Financial Institutions - Earnings Call - Q1 2025

Transcript

Operator (participant)

Hello everyone, and thank you for joining the Financial Institutions First Quarter 2025 Earnings Call. My name is Lucy, and I will be coordinating your call today. During the presentation, you can register a question by pressing star followed by one on your telephone keypad. If you change your mind, please press star followed by two on your telephone keypad. I will now hand over to your host, Kate Croft, Director of Investor Relations, to begin. Please go ahead.

Kate Croft (Director of Investor Relations)

Thank you for joining us for today's call. Providing prepared comments will be President and CEO Marty Birmingham and CFO Jack Plants. 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&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. 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 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 8-K 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, April 29, 2025. I'll now turn the call over to President and CEO Marty Birmingham.

Marty Birmingham (President and CEO)

Thank you, Kate. Good morning, everyone, and thank you for joining us today. Our first quarter results illustrate the transformative impact that our late 2024 investment securities restructuring had on our balance sheet and earnings profile, as well as the solid performance delivered by lines of business. Net interest income was up more than 12% from the fourth quarter and 17% year-over-year, while net interest margin expanded by 44 and 57 basis points, respectively. Both NII and margin reflect a significant improved yield on our securities portfolio and further benefit from reduced funding costs. Non-Interest Income was $10.4 million, as enhancements we made to our company-owned life insurance portfolio and increased investment advisory income, among other things, helped offset the absence of insurance income as compared to the year-ago quarter.

Asset quality metrics were improved, with net charge-offs declining both on a dollar basis and as an annualized percentage of average loans from the linked and year-ago quarters. From a profitability perspective, improved revenue generation and lower expenses than anticipated in the first quarter resulted in an efficiency ratio of 59%, consistent with our full-year target of below 60%. Annualized return on average assets was 110 basis points, while return on average equity was 11.82%. Coming off of a challenging and dynamic 2024, we are keenly focused on maintaining the momentum that our capital raise and investment securities restructuring generated for us to deliver strong results and profitability throughout 2025. I'm very proud of our team for delivering on the profitability, return, and efficiency objectives in the first quarter.

Their ability to meet the needs of our customers and deliver growth in loans, deposits, and assets under management in the first three months of this year puts us in a strong position. This strong footing is especially important as we face what appears to be another challenging outlook for the industry, given the uncertainty posed by the fast-moving political and macroeconomic environments. Amid this, we intend to stay focused on driving efficiency internally, controlling what we are able, and remaining disciplined in our approach to credit extension and management. Total loans increased 1.7% during the quarter, driven by both C&I and CRE lending, matching the fourth quarter's growth rate. You'll recall our pipelines had been in a rebuilding phase in the second half of 2024 and were solid heading into the new year.

Based on the current size of our commercial pipelines and discussions with borrowers, we believe that loan growth will be concentrated in the first and second quarters. The uncertain economic landscape, especially with respect to tariffs, inflation, and interest rates, limits visibility into the back half of 2025. Despite the increased sentiment of uncertainty and volatility being felt universally by businesses of all sizes, we continue to feel the low single-digit growth guide we shared with you in January is appropriate. Our 2025 guidance reflected the intentional approach we took in preparing this year's budget, remaining mindful that the economy had experienced significant inflationary pressures for some time and there was uncertainty ahead. Of course, the level of volatility and pace of policy change has been more significant than many expected, but at this time, it has not led us to change our full-year expectations.

Commercial business loans increased 6.6% during the quarter, reflecting both new originations and increased line utilization, and were flat year-over-year. Commercial mortgage loans were up 1.3% in the quarter and 9% from March 31st, 2024, driven by growth in our Upstate New York market. We've been in close contact with our commercial customers and believe that our consistent approach to credit discipline and selectivity supports stable performance. From an asset quality perspective, non-performing loans declined $1.4 million-$40 million at March 31st, 2025, and continue to primarily relate to two separate commercial relationships. As we've previously disclosed, one is a $15.5 million loan in the Buffalo region that was placed on non-accrual in the third quarter of 2024, and the other is a $13.5 million relationship that includes multiple credit facilities through a CRE sponsor in our Southern Tier region.

