UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
FORM 10-K
(Mark One)
þ | Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the fiscal year ended December 31, 2016
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: 001-34653
FIRST INTERSTATE BANCSYSTEM, INC.
(Exact name of registrant as specified in its charter)
Montana (State or other jurisdiction of incorporation or organization) | 81-0331430 (IRS Employer Identification No.) | |
401 North 31st Street Billings, Montana (Address of principal executive offices) | 59116 (Zip Code) | |
(406) 255-5390
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Class A common stock (Title of each class) | NASDAQ Stock Market (Name of each exchange on which registered) | |
Securities registered pursuant to Section 12(g) of the Act:
Class B common stock
(Title of class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. o Yes þ No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. o Yes þ No
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. þ Yes o No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§223.405 of this chapter) during the preceding 12 months (or for such shorter period that registrant was required to submit and post such files). þ Yes o No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
o Large accelerated filer | þ Accelerated filer | o Non-accelerated filer (Do not check if a smaller reporting company) | o Smaller reporting company |
Indicate by check mark if the registrant is a shell company (as defined in Rule 12b-2 of the Act.) o Yes þ No
The aggregate market value of voting and non-voting common equity held by non-affiliates, computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter, was $665,604,447.
Indicate the number of shares outstanding of each of the registrant’s classes of common stock as of January 31, 2017:
Class A common stock | 21,753,730 | |
Class B common sock | 23,241,905 | |
Documents Incorporated by Reference
The registrant intends to file a definitive Proxy Statement for the Annual Meeting of Shareholders scheduled to be held May 24, 2017. The information required by Part III of this Form 10-K is incorporated by reference from such Proxy Statement.
EX-21.1 |
EX-23.1 |
EX-31.1 |
EX-31.2 |
EX-32 |
PART I
Item 1. Business
The disclosures set forth in this report are qualified by Item 1A. Risk Factors included herein and the section captioned “Cautionary Note Regarding Forward-Looking Statements and Factors that Could Affect Future Results” included in Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. When we refer to “we,” “our,” “us” or the “Company” in this annual report, we mean First Interstate BancSystem, Inc. and our consolidated subsidiaries, including our wholly-owned subsidiary, First Interstate Bank, unless the context indicates that we refer only to the parent company, First Interstate BancSystem, Inc. When we refer to the “Bank” in this annual report, we mean First Interstate Bank.
Our Company
We are a financial and bank holding company incorporated as a Montana corporation in 1971. We are headquartered in Billings, Montana. As of December 31, 2016, we had consolidated assets of $9.1 billion, deposits of $7.4 billion, loans of $5.5 billion and total stockholders’ equity of $983 million. We currently operate 80 banking offices, including detached drive-up facilities, in 46 communities located in Montana, Wyoming and South Dakota. We also offer internet and mobile banking services. Through our wholly-owned subsidiary, First Interstate Bank, or FIB, we deliver a comprehensive range of banking products and services to individuals, businesses, municipalities and other entities throughout our market areas. Our customers participate in a wide variety of industries, including energy, healthcare and professional services, education and governmental services, construction, mining, agriculture, retail and wholesale trade and tourism. Our principal markets range in size from approximately 23,000 to 150,000 people, have diversified economic characteristics and positive population growth prospects and usually serve as trade centers for larger rural areas.
In January 2017, we acquired for cash, all rights, title and interest in and to all First Interstate-related U.S. trademark registrations, or Trademarks, domain names and common law rights and goodwill associated with the Trademarks that were previously owned by Wells Fargo & Company. We are now able to use the “First Interstate” name and logo throughout the United States.
Our goal is to be the premier financial services provider within the communities we serve. We are committed to be a leader in the financial and social fabric of our communities by continuously strengthening our relationships with our employees and our clients while driving long-term shareholder value. As a community bank we adhere to six common values that provide a foundation for our growth and success. They are: (1) we put people first; (2) we strive for excellence; (3) we act with integrity; (4) we embrace change; (5) we are committed to our communities; and, (6) we celebrate success. These values support our commitment to our employees, our clients, our communities and our shareholders.
