Financial Institutions Q1 2024 Earnings Call Transcript

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Provided by Quartr
April 26, 2024

Key Takeaways

  • Q1 included an $18.4 M fraud event charge-off, cutting EPS to $0.11, though ex-fraud EPS would have been $1.12 with a 69% efficiency ratio.
  • Sold SDN Insurance Agency for $27 M in cash, realizing an ~$11.2 M after-tax gain and adding 40 bps of regulatory capital.
  • Deposits grew by $183.8 M (3.5%) and liquidity approached $1.5 B, while credit quality remained strong with NPLs at 0.60% and improved indirect loan delinquencies.
  • Net interest margin stabilized at 2.78% in Q1 and full-year NIM guidance of 2.85–2.95% was maintained, supported by $1.1 B of redeployment opportunities.
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Earnings Conference Call
Financial Institutions Q1 2024
00:00 / 00:00

There are 6 speakers on the call.

Operator

Hello, everyone, and welcome to the Financial Institutions Incorporated First Quarter 20 24 Earnings Call. My name is Harry and I'll be your operator. I will now hand over to Kate Croft to begin. 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, Jack Plant. They will be joined by additional members of the company's financial leadership teams 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 for a 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 Investor Relations presentation available on our IR website, www.fisi investors.com. Please note this call includes information that may only be accurate as of today's date, April 26, 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. Heading into 2024, we knew that the challenging operating environment would persist. In the Q4, you'll recall we took steps to optimize the configuration of our balance sheet and completed a strategic reorganization to enhance the earnings potential of the company while positioning us to sustain incremental performance in the future. Given the fraud event we experienced, we never could have imagined the intensity of the challenges we have faced and vigorously managed in the last several weeks.

Speaker 2

As previously disclosed, in early March 2024, we discovered fraudulent activity conducted by an in market deposit only Five Star Bank business customer that resulted in an $18,400,000 deposit related charge off in the Q1. This has been broken out in our income statement from other expenses. The charge is modestly lower than the $18,900,000 potential exposure we originally estimated, reflecting funds recouped in late March. We are actively pursuing all legal recourse available to us recover additional funds from the customer and minimize this loss. This event certainly had a significant impact on our otherwise solid Q1 2024 financial results with the associated pre tax fraud loss and elevated legal and consulting expenses totaling approximately $19,000,000 As we recognize this loss in the Q1, net income available to common shareholders was $1,700,000 or $0.11 per diluted share compared to $9,400,000 or $0.61 per share in the linked Q4 and $11,700,000 or $0.76 per share in the Q1 of 2023.

Speaker 2

We reported annualized return on average assets of 13 basis points and an efficiency ratio of approximately 106%. Excluding the impact of expenses related to this fraud event, the company would have reported $1.12 of earnings per diluted share, ROA of 1.14 percent and an efficiency ratio of approximately 69%. Even as we navigated this matter, we remain focused on strategic action to enhance liquidity, capital and earnings. On April 1, we announced and closed the sale of the assets of our insurance subsidiary, SDN Insurance Agency, to NFP Property and Casualty Services, a leading property and casualty broker and benefits consultant. In addition to having a meaningful contribution to overall net income, the sale occurred at an opportune time when this line of business was generating what we believe was a peak EBITDA margin.

Speaker 2

The $27,000,000 all cash transaction represents 4x 2023 insurance revenue and approximately 10x earnings. This transaction allowed us to capture strong value premium in this business, generating a gain of approximately $11,200,000 on an after tax basis prior to selling costs, while also eliminating $11,300,000 dollars of goodwill and other intangible assets. Importantly, the transaction provides at least 40 basis points of incremental regulatory capital that positively impacts our TCE ratio by more than 30 basis points, which will be reflected in the 2nd quarter results. We were pleased to have the opportunity to source capital at a time when it is needed in such an efficient and shareholder friendly manner. For the 10 years since we acquired SDN and supported revenue diversification and allowed us to expand the capabilities and services we provide our customers.

Speaker 2

We enhanced our former insurance subsidiary through bolt on acquisitions in the Buffalo and Rochester markets and helped it grow into a leading insurance agency serving Western New York and clients nationally. We evaluated potential buyers for this business. NFP's offer was compelling both financially and in terms of its vision for us to end the future and continued collaboration with our 5 Star Bank team. Looking forward, NFP will be the bank's insurance partner of choice, ensuring our customers have continued access to exceptional insurance counsel, products and services. We expect to deploy proceeds from the sale into our core banking business in the form of high quality, credit disciplined loan origination to drive higher yielding earning asset growth and support net interest margin expansion through the year.

