Q1 2024 Financial Institutions Inc Earnings Call

Participants

Kate Croft; Investor Relations; Financial Institutions Inc

Martin Birmingham; President, Chief Executive Officer and Director; Financial Institutions Inc

W. Jack Plants; Chief Financial Officer, Executive Vice President, Treasurer; Financial Institutions Inc

Damon DelMonte; Analyst; Keefe, Bruyette & Woods, Inc.

Presentation

Operator

Hello, everyone, and welcome to the Financial Institutions Inc. First Quarter 2024 earnings call. My name is Harry, and I'll be your operator if you'd like to ask a question during Q&A, you may do so by pressing star one on your telephone keypad. I will now hand over to Kate Croft to begin. Please go ahead.

Kate Croft

Thank you for joining us for today's call, Providing prepared comments will be President and CEO, Marty Birmingham, and CFO, Jack plants will be joined by additional members of the company's financial leadership teams during the question and answer session of today's prepared comments and Q&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. Please refer 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 and will 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 eight K or our Investor Relations presentation available on our IR website, w. w. w. dot FISI. dash Investor.com. Please note this call includes information that may only be accurate as of today's date, April 25th, 2024.
I'll now turn the call over to President and CEO, Marty Birmingham.

Martin Birmingham

Thank you. Good morning, everyone, and thank you for joining us today. Heading into 2024, we knew that the challenging operating environment would persist in the fourth quarter. 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 for sustained 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.
As previously disclosed, in early March 2020 quarter, we discovered fraudulent activity conducted by in-market deposit only Five Star Bank business customer that resulted in an $18.4 million deposit related charge-off in the first quarter. This has been broken out in our income statement from other expenses. The charges modestly lower than the $18.9 million potential exposure we originally estimated reflecting funds recouped in late March. We are actively pursuing all legal recourse available to us to recover additional funds to the customer and minimize this loss. This event certainly had a significant impact on our otherwise solid first quarter 2024 financial results with the associated pretax fraud loss and elevated legal and consulting expenses totaling approximately $19 million.
As we recognize this loss of first quarter net income available to common shareholders was $1.7 million, or $0.11 per diluted share compared to $9.4 million or $0.61 per share in the linked fourth quarter and $11.7 million or $0.76 per share in the first quarter of 2023, 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% 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 enhance the property and casualty Services, a leading property and casualty broker and benefits consult in addition to having a meaningful contribution to overall net income sale occurred at an opportune time when this line of business was generating what we believe was a peak EBITDA margin. The $27 million all-cash transaction represents four times 2023 insurance revenue and approximately 10 times earnings.
This transaction allowed us to capture strong value premium in this business, generating a gain of approximately $11.2 million on an after-tax basis prior to selling costs, while also eliminating $11.3 million of goodwill and other tangible assets. Importantly, the transaction provides at least 40 basis points of incremental regulatory capital, which positively impacts our TCE ratio by more than 30 basis points, which will be reflected in the second quarter results. We were pleased to have the opportunity to source capital at a time when it is needed in such an efficient shareholder-friendly manner.
In the 10 years since we acquired S, the ad supported revenue diversification allowed us to expand the capabilities and services we provide our customers. We enhanced our former insurance subsidiary to bolt-on acquisitions in the Buffalo and Rochester markets and help them grow into a leading insurance agency serving Western New York and clients nationally, we evaluated potential buyers for these two entities offer was compelling, both financially and in terms of its vision for ESPN's future and continued collaboration with our five star maintain looking forward and our team will be the bank's insurance partner of choice, ensuring our customers have continued access to exceptional Insurance Council 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.
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 first quarter. 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 spending cash flow it provides while total loan balances were relatively flat to the end of 2023, down $20 million 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 first quarter with nonperforming loans to total loans of 60 basis points at March 31st, 2024 and December 31st, 2023. Annualized net charge-offs to average loans were 28 basis points of the current quarter, an improvement of 10 basis points from the fourth quarter. While we have seen higher charge-off rates in our indirect portfolio in the last few quarters, the trend that continued into the first quarter of 2024, we saw positive trends in overall and direct delinquencies during the quarter. As an example, total delinquencies, including nonaccruals, declined by more than $12 million during the first three months of the year to 1.24% at March 31st, essentially half from the 2.53% we saw at December 31st, 2023. Overall, we remain confident in the health of our loan portfolio and associated asset quality metrics.
Deposit growth was a highlight for our first quarter performance with balances up $183.8 million or 3.5% from year end 2023. While seasonality of public deposits was the main driver of this increase, we experienced growth of nonpublic and reciprocal deposits as well. Banking as a Service or batch related deposits were down modestly from the end of 2023 to approximately $116 million, 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 balance 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 best partners, coupled with a control 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 lasting partnership.
This concludes my introductory comments. It's now my pleasure to turn the call over to Jack for additional details on results at the details of our 2024 guidance.

