First Interstate BancSystem, Inc. — Q2 2013 Form 10-Q
Reporting period: Three and six months ended June 30, 2013. First Interstate is a bank holding company headquartered in Billings, Montana, operating 74 banking offices in Montana, Wyoming and western South Dakota. Unless otherwise noted, amounts below are in millions; income comparisons are year over year and balance-sheet comparisons are with December 31, 2012.
Financial results and condition
| Metric | Q2 2013 / June 30, 2013 | Comparison |
|---|---|---|
| Net income | $21.5; diluted EPS $0.49 | Q2 2012: $13.0; diluted EPS $0.28 |
| Six-month net income | $41.5; diluted EPS $0.95 | First half 2012: $25.2; diluted EPS $0.55 |
| Net interest income | Q2 $58.8; first half $118.0 | Down 3.9% and 3.1%, respectively |
| Net interest margin, FTE | Q2 3.56%; first half 3.55% | Down 18 basis points in both comparisons |
| Non-interest income | Q2 $29.6; first half $58.4 | Up 6.9% and 8.1%, respectively |
| Non-interest expense | Q2 $55.0; first half $111.7 | Down 4.0% and 2.6%, respectively |
| Provision for loan losses | Q2 $0.4; first half $0.9 | Q2 2012: $12.0; first half 2012: $23.3 |
| Total assets | $7,291.5 | Down $430.3, or 5.6% |
| Loans, including held-for-sale mortgages | $4,297.4 | Up $73.5, or 1.7% |
| Deposits | $5,930.3 | Down $310.1, or 5.0% |
| Cash and cash equivalents | $368.2 | Down $433.1, or 54.0% |
| Stockholders’ equity | $770.0 | Up $18.8; AOCI shifted from $16.0 gain to $9.0 loss |
Cash flow, funding and capital
- For the first half, operating cash flow was $56.0 million, investing cash flow was negative $44.6 million, and financing cash flow was negative $444.4 million. Financing outflows included a $50.0 million preferred-stock redemption, a $310.1 million net deposit decline, and lower repurchase-agreement balances.
- Long-term debt was $37.1 million and subordinated debentures were $82.5 million at quarter-end. Repurchase agreements were $421.3 million. The filing does not report a single aggregate debt figure in its discussion.
- Consolidated regulatory capital ratios were 9.73% leverage, 14.45% Tier 1 risk-based, and 16.29% total risk-based. The bank subsidiary exceeded applicable “well-capitalized” thresholds.
- Management said liquidity is supported by cash, securities, core deposits and access to other funding sources, and reported no known event expected to materially impair liquidity. The company generally funds loans with customer deposits and reports minimal reliance on wholesale funding.
Material changes and management commentary
- Earnings improved substantially as the much lower loan-loss provision and lower operating expenses more than offset lower net interest income. The provision decline reflected improved and stabilizing credit quality, economic trends and unusually high recoveries of previously charged-off loans.
- Non-performing assets declined to $128.3 million, or 2.97% of loans and OREO, from $142.6 million, or 3.35%, at year-end. Non-performing loans were $105.5 million; OREO was $22.8 million. Criticized loans fell to $406.4 million from $467.6 million.
- Net charge-offs were negative $0.25 million in Q2, meaning recoveries exceeded charge-offs; first-quarter net charge-offs were $3.1 million. The allowance was $98.5 million, or 2.29% of period-end loans.
- Loan growth was concentrated in residential real estate and consumer lending. Commercial and commercial real estate balances declined, which management attributed to weak demand and lower-quality loans exiting through payoff, charge-off or foreclosure.
- Interest income pressure reflected lower yields on loans and securities. Lower funding costs and higher average loan and investment balances partly offset the decline. Mortgage-sale income and wealth management revenues increased.
- OREO sales generated a $2.7 million net gain in the first half; OREO declined by $9.8 million. The company also recorded $2.6 million of OREO fair-value write-downs in the first half.
- Available-for-sale securities had a $35.6 million pretax unrealized loss in Q2, contributing to a $21.6 million after-tax comprehensive loss for the quarter despite positive net income. Management attributed unrealized losses primarily to interest-rate movements and said it did not intend, nor expect, to be required, to sell the affected securities before recovery.
Outlook, risks and contingencies
- No earnings or financial guidance was provided. Management cautioned that first-half results are not necessarily indicative of full-year 2013 results.
- The company’s initial analysis indicated it would meet fully phased-in Basel III capital adequacy requirements; the new minimum capital rules were expected to apply beginning January 1, 2015, with the capital conservation buffer phased in later.
- A shelf registration allows potential issuance of up to $160 million of Class A common shares. The company reported no specific use of proceeds or current offering plan.
- Key disclosed risks include economic weakness in its regional markets, real-estate and commercial credit exposure, allowance adequacy, interest-rate changes, funding access and liquidity, regulation, competition, operational and technology risks, and the ability of the bank subsidiary to pay dividends.
- Management said ordinary-course claims and litigation were not expected to materially affect financial condition, results or liquidity. The filing reported no material changes to previously disclosed risk factors or legal proceedings.
- The board declared a $0.14-per-share quarterly common dividend on July 25, payable August 15, 2013. Disclosure controls were assessed as effective; no material change in internal control over financial reporting was reported.
Important facts for investors to verify
- Whether lower credit costs and improving non-performing-asset trends persist, and whether the $98.5 million allowance remains adequate as economic and collateral conditions change.
- Whether loan-yield pressure and the 18-basis-point decline in net interest margin continue, particularly if interest rates rise and securities duration extends.
- What drove the $310.1 million first-half deposit decline and $433.1 million decline in cash, and whether liquidity and funding remain adequate.
- The sensitivity of equity and reported comprehensive income to further changes in available-for-sale securities values; unrealized losses increased significantly during the period.
- Potential dilution or capital effects if the company uses its $160 million shelf registration, and the effect of Basel III implementation on capital requirements.
- Credit commitments totaled approximately $1.11 billion, with $71.0 million of standby letters of credit; outstanding commitments are not necessarily expected to be drawn in full.