FIBK

Business Context and Reporting Period

Company: First Interstate BancSystem, Inc.
Filing Type: Form 10-Q (Unaudited)
Period Ended: March 31, 2008
Overview: The Company operates two primary segments: Community Banking and Technology Services. The reporting period is significantly impacted by the acquisition of The First Western Bank Sturgis, First Western Bank, and First Western Data, Inc. on January 10, 2008, which expanded the Company's presence in South Dakota.

Key Financial Metrics

Material Changes vs. Prior Period

• Acquisition Impact: The First Western acquisition drove a 20.5% increase in total assets and a 23.2% increase in total loans. Approximately $731 million of loan growth and $796 million of deposit growth is attributable to the acquired entities.
• Profitability: Net income increased 4.9% year-over-year. Diluted earnings per share rose 8.6% to $2.14.
• Interest Margin Compression: Despite a 17 basis point increase in the interest rate spread, the Net FTE Interest Margin decreased from 4.46% to 4.29%. This was caused by the deployment of funds into non-earning assets (goodwill, core deposit intangibles) related to the acquisition and a lower percentage of free funding sources.
• Expense Growth: Noninterest expenses rose 23.9% to $53.2 million. Significant drivers included a $3.6 million impairment charge on mortgage servicing rights (up from $0.8 million in 2007) and $4.3 million in higher salary and benefit costs.
• Asset Quality: Non-performing assets increased 65.1% to $58.9 million, primarily due to the acquisition. However, the allowance for loan losses to total loans ratio remained stable at 1.56%.

Guidance, Outlook, and Risks

• Management Commentary: Management notes that local economies in Montana, Wyoming, and South Dakota have not been as severely impacted by the national subprime crisis as other regions. However, they highlight that future provisions for loan losses are subject to ongoing evaluation of portfolio risks.
• Unusual Items:
  • Visa Gain: A one-time $1.6 million gain was recorded from the mandatory redemption of Class B Visa shares.
  • iPay Gain: A non-recurring $1.1 million gain resulted from the release of escrowed funds from a prior sale.
  • Impairment: A $3.6 million charge was recorded for mortgage servicing rights impairment due to changes in prepayment speeds and discount rates.
• Risk Factors: Key risks include credit risk, concentrations of real estate loans, commercial loan risk, economic conditions in the operating states, and the ability to integrate the First Western operations. The Company also faces risks related to Visa indemnification obligations and potential litigation.
• Capital: The Company exceeded "well-capitalized" requirements. Equity increased by $60 million, largely due to the issuance of $50 million in Series A Preferred Stock to fund the acquisition.

Investor Verification Checklist

• Acquisition Integration: Verify the progress of integrating First Western entities and the realization of expected synergies.
• Asset Quality Trends: Monitor the trajectory of non-performing assets and the adequacy of the allowance for loan losses, particularly regarding the acquired loan portfolio.
• Mortgage Servicing Rights: Assess the sensitivity of mortgage servicing rights valuation to changes in interest rates and prepayment speeds, given the significant impairment charge in Q1.
• Net Interest Margin: Track whether the margin compression caused by the acquisition's non-earning assets stabilizes as the portfolio matures.
• Debt Covenants: Review compliance with covenants in the new $59 million syndicated credit agreement and $20 million subordinated term loan used to fund the acquisition.