UNITED STATESSECURITIES AND EXCHANGE COMMISSION
FORM 10-Q
For the quarterly period ended March 31, 2004
OR
For the transition period from to
COMMISSION FILE NUMBER 000-49733
First Interstate BancSystem, Inc.
Registrant’s telephone number, including area code: 406/255-5390
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes[ ] No [X]
The Registrant had 7,896,614 shares of common stock outstanding on March 31, 2004.
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FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
Quarterly Report on Form 10-Q
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See accompanying notes to unaudited consolidated financial statements.
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Notes to Unaudited Consolidated Financial Statements(Dollars in thousands, except share and per share data)
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Item 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2003, including the audited financial statements contained therein, filed with the Securities and Exchange Commission.
FORWARD LOOKING STATEMENTS
Certain statements contained in this document including, without limitation, statements containing the words “believes,” “anticipates,” “expects,” and words of similar import, constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of the Company to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include, among others, general economic and business conditions in those areas in which the Company operates; demographic changes; competition; fluctuations in interest rates; changes in business strategy or development plans; changes in governmental regulation; credit quality; and, the availability of capital to fund expansion of the Company’s business, and other factors identified under the caption “Risk Factors” in Part I, Item 1, of the Company’s Annual Report on Form 10-K for the year ended December 31, 2003. Given these uncertainties, holders of the Company’s securities and prospective investors are cautioned not to place undue reliance on such forward-looking statements. The Company disclaims any obligation to update any such factors or to publicly announce the results of any revisions to any of the forward-looking statements contained herein to reflect future events or developments.
OVERVIEW
The Company reported net income of $9.7 million, or $1.22 per diluted share, for the three months ended March 31, 2004 as compared to $8.8 million, or $1.12 per diluted share, for the same period in 2003 primarily due to higher net interest income.
RESULTS OF OPERATIONS
Net Interest Income. Net interest income, the Company’s largest source of operating income, is derived from interest and fees received on interest earning assets, less interest expense incurred on interest bearing liabilities. The most significant impact on the Company’s net interest income between periods is derived from the interaction of changes in the volume of and rates earned or paid on interest earning assets and interest bearing liabilities (“spread”). The volume of loans, investment securities and other interest earning assets, compared to the volume of interest bearing deposits and indebtedness, combined with the spread, produces changes in the net interest income between periods. Net interest income, on a fully taxable equivalent (“FTE”) basis, increased $3.7 million, or 11.3%, to $36.5 million for the three months ended March 31, 2004, as compared to $32.8 million for the same period in 2003. This increase is primarily due to higher average interest earning assets, primarily loans, outstanding during the three months ended March 31, 2004 coupled with a lower average funding cost. The FTE net interest margin ratio increased 7 basis points to 4.40% for the three months ended March 31, 2004 as compared to 4.33% for the same period in the prior year.
Noninterest Income. The Company’s principal sources of noninterest income include other service charges, commissions and fees; service charges on deposit accounts; technology services revenues; and, income from fiduciary activities, comprised principally of fees earned on trust assets. Noninterest income decreased $1.2 million, or 6.5%, to $16.6 million for the three months ended March 31, 2004 as compared to $17.8 million for the same period in 2003. Significant components of the decrease are discussed below.
Other service charges, commissions and fees primarily include origination and processing fees on residential real estate loans held for sale; mortgage loan servicing fee income; gains on loans sold; credit card fee income; brokerage revenues; debit card interchange fee income; and, ATM service charge revenues. Other service charges, commissions and fees decreased $1.3 million, or 16.8%, to $6.2 million for the three months ended March 31, 2004 as compared to $7.5 million for the same period in 2003. Revenues from the origination and sale of residential real estate loans decreased $2.3 million during the three months ended March 31, 2004 as compared to the same period in 2003 primarily due to lower volumes of loans originated for sale. This decrease was partially offset by increases in revenues from brokerage activities and mortgage loan servicing.
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Service charges on deposit accounts increased $810 thousand, or 21.0%, to $4.7 million for the three months ended March 31, 2004 as compared to $3.9 million for the same period in 2003 primarily due to increases in service fee rates for check processing, account overdraft processing and stopping check payments that became effective during the second and third quarters of 2003.
