First Interstate BancSystem, Inc. — FY2017 Form 10-K
Reporting period: Fiscal year ended December 31, 2017; comparisons are primarily with FY2016. The company is a Montana-based community banking holding company operating 126 offices in six states. Financial results include Bank of the Cascades from its May 30, 2017 acquisition date.
Financial performance and position
| Metric | FY2017 / year-end 2017 | FY2016 / year-end 2016 |
|---|---|---|
| Total assets | $12.21 billion | $9.06 billion |
| Loans, net | $7.54 billion | $5.40 billion |
| Deposits | $9.93 billion | $7.38 billion |
| Net interest income | $349.8 million | $279.8 million |
| Net interest margin (FTE) | 3.64% | 3.57% |
| Non-interest income | $141.8 million | $136.5 million |
| Non-interest expense | $323.8 million | $261.0 million |
| Net income | $106.5 million | $95.6 million |
| Diluted earnings per share | $2.05 | $2.13 |
| Operating cash flow | $154.7 million | $118.1 million |
| Cash and cash equivalents | $759.0 million | $782.0 million |
| Common stockholders’ equity | $1.43 billion | $982.6 million |
FY2017 income before taxes was $156.7 million; income tax expense was $50.2 million. The reported efficiency ratio was 64.77%, up from 61.88%. Return on average assets was 0.98%, versus 1.10%; return on average common equity was 8.57%, versus 9.93%.
Provision for loan losses was $11.1 million; net charge-offs were $15.2 million, or 0.23% of average loans. Non-performing loans were $72.5 million (0.95% of loans), down from $76.6 million (1.40%). The allowance was $72.1 million, or 0.95% of loans, versus $76.2 million, or 1.39%.
Year-end regulatory capital ratios remained above applicable requirements: consolidated common equity Tier 1 was 11.04%, Tier 1 capital 11.93%, total risk-based capital 12.76%, and leverage 8.86%. Long-term debt was $13.1 million; subordinated debentures were $82.5 million. The company also had $643.0 million of repurchase agreements, generally due the next business day.
Material changes and unusual items
- Assets grew 34.7%, mainly from the $541.0 million Cascade Bancorp acquisition, completed May 30, 2017. Approximately $3.04 billion of assets, $2.67 billion of deposits and $2.08 billion of loans were acquired. Integration was completed August 11.
- Loans increased 39.0%, but organic loan growth was only 0.8% for the year. Deposits increased 34.7%, primarily from the acquisition. The company issued about 11.3 million Class A shares, valued at $386.0 million, as part of the purchase consideration.
- Net interest income rose 25.0%, reflecting acquired and organic loan balances, higher asset yields, acquired-loan accretion and recoveries of charged-off interest. Higher funding costs partly offset these gains. FY2017 included $10.7 million of acquired-loan accretion and $5.6 million of recovered charged-off interest.
- Non-interest expense increased 24.1%, including $27.2 million of acquisition-related costs, versus $2.8 million in 2016. Net income rose, but diluted EPS declined as the weighted-average share count increased substantially following the acquisition.
- Non-interest income included a one-time $3.0 million gain from selling Health Savings Account custodial rights. Mortgage banking revenue declined 22.3% to $28.9 million as refinancing softened. Payment-services revenue rose 25.9% to $43.3 million, partly due to the acquisition.
- The 2017 tax expense reflects the Tax Cuts and Jobs Act, including a provisional $2.2 million benefit from remeasuring deferred taxes for the federal rate reduction to 21% effective in 2018. The company reported $2.6 million of tax benefits from stock-based compensation.
- Fourth-quarter net income was $34.2 million and diluted EPS was $0.61, compared with $24.8 million and $0.55 in Q4 2016. The company paid $0.24 per share in each 2017 quarter and declared a subsequent quarterly dividend of $0.28 per share.
Outlook, commentary and risks
The filing provides no specific earnings or revenue guidance. Management describes a strategy of disciplined organic growth and selective expansion. It states that liquidity and capital are adequate and that it knows of no event reasonably likely to materially harm liquidity, capital resources or operations.
- Regulatory costs and interchange: Assets exceeded $10 billion in 2017, triggering enhanced regulatory requirements. Management expects the Durbin Amendment to reduce annual interchange revenue by approximately $11.5 million, including an estimated $5.8 million impact in the second half of 2018.
- Energy exposure: Direct oil-and-gas loans were about $75.6 million, with $17.7 million of additional commitments; 67.6% of outstanding oil-and-gas loans were criticized. Weak energy activity and coal demand could affect regional economies and collateral values.
- Credit and concentration: Commercial loans, including commercial real estate, were approximately 52.6% of the loan portfolio. Deteriorating local economies, real estate values or borrower cash flows could increase losses and provision needs.
- Interest-rate and funding risk: Earnings depend heavily on net interest income. Deposit repricing, competition for deposits and changes in rates could pressure margins. The company’s model estimated a 1.30% increase in 12-month net interest income under a gradual 0.5% rate increase, but this is not a forecast; management did not model a rate decrease.
- Acquisition and accounting risks: Integration benefits and cost savings are not assured. Goodwill rose to $444.7 million after the acquisition; management reported no impairment in its 2017 test. The company was evaluating the future CECL credit-loss standard, effective for it in 2020, which could change allowance requirements.
- Other risks: The filing identifies cybersecurity, third-party technology providers, regulation, liquidity, competition and litigation as risks. Management did not expect ordinary-course litigation to have a material adverse effect. The auditor issued unqualified opinions on the financial statements and internal control over financial reporting.
Investor verification priorities
- Separate Cascade’s acquired contribution from organic growth, particularly for loans, deposits, revenue and expenses; assess whether integration benefits materialize after the reported $27.2 million acquisition costs.
- Track net interest margin and funding costs as rates and deposit competition change, and verify the realized Durbin Amendment impact against management’s estimates.
- Review energy-sector criticized credits, commercial real estate concentrations, charge-offs and allowance adequacy; note that acquired loans were initially recorded at fair value without a carried-over allowance.
- Monitor goodwill and acquired-loan fair-value accretion, including potential impairment or reductions in expected cash collections.
- Assess the effects of share issuance on per-share earnings, capital ratios and future dividend capacity; consider the Scott family’s reported 73.6% voting control.