UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, 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 March 31, 2003
OR
o Transition report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from _________ to _________
COMMISSION FILE NUMBER 000-49733
First Interstate BancSystem, Inc.(Exact name of registrant as specified in its charter)
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 o
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
The Registrant had 7,865,134 shares of common stock outstanding on April 30, 2003.
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TABLE OF CONTENTS
FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
Quarterly Report on Form 10-Q
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Consolidated Balance Sheets(Dollars in thousands, except share and per share data)(Unaudited)
See accompanying notes to unaudited consolidated financial statements.
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Consolidated Statements of Income(Dollars in thousands, except per share data)(Unaudited)
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Consolidated Statements of Stockholders’ Equity and Comprehensive Income(Dollars in thousands, except share and per share data)(Unaudited)
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FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIESConsolidated Statements of Cash Flows(Dollars in thousands)(Unaudited)
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FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIESNotes to Unaudited Consolidated Financial Statements(Dollars in thousands, except share and per share data)
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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 OF.FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion focuses on significant factors affecting the financial condition and results of operations of the Company during the three-month period ended March 31, 2003, with comparisons to 2002 as applicable.
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 the expected expansion of the Company’s business. Given these uncertainties, shareholders, trust preferred security holders 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.
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 periods of 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 which either reprice or mature within a given period of time. Management monitors the sensitivity of net interest margin by utilizing income simulation models and traditional interest rate gap analysis. However, there can be no assurance as to the actual effect changes in interest rates will have on the Company’s net interest margin.
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 shareholders. The Company monitors sources and uses of funds on a daily basis to maintain an acceptable liquidity position.
The Company’s current liquidity position is supported by the management of its investment portfolio, which provides a flow of reinvestable cash. In addition, redeployment of maturing balances in the Company’s loan portfolio provides an important source of funds for immediate to long-term liquidity. Additional sources of liquidity include Federal funds lines, borrowings and access to capital markets. The Company does not 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 $24 million for the three months ended March 31, 2003 as compared to $14 million for the same period in the prior year. This change is primarily due to the timing of corporate income tax payments. Investing activities principally include investment security transactions and net extensions of credit to customers. Net cash used in investing activities totaled $74 million for the three months ended March 31, 2003 as compared to net cash provided by investing activities of $21 million for the same period in the prior year. This change is primarily due to the investment of funds generated through deposit growth. Net cash used in or provided by financing activities is primarily generated through changes in customer deposits, borrowings or the issuance of securities or stock. Net cash provided by financing activities totaled $54 million for the three months ended March 31, 2003 as compared to net cash used in financing activities of $77 million for the same period in the prior year. This change is primarily due to issuance of capital trust preferred securities in March 2003.
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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 subsidiaries. There are statutory and regulatory provisions that could limit the ability of the Company’s banking subsidiary to pay dividends to the Parent Company.
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, 2003 the Company and its bank subsidiary each exceeded the “well-capitalized” requirements issued by the Federal Reserve Board.
OVERVIEW
The Company reported net income of $8.8 million, or $1.12 per diluted share, for the three months ended March 31, 2003, as compared to $8.9 million, or $1.13 per diluted share, for the same period in 2002.
Results of Operations
Net Interest Income. Net interest income, the Company’s largest source of operating income, is derived from interest, dividends 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. 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. On a fully-taxable equivalent (“FTE”) basis, net interest income decreased $747 thousand, or 2.2%, to $33.5 million for the three months ended March 31, 2003 compared to $34.3 million for the same period in the prior year primarily due to continued low interest rates. Redeployment of funds generated through significant residential real estate loan refinancing and prepayment of mortgage-backed investment securities at lower interest rates resulted in a decline in net interest margin ratio. The FTE net interest margin ratio decreased 51 basis points to 4.33% for the three months ended March 31, 2003 as compared to 4.84% for the same period in the prior year. The decrease in net interest margin due to lower yields on interest earning assets was partially offset by growth in loans and investment securities.
Non-interest Income. The Company’s principal sources of non-interest income include service charges on deposit accounts; technology services revenues; other service charges, commissions and fees; and, income from fiduciary activities, comprised principally of fees earned on trust assets. Non-interest income increased $4.6 million, or 35.2%, to $17.8 million for the three months ended March 31, 2003 from $13.2 million for the same period in the prior year. Significant components of the increase are discussed below.
Other service charges, commissions and fees primarily include origination and processing fees on residential real estate loans held for sale; mortgage 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 increased $2.5 million, or 52.7%, to $7.3 million for the three months ended March 31, 2003 as compared to $4.8 million for the same period in 2002. Origination and processing fees on residential real estate loans sold increased $1.8 million during the first quarter of 2003 as compared to the same period in the prior year principally due to the high volume of refinancing activity resulting from lower residential lending rates. The remaining increase is primarily attributable to fee income resulting from higher volumes of credit and debit card transactions and increases in mortgage servicing fees and brokerage revenues.
