UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transaction period from _______ to _______ COMMISSION FILE NUMBER 333-3250 FIRST INTERSTATE BANCSYSTEM, INC. --------------------------------- (Exact name of registrant as specified in its charter) Montana 81-0331430 - -------------------------------- ------------------- (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) PO Box 30918, 401 North 31st Street, Billings, MT 59116-0918 ---------------------------------------------------------------- (Address of principal executive offices) (Zip Code) 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 ----- ----- The Registrant had 8,009,346 shares of common stock outstanding on June 30, 1998. 1
FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES Quarterly Report on Form 10-Q <TABLE> <CAPTION> Index Page ----- ---- <S> <C> PART I. FINANCIAL INFORMATION Item 1 - Financial Statements Consolidated Balance Sheets June 30, 1998 and December 31, 1997 3 Consolidated Statements of Income Three and six months ended June 30, 1998 and 1997 4 Consolidated Statements of Comprehensive Income Three and six months ended June 30, 1998 and 1997 5 Consolidated Statements of Cash Flows Six months ended June 30, 1998 and 1997 6 Notes to Unaudited Consolidated Financial Statements 7 Item 2 - Management's Discussion and Analysis of Financial Condition And Results of Operations 9 Item 3 - Quantitative and Qualitative Disclosures about Market Risk 13 PART II. OTHER INFORMATION Item 1 - Legal Proceedings 14 Item 2 - Changes in Securities 14 Item 3 - Defaults on Senior Securities 14 Item 4 - Submission of Matters to a Vote of Security Holders 14 Item 5 - Other Information 14 Item 6 - Exhibits and Reports on Form 8-K 14 SIGNATURES 15 </TABLE> 2
FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES Consolidated Balance Sheets (Dollars in thousands, except share data) <TABLE> <CAPTION> June 30, ASSETS 1998 December 31, (unaudited) 1997 ---------- --------- <S> <C> <C> Cash and due from banks $ 140,103 136,025 Federal funds sold 45,750 58,675 Interest bearing deposits in banks 7,073 34,447 Investment securities: Available-for-sale 293,651 188,650 Held-to-maturity 226,679 236,953 ---------- --------- 520,330 425,603 Loans 1,485,589 1,470,414 Less allowance for loan losses 29,309 28,180 ---------- --------- Net loans 1,456,280 1,442,234 Premises and equipment, net 61,095 61,274 Accrued interest receivable 23,905 22,046 Goodwill, net of accumulated amortization of $9,759 at June 30, 1998 (unaudited) and $8,486 at December 31, 1997 30,528 31,801 Other real estate owned, net 1,329 1,362 Deferred tax asset 8,113 5,946 Other assets 16,331 15,351 ---------- --------- $2,310,837 2,234,764 ---------- --------- ---------- --------- LIABILITIES AND STOCKHOLDERS' EQUITY Deposits: Noninterest bearing $ 369,273 372,056 Interest bearing 1,525,292 1,432,950 ---------- --------- Total deposits 1,894,565 1,805,006 Federal funds purchased - 4,025 Securities sold under repurchase agreements 163,595 176,350 Accounts payable and accrued expenses 22,530 20,599 Other borrowed funds 11,902 11,591 Long-term debt 24,581 31,526 ---------- --------- Total liabilities 2,117,173 2,049,097 Mandatorily redeemable securities of subsidiary trust 40,000 40,000 Stockholders' equity: Common stock without par value; authorized 20,000,000 shares; issued and outstanding 8,009,346 shares as of June 30, 1998 (unaudited) and 8,030,799 shares as of December 31, 1997 10,801 11,490 Retained earnings 141,971 133,277 Unrealized gain on securities available-for-sale 892 900 ---------- --------- Total stockholders' equity 153,664 145,667 ---------- --------- $2,310,837 2,234,764 ---------- --------- ---------- --------- Book value per common share $ 19.19 18.14 ---------- --------- ---------- --------- </TABLE> SEE ACCOMPANYING NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS. 3
FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES Consolidated Statements of Income (Dollars in thousands, except share data) (Unaudited) <TABLE> <CAPTION> For the three months For the six months ended June 30, ended June 30, -------------------- ------------------ 1998 1997 1998 1997 ------- ------- ------- ------- <S> <C> <C> <C> <C> Interest income: Interest and fees on loans $36,107 34,903 71,297 68,233 Interest and dividends on investment securities: Taxable 6,971 5,419 13,294 10,762 Exempt from Federal taxes 458 276 784 527 Interest on deposit with banks 123 12 318 97 Interest on Federal funds sold 832 559 1,798 711 ------- ------- ------- ------- Total interest income 44,491 41,169 87,491 80,330 ------- ------- ------- ------- Interest expense: Interest on deposits 16,910 14,083 33,147 27,470 Interest on Federal funds purchased 6 767 44 1,085 Interest on securities sold under repurchase agreements 1,748 1,486 3,522 2,811 Interest