Speaker 2

We continue to expect that our full year loan growth will be driven by our commercial lending group, which operates across Western and Central New York and our Mid Atlantic region. In the Q1, growth in this portfolio was offset by anticipated declines in our indirect auto segment as we continue to enhance the profitability of this line of business while benefiting from the steady cash flow it provides. While total loan balances were relatively flat to the end of 2023, down $20,000,000 or 50 basis points, We have solid pipelines and have closed several notable commercial deals so far in the second quarter. Credit quality remained strong and stable in the Q1 with non performing loans to total loans of 60 basis points at both March 31, 2024 and December 31, 2023. Annualized net charge offs to average loans were 28 basis points in the current quarter, an improvement of 10 basis points from the 4th quarter.

Speaker 2

While we have seen higher charge off rates in our indirect portfolio in the last few quarters, the trend that continued into the Q1 of 2024, we saw positive trends in overall indirect delinquencies during the quarter. As an example, total delinquencies, including non accruals, declined by more than $12,000,000 during the 1st 3 months of the year to 1.24% at March 31, essentially half of the 2.53% we saw at December 31, 2023. Overall, we remain confident in the health of our loan portfolio and associated asset quality metrics. Deposit growth was a highlight for our Q1 performance with balances up $183,800,000 or 3.5 percent from year end 2023. While seasonality of public deposits was the main driver of this increase, we experienced growth in non public and reciprocal deposits as well.

Speaker 2

Banking as a Service or BaaS related deposits were down modestly from the end of 2023 to approximately $116,000,000 reflecting normal fluctuation within end user accounts. We remain energized about the opportunity this line of business presents while mindful of the challenges others in this space have experienced. As we have stated in the past, our approach to BaaS has been measured, deliberately aligned with our organizational risk appetite statement and focused on select partners serving small and midsized businesses, affinity groups and niche markets. Our risk adjusted process for evaluating BaaS partners coupled with a controlled approach to transitioning them onto our platform has resulted in modest but sustainable growth in this line of business and a reduction in our partnership pipeline. We deem this prudent and are currently focused on cultivating strong and lasting partnership.

Speaker 2

This concludes my introductory comments. It's now my pleasure to turn the call over to Jack for additional details on results and details of our 2024 guidance.

Speaker 3

Thank you, Marty. Good morning, everyone. Net interest income of $40,100,000 for the Q1 was up 196 $1,000 from the Q4 of 2023. Interest earning asset yields increased 11 basis points, in line with overall cost of funds, reflective of the impacts of the continued high interest rate environment, the inward yield curve and strong competition in our markets. Margin has stabilized and we reported NIM on a fully taxable equivalent basis of 2.78 basis points for both the current and linked quarters.

Speaker 3

Margin increased incrementally on a monthly basis in the Q1. Given our $1,100,000,000 of anticipated cash flow in 2024, we have ample opportunity to redeploy funds into higher yielding earning assets. And looking at our total deposit portfolio, relative to the magnitude of FOMC rate increases that occurred in 20222023, we have experienced a cycle to date beta of 46%. Excluding the cost of time deposits, the non maturity deposit portfolio had a beta of 28%. Given FOMC expectations and internal modeling, we expect the trajectory of deposit beta to slow in 2024.

Speaker 3

Non interest income totaled $10,900,000 in the 1st quarter, down $4,500,000 on a linked quarter basis. This variance was largely driven by lower company owned life insurance or COLI income in the current quarter. As you'll recall, we reported $9,100,000 of COLI income in the 4th quarter, of which approximately $8,000,000 related to a higher crediting rate on the investment of the premium into a separate account product during that period. As expected, incremental income associated with cash to undervalue those policies and stable value component has stabilized and is reflected in our Q1 of 2024 results. In the linked Q4, we also reported a $3,600,000 loss on investment securities related to the repositioning we completed in October, which along with seasonally higher insurance income in the quarter partially offset the COLI income variance between periods.