Net investment securities gains of $1.5 million during the three months ended March 31, 2003 increased from $1 thousand for the same period in 2002. Net gains on investment securities during the first quarter of 2003 were used to partially offset impairment charges on capitalized mortgage servicing rights recorded during the same period.
Other income primarily includes increases in the cash surrender value of bank-owned life insurance, check printing income, agency stock dividends and gains on sales of fixed assets. Other income increased $235 thousand, or 26.0%, to $1.1 million for the three months ended March 31, 2003 from $903 thousand for the same period in the prior year primarily due to increases in the cash surrender value of bank-owned life insurance.
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Non-Interest Expense. Non-interest expense increased $4.5 million, or 14.8%, to $34.6 million for the three months ended March 31, 2003 from $30.1 million for the same period in the prior year primarily due to increases in other expenses.
Other expenses include advertising and public relation costs; legal, audit and other professional fees; office supply, postage, freight, telephone and travel expenses; other losses; amortization of mortgage servicing rights; and, impairment charges related to mortgage servicing rights and long-lived assets pending disposition. Other expense increased $4.2 million, or 59.7%, to $11.1 million for the three months ended March 31, 2003 as compared to $7.0 million for the same period in the prior year. An impairment charge of $2.4 million related to mortgage servicing rights was recorded during the first quarter of 2003 as compared to an impairment reversal of $630 thousand during the same period in the prior year. In addition amortization of mortgage servicing rights increased $765 thousand to $1.1 million for the three months ended March 31, 2003 as compared to $349 thousand for the same period in the prior year.
Income Tax Expense. The Company’s effective combined federal and state income tax rate was 34.9% and 36.3% for the three months ended March 31, 2003 and 2002, respectively. The lower effective income tax rate in the current year is primarily due to an increase in tax exempt interest income as a percentage of income before taxes and additional earnings on bank-owned life insurance.
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, 2003 and 2002.
Community Banking. Community banking net income decreased $662 thousand, or 6.6%, to $9.4 million for the three months ended March 31, 2003 as compared to $10.0 million for the same period in the prior year. Significant components of the decrease are discussed below.
Net interest income decreased $773 thousand, or 2.2%, to $34.1 million for the three months ended March 31, 2003 as compared to $34.9 million for the same period in the prior year primarily due to continued low interest rates. Redeployment of funds generated through significant residential real estate loan refinancing and prepayment of mortgage-backed investment securities at lower interest rates resulted in a 51 basis point decline in the FTE net interest margin ratio. Noninterest expense increased $5.2 million, or 19.4%, to $32.2 million for the three months ended March 31, 2003 as compared to $27.0 million for the same period in the prior year primarily due to impairment charges related to mortgage servicing rights and the acceleration of amortization of remaining mortgage servicing rights due to rapid repayments; and, increases in internal data and management fee expenses. Expense increases were partially offset by increases in noninterest income. Noninterest income increased $4.5 million, or 43.5%, to $15.0 million for the three months ended March 31, 2003 as compared to $10.4 million for the same period in the prior year primarily due to increases in origination and processing fees on real estate loans held for sale; higher net gains on the sale of investment securities; increases in the cash surrender value of bank-owned life insurance; and, increases in fee income resulting primarily from higher volumes of credit and debit card transactions and increases in mortgage servicing fees and brokerage revenues.
Technology Services. Technology services net income increased $368 thousand, or 43.3%, to $ 1.2 million for the three months ended March 31, 2003 as compared to $850 thousand for the same period in the prior year primarily due to increases in internal data processing revenues.
Other. Other net losses decreased $259 thousand, or 12.8%, to $1.8 million for the three months ended March 31, 2003 as compared to $2.0 million for the same period in the prior year primarily due to reductions in required reinsurance claims reserves and decreases in interest expense on long-term debt.
Financial Condition
Loans. Total loans increased $123 million, or 5.5%, to $2,360 million as of March 31, 2003 from $2,237 million as of December 31, 2002. Approximately 29% of the increase is due to the acquisition of a bank holding company and its bank subsidiary in January 2003. The remaining increase is due to internal growth primarily in real estate and commercial loans.
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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 satisfy pledging requirements for deposits of state and political subdivisions and securities sold under repurchase agreements. Investment securities decreased $15 million, or 1.9%, to $785 million as of March 31, 2003 from $800 million as of December 31, 2002. Proceeds from maturities, paydowns and sales of investment securities during the first quarter of 2003 were used to fund increases in higher yielding assets, primarily loans.
Goodwill. Goodwill increased $5 million, or 13.9%, to $38 million as of March 31, 2003 from $33 million as of December 31, 2002 due to the acquisition of a bank holding company and its bank subsidiary in January 2003.
