First Interstate BancSystem, Inc. — FY2018 Form 10-K
Reporting period: Year ended December 31, 2018; includes unaudited fourth-quarter results. First Interstate is a regional community bank headquartered in Billings, Montana, operating 147 banking offices across six states. All figures are consolidated and in U.S. dollars unless stated otherwise.
Financial performance and condition
| Metric | FY2018 / year-end 2018 | FY2017 / year-end 2017 |
|---|---|---|
| Total assets | $13.30 billion | $12.21 billion |
| Total loans | $8.50 billion | $7.61 billion |
| Deposits | $10.68 billion | $9.93 billion |
| Net interest income | $432.5 million | $349.8 million |
| Net interest margin, FTE | 3.88% | 3.64% |
| Non-interest income | $143.3 million | $141.8 million |
| Non-interest expense | $360.9 million | $323.9 million |
| Net income | $160.2 million | $106.5 million |
| Diluted EPS | $2.75 | $2.05 |
| Return on average assets | 1.27% | 0.98% |
| Efficiency ratio | 61.31% | 64.77% |
| Common stockholders’ equity | $1.69 billion | $1.43 billion |
Net interest income increased 23.6%; management attributed the gain principally to acquired and organic loan growth, higher asset yields, acquired-loan interest accretion and recoveries of previously charged-off interest. The average cost of interest-bearing liabilities rose to 0.51% from 0.39%, reflecting higher deposit rates. Loan growth was 11.7%, including $713.1 million of INB-acquired loans; excluding INB, loans grew organically 2.3%. Deposit growth was 7.5%, including $696.3 million from INB.
Credit indicators improved: non-performing loans were $58.1 million, or 0.68% of loans, versus $72.5 million, or 0.95%, a year earlier. Net charge-offs were $7.7 million, or 0.10% of average loans, versus $15.1 million, or 0.23%. The allowance for loan losses was $73.0 million, 0.86% of loans, compared with $72.1 million, 0.95%; the lower coverage ratio partly reflects acquired loans initially recorded at fair value without a transferred allowance.
Operating cash flow was $220.2 million, investing cash outflow was $182.3 million, financing cash inflow was $25.2 million, and cash and cash equivalents increased $63.1 million to $822.0 million. The loan-to-deposit ratio was 79.62%, versus 76.64%. Deposits remained the primary funding source; year-end repurchase agreements were $712.4 million. Long-term debt was $15.8 million and subordinated debentures were $86.9 million; no FHLB advances were outstanding, and approximately $1.40 billion of FHLB borrowing capacity was available subject to collateral. Regulatory capital ratios exceeded fully phased-in requirements: consolidated CET1 11.40%, Tier 1 12.26%, total capital 12.99%, and leverage 9.47%.
Material changes and notable items
- Completed the $176.3 million acquisition of Northwest Bancorporation/INB in August 2018, issuing approximately 3.84 million Class A shares and paying about $3.0 million cash for warrants. INB integration was completed in November. The preliminary purchase allocation included $101.1 million of goodwill and remained subject to valuation finalization.
- Signed agreements to acquire Idaho Independent Bank, valued at approximately $181.3 million, and Community 1st Bank, valued at approximately $21.5 million. Both all-stock transactions were expected to close and convert systems in the second quarter of 2019, subject to shareholder and regulatory approvals.
- Acquisition-related expense was $12.4 million, down from $27.2 million in 2017; total non-interest expense nevertheless increased 11.4%, including higher staffing, benefits, technology, and integration costs. Reported EPS included an after-tax acquisition-cost impact of $0.17 in 2018.
- The effective federal tax rate was 17.1%, versus 27.2% in 2017, reflecting the lower federal rate under the Tax Cuts and Jobs Act and tax credits, among other factors. FY2017 included a deferred-tax remeasurement effect.
- Mortgage banking revenue declined 13.8% to $24.9 million amid weaker refinancing demand and lower gain-on-sale margins. Payment-services revenue was flat at $43.3 million; management reported a $6.5 million reduction in 2018 attributable to the Durbin Amendment beginning July 1.
- Goodwill rose to $546.7 million, or 32.3% of stockholders’ equity. The annual impairment assessment found no impairment. Available-for-sale securities had $20.0 million of gross unrealized losses on securities in a continuous loss position for more than 12 months, primarily attributed to interest rates; no impairment loss was recorded.
- Quarterly net income was $40.4 million in Q4 2018 versus $34.2 million in Q4 2017; diluted EPS was $0.67 versus $0.61. Q4 2018 net interest income was $118.9 million and non-interest expense was $99.4 million.
Outlook, risks, and contingencies
The filing provides no formal earnings or revenue guidance. Management describes a strategy of disciplined organic growth and selective expansion, with customer deposits as the principal funding source. It reported no known event expected to materially adversely affect liquidity or capital, and said the company met well-capitalized standards.
- Key exposures include commercial real estate and commercial lending, regional economic conditions, interest-rate and deposit-cost changes, and borrower sensitivity to agriculture, construction, energy, and real estate cycles. Commercial real estate and commercial business loans together represented approximately 52.9% of the loan portfolio.
- Direct oil-and-gas exposure was approximately $78.2 million in commitments, including $61.8 million advanced; 52.1% of outstanding oil-and-gas loans were criticized. Management also cited potential regional effects from coal-market weakness and trade tariffs.
- Acquisition integration, realization of expected benefits, potential customer or employee attrition, and the pending Idaho transactions’ approvals and execution remain uncertainties.
- Other material risks discussed include LIBOR’s anticipated cessation after 2021 and transition to alternative rates, cybersecurity and third-party service disruptions, competition, liquidity access, regulatory burdens, and possible goodwill impairment. The company was evaluating CECL, effective for it January 1, 2020, but could not reasonably estimate its impact; it could increase credit-loss allowances and affect capital.
- Commitments to extend credit totaled $2.62 billion and standby letters of credit $46.7 million at year-end. Management considered litigation exposure not material; the filing reports no material legal proceeding expected to adversely affect the company.
- Management and the auditor reported effective internal control over financial reporting and an unqualified financial-statement audit opinion. The INB subsidiary, representing about 6% of consolidated assets at merger, was excluded from the 2018 internal-control assessment and audit scope.
Most important facts for investors to verify
- How much of earnings and margin improvement came from sustainable organic growth versus acquisitions, acquired-loan accretion, and recoveries of charged-off interest.
- Whether INB integration and the planned Idaho acquisitions close on schedule, meet expected financial benefits, and avoid meaningful dilution or added costs.
- Credit quality and reserve adequacy, particularly criticized energy loans, commercial real estate concentrations, and the rise in OREO to $14.4 million.
- Deposit pricing, funding mix, and net interest margin sensitivity as rates and competition change; management’s model estimated a 0.42% increase in one-year net interest income under an immediate 100-basis-point rate increase.
- The eventual CECL allowance and capital impact, and the completion of purchase-accounting valuations, including the provisional INB goodwill and acquired-loan marks.
- Execution of LIBOR contract remediation and control integration following the INB acquisition, given the stated transition and excluded-control-scope risks.