The latter relationship moved to non-accrual in December of 2023 and is comprised of three separate loans: a $4.5 million multi-bank deal, a $4 million commercial mortgage loan, and a $5 million commercial line of credit, which all are secured by properties in the Tompkins County Ithaca area. This credit relationship is with a developer that has been very successful over the long term, including managing properties that support thousands of student housing beds for Cornell University. Prior to the first quarter of 2025, we recorded a specific reserve on this relationship of $1.9 million. During the first quarter of this year, an appraisal was updated on the $4.5 million multi-bank deal, which resulted in a $1.2 million specific reserve on that portion of the relationship. This brings the specific reserve on the entire $13.5 million credit exposure to $3.1 million as of March 31st, 2025.

The multi-bank deal is associated with a high-tech business park that is about 80% occupied and includes many high-quality tenants, including the local health system and Cornell University. We continue to actively manage this situation in pursuit of resolution while evaluating underlying collateral, and we will take appropriate action to ensure specific reserves are timely and appropriate. Turning to consumer lending, indirect balances were up just shy of 1% from December 31st and down 7% year-over-year. Consumer indirect net charge-offs and non-performing loans improved from the comparable prior periods. Indirect has proven to be a durable asset class through various economic cycles, given our approach to prime credit originations. Generally, our borrowers have prioritized car payments in support of jobs and economic stability, considering the limited mass transportation in our upstate New York markets.

Should the economy soften, we believe that reliable transportation will be important to ensure borrowers are able to maintain stable employment. Another dynamic to consider is that while tariffs are likely to impact the supply chain and new car availability, used car prices are expected to increase, which we have started to observe. This has the potential to reduce average losses on repossessed vehicles, which would support lower net charge-off ratios. Residential lending was down 1% from both the linked and year-ago quarters, given the high competition and tight housing inventory in our Upstate New York markets. The credit quality in this portfolio has been solid and consistent for us, and net charge-offs have remained fairly benign. Deposits were up 5.3% from year-end 2024, driven by seasonally higher public deposit balances and an increase in broker deposits.

Deposits were relatively flat with March 31st, 2024, down a modest 0.4%, primarily due to a decrease in reciprocal deposits and the wind-down of our banking-as-a-service offering. Tax-related deposits totaled approximately $55 million at March 31, 2025. Based on when our remaining fintech partners transition to new banking providers, we may see a small portion of these deposits remain on the balance sheet into the third quarter, but we expect most of what remains to flow out in the second quarter. We remain committed to core in-market deposit gathering with relationship-based accounts. Finally, in mid-April, we utilized a portion of the proceeds of our public equity offering to call $10 million of fixed-to-floating sub-debt that was issued in April 2015 and repriced earlier this month.

Outstanding subordinated debt for the company currently totals $65 million, including the remaining $30 million tranche from April 2015 and the $35 million tranche issued in October 2020. We will continue to evaluate options for these sub-debt facilities moving forward. It's now my pleasure to turn the call over to Jack for additional commentary on our financial results and 2025 expectations.

Jack Plants (EVP, CFO and Treasurer)

Thank you, Marty. Good morning, everyone. Our first quarter results were strong by many measures and put us on solid footing early in the year. Net income was $16.9 million, and diluted EPS was $0.81 for the quarter. Driven by improved net interest income, as previously mentioned, coupled with our ongoing focus on non-interest expense management. We were also pleased to report return on average common equity of 11.92% and return on average tangible common equity of 13.36%. Our 2025 guidance remains largely unchanged outside of an upward revision to non-interest income expectations that I'll touch on shortly. We continue to expect a full-year net interest margin of between 345 and 355 basis points. Using a spot rate forecast as of March 31st, 2025, this does not factor in future rate cuts.

