Business context and reporting period
First Interstate BancSystem, Inc. is a Montana-based bank holding company serving Montana, Wyoming and western South Dakota through 83 banking offices in 45 communities. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2015; comparisons are with the corresponding 2014 periods unless stated otherwise. Amounts below are in millions except per-share data and ratios.
Financial and operating performance
- Earnings: Second-quarter net income was $22.2 million, up 5.4%; diluted EPS was $0.49 versus $0.47. First-half net income was $43.2 million, up 1.7%; diluted EPS was $0.94 versus $0.95.
- Interest income and margin: Second-quarter net interest income was $65.3 million, up 9.3%; first-half net interest income was $129.6 million, up 10.0%. Fully taxable-equivalent net interest income rose 9.2% in the quarter and 9.8% year to date. Net interest margin declined to 3.47% for the quarter from 3.54%, and to 3.45% for the first half from 3.53%, reflecting lower asset yields, partly offset by asset growth and lower funding costs. Acquired-loan fair-value accretion also supported interest income.
- Non-interest income and expense: Non-interest income increased 19.6% to $31.8 million for the quarter and 17.5% to $59.6 million for the first half. Growth reflected loan origination and sale income, service fees, and other income. Non-interest expense rose 10.8% to $62.0 million and 10.3% to $121.6 million, respectively, including acquired-business costs, higher operating expenses, unusually elevated card fraud losses, and a one-time $0.9 million payment-services contract termination fee.
- Balance sheet: At June 30, assets were $8.386 billion, down 2.6% from year-end; loans were $5.104 billion, up 4.2%; deposits were $6.804 billion, down 2.9%; and stockholders’ equity was $924.9 million, up 1.8%. Cash and cash equivalents declined to $506.4 million from $798.7 million as available funds supported loan growth. Investment securities totaled $2.139 billion, down 6.5%.
- Credit quality: Non-performing assets were $84.8 million, or 1.01% of assets, compared with $78.3 million, or 0.91%, at year-end; they declined from $94.3 million at March 31, 2015. Non-performing loans were $73.0 million, or 1.43% of loans, versus $64.8 million, or 1.32%, at year-end. The allowance for loan losses was $76.6 million, or 1.50% of loans, compared with $74.2 million, or 1.52%, at year-end. First-half provision was $2.4 million, versus a $7.0 million reversal in the prior-year period.
- Cash flow and funding: First-half operating cash flow was $28.2 million; investing activities used $59.2 million and financing activities used $261.2 million, producing a $292.2 million decrease in cash. The financing outflow included a $201.8 million decrease in deposits, $33.1 million lower repurchase-agreement balances, $15.3 million of share repurchases and $18.2 million of dividends. Repurchase agreements were $469.1 million at period-end. Long-term debt was $43.1 million, and subsidiary-trust subordinated debentures were $82.5 million.
- Capital: The company reported a 12.6% consolidated CET1 ratio, 13.9% Tier 1 risk-based ratio and 10.1% leverage ratio; First Interstate Bank’s CET1 ratio was 13.0%. The company stated that it exceeded applicable capital adequacy requirements.
Material changes and notable items
- Management attributed higher net interest income primarily to the July 2014 Mountain West acquisition and organic loan growth; average loans rose year over year. Lower net interest margin remained a countervailing trend.
- Loan growth was concentrated in commercial, commercial real estate, indirect consumer and agricultural lending. Deposits declined seasonally, while the mix shifted toward lower-cost demand and savings balances and away from time deposits.
- Non-performing loans increased from year-end, largely after loans to one commercial and one commercial real estate borrower were placed on non-accrual. OREO declined to $11.8 million; first-half sales generated net gains of $1.7 million.
- On July 24, 2015, after quarter-end, the company acquired Absarokee Bancorporation for $7.2 million in cash and merged its United Bank subsidiary into First Interstate Bank. Absarokee had approximately $73 million of assets, $38 million of loans and $64 million of deposits at acquisition.
- The company declared a $0.20-per-share quarterly dividend in July, payable in August. First-half dividends declared were $0.40 per share, compared with $0.32 in 2014.
Outlook, risks and contingencies
The filing provides no quantified earnings or revenue guidance. Management cautioned that interim results are not necessarily indicative of full-year results. It cited economic conditions in its markets, credit losses and allowance adequacy, interest-rate changes, funding access, regulatory and technology risks, cybersecurity, competition, and other factors as risks to future results. Management said it was unaware of events reasonably likely to materially adversely affect liquidity, capital resources or operations.
A material litigation contingency concerns a lender-liability case: a final judgment entered in April 2015 totaled $24.638 million plus interest, including $16.760 million in punitive damages and $7.5 million in plaintiff attorney fees. The company had accrued $4.0 million in 2014, believes it has grounds to appeal, and expected mediation in third-quarter 2015 before any appeal. It warned the outcome could materially affect financial condition, results or liquidity.
At June 30, commitments to extend credit were approximately $995.4 million, including $528.9 million of unused credit-card lines; standby letters of credit were $58.1 million. These are not necessarily expected cash outflows because commitments may expire undrawn. The company also reported elevated fraudulent credit-card activity and a one-time contract termination fee in the quarter.
Important facts for investors to verify
- Developments and any subsequent resolution of the litigation, including whether the $4.0 million accrual remains adequate against the judgment and related interest.
- Whether non-performing loans and impaired credits continue to rise, and whether the allowance remains sufficient as the loan portfolio grows.
- Deposit trends, liquidity after the substantial first-half cash decline, and the company’s ability to fund continued lending without materially higher-cost funding.
- Whether net interest margin stabilizes, and how much reported interest income continues to depend on acquired-loan accretion.
- Integration and financial effects of the Absarokee acquisition, along with ongoing fraud losses and expense control.