W. Jack Plants

Thank you, Marty. Good morning, everyone. Net interest income of $40.1 million for the first quarter was up 196,000 from Q4 of 2023. Interest-earning asset yields increased 11 basis points in line with overall cost of funds reflective of the impact of the continued high interest-rate environment, the inverted yield curve, strong competition in our markets margin has stabilized and we reported them on a fully taxable equivalent basis of 278 basis points for both the current and linked quarters. Margin increased incrementally on a monthly basis in the first quarter, given our $1.1 billion 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 2022 and 2023.
We have experienced a cycle to date data of 46%, excluding the cost time deposits. The non-maturity deposit portfolio had a beta of 28% given on C. expectations and internal modeling, we expect the trajectory of deposit betas slow in 2024. Noninterest income totaled $10.9 million in the first quarter, down $4.5 million on a linked quarter basis. This variance was largely driven by lower company-owned life insurance or quarterly income in the current quarter. As you'll recall, we reported $9.1 million of core income in the fourth quarter, of which approximately $8 million related to a higher crediting rate on the investment of the premium into separate account product during that period.
As expected, incremental income associated with the cash surrender value, those policies and stable value component has stabilized and is reflected in our first quarter of 2020 forward loans. In the linked fourth quarter, we also reported a $3.6 million 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 quarterly income variance between periods, investment advisory income, largely driven by courier capital our RIA. subsidiary serving mass affluent and high net worth individuals and families, institutional clients and 41 K plan sponsors was down about 87,000 from the linked quarter.
As of March 31st, 2024, Courier Capital had assets under management, approximately $3 billion. As Marty noted, increased noninterest expense was primarily attributable to the fraud that we experienced in March 2024, including an $18.4 million deposit related fraud charge of approximately 660,000 in related legal and consulting expenses. Excluding these two items, non-interest expense would have been flat with the linked fourth 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. The primary driver of the improved qualitative factor in our model was the lower level of consumer direct delinquencies relative to year-end 2023 this qualitative factor for trends in delinquencies is purely quantitative in nature and corresponds to the range of delinquencies in the portfolio over a 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 $126.3 million at March 31, 2024, compared to $119.9 million at December 31st, 2023. We reported a TCE ratio at March 31 of 5.72%, tangible common book value per share, $23.6. 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 key areas following our April first, 2024 insurance transaction. We now expect recurring non-interest income between $8.9 million per quarter or $36.5 million to $38 million 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 SDSL.
We're now projecting noninterest expense of $33 million to $34 million per quarter for the remainder of 2024, again, reflecting the sale of SPS. This translates to full year noninterest expense of $135 million to 136 million excluding the $19 million of expense related to the fraud of that recognized in the first quarter, we now expect the 2024 effective tax rate to fall in a range of 13% to 15%, including the impact of the fraud event in the first quarter. The SCM sales in the second quarter and the amortization of tax credit investments placed in service in recent years will continue to evaluate tax credit opportunities and the positive impact of these investments would have on our effective tax rate.
Our previous guidance on loan and deposit growth of between 1% to 3%, net interest margin of between 285 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. We continue to be well capitalized and maintain a steady level of regulatory capital during the first quarter, despite the challenges we face, reporting a common equity Tier one ratio of 9.43%, consistent with year end 2023, our liquidity position is among the strongest we've seen approaching $1.5 billion, and our 12 12-month anticipated cash flow continues to exceed $1 billion, putting us in a strong position to continue to support our customers and communities.
That concludes my prepared remarks updated guidance. I'll now turn the call back to Marty.