Of the 44 basis points of margin expansion that occurred on a linked quarter basis, 37 basis points was driven by the late 2024 investment securities restructuring, with approximately seven basis points attributed to core NIM expansion. Continued margin build in the upcoming quarters is expected to be driven by a combination of loan production and mix, as well as downward deposit repricing, due largely to maturities and renewals of time deposits and pricing reductions on higher-yielding money market products. We were effective in our ability to reprice deposits in the first quarter, reducing the cost of products across retail, commercial, and municipal deposits at a slightly faster clip than loans repriced. Overall, cost of funds decreased nine basis points, while average loan yields decreased eight basis points. As a reminder, approximately 40% of our loan portfolio is floating, with the majority priced off prime and SOFR indices.

In January, we outlined expectations for non-interest income of between $9.5 million-$10 million per quarter, or between $38 million-$40 million for the full year 2025. This guidance excludes losses on investment securities, impairment of investment tax credits, and other categories that are difficult to predict, such as limited partnership income. In the first quarter, the aforementioned categories had somewhat of an offsetting effect, and excluding them, non-interest income for the quarter would have been about $10.5 million. Among the drivers of this above-guided quarterly non-interest income was a company-owned life insurance restructuring initiated in the first quarter. While this surrender and redeploy strategy is expected to support a higher level of COLI income moving forward, the level will moderate starting in the third quarter.

Presently, we continue to recognize income on the surrendered policies as we await receipt of approximately $73 million of surrendered policy proceeds from the carrier, which is expected to occur in June. As a result, the second quarter will be elevated relative to the future COLI run rate by about $275,000. Given the impact of the COLI strategy initiated in the first quarter, we are increasing our expectations for non-interest income to between $10million-$10.5 million per quarter, or between $40million-$42 million for full year 2025. Investment advisory revenue increased seven percent on a linked quarter basis and six percent from the first quarter of 2024, driven by a combination of new business and market-driven growth positively impacting assets under management, as AUMs at our wealth management subsidiary, Courier Capital, increased to $3.17 billion, up approximately $72 million from December 31st.

As we shared on our last call, we welcomed a new team that was the primary driver of new business in the quarter, and we look forward to their continued contributions as we seek to grow our RIA subsidiary. Non-interest expense of $33.7 million was lighter than the $35 million quarterly expense rate we guided, largely due to lower salaries and benefits driven by favorability and vacancy, as we carried a higher level of open positions than planned. We have maintained a prudent approach to attrition and filling open positions to ensure our human resource investments are thoughtful and focused on our highest priority needs. We also benefited from a $600,000 recovery on a prior year fraud loss that resulted in lower charge-off items than our typical run rate.

We continue to expect approximately $35 million of quarterly non-interest expense through the remainder of 2025, consistent with our original full-year guidance. We remain focused on effective expense management, even as we invest in our people, processes, and technology to support our future growth and performance. Our provision for credit losses was $2.9 million in the current quarter, compared to a provision of $6.5 million in the linked quarter. First quarter 2025 provision for credit losses was driven by a combination of factors, including the impact of loan growth and an increase in specific reserves, as Marty covered. These factors were partially offset by modest improvement in forecasted losses and qualitative factors, primarily reflecting a reduction in consumer indirect delinquencies.

At March 31st, 2025, the loan loss reserve coverage ratio was 1.08%, compared to 1.07% at December 31st, 2024, and we remain comfortable at this level, given our commitment to the importance of credit discipline. Our net charge-offs for Q1 were 21 basis points, below our full-year guided range. We are maintaining our full-year net charge-off expectations of between 25-35 basis points of average loans, as we are being conservative with our outlook, given the current uncertain political and economic environment. We also maintain our guidance for the 2025 effective tax rate of between 17%-19%, including the impact of the amortization of tax credit investments placed in service in recent years. Our 2025 performance targets are focused on profitability and credit-disciplined loan growth.

We delivered on this promise in the first quarter and are very well positioned to continue executing on these objectives in 2025 and forward. That concludes my prepared remarks. I'll now turn the call back to Marty.

