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 September 30, 2002
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 333-3250
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
The Registrant had 7,803,938 shares of common stock outstanding on October 31, 2002.
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TABLE OF CONTENTS
FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
Quarterly Report on Form 10-Q
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FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIESConsolidated Balance Sheets(Dollars in thousands, except share and per share data)(Unaudited)
See accompanying notes to unaudited consolidated financial statements.
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FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIESConsolidated Statements of Income(Dollars in thousands, except per share data)(Unaudited)
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FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIESConsolidated 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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Notes to Unaudited Consolidated Financial Statements(Dollars in thousands, except share and per share data)
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Selected business line information for the three and nine month periods ended September 30, 2002 and 2001 follows:
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Item 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL 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 and nine-month periods ended September 30, 2002, with comparisons to 2001 as applicable. All earnings per share figures are presented on a diluted basis.
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, stockholders, 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. The Company’s balance sheet structure is primarily short-term in nature with most assets and liabilities repricing or maturing in less than five years. The Company attempts to maintain a mix of interest earning assets and deposits 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. 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 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 the management of its investment portfolio, which provides a structured flow of maturing and reinvestable funds that could be converted to cash, should the need arise. Maturing balances in the Company’s loan portfolio also provide options for cash flow management. The ability to redeploy these funds is 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.
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Net cash provided by operating activities, primarily net income, increased $15 million to $48 million during the nine months ended September 30, 2002 as compared to $33 million during the same period in the prior year.
Investing activities principally include investment security transactions and net extensions of credit to customers. Net cash used in investing activities increased $27 million to $221 million during the nine months ended September 30, 2002 as compared to $194 million during the same period in 2001 primarily due to the Company’s investment in bank owned life insurance.
Net cash used in or provided by financing activities is primarily generated through changes in customer deposits, advances and repayments of short and long term borrowings or the issuance of common stock. Net cash provided by financing activities decreased $32 million to $224 million during the nine months ended September 30, 2002 as compared to $256 million for the same period in the prior year primarily due to repayment of 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 to paying dividends that do not exceed current year net profits together with retained earnings from the two preceding calendar years. As of September 30, 2002, the banking subsidiary had approximately $43 million available to be paid as dividends to the Parent Company. However, in order for the banking subsidiary to continue to meet the “well-capitalized” requirements issued by the Federal Reserve Board, the amount available to be paid as dividends to the Parent Company is limited to approximately $28 million.
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 September 30, 2002 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 $8.4 million, or $1.07 per share, during the three months ended September 30, 2002, as compared to $8.9 million, or $1.12 per share, for the same period in 2001. Net income for the nine months ended September 30, 2002 of $25.9 million, or $3.31 per share, increased $2.4 million, or 10.4%, from $23.5 million, or $2.95 per share, for the same period in 2001. Net income adjusted for the exclusion of goodwill amortization, net of tax effect, was $9.3 million, or $1.18 per share, and $24.9 million, or $3.13 per share, for the three and nine month periods ended September 30, 2001, respectively.
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. On a fully-taxable equivalent (“FTE”) basis, net interest income increased $1.9 million, or 5.7%, to $35.4 million for the three months ended September 30, 2002 compared to $33.5 million for the same period in the prior year. For the nine months ended September 30, 2002, FTE net interest income of $105.1 million increased $11.6 million, or 12.4%, from $93.5 million for the same period in 2001. These increases are primarily the result of higher loan volumes combined with an increase in the spread between rates earned on interest earning assets and rates paid on interest bearing liabilities. The FTE net interest margin ratio increased 12 basis points to 4.76% for the nine months ended September 30, 2002 as compared to 4.64% for the same period in the prior year.
