (up 2 bps QoQ), and full-year NIM is now guided to 2.85–2.90%; 2024 loan growth is expected at the low end of the prior 1–3% range.
  • Credit quality remains sound with zero commercial net charge-offs in Q3 despite a $15.5 million nonperforming commercial relationship; the bank says reserves are adequate for the identified exposures.
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Earnings Conference Call
Financial Institutions Q3 2024
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