Business Context and Reporting Period
Company: First Interstate BancSystem, Inc.
Reporting Period: Fiscal year ended December 31, 2008.
Business Overview: A financial and bank holding company headquartered in Billings, Montana, operating 70 banking offices across Montana, Wyoming, and South Dakota. The company primarily engages in community banking, offering commercial, consumer, agricultural, and real estate loans, as well as deposit and wealth management services.
Key Strategic Events:
- Acquisition: Completed the acquisition of First Western Bancorp entities in January 2008, expanding into western South Dakota.
- Disposal: Sold its technology services subsidiary, i_Tech Corporation, to Fiserv Solutions Inc. on December 31, 2008, resulting in a one-time gain of $27.1 million (pre-tax).
Key Financial Metrics
| Metric | 2008 | 2007 |
|---|---|---|
| Total Assets | $6.63 billion | $5.22 billion |
| Total Loans | $4.77 billion | $3.56 billion |
| Total Deposits | $5.17 billion | $4.00 billion |
| Net Interest Income | $235.4 million | $199.6 million |
| Net Interest Margin (FTE) | 4.25% | 4.46% |
| Provision for Loan Losses | $33.4 million | $7.8 million |
| Net Income | $70.6 million | $68.6 million |
| Net Income Available to Common Shareholders | $67.3 million | $68.6 million |
| Diluted EPS | $8.38 | $8.25 |
| Stockholders' Equity | $539.1 million | $444.4 million |
| Allowance for Loan Losses | $87.3 million (1.83% of loans) | $52.4 million (1.47% of loans) |
Material Changes vs. Prior Period
- Asset Growth: Total assets increased 27.1% to $6.63 billion, driven primarily by the First Western acquisition ($913 million in assets) and organic loan growth.
- Credit Quality Deterioration: Non-performing assets increased 171.7% to $96.9 million (2.03% of total loans and OREO) from $35.7 million in 2007. This was largely due to deterioration in real estate development loans.
- Provision Increase: The provision for loan losses surged 330.4% to $33.4 million, reflecting the impact of the recession and higher levels of non-performing assets.
- Net Interest Margin Compression: Net FTE interest margin decreased 21 basis points to 4.25%, attributed to the acquisition of non-earning assets (goodwill) and lower federal funds rates.
- One-Time Gain: Reported net income included a $17.0 million after-tax gain from the sale of i_Tech. Excluding this gain, net income decreased 26.7% from 2007.
- Debt Levels: Long-term debt increased significantly to $84.1 million from $5.1 million to finance the First Western acquisition.
Guidance, Outlook, and Risks
Management Commentary:
- Management expects credit quality deterioration and higher levels of non-performing loans to continue in 2009 due to the national recession and local economic slowdowns.
- The company is focusing on building capital, improving liquidity, and managing loan quality.
- FDIC insurance premiums are expected to increase significantly in 2009, with a potential special assessment of 20 basis points estimated to cost approximately $10.4 million.
- Net interest income sensitivity modeling suggests a 2% increase in short-term rates would decrease net interest income by less than 1%.
- The company has applied for participation in the TARP Capital Purchase Program but had not received a decision as of the filing date.
- Credit Risk: High concentration in real estate loans (65% of portfolio) and commercial loans (49% of portfolio) exposes the company to declining collateral values and borrower defaults.
- Liquidity Risk: Potential inability to meet cash flow requirements if funding sources become unavailable or expensive.
- Regulatory Risk: Potential failure to meet debt covenants related to non-performing assets, which were waived in October 2008 but remain a concern.
- Market Risk: Sensitivity to interest rate changes and the soundness of other financial institutions.
Investor Verification Checklist
- Credit Quality Trends: Verify the trajectory of non-performing assets and the adequacy of the allowance for loan losses given the 171% increase in non-performing assets.
- Debt Covenant Compliance: Confirm ongoing compliance with amended debt covenants related to non-performing assets and capital ratios.
- TARP Application Status: Determine if the company was accepted into the TARP Capital Purchase Program and the terms of participation.
- FDIC Assessment Impact: Assess the financial impact of the proposed 20 basis point special assessment and increased base rates on 2009 earnings.
- Real Estate Exposure: Analyze the specific concentration of risk within the $3.1 billion real estate loan portfolio, particularly in land development.
- Stock Liquidity: Note that common stock is not publicly traded and 91% of shares are subject to contractual transfer restrictions.