Marty Birmingham (President and CEO)

Thanks, Jack. Overall, our first quarter illustrates what we believe we're capable of: higher returns on average assets and equity, a more efficiently run business, and a financial institution that meets the needs of the individuals and families, businesses, municipalities, and not-for-profits in our markets in a simple, connected, and trusted way. Our leadership is firmly focused on these outcomes. As we announced in March, we recently welcomed a new executive to our team. Eric Marks has joined us as Chief Consumer Banking Officer, bringing deep in-market banking experience that spans many facets of consumer banking leadership, financial oversight, and strategic planning. We look forward to his contributions as we focus on driving sustainable customer growth and customer service excellence in Five Star's retail network and our 49 banking locations across Western and Central New York. Earlier this month, we filed our 2025 proxy statement.

Among the directors up for election this year are Angela Panzarella, who was appointed in January to our board and has deep corporate strategy, financial, and business operations experience grounded in public company governance and professional experiences, and Bob Schrader, a new director nominee bringing more than 25 years of experience in corporate finance and public accounting, including his current role as Chief Financial Officer of Paychex, which qualifies him as a financial expert for SEC reporting purposes. Mr. Schrader succeeds Sam Gullo, who is retiring at our May 28 annual meeting following 25 years of dedicated service to our company. We are grateful for his counsel and leadership over the years, and we look forward to the contributions our two newest directors will make as we continue to execute our strategic objectives.

In addition to voting on the election of directors, executive compensation, and the ratification of our outside audit firm, shareholders are being asked to vote on an amendment to our long-term incentive plan. Details of the proposed changes are outlined in our proxy, so we encourage you to read the material that is available at proxydocs.com/fisi and vote your shares to be represented. That concludes our prepared remarks. Operator, please open the call for questions.

Operator (participant)

Thank you. 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. When preparing to ask your question, please ensure your device is unmuted locally. Our first question is from Frank Schiraldi of Piper Sandler. Your line is now open. Please go ahead.

Frank Schiraldi (Managing Director)

Morning. Just on loan growth. You guys were obviously strong loan growth in the first quarter. You mentioned Marty driven by commercial. Many banks I talked to are assuming more of a pickup in the back half of the year as maybe we get more certainty around policy. It seems like you guys are sort of thinking the opposite. Just wanted to get your thoughts on maybe perhaps that loan growth outlook for the year is quite conservative at this point, or I guess just how confident are you that loan growth should be front-loaded here?

Marty Birmingham (President and CEO)

As Jack commented as well, we're comfortable with what we've guided. We have been working with our teams over the course of the last six to eight months to ensure that there's a focus and a consistent activity relative to business development activities across all of our lending areas, particularly focused on commercial of all sizes and types. We saw the outcome clearly carry through in this quarter, which we're very pleased with. Frank, we've been, like everyone, observing what's happened since the election and kind of the very positive feelings that were happening there with maybe possibly more business-focused, streamlined regulatory environment in general, and how the markets reacted to that, to how it has evolved to lots of executive orders, tariffs, pressure on inflation, outlook for rates, etc. That's translated into what we've all read about our customers.

We've canvassed them, all of them, really. We've asked our lenders to reach out to all of them in this time of uncertainty. With uncertainty, folks have really started to pause, anticipated investment in their plant equipment, projects, whatever it might be, until some of this works its way through. We're going to continue to over-communicate with our customers. We're going to continue our consistent approach to calling and servicing our markets. Right now, it just seems like folks have generally, with uncertainty and increased volatility, taken a step back to, like all of us, see where this goes.

Frank Schiraldi (Managing Director)

Okay. The other side of that is the NIM guide in terms of I wondered if you could just talk to some levers to get you up into that range that you cite for full-year guide. Maybe along with that, if you have the detail around CDs coming up, maturing, the sort of the numbers there and what you are expecting you can pick up in average costs as you move through the year on that book.

Jack Plants (EVP, CFO and Treasurer)

Yeah. Frank, this is Jack. I can take that one. Some of the levers that we have that are driving that continued improvement in margin are the $1.2 billion of cash flow that we have coming off the portfolio on a rolling 12-month basis. If you refer to the investor presentation, there is a slide in there that highlights roll-off yield and roll-on yield. On the commercial portfolio for the first quarter, we saw roll-on yield coming on about 70-80 basis points on average, higher than what was coming off the portfolio. That has benefited from the earning asset side. We have continued to push down on deposit repricing, which has benefited us from a cost-of-funds perspective. We have about $500 million of CDs coming up on maturity for renewal in the next nine months, which will continue to benefit us.