on other borrowed funds 114 446 222 519 Interest on long-term debt 622 1,199 1,283 2,488 Interest on mandatorily redeemable securities of subsidiary trust 882 - 1,770 - ------- ------- ------- ------- Total interest expense 20,282 17,981 39,988 34,373 ------- ------- ------- ------- Net interest income 24,209 23,188 47,503 45,957 Provision for loan losses 1,028 1,058 2,093 2,281 Net interest income after provision for loan losses 23,181 22,130 45,410 43,676 Other operating income: Income from fiduciary activities 1,180 989 2,386 2,022 Service charges on deposit accounts 2,607 2,531 5,097 4,910 Data processing 1,946 1,826 4,250 3,667 Other service charges, commissions, and fees 1,041 1,047 1,910 1,939 Net investment securities gains (losses) (33) 15 9 73 Other income 471 452 885 874 ------- ------- ------- ------- Total other operating income 7,212 6,860 14,537 13,485 ------- ------- ------- ------- Other operating expenses: Salaries and wages 8,141 7,215 15,938 14,202 Employee benefits 2,393 1,836 5,200 3,832 Occupancy expense, net 1,509 1,481 3,120 3,081 Furniture and equipment expense 2,130 1,935 4,182 3,754 Other real estate expense (income), net 14 19 (171) (115) FDIC insurance 54 50 108 101 Other expenses 6,135 5,748 11,765 11,132 ------- ------- ------- ------- Total other operating expenses 20,376 18,284 40,142 35,987 ------- ------- ------- ------- Income before income taxes 10,017 10,706 19,805 21,174 Income tax expense 3,787 4,074 7,502 8,080 ------- ------- ------- ------- Net income $ 6,230 6,632 12,303 13,094 ------- ------- ------- ------- ------- ------- ------- ------- Basic earnings per common share $ 0.78 0.80 1.53 1.54 Diluted earning per common share $ 0.77 0.79 1.52 1.54 Dividends per common share $ 0.23 0.25 0.45 0.46 </TABLE> SEE ACCOMPANYING NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS. 4
FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES Consolidated Statements of Comprehensive Income (Dollars in thousands) (Unaudited) <TABLE> <CAPTION> For the three months For the six months ended June 30, ended June 30, -------------------- ------------------- 1998 1997 1998 1997 ------- ------ ------ ------ <S> <C> <C> <C> <C> Net income $6,230 6,632 12,303 13,094 Other comprehensive income (loss): Unrealized gains (losses) on investment securities: Realized and unrealized holding gains (losses) arising during period 64 210 5 (35) Add: reclassification adjustment for (gains) losses included in net income 33 (15) (9) (73) ------- ------ ------ ------ Other comprehensive income (loss), before tax 97 195 (4) (108) Income tax benefit (expense) related to items of other comprehensive income 13 (6) (4) (29) ------- ------ ------ ------ Other comprehensive income (loss), after tax 110 189 (8) (137) ------- ------ ------ ------ Comprehensive income $6,340 6,821 12,295 12,957 ------- ------ ------ ------ ------- ------ ------ ------ </TABLE> SEE ACCOMPANYING NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS. 5
FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows (Dollars in thousands, except per share data) (Unaudited) <TABLE> <CAPTION> For the six months ended June 30, ------------------------ 1998 1997 --------- ------- <S> <C> <C> Cash flows from operating activities: Net income $ 12,303 13,094 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan and other real estate losses 2,093 2,277 Depreciation and amortization 4,622 4,153 Net premium amortization on investment securities 208 289 Gain on sales of investments (9) (73) Gain on sales of other real estate owned (240) (190) Loss (gain) on sales of property and equipment 127 (14) Provision for deferred income taxes (2,144) (1,655) Increase in interest receivable (1,859) (1,493) Decrease (increase) in other assets (1,180) 1,177 Increase in accounts payable and accrued expenses 1,931 615 --------- ------- Net cash provided by operating activities 15,852 18,180 --------- ------- Cash flows from investing activities: Purchases of investment securities: Held-to-maturity (42,894) (333,219) Available-for-sale (168,663) (237) Proceeds from maturities and paydowns of investment securities: Held-to-maturity 52,960 298,953 Available-for-sale 35,449 9,579 Proceeds from sales of available-for-sale investment securities 28,191 31,158 Decrease in interest bearing deposits in banks 27,374 6,508 Extensions of credit to customers, net of repayments (17,837) (99,191) Recoveries of loans charged-off 1,240 1,652 Proceeds from sales of other real estate 731 879 Capital distributions from joint venture 200 - Capital expenditures, net (3,297) (3,619) --------- ------- Net cash used in investing activities (86,546) (87,537) --------- ------- Cash flows from financing activities: Net increase (decrease) in deposits 89,559 (6,389) Net increase (decrease) in Federal funds and repurchase agreements (16,780) 