Business context and reporting period
First Interstate BancSystem, Inc. is a Montana-based financial holding company operating banking offices in Montana, Wyoming and South Dakota. This unaudited Form 10-Q covers the quarter and nine months ended September 30, 2016; balance-sheet comparisons are with December 31, 2015. Unless otherwise noted, amounts below are in millions of dollars.
In August 2016, the company acquired Flathead Bank of Bigfork for $34.1 million in cash. Flathead contributed approximately $254 million of assets, $83 million of loans and $210 million of deposits at acquisition. The purchase accounting remained provisional; results were included from August 12, and the company said acquired-bank results could not be separately identified after integration.
Financial performance and condition
- Third-quarter earnings: Net income was $25.2 million, up about 25% from $20.2 million a year earlier. Diluted EPS was $0.56 versus $0.44. For the first nine months, net income was $70.9 million versus $63.4 million, and diluted EPS was $1.58 versus $1.39.
- Net interest income and margin: GAAP net interest income was $70.6 million in Q3, up 6.4%, and $206.2 million for nine months, up 5.2%. Fully taxable-equivalent net interest margin was 3.58% in Q3 and 3.56% for nine months, each 11 basis points above the comparable 2015 period. Management cited loan growth and a shift from securities toward higher-yielding loans; acquired-loan accretion and recoveries of charged-off interest also contributed.
- Credit costs and fee income: Provision for loan losses rose to $2.4 million in Q3 from $1.1 million, and to $8.9 million for nine months from $3.5 million. Non-interest income increased 2.2% to $31.9 million in Q3 and 3.1% to $93.7 million for nine months. The nine-month comparison includes a $3.75 million litigation recovery in 2016.
- Expenses and margins: Non-interest expense fell 6.2% to $62.1 million in Q3 and 2.4% to $183.5 million for nine months. A key comparison is the $5.0 million lender-liability loss contingency recorded in Q3 2015, absent in 2016. Outsourced technology expense increased as the company invested in systems and reclassified certain software costs from furniture and equipment. The filing does not provide a clear efficiency-ratio value in the supplied text.
- Balance sheet and funding: Total assets were $8.97 billion, up 2.8%; loans were $5.53 billion, up 5.4%; and deposits were $7.33 billion, up 3.4%. Flathead accounted for approximately $228 million of asset growth, $83 million of loan growth and $210 million of deposit growth. Cash and cash equivalents fell to $701 million from $780 million. Non-interest-bearing deposits were 26.8% of total deposits, up from 25.7% at year-end; management also reported a shift away from higher-cost time deposits.
- Cash flow and debt: Nine-month operating cash flow was $79.1 million; investing activities used $85.5 million and financing activities used $72.6 million. Cash decreased $79.1 million over the period. At September 30, long-term debt was $27.9 million, subordinated debentures were $82.5 million and repurchase agreements were $476.8 million. The filing reports no material liquidity concern known to management.
- Capital and shareholder returns: Stockholders’ equity was $982.5 million, up from $950.5 million at year-end. Consolidated regulatory capital ratios included 12.3% CET1, 13.6% Tier 1 risk-based capital and 14.9% total risk-based capital; management said the company and bank exceeded applicable capital requirements. The company repurchased about 976,000 Class A shares for approximately $25.5 million during the first nine months and declared a subsequent quarterly dividend of $0.22 per share.
Material changes and asset quality
- Organic loan growth was approximately $202 million, with notable growth in indirect consumer, construction, commercial and commercial real estate lending. Indirect consumer loans grew 17.6% from year-end.
- Non-performing loans were $79.6 million, or 1.44% of loans, versus $72.0 million, or 1.37%, at December 31, 2015. Non-performing assets were $89.0 million, or 1.61% of loans and OREO, versus $78.2 million, or 1.49%. Non-accrual loans included hospitality-sector commercial real estate borrowers and an agricultural real estate borrower; past-due accruing loans included an energy-sector borrower.
- The allowance for loan losses was $81.2 million, or 1.47% of period-end loans, compared with $76.8 million, or 1.46%, at year-end. Criticized loans increased to $370.0 million from $320.4 million. Management attributed higher provisions to loan growth, energy-related reserves and increased criticized and non-performing loans.
- Direct energy-sector loans were approximately $61 million, with another $24 million of lending commitments. Reserves allocated to energy loans were 12.4% of those loans, compared with 7.8% at year-end.
- Available-for-sale securities unrealized gains increased, contributing to accumulated other comprehensive income of $8.8 million versus $0.4 million at year-end. The company reported no investment-security impairment losses.
Outlook, commentary, risks and unusual items
The filing gives no specific earnings, revenue or margin guidance. Management said operating results for the first nine months are not necessarily indicative of full-year results, and described continued lending and investment in technology to support growth. Management reported no known event expected to materially impair liquidity, capital resources or operations.
Key disclosed risks include credit deterioration and allowance-estimate uncertainty; economic weakness in Montana, Wyoming and South Dakota, particularly exposure to energy prices; interest-rate and funding risks; acquisition integration and goodwill impairment; technology, cybersecurity and vendor risks; and regulatory, litigation and liquidity risks. The company was below $10 billion in assets at quarter-end and identified additional regulatory requirements if assets exceed that threshold. Other claims and litigation were not expected by management to have a material adverse effect; no material changes to previously disclosed legal proceedings or risk factors were reported.
Comparability is affected by 2016 accounting presentation changes: direct standard costs of originating mortgage loans held for sale were netted against mortgage banking revenue rather than salaries and wages, and loans held for sale were carried under the fair value option. The company reported that fair-value changes reduced Q3 mortgage banking revenue by $0.75 million but increased nine-month revenue by $1.9 million. Acquisition expenses were $1.2 million in 2016; a $3.75 million recovery of prior-year litigation settlement expense benefited nine-month non-interest income.
Important facts for investors to verify
- Whether growth in non-performing, criticized and energy-related loans leads to further provisions, charge-offs or reserve increases.
- How Flathead’s provisional purchase accounting, integration and expected cost savings develop; acquired results are not separately disclosed.
- Underlying mortgage banking performance after adjusting for the changed cost presentation and fair-value marks.
- Whether deposit growth and mix, cash levels and alternative funding sources remain adequate as lending and shareholder distributions continue.
- Whether reported earnings growth persists without the one-time litigation recovery and despite higher credit costs and technology spending.