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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 $4.3 million, or 32.2%, to $17.7 million for the three months ended September 30, 2002 from $13.4 million for the same period in 2001. Non-interest income increased $7.6 million, or 20.4%, to $44.8 million for the nine months ended September 30, 2002 from $37.2 million for the same period in 2001. Significant components of the quarter-to-date and year-to-date increases 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, credit card fee income, brokerage revenues, debit card interchange fee income and ATM service charge revenues. Other service charges, commissions and fees increased $433 thousand, or 9.1%, to $5.2 million for the quarter ended September 30, 2002 as compared to $4.8 million for the same period in the prior year. For the nine months ended September 30, 2002, other service changes, commissions and fees of $14.8 million increased $2.7 million, or 22.8%, from $12.0 million for the same period in 2001. Origination and processing fees on residential real estate loans sold increased $1.7 million during the first nine months of 2002 as compared to the same period in the prior year principally due to the high volume of refinancing activity spurred by decreases in residential lending rates. The remaining quarter-to-date and year-to-date increases are primarily attributable to fee income resulting from higher volumes of credit and debit card transactions and increases in mortgage servicing income.
Net investment securities gains of $2.3 million for the nine months ended September 30, 2002 increased $2.1 million from $142 thousand for the same period in the prior year primarily due to gains on investment securities sold during third quarter 2002 principally to offset impairment charges related to capitalized mortgage servicing rights.
Other income increased $1.3 million, or 113.2%, to $2.4 million for the quarter ended September 30, 2002 as compared to $1.1 million for the same period in the prior year. For the nine months ended September 30, 2002, other income of $4.4 million increased $1.1 million, or 34.9%, from $3.2 million for the same period in the prior year. These increases are primarily the result of a one-time gain of $1.2 million related to the third quarter 2002 sale of a branch banking office.
Non-Interest Expense. Non-interest expense increased $7.3 million, or 24.2%, to $37.2 million for the quarter ended September 30, 2002 from $29.9 million for the same period in 2001. Non-interest expense increased $13.4 million, or 15.5%, to $100.3 million for the nine months ended September 30, 2002 from $86.9 million for the same period in 2001. Significant components of the quarter-to-date and year-to-date increases are discussed below:
Salaries, wages and employee benefits expenses increased $1.8 million, or 11.5%, to $17.7 million for the quarter ended September 30, 2002 as compared to $15.9 million for the same period in the prior year. For the nine months ended September 30, 2002, salaries, wages and employee benefits expense of $51.9 million increased $6.1 million, or 13.4%, from $45.8 million for the same period in 2001. These increases are primarily due to inflationary wage increases, higher staffing levels associated with internal growth and rising group health insurance costs. Approximately 26% of the quarter-to-date and 15% of the year-to-date increases are attributable to new branches opened since first quarter 2001. The year-to-date increase was partially offset by a $400 thousand decrease in compensation expense related to outstanding stock options.
Occupancy expense increased $276 thousand, or 11.5%, to $2.7 million for the quarter ended September 30, 2002 compared to $2.4 million for the same period in 2001 and $882 thousand, or 12.6%, to $7.9 million for the nine months ended September 30, 2002 from $7.0 million for the same period in 2001. These increases are primarily due to higher rent, property tax and maintenance expenses. Approximately 29% of the quarter-to-date and 23% of the year-to-date increases are attributable to new branches opened since first quarter 2001. The remaining increase is primarily inflationary in nature.
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Furniture and equipment expenses increased $299 thousand, or 9.8%, to $3.4 million for the quarter ended September 30, 2002 from $3.1 million for the same period in 2001. For the nine months ended September 30, 2002, furniture and equipment expenses of $9.9 million increased $983 thousand, or 11.0%, from $9.0 million for the same period in 2001. These increases are primarily due to depreciation and maintenance expenses associated with upgrades of existing facilities, the addition of new facilities and technology upgrades. Approximately 32% of the quarter-to-date increase and 19% of the year-to-date increase is attributable to new branches opened since first quarter 2001.
Other intangible assets amortization expense increased $445 thousand, or 69.1%, to $1.1 million for the quarter ended September 30, 2002 as compared to $644 thousand for the same period in the prior year. For the nine months ended September 30, 2002, intangible amortization expense of $2.6 million increased $715 thousand, or 38.5%, as compared to $1.9 million for the same period in the prior year. These increases are due to higher mortgage servicing rights amortization expense, the result of growth in the mortgage servicing portfolio combined with an acceleration of amortization due to changes in estimated prepayment levels of the underlying loans.
