Good day and welcome to First Interstate BancSystem, FIBK's Second Quarter 2017 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note, this event is being recorded. I would like to turn the conference over to Margie Morse, Investor Relations Officer. Please go ahead.

Thanks, Francesca. Good morning. Thank you for joining us for our second 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 in our most recently filed Form 10-K. Relevant factors that would cause 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 Kevin Riley, our Chief Executive Officer; and Marcy Mutch, our Chief Financial Officer; along with other members of the management team. At this time, I'll turn the call over to Kevin Riley. Kevin?

Thanks, Margie. Good morning. Thanks, again, to all of you for joining us on the call today. I'm going to provide an overview of some of the major highlights for the quarter, and then Marcy will provide us more detail on the financials. We delivered a solid quarter with positive trends in most of our key metrics, including stronger loan growth, higher mortgage banking revenue and expended net interest margin and stable core expense levels. Our reported basis, we generated $0.45 per share for the quarter. However, excluding our merger-related expenses, we generated $0.59 of core earnings per share. $0.04 of our core earnings were related to a gain on the sale of custodial rights to our health savings accounts. HSAs were not part of our long-term core business model, and by selling the custodial rights to a third-party, we're able to provide our clients with better product while eliminating the need to make future technology investment required to manage this business. When that gain is excluded, our operating earnings were $0.55 per share. As we indicated on our last call, our loan pipeline was building nicely, and we saw a stronger loan growth in the second quarter, despite a few larger deals slipping into July. On an organic basis, total loans in the legacy First Interstate footprint increased $89.7 million during the quarter, which represents a 6.7% annualized growth rate. Commercial categories increased $63 million or 7.4% annualized, while the consumer categories increased $26.7 million or 5.3% annualized. Overall, we're pleased with the mix of net growth in the portfolio within the quarter, with 70% coming from commercial and 30% coming from consumer. The Cascade acquisition added $2.1 billion in loans to our balance sheet. For the month, excluding the sale of $32 million of their shared national credit…

Thanks, Kevin, and good morning. As you would expect, this is an unusual quarter in terms of variances from prior periods due to the purchase accounting adjustments and the contribution of one-month of operations from Cascade. As such, I'm going to forego the usual quarter-to-quarter comparison and simply discuss those items where I believe some additional color is warranted. I'll begin with a brief review of the purchase accounting related to the acquisition. Our preliminary marks against the Cascade loan portfolio totaled $31.7 million or approximately 1.5% of loan balances. The total consisted of a $21.3 million credit mark and a $10.4 million yield mark. This adjustment increased the overall dollar amount of the accretable discount on our books to approximately $34 million at June 30. Total accretion income on acquired loans was $1.7 million, up from $1.2 million last quarter. All of the increase in accretable income recognized this quarter, was attributable to the acquisition. Of the total accretion, $1.4 million was scheduled accretion and $330,000 was related to early payoffs, which is a similar early payoff amount compared to the first quarter. Going forward, we would anticipate scheduled accretion income will contribute approximately $2 million per quarter for the remainder of 2017. Accretion income contributed 8 basis points and interest recovery, about 9 basis points to our net interest margin, which was 3.6% in the second quarter. Excluding both of these items, our core net interest margin increased to 3.43% from 3.41% in the prior quarter. Now moving to non-interest income. We generated about $37.2 million of revenue in the second quarter. In addition to the contribution of Cascade, which added about $3 million, our non-interest income increased as we moved into the seasonally stronger period of the year for fee generation. As Kevin already mentioned, we sold…

