FIBK - First Interstate BancSystem: Dividend Yield Attractive But Equity Suffers

2023-11-01 03:52:40 ET

Summary

• First Interstate's stock price has reached a level not seen since 2014, despite beating EPS expectations.
• Loan growth is expected to be flat due to a sluggish market, but NPLs have decreased.
• Net interest income and margin are declining, but the bank may see improvement in Q1 2024 with the reinvestment of maturing securities.

Excluding early 2023, the last time this bank was trading consistently at $23 per share was 2014. Not even during the peak of the pandemic First Interstate ( FIBK ) had reached these levels.

In Q3 2023 released a few days ago, First Interstate beat analysts' estimates for EPS, but not for revenue.

• Normalized EPS was $0.70, $0.08 higher than expectations.
• Revenues were $255.70 million, $2.72 million less than expectations.

In any case, I don't think that narrowly missing the revenue target was what is driving down the price per share in recent days. There is a lot of tension in the markets because of both the upcoming Fed meeting and recent geopolitical news. First Interstate has its own issues to resolve, but the market may have overly punished this bank due to exogenous factors.

Loans, deposits, and net interest margin

The loan portfolio is worth $18.20 billion, down $50.10 million from the previous quarter. The largest category remains commercial RE, with a weight of 48 percent; second and third place commercial and residential RE, with 16 percent and 12 percent, respectively.

According to CEO Kevin Riley's words , total loans are expected to remain flat in the next quarter as well. The reason is not due to increased customer selection, but simply to a less active market than in the past. After all, not everyone is willing to take on debt at current market rates.

Well, we've always been selective when we refer the balance sheet. But I will tell you that the main reason why it's flattish is just due to the fact that we believe that there's not a lot of robust activity taking place right now in our markets, things are slowing down. So it's just a sluggish environment right now.

In any case, although loan growth is likely to be zero, at least loans already made are not a cause for concern. NPLs were $84.60 million, down $8.20 million from the previous quarter. The ACL/ NPL Ratio also improved, from 242 percent to the current 268 percent.

As for deposits, the decline in non-interest-bearing deposits continues, now accounting for 27 percent of total deposits. Last year they had a weight of 31 percent. This decline is not surprising given current money market rates compared to those in mid-2022. To replace this liquidity outflow First Interstate has relied on time deposits, which today have a weight of 13 percent: basically, more than doubled from a year ago.

Overall, total deposits are up $100.30 million from the previous quarter and the total cost is only 1.15%. This is an excellent result since many peers have already far exceeded 2%.

By relating total loans to total deposits, we can see that the LTD ratio for this bank is only 76.90%. Such a conservative value implies some operational flexibility for management, since cash from deposits largely covers the money used for loans.

Finally, net interest income is declining for the fourth consecutive quarter as is the net interest margin, which went from 3.71 percent to 3.07 percent. This income deterioration is in my opinion what has caused the price per share of this bank to touch price levels observed 10 years ago. Despite a low cost of deposits, the bank's assets have not improved enough to keep profitability stable. After all, having such a low LTD ratio inhibits earnings growth since that excess cash could be used to earn a return. At the same time, some of it has been invested in fixed-rate securities, but these have suffered sharp depreciations. It is likely that the same considerations can be made in the next quarter, but something may change starting in Q1 2024. I will explain why.

As we can see from this image, in the first three months of next year as many as $459.80 million of securities will mature. This means that the bank will be able to reinvest this amount of money in new fixed-rate securities that can yield much more than previous ones since current market rates are significantly higher than in the past. A stagnant lending market and a low LTD ratio favor this operation.

Of course, should the Fed cut rates in the short run, this reasoning would no longer apply, but it is highly unlikely that it would do so before mid-2024. So, in Q1 2024 both net interest income and net interest margin should rise again.

Equity and dividends

Minimum capital requirements are largely met, however there is some problem with tangible book value per share since it is declining for the second consecutive quarter. The latter is critical to grow over time since the value of any bank depends on it. If growth stops, the price per share will necessarily be affected.

In the case of First Interstate, the reason that triggered this deterioration is the unrealized losses on AFS securities. The latter are negatively weighing on equity by $521 million . As we saw earlier, the duration of the portfolio is 3.9 years, so it will still be some time before these losses are scaled back.

Finally, let's take a look at the dividend.

The current dividend yield is over 8 percent, a figure never reached in the past 10 years. This could be a sign of strong undervaluation, but it is best to be cautious in these situations. Although now there is no reason to think that this dividend is not sustainable, consider that the payout ratio is about 70% . This means that any unforeseen future issues could downsize the dividend issued. In other words, there is not a high enough margin of safety to be sure of the dividend in the event of a recession.

Conclusion

First Interstate is a bank that is having a difficult time as are many other regional banks. Its net interest income and net interest margin are steadily declining and unrealized losses of 14 percent of equity are weighing heavily. In any case, bargains are made in the worst of times and this may be one of them based on the dividend yield. It had never exceeded 8 percent in the past 10 years, and for those who believe it is sustainable even if the macroeconomic scenario worsens, they should probably consider taking a closer look at this bank. In my case I remain doubtful about future economic performance, not only because of a yield curve that is challenging the operations of all banks, but also because of geopolitical tensions that could result in new trade agreements.

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