Speaker 3

Investment advisory income, largely driven by Courier Capital, our RIA subsidiary serving mass affluent and high net worth individuals and families, institutional clients and 401 plan sponsors was down about 87,000 from the linked quarter. As of March 31, 2024, Courier Capital had assets under management of approximately $3,000,000,000 As Marty noted, increased non interest expense was primarily attributable to the fraud event we experienced in March 2024, including an $18,400,000,000 deposit related fraud charge off, approximately 660,000 dollars in related legal and consulting expenses. Excluding these two items, non interest expense would have been flat with the linked 4th quarter. We recorded a benefit for credit losses this quarter as a decrease in qualitative factors coupled with an improvement in forecasted loan losses and a decrease in consumer indirect loans resulted in a reserve release. We've provided additional details on Slide 19 of our investor presentation, but I'd like to touch on a couple of the contributing factors here.

Speaker 3

The primary driver of the improved qualitative factor in our model was the lower level of consumer indirect delinquencies relative to year end 2023. This qualitative factor for trends and delinquencies is surely quantitative in nature and corresponds to the range of delinquencies in the portfolio over the look back period since 2006. We also saw improved commercial delinquencies and observed favorable trends in our commercial credit review and administration functions. Income tax expense was $356,000 in the quarter, representing an effective tax rate of 14.7%. Our accumulated other comprehensive loss was $126,300,000 at March 31, 2024, compared to $119,900,000 at December 31, 2023.

Speaker 3

We reported at March 31 of 5.72 percent, intangible common book value per share of $23.06 Excluding the AOCI impact, the TCE ratio and tangible common book value per share would have been 7.53% and $30.37 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. I would now like to provide an update on our outlook for the remainder of 2024 in key areas. Following our April 1, 2024 insurance transaction, we now expect recurring non interest income between 8.5 $1,000,000 to $9,000,000 per quarter or $36,500,000 to $38,000,000 for the full year. This guidance excludes income related to investment tax credits, limited partnerships and gains or losses on investment securities and assets, including the FDM sale.

Speaker 3

We're now projecting non interest expense of $33,000,000 to $34,000,000 per quarter for the remainder of 2024, again reflecting the sale of SBM. This translates to full year non interest expense of $135,000,000 to $136,000,000 excluding the $19,000,000 of expense related to the fraud event recognized in the Q1. We now expect the 2024 effective tax rate to fall in the range of 13% to 15%. Including the impact of the fraud event in the Q1, the SBM sale in the 2nd quarter and the amortization of tax credit investments placed in service in recent years. We will continue to evaluate tax credit opportunities and the positive impact these investments would have on our effective tax rate.

Speaker 3

Our previous guidance on loan to deposit growth of between 1% to 3%, net interest margin of between 285 basis points to 295 basis points, full year net charge offs within our annual historical range of 30 to 40 basis points remain unchanged. Overall, our company remains in a strong financial position.

Speaker 2

We continue to be well capitalized and maintain a

Speaker 3

steady level of regulatory capital during the Q1 despite the challenges we faced, reporting a common equity Tier 1 ratio of 9.43 percent consistent with year end 2023. Our liquidity position is among the strongest we've seen, approaching $1,500,000,000 and our 12 month anticipated cash flow continues to exceed $1,000,000,000 putting us in a strong position to continue to support our customers and communities.

Speaker 2

That concludes my prepared remarks

Speaker 3

and updated guidance. I'll now turn the call back to Marty.

Speaker 2

Thank you, Jack. As challenging as the Q1 was, I'm very proud of our team for not allowing adversity to distract us from our focus of running the business, delivering on our objectives and executing on longer term initiatives. The second quarter is off to a strong start with a successful divestiture of our insurance subsidiary, supporting our capital ratios and earnings potential. Our pipelines are healthy and we remain focused on our core banking business and on nurturing strong customer relationships in order to sustain and grow our deposit base. Credit discipline loan growth has been and continues to be a fundamental focus of our retail, commercial, credit delivery and risk associates.

Speaker 2

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

Operator

Thank Our first question today is from the line of Damon DelMonte of KBW. Damon, your line is open now if you'd like to proceed.

Speaker 4

Hi, good morning. Thanks for taking my question. So just curious with regards to the provision reversal this quarter, I understand there's a combination of factors that were provided in the release that supports reversal. But I was just wondering what would have been the harm to kind of maintain a higher loan loss reserve, especially where we are in the cycle with credit trends today. It looks like the reserve now at 97 basis points is effectively kind of round tripped the day 1 CECL level.

