First Interstate BancSystem, Inc. — Q3 2012 Form 10-Q
Business context and reporting period. Unaudited results for the quarter and nine months ended September 30, 2012; balance-sheet comparisons are with December 31, 2011. The Montana-based bank holding company operated 72 banking offices in Montana, Wyoming and western South Dakota. Unless noted, amounts below are in millions of dollars.
Financial performance and condition
- Q3 earnings: Net income was $16.2 million, up 35.5% from $11.9 million a year earlier. Net income available to common shareholders was $15.3 million; diluted EPS was $0.35, versus $0.26.
- Nine-month earnings: Net income was $41.4 million, versus $31.3 million; diluted EPS was $0.90, versus $0.67.
- Revenue and margin: Q3 net interest income was $61.0 million, down 3.9%; nine-month net interest income was $182.8 million, down 2.7%. Fully taxable-equivalent net interest margin fell to 3.63% for Q3 from 3.84%, and to 3.70% for nine months from 3.80%. Non-interest income rose 30.5% in Q3 to $30.2 million and 29.8% for nine months to $84.2 million, led by mortgage origination and sale income.
- Credit costs and operating expenses: Provision for loan losses declined to $9.5 million in Q3 from $14.0 million, and to $32.8 million for nine months from $44.4 million. Non-interest expense rose 3.7% in Q3 to $57.1 million and 5.9% for nine months to $171.8 million.
- Assets, loans and deposits: Total assets were $7.46 billion, up 1.9% since year-end. Total loans were $4.18 billion, nearly unchanged; deposits grew 3.6% to $6.04 billion. Non-interest-bearing deposits were $1.44 billion, or 23.9% of deposits.
- Liquidity and cash flow: Cash and cash equivalents were $611.3 million, versus $472.4 million at year-end. Nine-month operating cash flow was $84.9 million, investing cash use was $41.3 million, and financing cash flow was $95.3 million. The company reported reliance primarily on customer core deposits and stated management knew of no event expected to materially impair liquidity.
- Debt and capital: Long-term debt was $37.2 million and subordinated debentures were $82.5 million. The company redeemed $41.2 million of junior subordinated debentures in June. Stockholders’ equity was $797.9 million. At September 30, consolidated total risk-based, Tier 1 risk-based and leverage capital ratios were 16.5%, 14.5% and 9.6%; the bank exceeded well-capitalized thresholds.
- Asset quality: Non-performing assets declined to $202.7 million, or 4.80% of loans and OREO, from $278.9 million, or 6.60%, at year-end. Non-accrual loans fell to $122.9 million from $200.0 million. The allowance for loan losses was $99.0 million, 2.37% of period-end loans, compared with $112.6 million and 2.69% at year-end.
Material changes versus prior periods
- Mortgage origination and sale income increased 111.6% in Q3 and 125.5% for nine months, as low rates drove a 93% increase in residential mortgage originations for the first nine months. Refinancing represented 64% of origination dollars, versus 49% a year earlier.
- Margin pressure continued: lower loan balances and yields on loans and investments outweighed lower funding costs. Management cited a shift toward lower-cost demand deposits as a partial offset.
- Credit indicators improved, although charge-offs remained material: nine-month net charge-offs were $46.3 million (gross charge-offs of $50.6 million less $4.3 million recoveries). Criticized loans declined to $519.3 million from $630.9 million at year-end.
- Deposits increased while repurchase agreements declined $55.4 million to $460.8 million. The company attributed part of the deposit-mix shift to discontinuing its savings sweep product, moving approximately $300 million into interest-bearing demand deposits.
Outlook, risks and unusual items
- Management expects further net interest margin compression in coming quarters under very low interest rates and low loan growth. It does not expect the current level of mortgage refinancing activity to continue.
- Management said it believed the allowance was adequate, but warned that economic deterioration or worsening asset quality could require material additional provisions. Real estate and construction lending, including land development, remain significant credit exposures.
- Q3 and nine-month expense comparisons include higher compensation and benefits. Nine-month other expense included $3.0 million of estimated collection and settlement costs related to one borrower, $1.5 million of donation expense associated with a building sale, and $428,000 of unamortized debt issuance costs on the redeemed debentures. The building sale also generated a $581,000 gain.
- Proposed Basel III-related capital rules were not final. Management stated that, as of September 30, it believed the company would meet the proposed requirements on a fully phased-in basis if then effective. A proposed Visa interchange litigation settlement could reduce issuer interchange fees for eight months; management did not expect a material impact.
- The filing identifies risks including credit losses, real estate concentrations, interest-rate changes, funding access, regulatory changes, and economic conditions in its markets. Management reported no material change in risk factors or legal proceedings and no subsequent events requiring disclosure.
Important facts for investors to verify
- Whether declining non-performing loans and criticized assets persist, and whether charge-offs or OREO additions reverse that improvement.
- Whether the $99.0 million allowance remains adequate relative to credit quality, collateral values and loan concentrations.
- How quickly net interest margin compresses and whether deposit-mix benefits can offset lower asset yields and limited loan growth.
- How sustainable mortgage-related income is as refinancing activity normalizes, and whether associated staffing and operating costs moderate.
- Final regulatory capital requirements and their effect on capital ratios, alongside the implications of the subordinated-debt redemption.
- Potential cash needs from $1.12 billion of commitments to extend credit and $68.9 million of standby letters of credit; disclosed commitment amounts do not necessarily represent expected funding.