First Interstate BancSystem, Inc. — Q3 2017 Form 10-Q
Business context and reporting period. This unaudited quarterly report covers the three and nine months ended September 30, 2017. First Interstate is a community bank holding company operating across Montana, Wyoming, South Dakota, Oregon, Idaho, and Washington. Results include Cascade Bancorp (Bank of the Cascades) from its May 30, 2017 acquisition; integration was completed August 11, 2017. The acquisition materially affects year-over-year comparisons.
Financial performance and condition
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net interest income | $100.8 million | $70.6 million | $249.0 million | $206.2 million |
| Non-interest income | $38.3 million | $35.2 million | $104.6 million | $101.7 million |
| Net income | $27.3 million | $25.2 million | $72.3 million | $70.9 million |
| Diluted EPS | $0.48 | $0.56 | $1.45 | $1.58 |
| Net interest margin, FTE | 3.71% | 3.58% | 3.61% | 3.56% |
- Q3 net interest income rose 42% year over year, primarily from acquired balances and higher yields; Q3 FTE margin also benefited from asset yields, while funding costs increased. Acquired-loan interest accretion was $4.0 million in Q3 and $6.9 million for the nine-month period.
- Non-interest expense was $94.7 million in Q3 and $238.7 million for nine months, up 44.7% and 24.7%, respectively. Acquisition-related costs were $13.0 million in Q3 and $23.9 million year to date. Q3 efficiency ratio was 68.1%.
- Mortgage banking revenue declined 27.0% in Q3 and 20.7% for nine months, reflecting a softer refinance market. Payment services revenue increased 37.1% in Q3, partly from Cascade activity and seasonal factors.
- Provision for loan losses was $3.4 million in Q3 and $7.5 million year to date, versus $2.4 million and $8.9 million in the comparable 2016 periods. Q3 net charge-offs were $4.6 million.
- At September 30, 2017, assets were $12.2 billion, loans $7.6 billion, deposits $9.9 billion, and stockholders’ equity $1.4 billion. Versus December 31, 2016, assets and deposits rose 34.7%; loans rose 37.8%, primarily due to Cascade. Excluding the acquisition and the sale of acquired shared national credits, loan growth was modest.
- Cash and cash equivalents totaled $882.8 million, up from $782.0 million at year-end. Nine-month operating cash flow was $94.7 million; investing activities provided $44.0 million and financing activities used $37.9 million.
- Long-term debt was $8.0 million and other borrowed funds $30.0 million. The shift largely reflects reclassification of $20.0 million of subordinated debt as its maturity moved within one year. Deposits were the principal funding source; the company reported no material liquidity concern known to management.
- The allowance for loan losses was $74.6 million, or 0.99% of period-end loans, down from 1.47% at September 2016, largely because acquired loans were recorded at fair value without a corresponding allowance. Non-performing assets were $90.5 million, or 0.74% of assets; non-performing loans were 1.06% of loans.
- Regulatory capital ratios exceeded well-capitalized thresholds: consolidated total risk-based capital was 12.76%, CET1 was 11.02%, and leverage was 8.71%. The bank subsidiary’s corresponding ratios were 12.78%, 11.91%, and 8.72%.
Material changes, outlook, and risks
- Cascade acquisition: The $541.0 million transaction included approximately $155.0 million cash and $386.0 million of issued Class A shares. Provisional goodwill was $232.2 million and the acquired core deposit intangible was $48.0 million; purchase accounting valuations remained subject to finalization. Management reported no goodwill impairment in its July 2017 assessment.
- Other unusual items: The company sold HSA custodial rights in Q2 and recorded a one-time net gain of approximately $3.1 million in the nine-month period; the acquired portion reduced the core deposit intangible. In Q3 it paid $1.1 million to terminate a cash-flow hedge swap, recognized as a loss. The prior-year nine-month results included a $3.8 million litigation recovery.
- Outlook: The filing provides no specific earnings or financial guidance. Management said it expects acquisition synergies and operating savings but noted its pro forma presentation did not include them. It cautioned that operating results are not necessarily indicative of full-year results.
- Risks and contingencies: Management cited economic weakness in its regional markets, including exposure to energy and coal, credit quality and allowance adequacy, interest-rate and liquidity risks, acquisition integration and profitability, regulatory requirements associated with assets exceeding $10 billion, cybersecurity and technology dependence, and litigation. Management did not expect other claims and litigation to materially harm financial condition, results, or liquidity. Off-balance-sheet commitments included approximately $2.1 billion of credit commitments and $52.6 million of standby letters of credit; commitments do not necessarily represent future cash outflows.
- The board declared a $0.24-per-share quarterly dividend after quarter-end, payable November 13, 2017. Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- How Cascade’s acquired assets, deposits, provisional goodwill, and core deposit intangible are finalized, and whether integration delivers expected efficiencies.
- Whether earnings growth persists after acquisition-related costs and acquired-loan accretion diminish; compare reported and acquisition-adjusted expenses and margins.
- Credit trends underlying the 0.99% allowance ratio, including non-performing assets, criticized loans, charge-offs, and acquired-loan performance.
- Deposit retention, funding costs, liquidity, and capital ratios as the combined bank operates above $10 billion in assets.
- The effect of a softer mortgage refinance market, changing interest rates, and regional energy and economic conditions on revenue and credit quality.