Mortgage Servicing Rights. Mortgage servicing rights decreased $847 thousand, or 10.1%, to $8 million as of March 31, 2003 as compared to December 31, 2002. Internal mortgage servicing rights origination during the first quarter of 2003 was more than offset by impairment charges of $2.4 million and amortization of $1.1 million.
Other Real Estate Owned. Other real estate owned increased $699 thousand, or 152.6%, to $1 million as of March 31, 2003 from $458 thousand as of December 31, 2002 primarily due to the addition of one agricultural property.
Net Deferred Tax Asset. Net deferred tax asset increased $3 million, or 110.0%, to $6 million as of March 31, 2003 from $3 million as of December 31, 2002 primarily due to unrealized gains on available-for-sale investment securities.
Deposits. Total deposits increased $56 million, or 1.9%, to $2,968 million as of March 31, 2003 from $2,912 million as of December 31, 2002. Approximately 75% of the increase is due to the acquisition of a bank holding company and its bank subsidiary in January 2003. The remaining increase is the result of internal growth.
Long-term Debt. Long-term debt is comprised principally of fixed rate notes with the Federal Home Loan Bank of Seattle, an unsecured revolving term loan and unsecured subordinated notes. Long-term debt increased $17 million, or 71.3%, to $41 million as of March 31, 2003 from $24 million as of December 31, 2002 primarily due to advances on fixed rate, four and seven-year borrowings from the Federal Home Loan Bank during March 2003.
Other Funding Sources. Other funding sources include tax deposits due to the Federal government, repurchase agreements with primarily commercial depositors and, on a seasonal basis, Federal funds purchased. Other funding sources decreased $7 million, or 2.4%, to $301 million as of March 31, 2003 from $308 million as of December 31, 2002 primarily due the timing of tax deposits made by customers and their subsequent withdrawal by the Federal government and seasonal decreases in repurchase agreements.
Trust Preferred Securities. Trust preferred securities increased $40 million, or 100%, to $80 million as of March 31, 2003 from $40 million as of December 31, 2002 due to the issuance of floating rate capital trust preferred securities during March 2003. On March 25, 2003, the Company called $40 million of previously issued trust preferred securities for redemption effective April 25, 2003.
Accounts Payable and Accrued Expenses. Accounts payable and accrued expenses increased $12 million, or 73.1%, to $29 million as of March 31, 2003 as compared to $17 million as of December 31, 2002. This increase is primarily due to timing of corporate income tax payments.
Common Stock. Common stock increased $28 million, or 911.3%, to $31 million as of March 31, 2003 from $3 million as of December 31, 2002 primarily due to a transfer of retained earnings to common stock during the first quarter of 2003 and the issuance of Company common stock in partial payment for the acquisition of a bank holding company and its bank subsidiary in January 2003.
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 increased $3 million, or 9.5%, to $37 million as of March 31, 2003 as compared to $34 million as of December 31, 2002 primarily due to two loans past due 90 days or more and still accruing interest in the process of renewal at March 31, 2003.
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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 $192 thousand, or 7.3%, to $2.4 million for the three months ended March 31, 2003 from $2.6 million for the same period in 2002. The allowance for loan losses of $38 million at March 31, 2003 remained at 1.62% of total loans as compared to $36 million, or 1.62% of total loans, at December 31, 2002.
Item 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURESABOUT MARKET RISK
As of March 31, 2003, 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, 2002.
Item 4.
DISCLOSURE CONTROLS AND PROCEDURES
Management of the Company is responsible for establishing and maintaining effective disclosure controls and procedures, as defined under Rules 13a-14 and 15d-14 of the Securities Exchange Act of 1934. As of March 31, 2003, 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 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.
Management’s responsibilities related to establishing and maintaining effective disclosure controls and procedures include maintaining effective internal controls over financial reporting that are designed to produce reliable financial statements in accordance with accounting principles generally accepted in the United States. Management assessed the Company’s system of internal controls over financial reporting as of March 31, 2003, in relation to criteria for effective internal controls over financial reporting. Based on this assessment, management believes that, as of March 31, 2003, its system of internal controls over financial reporting met those criteria.
There have been no significant changes in the Company’s internal controls or in other factors that could significantly affect internal controls subsequent to March 31, 2003.
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PART II.
OTHER INFORMATION
Item 1. Legal Proceedings
Item 2. Changes in Securities and Use of Proceeds
Item 3. Defaults upon Senior Indebtedness
Item 4. Submission of Matters to a Vote of Security Holders
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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CERTIFICATION OF QUARTERLY REPORT ON FORM 10-QPURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Thomas W. Scott, certify that :
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I, Terrill R. Moore, certify that :
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