First Interstate BancSystem, Inc. — 10-Q Summary
Reporting period: Quarter and nine months ended September 30, 2014. Unaudited consolidated results; financial amounts below are in millions unless otherwise noted.
Business context
First Interstate is a regional bank holding company headquartered in Billings, Montana, operating banking offices in Montana, Wyoming and western South Dakota. Its core business is lending and deposit-taking, supplemented by mortgage, wealth management and fee-based services. The company completed its acquisition of Mountain West Financial Corp. (MWFC) on July 31, 2014; MWFC’s bank was merged into First Interstate Bank on October 17, after quarter-end.
Financial performance and condition
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Net interest income | $65.1 | $59.0 | $182.9 | $177.0 |
| Net interest income, fully taxable equivalent (FTE) | $66.1 | $60.1 | $186.2 | $180.4 |
| Provision (reversal) for loan losses | $0.3 | $(3.0) | $(6.7) | $(2.1) |
| Non-interest income | $29.4 | $27.6 | $80.0 | $86.0 |
| Non-interest expense | $65.0 | $52.6 | $175.2 | $164.3 |
| Net income | $19.2 | $23.8 | $61.6 | $65.4 |
| Diluted EPS | $0.42 | $0.54 | $1.37 | $1.49 |
Q3 FTE net interest margin was 3.55%, versus 3.52% a year earlier; excluding acquired-loan early-payoff accretion and recoveries of previously charged-off interest, management reported 3.47%. The nine-month FTE margin was 3.54%, unchanged year over year, or 3.47% excluding those items, compared with 3.53%.
At September 30, assets were $8.48 billion, up 12.1% from year-end 2013; loans were $4.85 billion, up 11.7%, and deposits were $6.96 billion, up 13.5%. The acquisition contributed approximately $360 million of loans and $515 million of deposits. Excluding the acquisition, loans rose 3.4% and deposits rose 5.1%.
Cash and cash equivalents were $820.0 million, versus $534.8 million at December 31, 2013. For the first nine months, operating cash flow was $64.2 million, investing cash flow used $26.9 million and financing activities provided $247.9 million. Deposits were the principal funding source; management said it primarily uses core customer deposits and has limited reliance on wholesale funding. The filing reports no numerical forward guidance.
Total liabilities were $7.60 billion, including $6.96 billion of deposits, $432.5 million of repurchase agreements, $36.9 million of long-term debt and $102.9 million of subordinated debentures. Stockholders’ equity was $885.9 million. Consolidated regulatory capital ratios were 10.42% leverage, 14.71% Tier 1 risk-based and 16.34% total risk-based; the bank subsidiaries exceeded well-capitalized thresholds.
Credit indicators improved overall: non-performing loans were $73.3 million (1.51% of loans), down from $96.7 million (2.22%) at year-end 2013. Non-performing assets were $91.8 million, or 1.08% of assets, versus $112.2 million, or 1.48%. The allowance for loan losses was $74.2 million, or 1.53% of loans, down from $85.3 million, or 1.96%, at year-end. The lower coverage ratio partly reflects acquired loans recorded at fair value without a carryover allowance.
Material changes and management commentary
- Q3 net income fell 19.6% year over year, despite higher net interest income and non-interest income, as non-interest expense rose 23.5%. The quarter included $5.1 million of non-core costs: $1.1 million acquisition-related and $4.0 million litigation-related.
- Nine-month net income declined 5.7%. Net interest income improved, but non-interest income fell 6.9%, mainly because mortgage origination and sale income declined 35.8% amid lower refinancing demand. Mortgage production was down approximately 26% year over year.
- The nine-month loan-loss provision reversal was $6.7 million, compared with $2.1 million a year earlier. Management attributed the larger reversal mainly to reduced specific and general reserves, improved market conditions and lower criticized real estate and construction loans. Q3 recorded a provision, rather than a reversal, reflecting higher net charge-offs.
- Management cited lower funding costs and a shift toward lower-cost demand deposits as favorable factors. It also noted increased personnel and operating costs, including acquisition-related expenses, and higher fraud losses associated with payment-data breaches at major retailers.
- The MWFC acquisition consideration was $74.5 million, comprising $38.5 million cash and $36.0 million in Class A shares. Provisional purchase accounting recorded $21.0 million goodwill and an $11.0 million core deposit intangible. The company expects future cost savings from integration, but gave no quantified estimate.
Outlook, risks and contingencies
The filing provides no specific earnings or financial guidance. Management stated that results for the nine months are not necessarily indicative of full-year results and that it was not aware of events expected to materially adversely affect liquidity, capital resources or operations. Forward-looking risks include regional economic weakness, credit losses and allowance adequacy, interest-rate changes, funding access, regulatory changes, technology and operational risks, growth management and litigation.
A Montana jury awarded Kelly Logging $17.0 million, including $16.8 million in punitive damages. A conditional, non-final judgment was entered after quarter-end; post-trial motions and further court proceedings were pending. The company accrued $4.0 million in Q3, said it intended to defend itself and challenge the verdict, and cautioned that the outcome could materially affect financial condition, results or liquidity.
The company intended to redeem the approximately $20 million of MWFC-related subordinated debentures in December 2014, subject to regulatory approval, which it said it had received. It also had $1.49 billion of commitments to extend credit and $64.8 million of standby letters of credit; these commitments do not necessarily represent future cash needs.
Important facts for investors to verify
- Subsequent court rulings, legal fees and the ultimate Kelly Logging judgment or settlement compared with the $4.0 million accrual.
- Final MWFC purchase-accounting valuations, integration progress, realized cost savings and effects of the October bank merger.
- Whether loan growth, credit quality and allowance coverage remain sound as acquired loans are incorporated; monitor charge-offs, criticized loans and non-performing assets.
- Trends in mortgage production and fee income, operating expenses, and net interest margin excluding acquired-loan accretion and recoveries.
- Deposit growth and mix, liquidity, capital ratios, and completion and funding of the planned subordinated-debenture redemption.