Other expenses include advertising and public relations costs; legal, audit and other professional fees; office supply, postage, freight, telephone and travel expenses; other losses; and, impairment charges related to capitalized mortgage servicing rights and long-lived assets pending disposal. Other expenses increased $5.0 million, or 67.7%, to $12.3 million for the quarter ended September 30, 2002 from $7.3 million for the same period in 2001. For the nine months ended September 30, 2002, other expenses of $27.7 million increased $6.4 million, or 29.9%, from $21.3 million for the same period in 2001. During third quarter 2002, the Company recorded impairment charges of $2.9 million related to capitalized mortgage servicing rights and $847 thousand related to long-lived assets pending disposal. In addition, approximately 4% of the quarter-to-date increase and 6% of the year-to-date increase is attributable to new branches opened since first quarter 2001. The remaining quarter-to-date and year-to-date increases are primarily attributable to higher donation and professional fee expenses and normal inflationary expense increases.
Income Tax Expense. The Company’s effective combined federal and state income tax rate was 39.5% and 39.2% for the nine months ended September 30, 2002 and 2001, 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 and nine-month periods ended September 30, 2002 and 2001.
Community Banking. Community banking net income increased $2.0 million, or 7.0%, to $30.6 million for the nine months ended September 30, 2002 as compared to $28.6 million for the same period in the prior year primarily due to the discontinuation of goodwill amortization. During third quarter 2002, the community banking segment recorded a one-time gain of $1.2 million related to the sale of a branch banking office and gains of $2.1 million on sales of investment securities. Investment securities gains were used to offset impairment charges of $2.9 million related to capitalized mortgage servicing rights also recorded during third quarter 2002.
Technology Services. Technology services net income increased $31 thousand, or 1.3%, to $2.3 million for the nine months ended September 30, 2002 as compared to the same period in the prior year. Increases in external revenues were largely offset by decreases in interest income, additional expenses associated with technology upgrades, the addition of two item processing centers since first quarter 2001 and normal inflationary increases.
Other. Other net losses decreased $412 thousand, or 5.5%, to $7.0 million for the nine months ended September 30, 2002 as compared to $7.5 million for the same period in the prior year primarily due to decreases in interest expense on long-term debt, lower provisions for loan losses and decreases in compensation expense related to outstanding stock options. These cost savings were partially offset by third quarter 2002 impairment charges of $847 thousand related to a long-lived asset pending disposition.
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Financial Condition
Loans. Exclusive of residential real estate loans held for sale, total loans increased $120 million, or 5.8%, to $2,187 million as of September 30, 2002 from $2,067 million as of December 31, 2001 due to internal growth. All major categories of loans, except consumer loans, increased from December 31, 2001 with the most significant increases occurring in commercial and real estate loans. Consumer loans decreased less than 1% from December 31, 2001.
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 to satisfy pledging requirements for deposits of state and political subdivisions and securities sold under repurchase agreements. Investment securities increased $23 million, or 3.3%, to $716 million as of September 30, 2002 from $693 million as of December 31, 2001. This increase was primarily funded through internal deposit growth.
Cash and Cash Equivalents. Cash and cash equivalents include cash on hand, amounts due from banks, Federal funds sold for one day periods and interest bearing deposits in banks with original maturities of less than three months. Cash and cash equivalents increased $51 million, or 17.4%, to $344 million as of September 30, 2002 from $293 million as of December 31, 2001. Excess funds generated primarily through deposit growth were temporarily invested in short-term cash and cash equivalents.
