First Interstate BancSystem, Inc. — Q2 2017 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2017. The company is a regional community bank headquartered in Billings, Montana, operating across Montana, Wyoming, South Dakota, Oregon, Idaho and Washington. Figures below are in U.S. dollars; financial amounts are rounded to millions unless noted.
Financial performance and condition
- Q2 revenue and earnings: Reported interest and non-interest income totaled approximately $123.0 million, up from $109.0 million in Q2 2016. Net income was $21.9 million, down 14.4% from $25.6 million; diluted EPS was $0.45 versus $0.57.
- First-half results: Reported income totaled approximately $226.6 million versus $209.4 million. Net income was $45.0 million, down 1.5% from $45.7 million; diluted EPS was $0.96 versus $1.02.
- Net interest: Q2 net interest income was $79.3 million versus $67.6 million; first-half net interest income was $148.2 million versus $135.6 million. Fully taxable-equivalent net interest margin was 3.60% in Q2 (3.55% prior year) and 3.55% for the first half (unchanged). Excluding acquired-loan accretion and recoveries of previously charged-off interest, the margin was 3.43% for Q2 and 3.42% for the first half.
- Non-interest income and costs: Q2 non-interest income was $37.2 million, including a $3.4 million one-time gain on the sale of HSA custodial rights. Q2 non-interest expense rose to $80.4 million from $62.9 million, including $10.1 million of acquisition costs. First-half acquisition costs were $10.8 million. The comparable 2016 periods included a $3.75 million litigation recovery.
- Cash flow and liquidity: For the first half, operating cash flow was $88.6 million. Cash and cash equivalents increased $137.8 million to $919.8 million. At quarter-end, investment securities totaled $2.61 billion and deposits totaled $10.02 billion.
- Loans, credit and reserves: Total loans were $7.56 billion, up 37.9% from year-end, largely because of the Cascade acquisition. The allowance for loan losses was $75.7 million, or 1.00% of loans, versus $76.2 million, or 1.39%, at year-end. Non-performing assets were $97.3 million; non-performing loans were 1.14% of loans. Management noted that the lower reserve ratio and non-performing ratios partly reflect acquired loans and the larger balance-sheet denominator.
- Capital and debt: Stockholders’ equity was $1.41 billion. Consolidated regulatory capital ratios included total risk-based capital of 12.56%, Tier 1 of 11.69%, CET1 of 10.77%, and leverage of 10.65%; the company reported exceeding applicable capital requirements. Long-term debt was $28.0 million and subordinated debentures were $82.5 million; repurchase agreements were $579.8 million.
Material changes and unusual items
- On May 30, 2017, the company completed its $541.0 million acquisition of Cascade Bancorp, parent of Bank of the Cascades. Consideration included approximately $386.0 million in First Interstate shares and $155.0 million in cash. The preliminary purchase accounting recorded $231.5 million of goodwill; valuations remain provisional.
- The acquisition substantially increased reported assets, loans, deposits, securities, equity and operating costs. Cascade’s results were included from May 30; for that period through June 30, it reported $12.9 million in revenue and $3.0 million in net income. Management planned to integrate Bank of the Cascades with First Interstate Bank after August 11, 2017.
- Excluding the HSA gain in 2017 and litigation recovery in 2016, management said non-interest income increased $0.6 million in Q2 and $1.6 million for the first half year over year. Mortgage banking revenue declined amid lower refinance activity.
- Organic loan growth, excluding acquired loans and the disposition of acquired shared national credits, was reported as modest. Management also cited higher funding costs following interest-rate increases.
Outlook, risks and contingencies
The filing provides no numerical earnings or revenue guidance. Management described expected acquisition synergies, but the supplemental pro forma results do not include anticipated cost savings or other synergies. It cautioned that integration may fail to deliver expected benefits and that acquisition-related disruption, costs, asset-quality assessments and employee retention could affect results. Management stated it knew of no events reasonably likely to materially harm liquidity, capital resources or operations.
- Key exposures include economic conditions in the company’s six-state footprint, commercial real estate and commercial lending, interest-rate changes, funding costs, credit losses, and the adequacy of the allowance. At June 30, commercial loans were about $4.0 billion, including $2.8 billion of commercial real estate loans. The company disclosed $65 million of direct oil-and-gas loans, with 77.5% criticized, and $18.1 million of related lending commitments.
- At more than $10 billion in assets, the company is subject to heightened regulatory requirements, including CFPB oversight and annual stress-testing requirements. Other stated risks include acquisition integration, goodwill impairment, cybersecurity and vendor dependence, liquidity, and potential effects from new accounting standards.
- Commitments included approximately $2.25 billion to extend credit and $54.2 million of standby letters of credit. Mortgage loans sold with recourse provisions totaled $1.0 million. Management said other claims and litigation were not expected to have a material adverse effect; no material changes in legal proceedings were reported.
- A quarterly dividend of $0.24 per common share was declared after quarter-end, payable August 11, 2017. Management reported no material changes in market-risk disclosures and concluded disclosure controls were effective as of June 30.
Important facts for investors to verify
- How final purchase accounting, integration expenses and realized synergies affect post-acquisition earnings and the elevated goodwill balance.
- Whether credit quality trends stabilize, particularly criticized energy exposures, commercial real estate, non-performing loans and acquired loan performance.
- Whether margin and funding costs hold up as interest rates change, considering the gap between reported margins and margins excluding loan accretion and charged-off interest recoveries.
- Whether the company sustains capital and liquidity levels while meeting heightened regulatory obligations and funding growth.