Speaker 4

So just curious as to what the harm would have been to kind of keep the reserve a little bit higher and be a little bit more conservative?

Speaker 2

Damon, it's Marty. Thanks for the question. It's an important topic, I think, for the industry right now. There's dissonance relative to some of these reserve releases and to your point, what we think could happen relative to the economy and other challenges to credit, etcetera. We obviously all these CECL models were built at a time when interest rates were 0 to 25 basis points on a fed funds basis.

Speaker 2

We've not felt the impact of the velocity of interest rate increases. Obviously, the credit events that we've been talking about in the industry and in the financial press for the last 18 months, they didn't exist. So, we are thinking about that and the model and the times that we are in today versus when it was built and adopted in the late 2019 early 2020 and exploring other factors that would have acceptable statistical attribution in terms of predicting future credit losses. But Jack, you started to think about that. Sure.

Speaker 3

So David, let me start by saying that a coverage ratio of 97 basis points, I'm comfortable with that given the credit performance of our portfolio. When I look back to the 3rd Q4 last year when we were building reserves, it was driven by one of the qualitative drivers of our CECL model that's quantitatively driven and that's the delinquency on our indirect portfolio, which started to increase. And as a result, we saw higher net charge offs in the indirect portfolio in the Q4 of 2023 and again in the Q1 of this year. However, during the Q1, we saw delinquencies at basically 50% of what they were during the Q4 of last year, which a leading indicator of future charge offs in that portfolio. So given that performance and the quantitative factor around it, that drove the majority of our reserve release there.

Speaker 3

And with the underlying performance of that portfolio, I'm basically comfortable with our current coverage ratio.

Speaker 4

Got it. Okay. And there's apparently like there's no concern that if rates stay higher for longer and there's more stress on the consumer that that indirect portfolio could experience some weakness?

Speaker 3

We saw weakness in the portfolio through net charge offs in the 4th Q1 of this year. That was driven by a slug of loans that had been originated during the pandemic when consumers were flushed with liquidity from government stimulus programs. We're working through that. Given the current delinquencies on the portfolio, I expect to see some improved performance in that line business.

Speaker 4

Okay, great. Thank you. And then just one other question here on the margin, it came in at $278,000,000 this quarter. Do you happen to have what the margin was for the month of March?

Speaker 3

Yes, it was 2 80 basis points.

Speaker 4

Okay, great. Okay, that's all I had for now. Thanks.

Operator

Stay Our next question is from the line of Baidu Hichai of Piper Sandler. Baidu, your line is now open. Please go ahead.

Speaker 5

Hey, good morning guys. Just filling in for Alex today. I just wanted to ask about the NIM guidance. You guys guided to $285,000,000 to $295,000,000 for the year. Could you just walk us through the drivers of what would have to go right for it to hit the top end of the range, dollars 2.95,000,000 and vice versa to 285 throughout the year?

Speaker 3

Sure. So along with driving that is the cash flow that's coming off the portfolio with really tempered loan growth in that 1% to 3% range. So we're seeing all of the roll on yields in our commercial book come on 8% or higher, which is exceeding the cash flow that's coming off the portfolio. So that's driving the modest expansion we're forecasting. We're also including a modest amount of increased beta in the deposit book just given the higher rate environment.

Speaker 3

However, we think that that's at a much lower level than what we'd experienced last year. And as we indicated in the call script, we saw margin improvement each month during the Q1 at a modest level, which gets us to that guided range of what we projected for the full year.

Speaker 5

Got it. Thanks. And then just a follow-up also about the NIM. Is it fair to assume, I mean, you just gave the NIM for March was 280. Is it fair to assume that 1Q would be the bottom for the NIM?

Speaker 5

And should we expect an inflection next quarter?

Speaker 3

That's the expectation.

Speaker 5

Got it. That's all my questions. Thanks for taking them.

Operator

Thank you. We have no further questions in the queue at this time. So I would like to hand back to Marty Birmingham for any closing remarks.

Speaker 2

Appreciate everyone's participation this morning and interest in the company. We look forward to continuing this conversation and updating you on our results in the Q2 in July.

Operator

This concludes today's call. Thank you all for joining. You may now disconnect your lines.

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