We have grown our business by adhering to this set of values and we have a long-term disciplined perspective that emphasizes our commitment to providing high-quality financial products and services, delivering quality client service, effecting business leadership through professional and dedicated managers and employees, assisting our communities through socially responsible leadership and cultivating a strong and positive corporate culture. We intend to remain a leader in our markets by continuing to adhere to these core values that have contributed to our growth and success. In addition, we plan to continue to expand our business in a disciplined and prudent manner, including organic growth in our existing market areas and expansion into new and complementary markets when appropriate opportunities arise.
Recent Acquisitions
On April 6, 2016, our bank subsidiary, FIB, entered into a stock purchase agreement to acquire all of the outstanding stock of Flathead Bank of Bigfork, or Flathead Bank, a wholly-owned subsidiary of Flathead Holding Company of Bigfork, with branches located in western and northwestern Montana. The acquisition was completed on August 12, 2016 for cash consideration of $34 million. Flathead Bank was merged with FIB immediately subsequent to the acquisition. As of the date of the acquisition, Flathead Bank had total assets of $254 million, loans of $83 million and deposits of $210 million.
On July 24, 2015, we acquired all of the outstanding stock of Absarokee Bancorporation, Inc., a Montana-based bank holding company operating one wholly-owned subsidiary bank, United Bank, with branches located in three Montana communities adjacent to the Company's existing market areas. United Bank was merged with FIB immediately subsequent to the acquisition. We paid cash consideration for the acquisition of $7.2 million. As of the acquisition date, Absarokee Bancorporation, Inc. had total assets of $73 million, loans of $38 million and deposits of $64 million.
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For additional information regarding these acquisitions, see “Managements’ Discussion and Analysis — Recent Trends and Developments” included in Part II, Item 7 and “Notes to Consolidated Financial Statements — Acquisitions” included in Part IV, Item 15.
Pending Acquisition of Cascade Bancorp
On November 17, 2016, we entered into an agreement and plan of merger, the Agreement, to acquire all of the outstanding stock of Cascade Bancorp, parent company of Bank of the Cascades, an Oregon-based community bank with 50 banking offices across Oregon, Idaho and Washington. Under the terms of the Agreement, each outstanding share of Cascade Bancorp will convert into the right to receive 0.14864 shares of our Class A common stock and $1.91 in cash. Based on the closing price of the our Class A common stock on December 31, 2016, the merger consideration represents an aggregate purchase price of approximately $628 million. Upon completion of the merger, which is expected to close during third quarter 2017 subject to regulatory and shareholder approvals, we will become a regional community bank with over $12 billion in total assets with a geographic footprint that will span Montana, Wyoming, South Dakota, Idaho, Oregon and Washington.
For additional information regarding the pending acquisition, see “Managements’ Discussion and Analysis — Recent Trends and Developments” included in Part II, Item 7 and “Notes to Consolidated Financial Statements — Acquisitions” included in Part IV, Item 15. For additional information regarding risks associated with the pending acquisition, see "Risk Factors" included in Item 1A herein.
Community Banking
Community banking encompasses commercial and consumer banking services provided through our Bank, primarily the acceptance of deposits; extensions of credit; mortgage loan origination and servicing; and trust, employee benefit, investment and insurance services. Our community banking philosophy emphasizes providing customers with commercial and consumer banking products and services locally using a personalized service approach while strengthening the communities in our market areas through community service activities. We grant our banking offices significant authority in delivering products in response to local market considerations and customer needs. This authority enables our banking offices to remain competitive by responding quickly to local market conditions and enhances their relationships with the customers they serve. We also require accountability by having company-wide standards and established limits on the authority and discretion of each banking office. This combination of authority and accountability allows our banking offices to provide personalized customer service and be in close contact with our communities, while at the same time promoting strong performance and remaining focused on our overall financial performance.