48,851 Net increase in other borrowed funds 311 24,201 Proceeds from long-term borrowings 1,428 1,750 Repayment of long-term borrowings (8,373) (10,233) Proceeds from issuance of common stock 75 139 Payments to retire common stock (764) (730) Dividends paid on common stock (3,609) (3,656) Dividends paid on preferred stock - (846) --------- ------- Net cash provided by financing activities 61,847 53,087 --------- ------- Net decrease in cash and cash equivalents (8,847) (16,270) Cash and cash equivalents at beginning of period 194,700 165,907 --------- ------- Cash and cash equivalents at end of period $ 185,853 149,637 --------- ------- --------- ------- Supplemental disclosure of cash flow information: Cash paid during period for taxes $ 8,770 9,213 Cash paid during period for interest 27,389 21,454 --------- ------- --------- ------- Noncash Investing and Financing Activities: The Company transferred loans of $458 and $237 to other real estate owned during the six months ended June 30, 1998 and 1997, respectively. </TABLE> SEE ACCOMPANYING NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS.
FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES Notes to Unaudited Consolidated Financial Statements (Dollars in thousands, except share and per share data) (1) BASIS OF PRESENTATION In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments (all of which are of a normal recurring nature) necessary to present fairly the consolidated financial position at June 30, 1998 and December 31, 1997, and the results of consolidated operations and cash flows for each of the six month periods ended June 30, 1998 and 1997 in conformity with generally accepted accounting principles. The balance sheet information at December 31, 1997 is derived from audited consolidated financial statements, however, certain reclassifications have been made to conform to the June 30, 1998 presentation. In June 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standard ("SFAS") No. 130, "Reporting Comprehensive Income," which establishes standards for reporting and display of comprehensive income and its components in a full set of general-purpose financial statements. This statement requires that all items required to be recognized under accounting standards as components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. First Interstate BancSystem, Inc. and Subsidiaries (the "Company") adopted the provisions of SFAS No. 130 as of January 1, 1998. In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." This statement requires public business enterprises to disclose selected information about operating segments including segment income, revenues and asset data. Operating segments, as defined in SFAS No. 131, include those components for which financial information is available and evaluated regularly by the chief operating decision maker in assessing performance and making resource allocation determinations for operating components such as those which contribute 10 percent or more of combined revenue, income or assets. The Company adopted the provisions of SFAS No. 131 as of January 1, 1998. As of June 30, 1998, the Company had no reportable segments as defined by SFAS No. 131. In February 1998, the FASB issued SFAS No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits," which revises disclosure requirements for pensions and other postretirement benefits. The Company adopted the provisions of SFAS No. 132 as of January 1, 1998. Adoption did not have a material effect on the consolidated financial statements. In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." This statement establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. The statement is effective for all fiscal quarters or fiscal years beginning after June 15, 1999. As of June 30, 1998, the Company was not engaged in hedging activities nor did it hold any derivative instruments. (2) COMPUTATION OF EARNINGS PER SHARE Basic earnings per common share (EPS) is calculated by dividing net income less preferred stock dividends by the weighted average number of common shares outstanding during the period presented. Diluted earnings per common share is calculated by dividing net income less preferred stock dividends by the weighted average number of common shares and potential common shares outstanding during the period. The following table shows weighted average common shares and weighted average potential common shares for the three and six month periods ended June 30, 1998 and 1997. 7
FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES Notes to Unaudited Consolidated Financial Statements - Continued (Dollars in thousands, except share and per share data) <TABLE> <CAPTION> Three months ended Six months ended 6/30/98 6/30/97 6/30/98 6/30/97 --------- --------- --------- --------- <S> <C> <C> <C> <C> Weighted average common shares 8,014,509 7,794,688 8,019,154 7,900,260 Weighted average potential common shares 69,191 38,336 59,021 36,448 </TABLE> (3) CASH DIVIDENDS On July 15, 1998, the Company declared and paid a cash dividend on second quarter earnings of $0.23 per share to stockholders of record on that date. It has been the Company's practice to pay quarterly dividends based upon earnings. The July 1998 dividend represents 30% of the Company's net income for the quarter ended June 30, 1998. (4) COMMITMENTS AND CONTINGENCIES In the normal course of business, the Company is involved in various claims and litigation. In the opinion of management, following consultation with legal counsel, the ultimate liability or disposition thereof will not have a material adverse effect on the consolidated financial condition, results of operations or liquidity. The Company owns a 50% ownership interest in an aircraft and is jointly and severally liable for aircraft indebtedness of $1.7 million as of June 30, 1998. The Company is an anchor tenant in a building owned by a joint venture partnership in which the Company owns a 50% partnership interest. The Company is jointly and severally liable for joint venture partnership indebtedness of $10.2 million as of June 30, 1998. The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, in varying degrees, elements of credit and interest rate risk in excess of amounts recorded in the consolidated balance sheet. Standby letters of credit and financial guarantees written are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Most commitments extend for no more than two years. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Company holds various collateral supporting those commitments for which collateral is deemed necessary. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the commitment contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management's credit evaluation of the customer. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment and income-producing commercial properties. 8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion focuses on significant factors affecting the financial condition and results of operations of First Interstate BancSystem, Inc. and subsidiaries ("the Company") during the three and six month periods ended June 30, 1998, with comparisons to 1997 as applicable. All earnings per share figures presented are basic and do not account for the dilutive effect of potential common shares. FORWARD LOOKING STATEMENTS Certain statements contained in this review are "forward looking statements" that involve risk and uncertainties. The Company wishes to caution readers that the following factors, among others, 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 general economic and business conditions in those areas in which the Company operates, credit quality, demographic changes, competition, fluctuations in interest rates, changes in business strategy or development plans and changes in governmental regulations. OVERVIEW The Company reported net income of $6.2 million, or $0.78 per share for the three months ended June 30, 1998, as compared to $6.6 million, or $0.80 per share recorded in the same period in 1997. For the year to date period ended June 30, 1998, net income was $12.3 million, or $1.53 per share, as compared to $13.1 million, or $1.54 per share for the same period in 1997. EARNING ASSETS Earning assets of $2,058.7 million at June 30, 1998 increased $69.6 million, or 3.5%, from December 31, 1997. As of June 30, 1998, loans comprised 72% of total earning assets, investment securities comprised 25%, and Federal funds sold and interest bearing deposits in banks comprised the remaining 3% compared to 74%, 21% and 5%, respectively, as of December 31, 1997. LOANS. Total loans increased $15.2 million, or 1.0%, to $1,485.6 million as of June 30, 1998 from $1,470.4 million as of December 31, 1997. Growth in agricultural and commercial loans was partially offset by decreases in real estate and consumer loans. Growth in net loans of 1% during the first six months of 1998 was significantly lower than the 7% growth rate experienced during the same period of 1997. Management attributes this decline in growth rate to increasingly competitive loan pricing by competitors in the Company's market areas and the Company's unwillingness to expand credit risk to meet competition for certain consumer loans. INVESTMENT SECURITIES. The Company's investment portfolio is managed to result in the highest yield while meeting the Company's liquidity needs and meeting pledging requirements for public funds deposits and securities sold under repurchase agreements. The portfolio is comprised of U.S. Treasury securities, U.S. government agency securities, tax exempt securities, corporate securities, other mortgage-backed securities and other equity securities. Investment securities increased $94.7 million, or 22.3%, to $520.3 million as of June 30, 1998, from $425.6 million as of December 31, 1997. Additions to the investment portfolio during the six-month period were funded through growth in funding sources, primarily deposits. INTEREST BEARING DEPOSITS IN BANK AND FEDERAL FUNDS SOLD. Interest bearing deposits in bank consist of funds on deposit with the Federal Home Loan Bank. These deposits, along with Federal funds sold for one day periods, are used by the Company to fund daily liquidity needs, including the cash requirements of 9
