First Interstate BancSystem, Inc. — Q2 2016 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2016. Unaudited consolidated figures; dollar amounts below are in millions unless noted.
Business context and reporting period
Montana-headquartered bank holding company operating 76 banking offices in Montana, Wyoming and South Dakota. Its core business is accepting deposits and making commercial, real estate, consumer and agricultural loans.
Financial performance and condition
- Q2 revenue: Net interest income plus non-interest income was $104.6 million, up 7.8% from $97.1 million a year earlier. Net interest income was $67.6 million (+3.6%); non-interest income was $37.0 million (+16.5%).
- Profit: Q2 net income was $25.6 million, up 15.0% from $22.2 million; diluted EPS was $0.57 versus $0.49. For the first half, net income was $45.7 million versus $43.2 million, and diluted EPS was $1.02 versus $0.94.
- Margins and expenses: Fully taxable-equivalent net interest margin was 3.55% in Q2 versus 3.47% a year earlier; first-half margin was 3.55% versus 3.45%. Q2 non-interest expense increased 1.5% to $62.9 million. The filing attributes margin improvement mainly to loan growth and a more favorable earning-asset mix, partly offset by lower loan yields.
- Credit costs: Q2 provision for loan losses was $2.6 million versus $1.3 million; first-half provision was $6.6 million versus $2.4 million. The allowance was $80.3 million, or 1.48% of period-end loans, compared with $76.8 million, or 1.46%, at year-end 2015.
- Balance sheet: Total assets were $8.61 billion, down 1.4% from December 31, 2015. Total loans, including loans held for sale, rose 3.2% to $5.41 billion; deposits declined 1.5% to $6.98 billion. Cash and cash equivalents fell 39.0% to $476.1 million, which management attributed to loan growth, share repurchases and normal seasonal deposit declines.
- Cash flow and funding: First-half operating cash flow was $36.9 million versus $28.2 million in 2015. Investing activities used $146.0 million and financing activities used $195.2 million. Long-term debt was $27.9 million and subordinated debentures were $82.5 million; repurchase-agreement funding was $466.4 million. Management said it knew of no event reasonably likely to materially impair liquidity.
- Capital and shareholder returns: Consolidated regulatory capital ratios included 12.5% common equity tier 1 and 10.4% leverage; the company said it exceeded applicable capital requirements. It repurchased and retired about 976,000 Class A shares for $25.5 million during the first half and declared a $0.22-per-share quarterly dividend after quarter-end.
Material changes versus comparable periods
- Q2 non-interest income included a $3.75 million non-recurring recovery from settlement of prior-year litigation. The filing identifies this as a major contributor to the year-over-year increase in non-interest income.
- Loan growth and the shift from lower-yielding investments and bank deposits toward loans supported net interest income. First-half acquired-loan fair-value accretion was $3.3 million, including $1.3 million from early payoffs.
- Q2 loan-loss provision increased with loan growth, hospitality-sector commercial real estate specific reserves and lower recoveries of previously charged-off loans. First-half provision also reflected additional general and specific reserves related to energy-sector loans.
- Technology-cost presentation changed: certain software costs moved from furniture and equipment expense to outsourced technology services. Management said this reclassification accounted for about $1.4 million of the Q2 increase in outsourced technology expense; further technology investment supported scalability and growth.
- The company elected fair-value accounting for loans held for sale effective January 1, 2016; this generated mortgage banking revenue of $0.8 million in Q2 and $1.7 million in the first half.
Outlook, risks, contingencies and unusual items
- Outlook: The filing provides no quantitative earnings or revenue guidance. Management cautions that interim results are not necessarily indicative of full-year results.
- Asset quality: Non-performing loans were $78.8 million (1.46% of loans) at June 30, versus $72.0 million (1.37%) at year-end; non-performing assets were $86.7 million versus $78.2 million. Non-accrual loans increased to $74.3 million, primarily after four hospitality-sector commercial real estate borrowers were placed on non-accrual in Q2. Criticized loans rose to $359.9 million from $320.4 million.
- Energy exposure: Direct energy loans were about $66 million, with a further $26 million in commitments. Reserves allocated to energy loans were 11.3% of those loans, up from 7.8% at year-end. Management warns that economic deterioration or weaker asset quality could require material additional provisions.
- Acquisition: First Interstate Bank agreed to acquire Flathead Bank of Bigfork, which had $231.6 million of assets at December 31, 2015 and seven branches. Closing was expected in Q3 2016; cash consideration was approximately $34.2 million, subject to adjustments.
- Commitments and legal matters: Commitments to extend credit were approximately $1.60 billion; standby letters of credit were $51.8 million. Mortgage loans sold with recourse provisions still in effect totaled $3.1 million. Management said other litigation was not expected to materially adversely affect financial condition, results or liquidity.
- Other risks: The filing highlights sensitivity to regional economic conditions, energy prices, credit losses, interest-rate changes, funding access, regulatory requirements, technology and cybersecurity, and integration of acquired organizations. Management reported no material change in previously disclosed risk factors or market-risk disclosures.
Important facts for investors to verify
- Whether the Q2 earnings increase remains meaningful after excluding the $3.75 million litigation recovery and the effects of fair-value accounting for loans held for sale.
- Subsequent movement in hospitality-related non-accrual loans, criticized assets, charge-offs and the allowance for loan losses.
- Energy borrower performance, outstanding commitments and the adequacy of the 11.3% reserve allocation against direct energy loans.
- Flathead Bank acquisition closing, final purchase price adjustments, integration costs and expected contribution.
- Cash and deposit trends, funding costs, capital ratios and the sustainability of share repurchases and dividends.