If we look at our guided range, one of the areas that we did not include in our guidance was any change in interest rates. We budgeted and forecasted a spot rate forecast, which we updated again as of the end of the first quarter. The shape of the curve is very important to future outcomes there. If we see rate cuts and the long end of the curve kind of holds steady, we are fairly neutral within our guided range, probably closer to the lower end. If we see a steepening of the curve and rate cuts, then there is opportunity for outperformance on the higher end. I am very comfortable with the range we provided for margin.

Frank Schiraldi (Managing Director)

Okay. No, I appreciate that. That's great, Caller. And then just a quick follow-up to that, and I apologize if it's in some of your public documents, I can refer to that. But in terms of the CDs that you cited coming up, maturing over the next nine months through the rest of the year, what are those average costs? Do you have that?

Jack Plants (EVP, CFO and Treasurer)

Yeah. I think they're about 4.5%. They were typically anchored in shorter-term CD specials that we offered in 2024 that ranged anywhere from 4%-5%. The weighted average cost on those is about 4.5%.

Frank Schiraldi (Managing Director)

Great. Okay. Thanks for the call, guys. Appreciate it.

Jack Plants (EVP, CFO and Treasurer)

Thanks, Frank.

Operator (participant)

As a reminder, to ask a question, please press star followed by one on your telephone keypad now. Our next question is from Damon DelMonte of KBW. Your line is now open. Please go ahead.

Damon DelMonte (Managing Director)

Hey, good morning, everyone. I hope you're all doing well today. Just wanted to ask a question about the COLI expected income over the next couple of quarters. Jack, I think you had mentioned that you expect it to be elevated again here in the second quarter and then kind of a more normalized level. I mean, is this basically going to be flat from 1Q to 2Q and then drop back down to the $1.5 million range, or how do we kind of think about the cadence of that?

Jack Plants (EVP, CFO and Treasurer)

Yeah. There should be a slight increase in 2Q and then flat back beyond that. What we did was we surrendered some of the lower-performing general account and then added premium into an existing exposure that we had with our separate account, COLI, and that is what drove the significant increase in yield associated with it, given the underlying investment divisions that we have in that separate account structure. The general account that we surrendered, even though it was deemed surrendered and in good order, we have yet to receive back the cash surrender value on that to the tune of about $73 million, which is still out there yielding low single digits, and we expect to receive that back in June. That is what is causing the short-term increase in COLI income.

Damon DelMonte (Managing Director)

Okay. When it goes back to when all the dust settles and it goes back to a normalized rate, it's going to be higher than the 2024 quarterly level. Is that correct?

Jack Plants (EVP, CFO and Treasurer)

Correct.

Damon DelMonte (Managing Director)

Okay. All right. Thank you. As we think about provision and kind of outlook for credit, you guys kind of conservatively have reiterated the expected net charge-offs for the remainder of the year. If loan growth is kind of slowing a bit here in the second half, potentially, is it fair to kind of assume that the provision kind of takes a step down from where maybe kind of from this quarter's level or similar to this quarter's level?

Jack Plants (EVP, CFO and Treasurer)

I would suggest that our guided ACL to average loans ratio continue to hover around that 107-108 basis points for the rest of the year.

Damon DelMonte (Managing Director)

Okay. All right. That's helpful. We can back into that. I think that's all that I had. Thank you very much. Appreciate it.

Jack Plants (EVP, CFO and Treasurer)

Thanks, Damon.

Operator (participant)

We have no further questions, so I will hand back to Marty Birmingham for closing remarks.

Marty Birmingham (President and CEO)

Thank you very much for your help this morning, Operator. Thanks to all those that are listening in this morning, your interest in the company, your time this morning, and look forward to connecting again in July.

Operator (participant)

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