Other Intangible Assets. Other intangible assets include core deposit intangibles and capitalized mortgage servicing rights. Other intangible assets of $12 million as of September 30, 2002 decreased $275 thousand, or 2.3%, from December 31, 2001. Exclusive of impairment reserves, capitalized mortgage servicing rights increased $3 million, or 46.7%, to $11 million as of September 30, 2002 compared to $7 million as of December 31, 2001 primarily due to internal loan origination. Impairment reserves were $4 million as of September 30, 2002 and $1 million as of December 31, 2001. Core deposit intangibles decreased $1 million, or 19.4%, to $5 million as of September 30, 2002 from $6 million as of December 31, 2001 due to scheduled amortization.
Other Assets. Other assets increased $45 million, or 105.5%, to $88 million as of September 30, 2002 from $43 million as of December 31, 2002 primarily due to the purchase of $50 million of bank-owned life insurance. This increase was partially offset by the redemption of $4 million of Federal Home Loan Bank equity securities.
Deposits. Total deposits increased $221 million, or 8.3%, to $2,894 million as of September 30, 2002 from $2,673 million as of December 31, 2001 due to internal growth, principally in savings and time deposits.
Long Term Debt. Long-term debt is comprised principally of an unsecured revolving term loan and unsecured subordinated notes. Long-term debt decreased $10 million, or 28.3% to $25 million as of September 30, 2002 from $34 million as of December 31, 2001 primarily due to repayment of advances on the unsecured revolving term loan.
Accrued Interest Payable. Accrued interest payable decreased $3 million, or 15.5%, to $14 million as of September 30, 2002 from $17 million as of December 31, 2001 primarily due to reductions in interest rates paid on interest-bearing deposits.
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 11.3%, to $29 million as of September 30, 2002 as compared to $26 million as of December 31, 2001 primarily due to the loans of one commercial borrower aggregating approximately $6 million placed on nonaccrual during first quarter 2002.
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
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adequacy of the allowance for loan losses. The provision for loan losses decreased $154 thousand, or 6.7%, to $2.1 million for the three months ended September 30, 2002 from $2.3 million for the same period in 2001. The provision for loan losses increased $1.9 million, or 39.9%, to $6.7 million for the nine months ended September 30, 2002 from $4.8 million for the same period in the prior year. Year-to-date increases from the prior year are primarily due to increases in non-performing and potential problem loans; softening economic conditions in the Company’s market areas, particularly in agriculture and hotel/motel market sectors; and, slowing regional and national economies. The allowance for loan losses was $36 million, or 1.61% of total loans, at September 30, 2002 as compared to $34 million, or 1.61% of total loans, at December 31, 2001.
Item 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURESABOUT MARKET RISK
As of September 30, 2002, 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 December 31, 2001 Form 10-K.
Item 4.
CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
The Company, under the supervision and with the participation of the Company’s management, including its Chief Executive Officer and Chief Financial Officer, carried out an evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of October 31, 2002 (the “Evaluation Date”). Based upon this evaluation, the Chief Executive Officer and Chief Financial Officer concluded as of the Evaluation Date that the Company’s disclosure controls and procedures were effective for purposes of recording, processing, summarizing and timely reporting material information required to be disclosed in reports filed by the Company under the Securities Exchange Act of 1934.
Changes in Internal Controls
There were no significant changes in the Company’s internal controls or other factors that could significantly affect these controls subsequent to the Evaluation Date. The Company did not implement any corrective actions with regard to any significant deficiency or material weakness in its internal controls.
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PART II.
OTHER INFORMATION
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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 :
DATE: November 4, 2002.
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I, Terrill R. Moore, certify that :
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CERTIFICATION OF QUARTERLY REPORT ON FORM 10-QPURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
The undersigned are the Chief Executive Officer and the Chief Financial Officer of First Interstate BancSystem, Inc. (the “Registrant”). This Certification is made pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. This Certification accompanies the Quarterly Report on Form 10-Q of the Registrant for the quarterly period ended September 30, 2002.
We certify that such Quarterly Report on Form 10-Q fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that the information contained in such 10-Q Report fairly presents, in all material respects, the financial condition and results of operations of the Registrant.
This Certification is executed as of November 4, 2002.
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