Lending Activities
We offer short and long-term real estate, consumer, commercial, agricultural and other loans to individuals and businesses in our market areas. We have comprehensive credit policies establishing company-wide underwriting and documentation standards to assist management in the lending process and to limit our risk. Each loan must meet minimum underwriting standards specified in our credit policies. Minimum underwriting standards generally specify that loans (i) are made to borrowers located within a designated geographical lending area with the exception of participation loans and loans to national accounts; (ii) are made only for identified legal purposes; (iii) have specifically identified sources of repayment; (iv) mature within designated maximum maturity periods that coincide with repayment sources; (v) are appropriately collateralized whenever possible, (vi) are supported by current credit information; (vii) do not exceed the Bank's legal lending limit; (viii) with fixed interest rates that reset are adjusted within designated time frames; and (ix) require a flood determination prior to closing. In addition, our minimum underwriting standards include lending limitations to prevent concentrations of credit in agricultural, commercial, real estate or consumer loans. Further, each minimum underwriting standard must be documented as part of the loan approval process.
While each loan must meet minimum underwriting standards established in our credit policies, lending officers are granted certain levels of authority in approving and pricing loans to assure that the banking offices are responsive to competitive issues and community needs in each market area. Lending authorities are established at individual, branch and market levels. Branch loan officers are granted levels of credit authority in approving and pricing loans to assure that our banking offices are responsive to competitive issues and community needs in each market area. Credit authorities are established and assigned based on the credit experience and credit acumen of each branch loan officer. Credit authority is under the direction of our Chief Credit Officer or his designee and is reviewed on an ongoing basis. Credits over the authority of branch loan officers are approved by our credit administration group.
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Deposit Products
We offer traditional depository products including checking, savings and time deposits. Deposits at the Bank are insured by the Federal Deposit Insurance Corporation, or FDIC, up to statutory limits. We also offer repurchase agreements primarily to commercial and municipal depositors. Under repurchase agreements, we sell investment securities held by the Bank to our customers under an agreement to repurchase the investment securities at a specified time or on demand. All outstanding repurchase agreements are due in one business day.
Wealth Management
We provide a wide range of trust, employee benefit, investment management, insurance, agency and custodial services to individuals, businesses and nonprofit organizations. These services include the administration of estates and personal trusts; management of investment accounts for individuals, employee benefit plans and charitable foundations; and insurance planning. As of December 31, 2016, the estimated fair value of trust assets held in a fiduciary or agent capacity was $4.9 billion.
Centralized Services
We have centralized certain operational activities to provide consistent service levels to our customers company-wide, to gain efficiency in management of those activities and to ensure regulatory compliance. Centralized operational activities generally support our banking offices in the delivery of products and services to customers and include marketing; credit review; credit cards; mortgage loan sales and servicing; indirect consumer loan purchasing and processing; loan collections and, other operational activities. Additionally, specialized staff support services have been centralized to enable our branches to serve their markets more efficiently. These services include credit administration, finance, accounting, human resource management, internal audit, facilities management, technology, risk management, compliance and other support services.
Competition
There is significant competition among commercial banks in our market areas. We also compete with other providers of financial services, such as savings and loan associations, credit unions, financial technology companies, internet banks, consumer finance companies, brokerage firms, mortgage banking companies, insurance companies, securities firms, mutual funds and certain government agencies as well as major retailers, all actively engaged in providing various types of loans and other financial services. Some of our competitors have greater resources and, as such, may have higher lending limits and may offer other services that we do not provide. We generally compete on the basis of customer service and responsiveness to customer needs, available loan and deposit products, rates of interest charged on loans, rates of interest paid for deposits, and the availability and pricing of trust, employee benefit, investment and insurance services.
Employees
We recognize quality, engaged employees are critical to our ability to serve our customers and to the success of our company. We strive to be the employer of choice in the markets we serve. At December 31, 2016, we employed 1,721 full-time equivalent employees, none of whom are represented by a collective bargaining agreement. We consider our employee relations to be good. This is supported by the results of an employee engagement survey, in which 96% of our employees participated with an average engagement score of 76%.
Regulation and Supervision
Regulatory Authorities
We are subject to extensive regulation under federal and state laws. A description of certain material laws and regulations applicable to us is summarized below. This description is not intended to summarize all laws and regulations applicable to us. In addition to laws and regulations, state and federal banking regulatory agencies may issue policy statements, interpretive letters and similar written guidance. Those issuances may affect the conduct of our business or impose additional regulatory obligations. Descriptions of statutory and regulatory provisions and requirements do not purport to be complete and are qualified in their entirety by reference to those provisions.