Martin Birmingham

Thank you, Jack. As challenging as the first quarter was a very proud of our team for not allowing adversity to distract us from our focus on running the business, delivering on our objectives and executing on longer-term initiatives. The second quarter is off to a strong start with the 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 disciplined loan growth has been and continues to be a fundamental focus of our retail commercial credit delivery and risk Associates.
That concludes our prepared remarks. Operator, please open the call for questions.

Question and Answer Session

Operator

Thank you. If you would like to ask a question, please press star, followed by one on your telephone keypad. Now if you change your mind, please press star followed by two. And when preparing to ask your question, please ensure that your phone is unmuted locally. Our first question today is from the line of Damon DelMonte of KBW.

Damon DelMonte

So just curious, you know, with regards to the provision reversal this quarter, you know, I understand there's a combination of factors that were provided in the release that support the reversal. But I was just wondering what would be the harm to kind of maintain a higher loan loss reserve, especially where we are in the cycle with credit trends today. And it looks like the reserve now at 97 basis points is effectively kind of round trip the day one CECL level on. So just curious as to what the the harm would have been to kind of keep the reserve a little bit higher and be a little bit more conservative.

Martin Birmingham

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, you know, to your point what we think could happen relative to the economy and other challenges to credit, et cetera. And we obviously all they see. So miles were billed at a time when interest rates were on zero to 25 basis. Points on a Fed funds basis. With that, you know, it 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 19 and early 20 and exploring other factors that would have acceptable statistical attribution in terms of predicting future credit losses.
But Jack, you start to think about that for sure.

W. Jack Plants

So David, let me start by saying with a coverage ratio of 97 basis points, I'm comfortable that given the credit performance of our portfolio. When I look back to the third and fourth quarter last year when we were building reserves, it was driven by one of them 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 fourth quarter of 23 and again in the first quarter of this year. However, during the first quarter, we saw delinquencies at basically 50% of what they were during the fourth quarter of last year, which is the 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 that's with the underlying performance of that portfolio, obviously comfortable with our current coverage ratio.

Damon DelMonte

Got it. Okay. And 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 some weakness we saw we saw weakness in the portfolio through net charge-offs in the fourth and first quarter of this year.

W. Jack Plants

That was driven by a slug of loans that originated during the pandemic when consumers were flush 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 of business.

Damon DelMonte

Okay, great. Thank you. And then just one other question here on the margin. It came in at two 78 this quarter. Do you happen to have what the margin was? And for the month of March?

W. Jack Plants

Yes, it was 280 basis points.

Damon DelMonte

Okay, great. Okay. That's all I have for now.

Martin Birmingham

Thank you.

Operator

And as a reminder, if you'd like to ask a question, please dial star one on your telephone keypad. Now star-1 on your telephone keypad for any further questions. Our next question is from the line of (inaudible), Piper Sandler. Your line is now open. Please go ahead.

Hey, good morning, guys. Just filling in for Alex today. Peter, I just wanted to ask about the new guidance. You guys guided to 85 to 95 for the year on. 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 to 95 and vice versa two to 85 throughout the year?

Martin Birmingham

Sure. So a lot of what's driving that cash flow coming off the portfolio with really tempered loan growth in that 1% to 3% range. So we're seeing the roll-on yields in our commercial book come on 8% or higher, which is exceeding the cash flow coming off the portfolio. So that's driving the modest expansion that we're forecasting. We're also including no modest amount of no increased beta in the deposit book, just given a higher rate environment. 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 a margin improvement each month during the first quarter at a modest level, which gets us to that guided range of what we projected full year.

Got it. Thanks on. And then just the follow up also about them on. Is it fair to assume I mean, you just gave the um, the NIM. from March's to eight, is it fair to assume that 1Q would be the bottom for the NIM. on and should we expect an inflection next quarter.

Martin Birmingham

That's the expectation.

Got it. If that's all my questions.

Martin Birmingham

Thank you.

Operator

We have no further questions in the queue at this time. So I'd like to hand back to multibranding and for any closing remarks.

Martin Birmingham

Appreciate everyone's time participation this morning and interest in the Company, and we look forward to continuing this conversation and updating you on our results for the second quarter July.

Operator

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