Net investment securities gains decreased $1.4 million, or 98.0%, to $30 thousand during the three months ended March 31, 2004 as compared to $1.5 million during the same period in 2003. Prior year gains were primarily used to offset impairment charges related to capitalized mortgage servicing rights recorded during the same period.
Other income primarily includes increases in bank-owned life insurance revenues, check printing income, agency stock dividends and gains on sales of fixed assets. Other income increased $250 thousand, or 25.5%, to $1.2 million for the three months ended March 31, 2004 as compared to $982 thousand for the same period in 2003 primarily due to higher revenues from bank-owned life insurance and increases in earnings of unconsolidated subsidiaries.
The Company recorded net income related to other real estate owned (“OREO”) of $33 thousand during the three months ended March 31, 2004 as compared to net OREO expense of $16 thousand during the same period in 2003. Variations in net OREO income or expense during the periods are primarily the result of realized gains or losses on sales of OREO. OREO income or expense is directly related to prevailing economic conditions and could fluctuate significantly as economic changes occur in the Company’s market areas.
Noninterest Expense. Noninterest expense increased $1.1 million, or 3.3%, to $35.7 million for the three months ended March 31, 2004 as compared to $34.6 million for the same period in 2003. Significant components of the increase are discussed below.
Furniture and equipment expenses increased $499 thousand, or 16.4%, to $3.5 million for the three months ended March 31, 2004 as compared to $3.0 million for the same period in 2003 primarily due to depreciation expense associated with computer mainframe hardware and software placed into service in June 2003.
Other expenses include advertising and public relation costs; legal, audit and other professional fees; office supply, postage, freight, telephone and travel expenses; other losses; and, amortization of and impairment charges or reversals related to capitalized mortgage servicing rights. Other expenses decreased $364 thousand, or 3.3%, to $10.7 million for the three months ended March 31, 2004 as compared to $11.1 million for the same period in 2003 primarily due to lower amortization expense and impairment charges related to capitalized mortgage servicing rights. Amortization expense and impairment charges aggregated $1.9 million during the three months ended March 31, 2004 as compared to $3.5 million during the same period in the prior year. These decreases were partially offset by three non-recurring losses aggregating $553 thousand and normal inflationary increases in other expenses occurring during the first quarter of 2004.
Income Tax Expense. The Company’s effective combined federal and state income tax rate was 35.1% and 34.9% for the three months ended March 31, 2004 and 2003, respectively.
Business Line Results
The following paragraphs contain a discussion of the financial performance of each of the Company’s reportable segments for the three months ended March 31, 2004 and 2003.
Community Banking. Community banking net income increased $1.0 million, or 10.7%, to $10.4 million for the three months ended March 31, 2004 as compared to $9.4 million for the same period in 2003. Significant components of the increase are discussed below.
Net interest income increased $3.1 million, or 9.1%, to $37.2 million for the three months ended March 31, 2004 as compared to $34.1 million for the same period in 2003 primarily due to higher average interest earning assets outstanding during the three months ended March 31, 2004 coupled with a lower average funding cost.
Noninterest income decreased $1.5 million, or 10.0%, to $13.5 million for the three months ended March 31, 2004 as compared to $15.0 million for the same period in 2003 primarily due to fluctuations in gains and losses on sales of investment securities and decreases in revenues from the origination and processing of residential real estate loans held for sale. These decreases were partially offset by increases in deposit account service fee rates and higher revenues from brokerage activities and mortgage loan servicing.
Noninterest expense increased $217 thousand, or 0.7%, to $32.5 million for the three months ended March 31, 2004 as compared to $32.2 million for the same period in 2003. Decreases in noninterest expense due to lower amortization expense and impairment charges related to mortgage servicing rights were offset by increases in salaries, wages and benefits expense, non-recurring losses of $268 thousand and inflationary increases in other operating expenses.
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Technology Services. Technology services net income decreased $296 thousand, or 24.3%, to $922 thousand for the three months ended March 31, 2004, as compared to $1.2 million for the same period in 2003 primarily due to increases in computer equipment rental and salaries, wages and benefits expenses.
Other. Other net losses decreased $171 thousand, or 9.7%, to $1.6 million for the three months ended March 31, 2004 as compared to $1.8 million for the same period in 2003 primarily due to lower interest expense on a reissued subordinated debenture and long-term debt. These decreases were partially offset by a non–recurring loss of $285 thousand.
