First Interstate BancSystem, Inc. — Q3 2011 Form 10-Q
Business context and reporting period. The company is a Montana-based bank holding company operating 71 banking offices in Montana, Wyoming and western South Dakota. This unaudited filing covers the quarter and nine months ended September 30, 2011; balance-sheet comparisons are with December 31, 2010. Dollar amounts below are in millions unless stated otherwise.
Financial performance and position
- Q3 earnings: Net income was $11.9 million, up from $8.7 million in Q3 2010; net income available to common shareholders was $11.1 million, or $0.26 per share, versus $7.9 million, or $0.18 per share.
- Nine-month earnings: Net income was $31.3 million, compared with $26.5 million in 2010; diluted EPS was $0.67 versus $0.61.
- Revenue and margins: Q3 net interest income was $63.5 million and non-interest income $23.1 million; nine-month amounts were $187.8 million and $64.9 million, respectively. Fully taxable-equivalent net interest margin was 3.84% for Q3 and 3.80% year to date, down 5 and 15 basis points, respectively, from 2010.
- Credit costs: Loan-loss provision was $14.0 million in Q3 and $44.4 million for nine months, down from $18.0 million and $49.4 million in comparable 2010 periods. Q3 net charge-offs were $18.3 million, versus $12.1 million a year earlier.
- Assets and loans: Total assets were $7.307 billion, down 2.6% from year-end 2010. Total loans were $4.276 billion, down 2.1%; net loans were $4.155 billion. The allowance for loan losses was $120.3 million, or 2.81% of period-end loans.
- Credit quality: Non-performing assets were $287.7 million, or 6.69% of loans and OREO, versus $244.3 million and 5.55% at year-end 2010. Non-accrual loans increased to $224.0 million from $195.3 million. Total criticized loans declined to $701.0 million from $742.9 million. Troubled debt restructurings totaled $119.6 million, including $84.0 million on non-accrual status; the filing reports approximately 92% of the $35.6 million accruing TDR balance was performing to modified terms.
- Funding and liquidity: Deposits were $5.851 billion, down 1.3%; non-interest-bearing deposits rose to $1.244 billion from $1.064 billion, while time deposits declined. Repurchase agreements fell to $475.5 million from $620.2 million. Cash and equivalents were $504.2 million, down from $685.6 million at year-end. Management stated it knew of no events expected to materially harm liquidity.
- Cash flow, nine months: Operating activities provided $99.4 million, investing activities used $45.1 million and financing activities used $235.7 million; cash and equivalents declined by $181.4 million. In 2010, the corresponding cash flows were +$82.0 million, −$321.9 million and +$158.7 million.
- Debt and capital: Long-term debt was $37.5 million and trust-preferred subordinated debentures were $123.7 million; repurchase agreements and other borrowed funds were $475.5 million and $5.1 million. Stockholders’ equity was $768.0 million, up 4.2%. Consolidated total risk-based, Tier 1 risk-based and leverage capital ratios were 16.3%, 14.3% and 9.8%; the bank exceeded well-capitalized thresholds.
Material changes and management commentary
- Earnings improved despite slightly lower net interest income and a lower margin. Lower funding costs and reduced non-interest expense helped offset lower loan interest income; reduced loan-loss provision also supported earnings.
- Management attributed margin pressure to weaker loan demand and lower yields on loans and securities, partly offset by lower funding costs and more non-interest-bearing funding.
- Loan balances contracted, particularly construction and other real estate lending; residential real estate loans increased. Management cited sluggish economic conditions, lower construction activity and problem-loan exits as factors.
- Non-performing assets edged down from Q2 2011 but remained materially above year-end 2010. Management said charge-offs could remain elevated in coming quarters and expected provisions to decline as credit quality improved. These are expectations, not guarantees.
- About 43% of non-performing assets were in the Flathead, Gallatin Valley and Jackson market areas, compared with 18% of total loans. Management identified depressed real estate values and limited sales activity as continuing concerns.
- FDIC insurance premiums declined following a rule change effective April 1, 2011. The company said debit-card interchange restrictions did not apply to it because it was below the $10 billion asset threshold.
- The annual goodwill impairment test passed Step 1 as of July 1, 2011. Management said it would consider an interim test if adverse market indicators persisted. No investment-security impairment losses were recorded; unrealized losses were primarily attributed to interest-rate fluctuations.
- The company declared a quarterly common dividend of $0.1125 per share, payable October 17, 2011. Management reported no material subsequent events, no material legal-proceeding changes and no material changes in risk factors.
Risks, contingencies and controls
- Principal disclosed risks include credit losses, real estate and commercial-loan concentrations, allowance adequacy, local economic conditions, interest-rate changes, funding access, regulatory changes, liquidity, technology/vendor dependence and capital requirements.
- Off-balance-sheet commitments included approximately $1.013 billion of commitments to extend credit and $74.1 million of standby letters of credit. These amounts do not necessarily represent expected cash outflows.
- Management, after consulting legal counsel, did not expect pending claims and litigation to materially adversely affect financial condition, results or liquidity. Construction-contract commitments were $4.5 million.
- Management concluded disclosure controls were effective as of September 30, 2011; no materially affecting changes in internal control were reported for the quarter.
Important facts for investors to verify
- Whether non-performing loans, TDRs and net charge-offs continue to improve, and whether the allowance remains adequate against the portfolio’s risk profile.
- Exposure and collateral valuations in the Flathead, Gallatin Valley and Jackson markets, which represented a disproportionate share of problem assets.
- Drivers of the declining net interest margin and the pace of loan growth, deposit mix changes and funding costs.
- Cash and liquidity trends, including deposit outflows, repurchase-agreement balances and the effect of customer credit commitments if drawn.
- Whether management’s expectations for lower provisions and the dividend remain supportable under changing economic and credit conditions.