Thanks, Marcy. That was a lot of financial information. I'm going to wrap up with a few comments about our outlook. We anticipate the positive trends that we had experienced in the second quarter should continue into the second half of the year. Currently, our loan pipeline is very strong for the entire company. And as a result, we expect to see good loan production in the third quarter. Loan pricing is moving in a favorable direction. This will allow us to offset any deposit pricing pressure we may see, and keep our net interest margin relatively stable. You may have noticed this week that we were issued a Kroll rating of BBB+. While our capital levels remain strong and there is no intent to issue any debt at this time, we believe it is good to have funding options readily available should opportunities present themselves. Now that we are over $12 billion in assets, we are focused on preparing for divest testing, and we feel confident that we will meet the necessary regulatory requirements and the timelines. And despite the increased spending in the areas of compliance and risk management, we are maintaining good overall expense control and should continue to drive more positive operating leverage in the business as we add scale. The addition of the Cascade operation will also provide a boost in the second half of the year, and we are on track to begin the system conversion at the close of business on August 11. And we're excited that on Monday, August 14, all 127 banking offices across our 6 states will open their doors as First Interstate. This will put us on track to realize all the cost saves that we projected for this transaction by the end of the third quarter. We believe we're in a good position to a deliver a strong year of growth and probability in 2018. We expect this trend to continue in the years ahead as we capitalize on the strong economic conditions in our new markets. So with that, I'm going to open the call for questions.

We’ll now begin the question-and-answer session. [Operator Instructions] The first question comes from Jeff Rulis of D.A. Davidson. Please go ahead.

Good morning. This is Matt on for Jeff. I just had a question about expenses. When you initially announced the Cascade deal, you had stated 20% cost savings of CACB's core expenses. Is that still the estimate? And what is the dollar amount of cost savings?

Total $25 million.

The total cost savings we announced with the deal was about $25 million.

And just as a follow-up, what is the run rate for core expenses for the entire bank?

Well, $64 million a quarter for us, and probably another $8 million.

Yes, going forward. After we get the rest of the expenses out, about $8 million for them.

No, it's $6 million.

So it's $6 million.

No, $8 million.

We'll get back to you.

Okay. Thank you very much. I’ll step back.

The next question comes from Jared Shaw of Wells Fargo Securities. Please go ahead.

Hi, Jared.

Hi, good morning. Thanks for the questions. On the HSA transaction, can you just walk me through that? So you sold the custodial rights. But does that mean that you still retain the funding? And if that is the case, what do you actually give up by selling the custodial rights?

We do give up the funding. We're giving up about $58 million in deposit balances.

Okay. So it's just effectively just a sale of the deposits.

That's correct.

Okay. And then was that a competitive process? Or how did that, I guess, come about?

Well, we did look at several different vendors and just felt like HealthEquity was our best option. They do allow us to co-brand those accounts. So they'll also have First Interstate branding. And eventually, our customers will be allowed to access those accounts through our digital process.

Okay. All right. And then, shifting over to the margin. Kevin, you're saying stable margin. Are we looking at stable core margin from that 3.43% basis going through or at the stated margin with the – some of the benefits that we saw this quarter?

Well, first of all, talking about the core margins should be stable. But I think that some of that margin might come down a little bit. We're projecting somewhere 3.55% to 3.60%, in that range.

All right. That's helpful. And then, just on the – following up on the expense question from before. You seem pretty optimistic about the savings. I guess, how much of the savings were included in the second quarter? How much of the $25 million cost savings run rate were included in the second quarter numbers?

You know, Jared, we can't break that out. We should've broken it out, and we'll get that to you, guys. But the thing is that most of the cost savings were really the higher-level executive aspects that were taken out at the beginning. The rest of the cost saves will be backroom staff, once we do the actual conversion. All the employees have been notified, who has a job and who will be departing us. So it's all baked in, but we didn't have – don't have the breakdown right now, and we should get that for you guys.

But going forward, Jared, just going forward, it'll be $76 million the quarter will be right around that will be our run rate of expenses after all the cost saves are baked in.

Okay. And then, it sounds like you're pretty optimistic in terms of positive operating leverage. And now that you've had this on the books for a few months, do you think that the total cost saves, ultimately, could even be higher than $25 million or just sticking with the $25 million level?

If we were going to run the bank as it currently is, we'd probably get more cost saves. But we're reinvesting in some more talent in some of the markets to provide deeper lending. They kind of abandoned some of their markets with regards to lending. So if we were going to put that investment back in those markets, we would probably receive more. But I would say that we're well on track. As you know, when we do due diligence on an acquisition, we do it by individual, individual. We do a bottoms-up budget. We have reconciled back and forth, and we have definitely achieved all the saves that we anticipated through our due diligence process.

Great. Thanks very much.

The next question comes from Matthew Forgotson of Sandler O'Neill. Please go ahead.

Hi, Matt.