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As a financial and bank holding company, we are subject to regulation under the Bank Holding Company Act of 1956, as amended, and to supervision, regulation and regular examination by the Board of Governors of the Federal Reserve System, or Federal Reserve. Because we are a public company, we are also subject to the disclosure and regulatory requirements of the Securities Exchange Act of 1934, as amended, or the Exchange Act, as administered by the Securities and Exchange Commission, or the SEC.
The Bank is subject to supervision and regular examination by its primary banking regulators, the Federal Reserve and the Montana Department of Administration, Division of Banking and Financial Institutions, or Montana Division. Although the Bank is not currently directly supervised by the Consumer Financial Protection Bureau, or CFPB, certain of the Bank's consumer banking activities are also subject to CFPB regulations.
The Bank's deposits are insured by the Deposit Insurance Fund, or the DIF, of the FDIC in the manner and to the extent provided by law. The Bank is subject to the Federal Deposit Insurance Act, or the FDIA, and FDIC regulations relating to deposit insurance and may also be subject to supervision and examination by the FDIC.
The extensive regulation of the Bank limits both the activities in which the Bank may engage and the conduct of its permitted activities. Further, the laws and regulations impose reporting and information collection obligations on the Bank. The Bank incurs significant costs relating to compliance with various laws and regulations and the collection and retention of information. As the regulatory framework for bank holding companies and banks continues to grow and become more complex, the cost of complying with regulatory requirements continues to increase. In addition, when our consolidated assets exceed $10 billion, we will become subject to additional statutory and regulatory requirements and would incur additional compliance costs. As of December 31, 2016, our consolidated assets were $9.1 billion. However, the pending acquisition of Cascade Bancorp, if consummated, would cause us to exceed $10 billion in assets.
Financial and Bank Holding Company
We are a bank holding company and have registered as a financial holding company under regulations issued by the Federal Reserve. Under federal law, we are required to serve as a source of financial and managerial strength to the Bank, which may include providing financial assistance to the Bank if the Bank experiences financial distress. Under existing Federal Reserve source of strength policies, the Federal Reserve may require a bank holding company to make capital injections into a troubled subsidiary bank. The Federal Reserve may also determine that the bank holding company is engaging in unsafe and unsound practices if it fails to commit resources to a subsidiary bank.
We are required by the Bank Holding Company Act to obtain Federal Reserve approval prior to acquiring, directly or indirectly, ownership or control of voting shares of any bank, if, after such acquisition, we would own or control more than 5% of its voting stock. The Federal Reserve considers a number of factors in evaluating acquisitions including, but not limited to, the financial and managerial resources and future prospects of the parties, the convenience and needs of the communities served and competitive factors. Under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, or the Dodd-Frank Act, when considering an application, the Federal Reserve is also required to evaluate whether the transaction would result in more concentrated risks to the United States banking or financial system. Under federal law and regulations, a bank holding company may acquire banks in states other than its home state if, among other things, the bank holding company is both “well capitalized” and “well managed” both before and after the acquisition.
Banks may also merge across state lines. With additional changes made to federal statutes under the Dodd-Frank Act, banks are also permitted to establish new interstate branches if a bank located in the target state could establish a new branch at the proposed location without regard to state laws limiting interstate de novo branching. A state can prohibit interstate mergers entirely or prohibit them if the continuing bank would control insured bank deposits in excess of a specified percentage of total insured bank deposits in the state. Under Montana law, a bank cannot acquire control of a bank located in Montana if, after the acquisition, the acquiring institution would control, in the aggregate, more than 22% of the total deposits of insured depository institutions located in Montana. As of December 31, 2016, the Bank controlled approximately 18% of the total deposits of all insured depository institutions located in Montana. The state limitation may limit our ability to directly or indirectly acquire additional banks located in Montana.