correspondent banks. Interest bearing deposits in banks decreased $27.3 million, or 79.5%, to $7.1 million as of June 30, 1998 from $34.4 million as of December 31, 1997. Federal funds sold decreased $13.0 million , or 22.0%, to $45.8 million as of June 30, 1998 compared to $58.8 million as of December 31, 1997. Funds temporarily invested in interest bearing deposits in banks and Federal funds sold at December 31, 1997 were invested in higher yielding investments, principally loans and available for sale investment securities or used to reduce other borrowings and long-term debt. INCOME FROM EARNING ASSETS Interest income was $44.5 million for the three month period ended June 30, 1998, as compared to $41.2 million for the same period in 1997. The increase of $3.3 million, or 8.1%, resulted from increases in earning assets, primarily loans and investments, generated through internal growth. For the six months ended June 30, 1998 and 1997, interest income was $87.5 million and $80.3 million, respectively. Total average earning assets of $2,014.6 million increased $185.0 million, or 10.1%, over the six month average in 1997. The yield on average earning assets was 8.76% during the first six months of 1998, as compared to 8.85% during the same period in 1997. During the first six months of 1998, the increase in average earning assets contributed $8.1 million towards the increase over the same period in 1997, while the 9 basis point reduction in yield caused a $941,000 decrease. FUNDING SOURCES The Company utilizes traditional funding sources to support its earning asset portfolio including deposits, borrowings, federal funds purchased and repurchase agreements. DEPOSITS. Total deposits increased $89.6 million, or 5.0%, to $1,894.6 million as of June 30, 1998 from $1,805.0 million as of December 31, 1997. Seasonal decreases in total deposits that have historically occurred during the first six months of the year were offset in 1998 by internal growth resulting from the Company's successful efforts to gain market share system-wide. Yields on interest-bearing deposits increased 67 basis points to 4.89% during the first six months of 1998 compared to 4.22% during the same period in 1997. OTHER FUNDING SOURCES. Other funding sources include Federal funds purchased for one day periods, other borrowed funds consisting primarily of short-term borrowings from the Federal Home Loan Bank, repurchase agreements with primarily commercial depositors and long-term debt. These other funding sources decreased $23.4 million, or 10.5%, to $200.1 million as of June 30, 1998 from $223.5 million as of December 31, 1997. Because the Company's funding requirements were primarily met through deposit growth, funding from other sources was reduced during the first six months of 1998. RECAPITALIZATION. During the fourth quarter 1997, the Company issued $40.0 million of mandatorily redeemable preferred securities of subsidiary trust ("trust preferred securities"). Proceeds from the issuance were used to redeem long-term indebtedness and preferred stock. As a result of this recapitalization, interest expense on long-term indebtedness decreased $1.2 million, or 48.4%, to $1.3 million for the six months ended June 30, 1998 from $2.5 million for the same period in 1997. Interest expense related to the trust preferred securities of $1.8 million was recorded during the first six months of 1998. COSTS OF FUNDS. Interest expense was $20.3 million for the three months ended June 30, 1998, as compared to $18.0 million for the same period in 1997. The increase of $2.3 million, or 12.8%, resulted from increases in interest-bearing liabilities, primarily deposits generated through internal growth. Interest expense increased $5.6 million, or 16.3%, to $40.0 million for the six month period ended June 30, 1998 compared to $34.4 million for the same period in 1997. Total average interest-bearing liabilities and trust preferred securities of $1,727.6 million at June 30, 1998 increased $167.0 million from June 30, 1997. Costs of average funds of 4.67% during the first six months of 1998 were 23 basis points higher than the same period last year. During the first six months of 1998, the increase in interest bearing liabilities and trust preferred securities contributed $3.9 million towards the increase, while the 23 basis point increase in costs of funds caused a $1.7 million increase. 10