Hi, good morning. I guess, one more on the cost savings. Just in terms of getting to that $76 million color that stabilized level. Do you think the third quarter's going to be – you're going to be trending lower and ultimately achieve that $76 million in the fourth quarter? Is that how we should be thinking about it? Or do you think you can get closer to that $76 million in the third quarter of the year?

No, no. It's going to be in the fourth quarter because – again, we're not doing the conversion until mid-August, and we're having some people stay around to help answer questions and everything. So it'll be all done by the end of the third quarter, so the $76 million run rate will be in the fourth quarter.

Perfect. Okay. I guess shifting over to loan growth. By my math, organic loans are up about 3% year-to-date on an annualized basis. Can you give us a feel for your expectation for getting into that mid-single-digit range, kind of, for the year?

Yes. Like I said in my remarks, a few large loans slipped into the third quarter. We feel better about this third quarter than the prior years. As you know, third quarter gives us somewhere between 0.5% to 1% of loan growth, kind of in that range. We believe we can do better than that in the third quarter. In the fourth quarter we run down usually. We think we can do a little better in the fourth quarter. So we're feeling pretty optimistic that the pipeline is pretty full, and the new team from the Bank of Cascade have pretty strong pipelines also.

Great, okay. So that mid-single-digit growth is still very much intact for the full-year.

We're counting on it.

Okay. And I guess just lastly, just shifting over to classified assets. They were up $46 million linked quarter. It appears all – you pointed in the release, all attributable to Cascade. How should we be thinking about this? Is this just kind of a onetime shock as you rerated the Cascade loans based on your system and we ought to see improvement going forward? Or should we brace for a little bit more volatility?

I'll turn it over to Steve Yose, our Credit Executive. Steve?

Yes, so on the – you're specifically referring to classified or criticized.

Excuse me, criticized loans.

So criticized loans, the increase – and I will say that they did a good job on risk identification from our due diligence. So the increase is really from the loans that they – that we just acquired and liked with any portfolio. And our actual criticized loans percentage goes from 7.1% last quarter to 5.7% total loans this quarter.

So the answer to your question, it's a one-time shot, and you shouldn't expect us to go through their portfolio and downgrade a lot more of their assets.

Correct. We already did basically two. We did the initial due diligence and then we did the final one just before acquisition. So we don't anticipate any further risk-rating changes from their portfolio other than the normal course of doing business.

Thanks for the clarity. Appreciate it.

Next question comes from Matthew Clark of Piper Jaffray. Please go ahead.

Hey, good morning.

Good morning.

Good morning.

Just wondering if you guys could help us isolate the fee revenue contribution from Cascade this quarter, the one month, just so that we are in the ballpark next quarter with a couple of more months of activity.

It was about $3 million in all the categories.

Okay. Anything depressing that amount? Or anything unusual in there?

No.

No.

Okay. Okay. And then just on the loan yield, the weighted-average rates on new production. I think you said 5.08% for legacy First Interstate and 4.51% for Cascade. Just curious what those rates were in 1Q, if you had them.

Hold on just a second, Matt. If I don't have them right here, if we don't have them right here, I'll call you with them.

Hold on.

In the first quarter, 5.07%, yes, for...

Production.

Production.

Okay. And Cascade, you have or no? If not, no worries.

Yes, we don't have Cascade. We don't have that.

We don't have that.

Okay. And then just on the tax rate, a little bit higher this quarter. Is 34.5% to 35% the right number to use going forward?

35.02% is the right number to use going forward, so right at 35%.

Okay. Okay, and then just curious on retention on the deposit side of things. Can you talk to the level of retention you've had on deposit side of Cascades?

We're not seeing anything that's showing any run off with the Bank of Cascades. It's all – I guess, I tried to put it in my remarks. It's all about how the employees feel about this acquisition. And I've been part of many acquisitions in my career and I got to tell you, I never met such a group of employees that are so excited about being a part of First Interstate. And I think that, that is really helping us retain other customers there because if they're excited about being part of the team, they're going to pass it on to the customers.

Okay, great. Thank you.

You bet.

Your next question comes from Jackie Bohlen of KBW.

Hi, good morning everyone.

Hi, Jackie.

Good morning, Jackie.

