FIBK

Business Context and Reporting Period

Company: First Interstate BancSystem, Inc. (FIBS)
Filing Type: Form 10-Q (Unaudited)
Period Ended: September 30, 2008
Operations: Community banking and technology services in Montana, Wyoming, and South Dakota. The reporting period includes the results of the First Western Bank acquisition completed on January 10, 2008, which added 18 banking offices in South Dakota.

Key Financial Metrics

Material Changes vs. Prior Period

• Acquisition Impact: Total assets increased 24.8% year-over-year and 33.3% in loans, primarily driven by the First Western acquisition. Goodwill increased from $37.4 million to $187.3 million.
• Profitability: Net income available to common shareholders decreased 21.9% for the quarter and 6.1% for the nine-month period compared to 2007. This decline was driven by higher provisions for loan losses and increased noninterest expenses.
• Asset Quality Deterioration: Nonperforming assets rose 160.5% to $93 million (1.96% of total loans) from $36 million (1.00%) at year-end 2007. This was largely due to deterioration in real estate development loans in two Montana counties.
• Provision Increase: The provision for loan losses increased 200.6% for the quarter and 136.8% for the nine months compared to the prior year periods to address credit quality issues.
• Expense Growth: Noninterest expenses increased 23.6% for the quarter and 21.5% for the nine months, attributed to the acquisition, inflationary wage increases, higher FDIC premiums, and mortgage servicing rights impairment.

Guidance, Outlook, Risks, and Unusual Items

• Market Conditions: Management notes significant disruption in financial markets and reduced business activity globally. While local economies in Montana, Wyoming, and South Dakota remain relatively stable, the company faces headwinds from the national real estate downturn.
• Government Programs: The company is assessing participation in the Troubled Asset Relief Program (TARP) and the FDIC Temporary Liquidity Guarantee Program but has not made a definitive decision.
• Debt Covenants: The company breached nonperforming asset covenants in its syndicated credit agreement as of June 30, 2008. On October 3, 2008, an amendment was executed to waive these defaults and revise covenants. The company is currently in compliance.
• Unusual Items:
  • Recorded $1.3 million in "other-than-temporary" impairment on an investment security held by an acquired entity.
  • Recorded $1.6 million in impairment of mortgage servicing rights for the quarter.
  • Recognized nonrecurring gains in 2008 from the mandatory redemption of Visa Class B shares ($1.6 million) and the release of escrowed funds from a prior sale ($1.1 million).
• Capital: Issued $50 million in Series A Preferred Stock and raised $11.8 million in common stock during the period to support growth and maintain "well-capitalized" status.

Investor Verification Checklist

• Credit Quality Trends: Verify the trajectory of nonperforming assets and the adequacy of the allowance for loan losses given the concentration in real estate development loans.
• Covenant Compliance: Monitor future compliance with the amended syndicated credit agreement covenants regarding nonperforming assets.
• Acquisition Integration: Assess the ongoing impact of the First Western acquisition on operating expenses and revenue synergies.
• Government Program Participation: Confirm the company's decision regarding TARP and FDIC guarantee programs and the associated impact on capital structure and executive compensation.
• Interest Rate Sensitivity: Review asset-liability management strategies as funding sources are repricing faster than earning assets in the current rate environment.