NET INTEREST INCOME Net interest income of $24.2 million for the quarter ended June 30, 1998 increased $1.0 million, or 4.4%, from $23.2 million for the same period in the prior year. Year-to-date net interest income of $47.5 million increased $1.5 million, or 3.4%, from the same period in 1997. The net interest margin was 4.81% during the first six months of 1998 as compared to 5.11% during the same period in 1997. This decline in net interest margin is the result of increasing competitive pressure on both deposit rates and loan pricing combined with significant deposit growth and a slower rate of loan growth. PROVISION FOR LOAN LOSS The provision for loan losses is maintained at a level that is, in management's judgment, adequate to absorb losses inherent in the loan portfolio given past, present and expected conditions. Fluctuations in the provision for loan losses result from management's assessment of the adequacy of the allowance for loan losses. Actual loan losses may vary from current estimates. The provision for loan losses for the second quarter of 1998 was $1.0 million, compared to $1.1 million for the same period in 1997. Provisions of $2.1 million and $2.3 million were recorded during the six months ended June 30, 1998 and 1997, respectively. ASSET LIABILITY MANAGEMENT INTEREST RATE SENSITIVITY. 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 fluctuations of 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. Management monitors the sensitivity of net interest margin by utilizing income simulation models and traditional gap analysis. LIQUIDITY. The objective of liquidity management is to maintain the Company's ability to meet the day-to-day cash flow requirements of its customers who either wish to withdraw funds or require funds to meet their credit needs. The Company manages its liquidity position to meet the needs of its customers, while maintaining an appropriate balance between assets and liabilities to meet the return on investment objectives of its stockholders. The Company monitors the sources and uses of funds on a daily basis to maintain an acceptable liquidity position, principally through deposit receipts and repayments; loan originations, extensions, and repayments; and management of investment securities. Alternate sources of liquidity are provided by Federal funds lines carried with upstream and downstream correspondent banks. Additional liquidity could also be generated through borrowings from the Federal Reserve Bank of Minneapolis and the Federal Home Loan Bank of Seattle. Additionally, the Company had $10.0 million available on its revolving term loan at June 30, 1998. OTHER OPERATING INCOME AND EXPENSE OTHER OPERATING INCOME The Company's principal sources of other operating income include service charges, data processing fees and income from fiduciary activities. Other operating income totaled $7.2 million for the quarter ended June 30, 1998, $352,000, or 5.1%, higher than that recorded during the same period in 1997. For the six months ended June 30, 1998 and 1997, other operating income was $14.5 million and $13.5 million, respectively. Increases in other operating income for the three and six months ended June 30, 1998 from the same periods in 1997 are primarily due to increases in data processing fees and income from fiduciary activities. 11
DATA PROCESSING FEES. The Company serviced approximately 760 locations in its ATM network at June 30, 1998 compared to approximately 542 locations at June 30, 1997. Data processing fees of $1.9 million were recorded during the second quarter of 1998, a $120,000, or 6.6%, increase from the same period in 1997. For the six months ended June 30, 1998, data processing fees increased $583,000, or 15.9%, to $4.3 million from $3.7 million for the same period in 1997. Increases are due to a non-recurring termination fee of $300,000 recorded during the first quarter of 1998, a greater number of data processing customers using the Company's ATM network and increases in core processing transaction volumes. INCOME FROM FIDUCIARY ACTIVITIES. Increases in the value of assets under trust management have resulted in increases in revenues from fiduciary activities during the three and six month periods ended June 30, 1998 as compared to the same periods in 1997. Revenues from fiduciary activities increased $191,000, or 19.3%, to $1.2 million for the three months ended June 30, 1998 from $989,000 for the same period in 1997 and year-to-date revenues through June 30, 1998 increased $364,000, or 18.0%, to $2.4 million from $2.0 million for the same period in 1997. OTHER OPERATING EXPENSE