I have question on the new production loan yields, and I know that Cascade's overall loan yield is lower than legacy First Interstate's. But when I look at the differentials of over 50 basis points on new production, is that mix driven or is that business-model driven?

It's a little bit mix. And they have a little bit more of a variable rate loan production than we do. We have a little more fixed, so that's kind of a mix between variable and fixed.

Okay. So there's – it's unlike that variance would stay. It's not something that it will gradually move up towards your interest rates?

No, because we love variable rate assets, so we're not going to try to change their way of banking. So no, it will probably stay in that range.

Okay. And then the press release had mentioned and I apologize if I somehow missed this in your prepared remarks. But it did mention some severance from legacy First Interstate. What does that relate to, and how much was it?

It was about $352 million – $352,000. And it just was kind of normal course of business severance, unrelated to the acquisition.

Okay. And would there be any more of that going forward or was that just kind of a onetime evaluation in the second quarter?

It could be a little and I think as we might have talked about this in the past, we're kind of doing a standardized banking model in the old footprint. And with that, they are found some extra people. So that's – these are just kind of dribbling in, but probably could see a little bit going forward, but not a big amount.

Okay. Thanks, Kevin. That’s helpful, and everything else was already asked and answered. Thank you.

Thanks Jackie.

Thanks Jackie.

The next question comes from Tim Coffey of FIG Partners.

Thank you. Good morning everybody.

Good morning, Tim.

Hi, Tim.

Kevin, as we think about provision going forward, would you base that off of kind of assumed basis point on net loan or new loans in the quarter. And kind of what would that – those basis points will be?

Hold on, I'm looking at my – it's kind of like it's a formula that it's really the piece on exactly the type of loans that gets booked. Each loan category has a different provisioning level. So it really depends on the different aspects. But on average, it's about 95 basis points.

Okay, thanks. That’s helpful. Do you have any kind of expectations for runoff for the Cascades book for the next to say 12 months?

Runoff of loans.

Yes.

We're not anticipating any runoff of loans. We anticipate growth across the board, so there's no anticipation of runoff.

That’s distinct portfolio.

Just distinct portfolio will be runoff, but that's not – it's going to just kind of dribble out.

Okay, thanks. And what amount of remaining merger expenses do you have with the conversion coming up next month?

It will be $8 million to $10 million. We still have all of our cost related, we still have some severance costs, and then we have the costs related to the technology.

Early termination.

Early termination.

Okay. And then, just kind of follow-up on comments you made last quarter about pricing pressure in your footprint. Are you still seeing that in terms of pricing pressure on the loans?

Yes. We're still seeing some of that. But I would say, it has come down a little bit, but there's still some banks out, there is some banks have woken up and are doing a better job and some other banks are still doing things that you kind of scratch your head and say, I don't understand.

And does that have any kind of impact on where your deposit prices might go? Do you any – do you still see – till those potentially rising?

We continue, on every increase, put a little bit back into our customers, because it's different. We handle deposit pricing, I think, different. I'm going to explain this a little bit. We are the biggest bank in our current footprint, so people are looking at us to move deposit pricing. When we look at the Bank of Cascade footprint, where we had a different pricing region, we're going to let the big banks determine the pricing levels, and we'll take their lead. But in our markets, every price goes up, we give a little bit back because we're kind of leading the market slightly up. But as you can see, we're not increasing our deposit rates at the speed that we did at that one increase. I think, right now, we've averaged a 25% beta. The last increase, I think we only provide about 6% beta with regards to the increase. So we are slightly increasing our deposits. We're trying to do a little work on moving depositors from variable rate deposit accounts, money market and stuff like that into time by giving them a little bit better rate in some of the long data times, see if we can start moving that back, because as you recall, time deposits usually represent about 40% of your deposits. And now with rates being so low, they're down under 20%. So we're trying to move that back to normality before rates start going any higher.

Okay. Thank you very much. Those are my questions. End of Q&A

[Operator Instructions] This concludes our question-and-answer session. I will like to turn the conference back over to Kevin Riley for any closing remarks.

As always, we welcome calls from our investors and analysts. Please reach out to us if you have any follow-up questions, and really appreciate you tuning in today. Goodbye.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.