First Interstate BancSystem, Inc. — FY 2011 Form 10-K
Reporting period: Fiscal year ended December 31, 2011; comparisons are principally with FY 2010. The filing is an annual report, not a standalone Q4 report. Amounts below are in U.S. dollars.
Business context
First Interstate is a Montana-based bank holding company operating 71 banking offices in Montana, Wyoming and western South Dakota. Its community banking business includes lending, deposits, mortgage services and wealth management. At year-end, consolidated assets were $7.33 billion, deposits $5.83 billion, gross loans $4.19 billion and stockholders’ equity $771 million.
Financial performance and condition
| Metric | FY 2011 / year-end | FY 2010 / year-end |
|---|---|---|
| Net interest income | $250.9 million | $251.4 million |
| Net interest margin, FTE | 3.80% | 3.89% |
| Provision for loan losses | $58.2 million | $66.9 million |
| Net income | $44.5 million | $37.4 million |
| Net income available to common shareholders | $41.1 million; diluted EPS $0.96 | $33.9 million; diluted EPS $0.85 |
| Non-interest income | $91.9 million | $90.9 million |
| Non-interest expense | $218.4 million | $221.0 million |
| Cash and cash equivalents | $472.4 million | $685.6 million |
| Long-term debt | $37.2 million | $37.5 million |
| Subordinated debentures held by subsidiary trusts | $123.7 million | $123.7 million |
Net interest income was nearly flat as lower asset yields and a smaller loan portfolio were largely offset by lower funding costs. Average cost of interest-bearing liabilities fell 37 basis points, while the yield on average earning assets fell 42 basis points. Total assets declined 2.3% to $7.33 billion; gross loans declined 4.2% to $4.19 billion, while investment securities rose 12.2% to $2.17 billion. Deposits declined 1.7%; the mix shifted toward lower-cost demand deposits and away from time deposits. No brokered time deposits were outstanding.
Operating cash flow was $143.1 million; investing cash flow was negative $125.9 million and financing cash flow was negative $230.3 million. Cash and cash equivalents fell by $213.2 million, primarily as liquidity was deployed into securities and deposits and repurchase agreements declined. Securities sold under repurchase agreements totaled $516.2 million. The bank reported $143.1 million of available FHLB capacity, subject to collateral, and a $301.9 million Federal Reserve line secured by indirect consumer loans.
Year-end total non-performing assets were $278.9 million, or 3.81% of assets, versus $244.3 million, or 3.26%, in 2010. Non-performing loans were $241.5 million; allowance for loan losses was $112.6 million, or 46.6% of non-performing loans. Net charge-offs rose to $66.1 million from $49.5 million. The loan portfolio was concentrated in real estate: $2.70 billion, approximately 65% of gross loans. Commercial loans, including commercial real estate, were approximately 54% of loans.
Regulatory capital remained above “well-capitalized” thresholds. At year-end, the bank’s total risk-based capital ratio was 13.8%, Tier 1 risk-based ratio 12.2% and leverage ratio 8.2%. The company’s ratios were 16.5%, 14.6% and 9.8%, respectively. The common dividend was $0.45 per share for 2011; the first-quarter 2012 declared dividend was $0.12 per share.
Material changes versus the prior comparable period
- Net income increased 19.2% and diluted EPS rose to $0.96 from $0.85, though earnings remained below 2009 levels.
- Provision expense fell 13.1%, but credit losses worsened: net charge-offs increased 33.6%, non-performing assets rose 14.2%, and troubled debt restructurings increased to $37.4 million from $13.5 million.
- Criticized loans decreased 15.1% to $630.9 million. Non-performing assets peaked at $292 million in Q2 2011 and ended the year higher than 2010.
- Non-interest expense decreased 1.2%, helped in part by FDIC insurance premiums declining to $7.3 million from $10.0 million. Mortgage servicing rights impairment was $1.3 million, compared with an impairment recovery of $0.8 million in 2010.
- Stockholders’ equity increased 4.6% to $771 million, supported by retained earnings and higher unrealized gains on available-for-sale securities.
Outlook, commentary and risks
- Management expected provisions to continue declining as criticized loans and credit quality improved, while warning that charge-offs would remain high as problem loans worked through the credit cycle. It expected construction loans to continue shrinking. Non-performing assets and provisions remained elevated in the first two months of 2012.
- No specific earnings, revenue or margin guidance was provided. Management noted signs of regional economic recovery, including lower unemployment, but described construction and resort/second-home markets as weak.
- Credit exposure is concentrated in real estate development and commercial real estate. The Flathead, Gallatin Valley and Jackson resort markets accounted for about 43% of non-performing assets and 18% of total loans. Real estate values, borrower performance and collateral appraisals are important uncertainties.
- Net interest income is sensitive to interest rates and deposit repricing. The company’s model projected a decrease of $1.7 million, or less than 1%, in 12-month net interest income under a parallel 2% rate increase; management cautioned that actual outcomes may differ. The company did not use derivatives or hedging activities for interest-rate risk.
- Goodwill was $183.7 million. An interim impairment test at December 31, 2011, following a prolonged decline in bank-stock prices, found no impairment.
- Contingencies include mortgage-sale repurchase provisions on $13.8 million of loans, approximately $1.05 billion of commitments to extend credit and $69.9 million of standby letters of credit. Management did not expect pending litigation to have a material adverse effect. A Visa-related derivative liability was $383, with value dependent on unresolved litigation and related conversion terms.
- The company identified extensive banking regulation, liquidity and funding access, competition, technology/vendor dependence and the ability of the bank subsidiary to pay dividends as risks. The Scott family controlled more than 80% of voting power through the dual-class share structure.
- The independent auditor issued unqualified opinions on the financial statements and internal control over financial reporting. Management also concluded disclosure controls and internal controls were effective at year-end.
Important facts for investors to verify
- Whether non-performing loans, criticized assets, troubled debt restructurings and charge-offs improved after year-end, especially in the resort and land-development markets.
- The adequacy of the $112.6 million loan-loss allowance relative to future collateral values, realized losses and portfolio migration.
- Whether loan demand, deposit mix and funding costs support net interest margin amid low rates and a shrinking loan portfolio.
- Liquidity available after considering pledged securities, repurchase-agreement needs and potential deposit outflows.
- Capital and dividend capacity, including regulatory limits on bank-to-parent distributions and the terms of the preferred stock and subordinated debt.
- Potential exposure from mortgage-sale recourse, credit commitments, the Visa derivative and other contingencies; and the status of the Visa litigation.