Other operating expenses increased $2.1 million, or 11.4%, to $20.4 million for the quarter ended June 30, 1998 from $18.3 million for the same period in 1997. For the six months ended June 30, 1998, other operating expenses increased $4.1 million, or 11.6%, to $40.1 million as compared to $36.0 million for the same period in 1997. The main components of the increase include salaries and wages expense, employee benefits expense, furniture and equipment expenses and other expenses. SALARIES AND WAGES EXPENSE. Salaries and wages expense, the largest component of other operating expenses, was $8.1 million for the second quarter of 1998, up $926,000, or 12.8%, from the same period in 1997. For the six months ended June 30, 1998 and 1997, salaries and wages expense amounted to $15.9 million and $14.2 million, respectively. The increase over 1997 is primarily attributable to inflationary wage increases, the addition of administrative personnel providing support for the data processing division including the Year 2000 conversion and staffing of the six new branch banks opened since June 30, 1997. EMPLOYEE BENEFITS EXPENSE. Employee benefits expense increased $557,000, or 30.3%, to $2.4 million for the quarter ended June 30, 1998 from $1.8 million for the same period in 1997. Employee benefits expense was up $1.4 million, or 35.7%, to $5.2 million for the six months ended June 30, 1998 from $3.8 million for the same period in 1997. During the first six months of 1998, the Company recorded adjustments to its regular stock option accruals of $570,000 for stock appreciation rights as a result of a 16% increase in the appraised value of its common stock. The remaining increase in employee benefits expense resulted from increases in salaries and wages. FURNITURE AND EQUIPMENT EXPENSE. Furniture and equipment expense increased $195,000, or 10.1%, to $2.1 million for the three months ended June 30, 1998 from $1.9 million for the same period in 1997. Year-to-date furniture and equipment expense through June 30, 1998 was $4.2 million, a $428,000, or 11.4%, increase from $3.8 million for the same period in the prior year. Increases are primarily due to depreciation expense resulting from additions of data processing equipment, upgrades of various other computer hardware and software used in the Company's operations and asset additions associated with new branch openings. OTHER EXPENSES. Other expenses primarily include advertising and public relations costs, professional fees, office supplies, postage and telephone expenses, and other losses. Other expenses, $6.1 million for the three months ended June 30, 1998, increased $387,000, or 6.7%, from $5.7 million for the same period in 1997. Year-to-date through June 1998, other expenses were $11.7 million, a $633,000, or 5.7%, increase from $11.1 million for the same period in the prior year. Approximately $151,000 of the year-to-date increase relates to the six new branches opened since June 30, 1997. The remaining quarter-to-date and year-to-date increases are due primarily to advertising and public relations expenses and losses on disposal of fixed assets. 12
Advertising and public relation expenses for the three and six month periods ended June 30, 1998 were approximately $41,000 and $215,000, respectively, higher than in the same periods in 1997. These increases are attributable to budgeted increases in advertising expense for the first half of 1998 combined with fluctuations in the timing of public relation events in the current year compared to 1997. During 1998, the Company wrote-off obsolete micro-computer equipment. Losses on disposal of $166,000 and $259,000 were recorded during the three and six month periods ended June 30, 1998, respectively. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK As of June 30, 1998, there have been no material changes in the quantitative and qualitative information about market risk provided pursuant to Item 305 of Regulation SK as presented in the Company's December 31, 1997 Form 10-K. 13
PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS None. ITEM 2. CHANGES IN SECURITIES None. ITEM 3. DEFAULTS UPON SENIOR INDEBTEDNESS None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. ITEM 5. OTHER INFORMATION Not applicable or required. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 27. Financial Data Schedule. (b) No reports were filed on Form 8-K during the quarter ended June 30, 1998. 14
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. Date August 14, 1998 /s/ THOMAS W. SCOTT -------------------------- -------------------------------------- Thomas W. Scott President and Chief Executive Officer Date August 14, 1998 /s/ TERRILL R. MOORE -------------------------- -------------------------------------- Terrill R. Moore Senior Vice President and Chief Financial Officer 15