We have voluntarily registered with the Federal Reserve as a financial holding company. As a financial holding company, we may engage in certain business activities that are determined by the Federal Reserve to be financial in nature or incidental to financial activities as well as all activities authorized to bank holding companies generally.
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We may engage in authorized financial activities, provided that we remain a financial holding company and are “well capitalized” and “well managed.” We do not currently engage in significant financial holding company businesses or activities not otherwise permitted for bank holding companies generally.
In order to assess the financial strength of the bank holding company, the Federal Reserve and the State of Montana also conduct periodic on-site and off-site inspections and credit reviews throughout the year. The federal banking agencies, including the Federal Reserve, may also require additional information and reports from us. In addition, the Federal Reserve may examine, and require reports and information regarding, any entity that we control, including entities other than banks or entities engaged in financial activities. In certain circumstances, the Federal Reserve may require us to divest of non-bank entities or limit the activities of those entities even if the activities are otherwise permitted to bank holding companies under governing law.
Dividends and Restrictions on Transfers of Funds
Dividends from the Bank are the primary source of funds for the payment of our operating expenses and for the payment of dividends to our shareholders. Under both state and federal law, the amount of dividends that may be paid by the Bank from time to time is limited. In general, the Bank is limited to paying dividends that do not exceed the current year net profits together with retained earnings from the two preceding calendar years unless the prior consent of the Federal Reserve is obtained. In addition, the Bank may not pay dividends in excess of the previous two years' net earnings without providing notice to the Montana Division.
The capital buffer rules adopted by the federal banking regulators in accordance with the Basel Accords impose further limitations on the Bank’s ability to pay dividends. In general, the Bank’s ability to pay dividends is limited under the capital buffer rules unless the Bank’s common equity conservation buffer exceeds the minimum required capital ratio by a specified amount which, when fully phased-in, will be 2.5% of risk-weighted assets.
A state or federal banking regulator may impose, by regulatory order or agreement of the Bank, specific dividend limitations or prohibitions in certain circumstances. The Bank is not currently subject to a specific regulatory dividend limitation.
In general, a bank is also prohibited from making capital distributions, including dividends, if it would be “under-capitalized” under the regulatory framework for corrective action after making such payments. See “Capital Standards and Prompt Corrective Action.”
The Federal Reserve has issued a policy statement regarding the payment of dividends and the repurchase of shares of common stock by bank holding companies. In general, the policy provides that dividends should be paid only out of current earnings and only if the prospective rate of earnings retention by the holding company appears consistent with the organization’s capital needs, asset quality and overall financial condition. Regulatory guidance provides for prior regulatory consultation with respect to capital distributions in certain circumstances such as where the company’s net income for the past four quarters (net of previous capital distributions) is insufficient to fully fund the dividend or the company’s overall rate of earnings retention is inconsistent with the company’s capital needs and overall financial condition. The ability of a holding company to pay dividends may be restricted if a subsidiary bank becomes under-capitalized. The policy statement also states that a holding company should inform the Federal Reserve supervisory staff prior to redeeming or repurchasing common stock or perpetual preferred stock if the holding company is experiencing financial weaknesses or if the repurchase or redemption would result in a net reduction, as of the end of a quarter, in the amount of such equity instruments outstanding compared with the beginning of the quarter in which the redemption or repurchase occurred. These regulatory policies may affect our ability to pay dividends, repurchase shares of common stock or otherwise engage in capital distributions.
Restrictions on Transactions with Affiliates, Directors and Officers
Under the Federal Reserve Act, the Bank may not lend funds or otherwise extend credit to us or any other affiliate, except on specified types and amounts of collateral generally upon market terms and conditions. The Federal Reserve also has authority to define and limit the transactions between banks and their affiliates. The Federal Reserve's Regulation W and relevant federal statutes, among other things, impose significant limitations on transactions in which the Bank may engage with us or with other affiliates, including per affiliate and aggregate limits on affiliate transactions.
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Federal Reserve Regulation O restricts loans to the Bank and Company insiders, which includes directors, certain officers and principal stockholders and their respective related interests. All extensions of credit to the insiders and their related interests must be on the same terms as, and subject to the same loan underwriting requirements as, loans to persons who are not insiders. In addition, Regulation O imposes lending limits on loans to insiders and their related interests and imposes, in certain circumstances, requirements for prior approval of the loans by the Bank board of directors.
