First Interstate BancSystem, Inc. — Q1 2018 Form 10-Q
Business context and reporting period. Unaudited results cover the three months ended March 31, 2018. First Interstate is a regional community bank operating 127 offices across Idaho, Montana, Oregon, South Dakota, Washington and Wyoming. Its financial statements include the May 2017 acquisition of Cascade Bancorp (Bank of the Cascades); consequently, year-over-year comparisons reflect the acquired business as well as organic activity.
Key financial metrics
| Metric | Q1 2018 | Comparable period / balance |
|---|---|---|
| Net interest income | $99.8 million | $68.9 million in Q1 2017 |
| Net interest margin | 3.75% FTE | 3.49% in Q1 2017; 3.71% in Q4 2017 |
| Non-interest income | $35.2 million | $29.1 million in Q1 2017 |
| Non-interest expense | $85.9 million | $63.7 million in Q1 2017 |
| Net income / diluted EPS | $36.7 million / $0.65 | $23.2 million / $0.51 in Q1 2017 |
| Cash and cash equivalents | $744.2 million | $758.9 million at Dec. 31, 2017 |
| Total assets | $12.27 billion | $12.21 billion at Dec. 31, 2017 |
| Total loans / deposits | $7.65 billion / $10.03 billion | $7.61 billion / $9.93 billion at Dec. 31, 2017 |
| Stockholders’ equity | $1.43 billion | $1.43 billion at Dec. 31, 2017 |
Operating cash flow was $63.4 million; investing activities used $126.7 million and financing activities provided $48.6 million. Cash and cash equivalents declined $14.7 million during the quarter. Period-end debt included $15.7 million of long-term debt and $82.5 million of subordinated debentures; securities sold under repurchase agreements were $633.8 million. The company repaid $20.0 million of other borrowed funds.
Regulatory capital remained above well-capitalized thresholds: consolidated total risk-based capital was 12.90%, common equity tier 1 was 11.15%, and leverage was 9.07%. The bank subsidiary’s corresponding ratios were 12.25%, 11.41%, and 8.55%.
Changes versus prior comparable period
- Net income rose 58% from Q1 2017, while diluted EPS increased from $0.51 to $0.65. Results benefited from the Cascade acquisition, loan growth, higher asset yields, and a lower effective tax rate (22.1% versus 29.1%, primarily reflecting the Tax Cuts and Jobs Act).
- Net interest income increased 45% year over year; management attributed the increase principally to acquired and organic loan balances. Higher loan and investment yields helped, partly offset by higher funding costs. Acquired-loan fair-value accretion contributed $3.1 million to interest income, including $1.1 million from early payoffs.
- Non-interest income increased 21%, led by payment services and deposit fees; mortgage banking revenue declined 17%, with management citing weaker refinancing demand.
- Non-interest expense increased 35%, reflecting the expanded Cascade branch network, staffing and operating costs, core deposit intangible amortization, and $2.3 million of acquisition-related costs (versus $0.7 million a year earlier). The efficiency ratio was 62.3%, versus 64.4% in Q1 2017.
- Loans grew $2.25 billion year over year, primarily due to Cascade, but increased only $32.5 million from year-end 2017. Deposits rose 0.9% from year-end.
Outlook, risks, contingencies and unusual items
- No formal earnings or financial guidance was provided. Management stated that results for the quarter are not necessarily indicative of full-year results and continues to evaluate acquisitions and other strategic opportunities.
- On April 25, 2018, the company announced an all-stock agreement to acquire Northwest Bancorporation, parent of Inland Northwest Bank, for approximately $160.9 million. Closing was expected in late Q3 or early Q4 2018, subject to regulatory and shareholder approvals.
- Asset quality improved from year-end: non-performing assets were $77.8 million, or 0.63% of assets, versus $82.6 million; criticized loans were $396.5 million versus $400.5 million. The allowance for loan losses was $73.5 million, or 0.96% of loans, compared with 0.95% at year-end and 1.41% in Q1 2017. Management cautioned that economic deterioration or weaker credit quality could require additional provisions.
- Available-for-sale securities had $46.3 million of gross unrealized losses at quarter-end; management attributed losses to interest-rate changes, reported no impairment charges, and said it intended and expected to be able to hold securities until recovery. Other comprehensive loss was $17.2 million after tax, mainly from securities valuation changes.
- Off-balance-sheet commitments to extend credit were approximately $2.22 billion, including $656.7 million of unused credit-card lines; standby letters of credit were $50.2 million. Sold mortgage loans with recourse provisions still in effect totaled $0.6 million. Management did not expect existing litigation to materially affect financial condition, results or liquidity.
- Key stated risks include regional economic weakness, credit and interest-rate exposure, integration and execution of acquisitions, funding and liquidity, regulatory requirements, cybersecurity, technology/vendor dependence, and potential goodwill impairment. Management reported effective disclosure controls and no material change in internal control over financial reporting.
Most important facts for investors to verify
- How much of earnings and net interest margin growth is sustainable after separating Cascade-related balances and acquired-loan accretion from organic performance.
- Whether expense growth and the 62.3% efficiency ratio improve as acquisition integration costs and expanded-network operating costs change.
- Credit trends, including non-performing and criticized loans, charge-offs, and whether the 0.96% allowance remains adequate as acquired loans season.
- Interest-rate effects on deposit costs, net interest margin, and the fair value of the securities portfolio; monitor the unrealized losses and accumulated other comprehensive loss.
- Regulatory and shareholder approvals, closing timing, consideration and integration risks for the proposed Inland Northwest Bank acquisition, along with its effects on capital and future expenses.