First Interstate BancSystem, Inc. — 2016 Form 10-K
Business context and reporting period. This annual report covers the fiscal year ended December 31, 2016, with comparative results for 2015 and 2014. First Interstate is a Montana-based bank holding company operating 80 banking offices in Montana, Wyoming and South Dakota. At year-end, it reported $9.1 billion in assets, $7.4 billion in deposits and $5.5 billion in loans.
Key financial results
| Metric | 2016 | 2015 | Change |
|---|---|---|---|
| Net interest income | $279.8 million | $264.4 million | +5.8% |
| Non-interest income | $136.5 million | $121.5 million | +12.3% |
| Provision for loan losses | $10.0 million | $6.8 million | Increased |
| Non-interest expense | $261.0 million | $248.6 million | +5.0% |
| Net income | $95.6 million | $86.8 million | +10.2% |
| Diluted earnings per share | $2.13 | $1.90 | +12.1% |
- Net interest margin rose to 3.57% from 3.46%; management attributed the increase to loan growth, improved earning-asset mix, lower-cost deposit mix and acquired-loan accretion.
- Efficiency ratio improved to 62.70% from 64.42%. Return on average assets was 1.10%, versus 1.02%; return on average common equity was 9.93%, versus 9.37%.
- Operating cash flow was $118.1 million; investing cash flow was negative $143.1 million and financing cash flow was positive $26.6 million. Cash and cash equivalents ended the year at $782.0 million.
- Year-end total assets increased 3.8% to $9.06 billion; deposits grew 4.1% to $7.38 billion and total loans rose 4.4% to $5.48 billion. Flathead Bank’s acquisition contributed $254 million of assets, $210 million of deposits and $83 million of loans.
- Stockholders’ equity was $982.6 million. Consolidated total risk-based capital was 15.13%, common equity Tier 1 was 12.65%, and the leverage ratio was 10.11%; the company reported capital above applicable requirements.
- Long-term debt was $28.0 million, with $82.5 million of subordinated debentures outstanding. The company also had $537.6 million of repurchase-agreement balances, generally due the next business day.
- The loan-to-deposit ratio was 74.27%. Deposits were primarily customer-funded; the company reported no brokered time deposits at year-end.
Material changes versus the prior comparable period
- Net income rose $8.8 million. Higher net interest income and non-interest income were partly offset by increased loan-loss provision and operating expenses.
- Non-interest income included a $4.2 million recovery related to a lender-liability lawsuit settled in 2015. Non-interest expense included $2.8 million of acquisition expenses; 2015 included $5.0 million of litigation-contingency expense and $0.8 million of acquisition expenses.
- Net charge-offs increased to $10.6 million from $4.2 million, and the allowance for loan losses declined to 1.39% of total loans from 1.46%. Non-performing loans increased to $76.6 million from $72.0 million; non-performing assets were 0.96% of assets versus 0.90%.
- Commercial and consumer loans grew, while residential real estate and agricultural loans declined organically. The company cited energy-related credit deterioration: $59 million of direct oil and gas loans were outstanding, $25 million of additional commitments existed, and 76.3% of outstanding oil and gas loans were criticized.
- The company repurchased approximately $25.5 million of Class A shares and paid $39.4 million in common dividends during 2016. Annual dividends per share increased to $0.88 from $0.80.
Outlook, commentary, risks and unusual items
- The company expected the pending Cascade Bancorp acquisition to close in the third quarter of 2017, subject to regulatory and shareholder approvals. The announced consideration was 0.14864 Class A shares plus $1.91 cash per Cascade share; the filing estimated a transaction value of about $628 million at the December 31, 2016 share price. Management anticipated a combined bank exceeding $12 billion in assets.
- Crossing $10 billion in assets would trigger additional regulatory requirements, including CFPB examination and enforcement authority, risk-management and stress-testing obligations, and debit-card interchange fee limits. The company estimated the interchange cap could have reduced 2016 debit-card interchange income by approximately $8 million.
- Management reported no known event expected to materially impair liquidity or capital. It modeled a 0.5% rate increase over four quarters as increasing net interest income by $2.5 million, or 0.9%; it did not model a rate decrease, noting that further declines could compress net interest income.
- Major risks include regional economic weakness, commercial real estate and other credit exposure, energy-sector stress, interest-rate and funding risk, acquisition execution and integration, regulatory costs, cybersecurity and technology dependence, and goodwill impairment. Goodwill was $212.8 million; the 2016 annual impairment test found estimated fair value above carrying value.
- Flathead Bank was acquired for $34.1 million in August 2016. In January 2017, the company acquired U.S. rights to its First Interstate trademarks, domains and related goodwill from Wells Fargo; the filing does not provide a clear purchase price for this transaction.
- The filing describes the 2016 mortgage-loan-held-for-sale fair-value election, which added $0.76 million to mortgage banking revenue. It also reports a 2016 post-retirement healthcare-plan amendment that ended future-retiree coverage beginning July 1 and reduced the benefit obligation by $2.8 million.
- The independent auditor issued unqualified opinions on the financial statements and internal control over financial reporting. Management reported effective disclosure controls and internal control; ordinary-course litigation was not expected by management to have a material adverse effect.
Important facts for investors to verify
- Progress, approvals, final terms and integration assumptions for the Cascade Bancorp acquisition, including expected synergies, funding needs, dilution and the timing of the $10 billion regulatory threshold.
- Subsequent trends in criticized, non-performing and energy-sector loans; reserve adequacy; charge-offs; and collateral values, especially given higher 2016 net charge-offs and oil-and-gas loan criticism.
- How much 2016 earnings growth reflects recurring operations versus the $4.2 million litigation recovery, acquired-loan accretion, interest recoveries and other unusual items.
- Whether deposit growth and low-cost funding persist, and how changing rates affect net interest margin, deposit costs and securities values.
- Capital, liquidity, dividend and repurchase capacity after acquisition-related cash consideration and share issuance; also review the bank’s regulatory limits on dividends to the parent.
- Potential effects of CECL credit-loss accounting, scheduled to become effective for the company for fiscal years beginning after December 15, 2019; management was still evaluating the impact.