FINANCIAL CONDITION
Loans. Total loans increased $14 million, or less than 1.0%, to $2,569 million as of March 31, 2004 from $2,555 million as of December 31, 2003 primarily due to internal growth in commercial loans.
Investment Securities. The Company’s investment portfolio is managed to attempt to obtain the highest yield while meeting the Company’s risk tolerance and liquidity needs and satisfying pledging requirements for deposits of state and political subdivisions and securities sold under repurchase agreements. Investment securities increased $7 million, or less than 1.0%, to $807 million as of March 31, 2004 from $800 million as of December 31, 2003. The Company evaluates its investment portfolio quarterly for other-than-temporary declines in the market value of individual investment securities. This evaluation includes monitoring credit ratings; market, industry and corporate news; volatility in market prices; and, determining whether the market value of a security has been below its cost for an extended period of time. As of March 31, 2004, no investment securities had been in a continuous loss position more than twelve months. The Company recorded no impairment losses during the three months ended March 31, 2004 and 2003.
Deferred Tax Asset. Deferred tax asset decreased $2 million, or 53.1%, to $2 million as of March 31, 2004 from $3 million as of December 31, 2003 primarily due to fluctuations in net unrealized gains and losses on available-for-sale investment securities.
Deposits. Total deposits decreased $20 million, or less than 1.0%, to $3,137 million as of March 31, 2004 from $3,157 million as of December 31, 2003. Seasonal declines in overall deposit growth have historically occurred during the first half of the year but have been offset in recent years by acquisitions and/or internal growth generated through new branch openings.
Repurchase Agreements. In addition to deposits, the Company uses repurchase agreements with primarily commercial depositors as an additional source of funds. All outstanding repurchase agreements are due in one day. Repurchase agreements increased $13 million, or 3.9%, to $336 million as of March 30, 2004 from $323 million as of December 31, 2003.
Accounts Payable and Accrued Expenses. Accounts payable and accrued expenses increased $1 million, or 7.5%, to $21 million as of March 31, 2004 from $19 million as of December 31, 2003 primarily due to timing of corporate income tax payments.
ASSET QUALITY
Non-performing Loans. Non-performing loans include loans past due 90 days or more and still accruing interest, non-accrual loans and restructured loans. Non-performing loans decreased $2 million, or 6.5%, to $29 million as of March 31, 2004 as compared to $31 million as of December 31, 2003 primarily due to the matured loans of one commercial borrower in the process of renewal at December 31, 2003.
Provision/Allowance for Loan Losses. The Company performs a quarterly assessment of the risks inherent in its loan portfolio, as well as a detailed review of each significant asset with identified weaknesses. Based on this analysis, the Company records a provision for loan losses in order to maintain the allowance for loan losses at a level considered sufficient to provide for known and inherent losses within the loan portfolio at each balance sheet date. Fluctuations in the provision for loan losses result from management’s assessment of the adequacy of the allowance for loan losses. The provision for loan losses decreased $12 thousand, or less than 1.0%, to $2.4 million for the three months ended March 31, 2004. The allowance for loan losses was $40 million, or 1.56% of total loans, as of March 31, 2004 as compared to $39 million, or 1.52% of total loans, at December 31, 2003.
ASSET LIABILITY MANAGEMENT
The primary objective of the Company’s asset liability management process is to optimize net interest income while prudently managing balance sheet risks by understanding the levels of risk accompanying its decisions and monitoring and managing these risks. The ability to optimize net interest margin is largely dependent on the achievement of an interest rate spread that can be managed during periods of
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fluctuating interest rates. Interest sensitivity is a measure of the extent to which net interest income will be affected by market interest rates over a period of time. Interest rate sensitivity is related to the difference between amounts of interest earning assets and interest bearing liabilities that reprice or mature within a given period of time. Management monitors the sensitivity of the net interest margin by utilizing income simulation models and traditional interest rate gap analysis. The Company’s balance sheet structure is primarily short-term in nature with most interest earning assets and interest bearing liabilities repricing or maturing in less than five years. The Company attempts to maintain a mix of interest earning assets and interest bearing liabilities such that no more than 5% of the net interest margin will be at risk over a one-year period should interest rates vary one percent. As of March 31, 2004, the Company’s income simulation models predict net interest income will decrease $15.5 million, or 10.3%, over the next twelve months assuming an immediate downward shift in market interest rates of 1.0%. Management considers the possibility of interest rates declining by one percent during the next twelve months as highly unlikely. However, no assurances can be given that the Company is not at risk in the event of rate increases or decreases and there can be no assurance as to the actual effect changes in interest rates will have on the Company’s net interest margin.
