First Interstate BancSystem, Inc. — Q2 2014 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2014. The company is a regional bank holding company headquartered in Billings, Montana, operating in Montana, Wyoming and western South Dakota. Unless otherwise noted, amounts below are in millions; income and cash-flow comparisons are year over year.
Financial performance and condition
- Q2 earnings: Net income was $21.1 million, down 2.0% from $21.5 million. Diluted EPS was $0.47 versus $0.49.
- First-half earnings: Net income was $42.5 million, up from $41.5 million; diluted EPS was $0.95 versus $0.95.
- Net interest income and margin: Q2 net interest income was $59.7 million, up from $58.8 million; six-month net interest income was $117.9 million, essentially unchanged from $118.0 million. Fully taxable-equivalent net interest margin was 3.54% for Q2 and 3.53% for the first half, each down 2 basis points year over year. Management said recoveries of previously charged-off interest lifted reported margins; excluding those recoveries, margins were 3.46% for Q2 and 3.48% for the first half.
- Other income and expenses: Non-interest income was $26.6 million in Q2 and $50.7 million for the first half, down 10.2% and 13.2%, respectively. Non-interest expense was $55.9 million in Q2, up 1.6%, and $110.3 million for the first half, down 1.3%.
- Balance sheet at June 30: Assets were $7.65 billion, up 1.1% from year-end; total loans were $4.51 billion, up 3.7%; deposits were $6.18 billion, up less than 1%. Stockholders’ equity was $838.5 million, up from $801.6 million.
- Credit quality: Non-performing assets were $97.1 million, or 1.27% of assets, down from $112.2 million, or 1.48%, at year-end. Non-performing loans were $80.7 million. The allowance for loan losses was $78.3 million, 1.74% of period-end loans, versus $85.3 million and 1.96% at year-end.
- Cash flow and liquidity: For the first half, operating cash flow was $30.3 million, investing cash use was $94.2 million and financing cash flow was $32.7 million. Cash and cash equivalents were $503.6 million at June 30, down $31.2 million from year-end. Management said liquidity was adequate and identified no known event expected to materially adversely affect liquidity.
- Funding and debt: Deposits were the primary funding source; non-interest-bearing deposits were $1.53 billion. Securities sold under repurchase agreements were $463.0 million; long-term debt was $36.9 million and subordinated debentures were $82.5 million. The company and bank exceeded regulatory capital requirements; consolidated leverage, Tier 1 risk-based and total risk-based ratios were 10.35%, 15.02% and 16.69%, respectively.
Material changes versus comparable periods
- Q2 net interest income increased modestly, while first-half net interest income declined slightly; lower asset yields were offset by loan growth and lower funding costs.
- Provision for loan losses was a reversal of $2.0 million in Q2 and $7.0 million for the first half, versus provisions of $0.4 million and $0.9 million in the respective 2013 periods. Management attributed the reversals to lower specific and general reserve needs, improved market conditions and lower criticized real estate and construction loans.
- Mortgage origination and sale income fell 36.5% in Q2 and 46.7% for the first half, mainly due to reduced refinancing demand. Total mortgage production declined about 36% in the first half.
- Loan growth was broad, including commercial, indirect consumer and residential lending. The deposit mix continued shifting from higher-cost time deposits toward demand and savings accounts.
- Non-performing assets and criticized loans declined from year-end; however, OREO rose 5.9% to $16.4 million, with about 69% of first-half additions associated with two borrowers.
Outlook, commentary, risks and unusual items
- Outlook: The filing provides no quantified earnings or margin guidance. Management cautioned that interim results are not necessarily indicative of full-year results.
- Acquisition: The company completed its acquisition of Mountain West Financial Corp. on July 31, 2014, after quarter-end, for $38.5 million cash and 1,378,230 Class A shares. Mountain West had approximately $623.4 million in assets, $380.4 million in net loans and $519.8 million in deposits at June 30. The bank merger was expected, subject to regulatory approval, on October 18, 2014.
- Unusual items: The company transferred $396.6 million amortized cost of available-for-sale mortgage-backed securities to held-to-maturity on June 27; associated unrealized losses of $7.8 million will be amortized over an estimated 4.3 years. It also recorded a $7.0 million first-half loan-loss provision reversal and $0.6 million of acquisition-related expense. First-half common dividends totaled $14.1 million ($0.32 per share), and the company repurchased and retired 325,418 Class A shares for $8.1 million.
- Risks and contingencies: Management highlighted regional economic conditions, credit losses and adequacy of reserves, interest-rate changes, funding access, liquidity, regulatory changes, competition, operational and technology risks, litigation and risks of integrating growth and acquisitions. Approximately $1.35 billion of commitments to extend credit and $65.1 million of standby letters of credit were outstanding; these are off-balance-sheet exposures and may not all be drawn. Management did not expect existing litigation to materially affect financial condition, results or liquidity.
- Controls: Management concluded disclosure controls were effective at June 30, 2014, and reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether the Mountain West acquisition and subsequent bank merger deliver expected integration, funding and credit outcomes.
- Whether the large loan-loss provision reversals are sustainable and how credit quality, criticized loans, OREO and the allowance evolve.
- Whether mortgage-related fee income stabilizes after the decline in refinancing activity, and whether loan growth offsets pressure from lower asset yields.
- The impact of the securities transfer, interest-rate movements and deposit-mix changes on future net interest margin and accumulated other comprehensive income.
- Capital, liquidity and share dilution after the acquisition consideration, ongoing dividends and remaining share-repurchase authorization.