Business context and reporting period
First Interstate BancSystem, Inc. is a regional banking holding company operating across Idaho, Montana, Oregon, South Dakota, Washington and Wyoming. This unaudited Form 10-Q covers the quarter and nine months ended September 30, 2018; balance-sheet comparisons are to December 31, 2017. Amounts are in millions of dollars unless stated otherwise.
On August 16, 2018, the company completed its acquisition of Northwest Bancorporation, parent of Inland Northwest Bank (INB), adding 20 offices and $713.1 million of loans and $696.3 million of deposits. INB contributed $5.9 million of revenue and $2.1 million of net income from acquisition through September 30. Its merger into First Interstate Bank was planned for November 9, 2018.
Financial results and condition
| Metric | Q3 2018 / Sep. 30, 2018 | Comparable period / prior balance date |
|---|---|---|
| Net interest income | $110.0; FTE net interest margin 3.88% | $100.8; 3.71% in Q3 2017 |
| Net income | $41.4; diluted EPS $0.71 | $27.3; diluted EPS $0.48 in Q3 2017 |
| Non-interest income | $36.2 | $38.3 in Q3 2017 |
| Non-interest expense | $90.7; efficiency ratio 60.7% | $94.7; efficiency ratio 66.7% in Q3 2017 |
| Loans / deposits | $8,518.0 / $10,845.6 | $7,614.3 / $9,934.9 at Dec. 31, 2017 |
| Total assets / equity | $13,355.8 / $1,654.4 | $12,213.3 / $1,427.6 at Dec. 31, 2017 |
| Cash and cash equivalents | $965.0 | $758.9 at Dec. 31, 2017 |
| Long-term debt / subordinated debentures | $22.4 / $86.9 | $13.1 / $82.5 at Dec. 31, 2017 |
For the first nine months, net income was $119.8 versus $72.3 in 2017, and diluted EPS was $2.09 versus $1.45. Net interest income was $313.6 versus $249.0. The reported nine-month FTE margin was 3.84% versus 3.61%.
Operating cash flow was $171.9 for the nine months, compared with $94.7 in 2017. Investing activities used $104.6, while financing activities provided $138.8; cash increased $206.1 to $965.0. The allowance for loan losses was $73.6, or 0.86% of period-end loans, versus $72.1, or 0.95%, at year-end 2017. Non-performing loans were $66.4 (0.78% of loans), and non-performing assets were $83.7 (0.63% of assets).
At September 30, consolidated capital ratios included total risk-based capital of 12.76%, common equity tier 1 of 11.15%, and leverage of 9.73%. Management stated liquidity was adequate and reported no known event expected to have a material adverse effect on liquidity or capital.
Material changes and notable items
- Loans rose $903.7 and deposits $910.7 from year-end, principally reflecting the Northwest acquisition; management attributed $190.6 of loan growth and $214.4 of deposit growth to organic activity.
- Q3 net income increased year over year while non-interest expense declined, partly because acquisition-related expenses fell to $3.1 from $13.0. The 2018 quarter also included $2.5 of INB operating expenses.
- Higher loan balances and yields contributed to margin growth; rising funding costs, primarily associated with Federal Funds rate increases, partly offset the benefit. Acquired-loan interest accretion was $3.6 in Q3 and $9.6 for the nine months.
- Q3 non-interest income fell 5.5%, chiefly as payment services revenue declined following the Durbin Amendment’s impact beginning July 1, 2018, and mortgage banking revenue fell with lower refinancing activity and narrower gain-on-sale margins. The nine-month totals increased 4.2%.
- The effective tax rate declined to 22.6% for Q3 and 22.3% for nine months, from 33.5% and 32.7%, respectively, primarily reflecting the Tax Cuts and Jobs Act.
- Available-for-sale securities had $55.9 of gross unrealized losses at quarter-end; the company attributed losses to interest-rate movements, stated it intended and was able to hold the securities, and recorded no impairment losses.
- After quarter-end, the company agreed to acquire Idaho Independent Bank for approximately $181.3 and Community 1st Bank for approximately $21.5, both in all-stock transactions expected to close in Q2 2019, subject to approvals and other conditions.
Outlook, risks and contingencies
The filing provides no quantified earnings or financial guidance. Management described continued evaluation of acquisitions and strategic opportunities. Forward-looking results depend on economic conditions in the company’s markets, loan quality and credit losses, interest rates and funding costs, acquisition integration and performance, regulatory and capital requirements, liquidity, competition, cybersecurity, vendors and other risks. Management cautioned that interim results are not necessarily indicative of full-year results.
Key contingencies include $2,515.4 of commitments to extend credit and $45.0 of standby letters of credit at September 30; these amounts do not necessarily represent future cash requirements. The company disclosed $0.5 of sold residential mortgage loans still subject to recourse provisions and $5.4 of construction-contract commitments. Management said other claims and litigation were not expected to have a material adverse effect. The Northwest purchase-price allocation, including $100.8 of provisional goodwill, remained subject to valuation finalization.
Important facts for investors to verify
- Separate acquisition-related balance-sheet growth and earnings from underlying organic performance, and track integration costs and expected synergies from Northwest.
- Review the trajectory of deposit pricing, funding costs, net interest margin and acquired-loan accretion as rates and loan payoffs change.
- Monitor asset quality, including the increase in agricultural real estate non-performing loans to $12.9 from $3.6 at year-end, higher OREO of $17.3, and allowance coverage as the loan book expands.
- Check the disclosed INB total risk-based capital ratio of 9.86% against the table’s 10.00% well-capitalized benchmark; the filing also states that capital requirements were met, so the subsidiary-specific position merits clarification.
- Assess the effect of the Durbin Amendment and weaker mortgage refinancing on fee income, and confirm approvals, timing, consideration and integration plans for the two announced Idaho acquisitions.