LIQUIDITY
Liquidity. The objective of liquidity management is to maintain the Company’s ability to meet the day-to-day cash flow requirements of customers who wish to withdraw funds or require funds to meet their credit needs. The Company manages its liquidity position to meet the needs of customers, while maintaining an appropriate balance between assets and liabilities to meet the return on investment objectives of stockholders. The Company monitors sources and uses of funds on a daily basis to maintain an acceptable liquidity position, principally through deposit receipts and check payments; loan originations, extensions, and repayments; and, management of investment securities.
The Company’s current liquidity position is also supported by management of its investment portfolio, which provides a flow of reinvestable cash. In addition, redeployment of maturing balances in the Company’s loan portfolio also provides an important source of immediate to long-term liquidity. Additional sources of liquidity include federal funds lines, borrowings and access to capital markets. The Company does not presently rely on off-balance sheet arrangements to provide financing, liquidity or market or credit risk support nor does it engage in derivatives and related hedging activities.
Net cash provided by operating activities, primarily net income, totaled $17 million for the three months ended March 31, 2004 as compared to $24 million for the same period in 2003. Investing activities principally include investment security transactions and net extensions of credit to customers. Net cash used in investing activities totaled $25 million for the three months ended March 31, 2004 as compared to $74 million for the same period in the prior year. Net cash provided by or used in financing activities is primarily a function of increases or decreases in customer deposits, borrowings or the issuance of securities or stock. Net cash used in financing activities totaled $11 million for the three months ended March 31, 2004 as compared to net cash provided by financing activities of $54 million for the same period in the prior year. The change in cash used in or provided by financing activities is primarily the result of decreases in deposits and long-term debt.
As a holding company, the Parent Company is a corporation separate and apart from its subsidiaries, and therefore, provides for its own liquidity. Substantially all of the Parent Company’s revenues are obtained from management fees and dividends declared and paid by its banking subsidiary. There are statutory and regulatory provisions that could limit the ability of the banking subsidiary to pay dividends to the Parent Company. In general, the banking subsidiary is limited, without the prior consent of its state and federal banking regulators, to paying dividends that do not exceed the current year net profits together with retained earnings from the two preceding calendar years.
CAPITAL RESOURCES
Capital Resources. The Company maintains adequate capitalization to assure depositor, investor and regulatory confidence. Management’s intent is to provide sufficient capital funds to support growth and to absorb fluctuations in income so that operations can continue in periods of uncertainty while at the same time ensuring investable funds are available to foster expansion. At March 31, 2004, the Company and its bank subsidiary each exceeded the “well-capitalized” requirements issued by the Federal Reserve Board.
Item 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURESABOUT MARKET RISK
As of March 31, 2004, there have been no material changes in the quantitative and qualitative information about market risk provided pursuant to Item 305 of Regulation S-K as presented in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003.
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Item 4.
CONTROLS AND PROCEDURES
Management of the Company is responsible for establishing and maintaining effective disclosure controls and procedures, as defined under Rules 13a-15 and 15d-15 of the Securities Exchange Act of 1934. As of March 31, 2004, an evaluation was performed, under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures. Based on that evaluation, management concluded that the Company’s disclosure controls and procedures as of March 31, 2004 were effective in ensuring that information required to be disclosed in this Quarterly Report on Form 10-Q was recorded, processed, summarized, and reported within the time period required by the SEC’s rules and forms.
There were no changes in the Company’s internal controls over financial reporting for the quarter ended March 31, 2004 that have materially affected, or are reasonably likely to materially affect, such controls.
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PART II.
OTHER INFORMATION
Item 1. Legal Proceedings
There have been no material changes in legal proceedings as described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003.
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
The following table provides information with respect to purchases made by or on behalf of the Company or any “affiliated purchases” (as defined in Rule 10b-18(a)(3) under the Securities Exchange Act of 1934), of the Company’s common stock during the three months ended March 31, 2004.
Item 3. Defaults upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable or required.
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
FIRST INTERSTATE BANCSYSTEM, INC.
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