Capital Standards and Prompt Corrective Action
Banks and bank holding companies are subject to various regulatory capital requirements administered by state and federal banking agencies, which involve quantitative measures of assets, liabilities and certain off-balance sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weighting and other factors. The capital requirements are intended to ensure that banking organizations have adequate capital given the risk levels of assets and off-balance sheet financial instruments and are applied separately to the Bank and the Company.
Federal regulations require FDIC-insured depository institutions and bank holding companies to meet several minimum capital standards: a common equity Tier 1 capital to risk-based assets ratio of 4.5%, a Tier 1 capital to risk-based assets ratio of 6.0%, a total capital to risk-based assets of 8%, and a 4% Tier 1 capital to total assets leverage ratio. The existing capital requirements were effective January 1, 2015 and are the result of a final rule implementing regulatory amendments based on recommendations of the Basel Committee on Banking Supervision and certain requirements of the Dodd-Frank Act.
For purposes of the regulatory capital requirements, common equity Tier 1 capital is generally defined as common stockholders’ equity and retained earnings. Tier 1 capital is generally defined as common equity Tier 1 and additional Tier 1 capital. Additional Tier 1 capital includes certain noncumulative perpetual preferred stock and related surplus and minority interests in equity accounts of consolidated subsidiaries. Total capital includes Tier 1 capital (common equity Tier 1 capital plus additional Tier 1 capital) and Tier 2 capital. Tier 2 capital is comprised of capital instruments and related surplus, meeting specified requirements, and may include cumulative preferred stock and long-term perpetual preferred stock, mandatory convertible securities, intermediate preferred stock and subordinated debt. Also included in Tier 2 capital is the allowance for loan and lease losses limited to a maximum of 1.25% of risk-weighted assets and, for institutions like us that have exercised an opt-out election regarding the treatment of Accumulated Other Comprehensive Income (“AOCI”), up to 45% of net unrealized gains on available-for-sale equity securities with readily determinable fair market values. Institutions that have not exercised the AOCI opt-out have AOCI incorporated into common equity Tier 1 capital (including unrealized gains and losses on available-for-sale-securities). Calculation of all types of regulatory capital is subject to deductions and adjustments specified in the regulations.
In determining the amount of risk-weighted assets for purposes of calculating risk-based capital ratios, all assets, including certain off-balance sheet assets (e.g., recourse obligations, direct credit substitutes, residual interests), are multiplied by a risk weight factor assigned by the regulations based on the risks believed inherent in the type of asset. Higher levels of capital are required for asset categories believed to present greater risk. For example, a risk weight of 0% is assigned to cash and U.S. government securities, a risk weight of 50% is generally assigned to prudently underwritten first lien one- to four-family residential mortgages, a risk weight of 100% is assigned to commercial and consumer loans, a risk weight of 150% is assigned to certain past due loans and a risk weight of between 0% to 600% is assigned to permissible equity interests, depending on certain specified factors.
In addition to establishing the minimum regulatory capital requirements, the regulations limit capital distributions and certain discretionary bonus payments to management if the institution does not hold a “capital conservation buffer” consisting of 2.5% of common equity Tier 1 capital to risk-weighted asset above the amount necessary to meet its minimum risk-based capital requirements. The capital conservation buffer requirement is being phased in beginning January 1, 2016 at 0.625% of risk-weighted assets and increasing each year until fully implemented at 2.5% on January 1, 2019.
In assessing an institution’s capital adequacy, the Federal Reserve takes into consideration, not only these numeric factors, but qualitative factors as well, and has the authority to establish higher capital requirements in individual cases where deemed necessary. The Federal Reserve has not established individual capital requirements applicable to us or the Bank.
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The Dodd-Frank Act and the revised regulations limit the use of hybrid capital instruments in meeting regulatory capital requirements, including instruments similar to those which we currently have issued and outstanding. However, because we met the criteria for grandfathering under the Dodd-Frank Act, the limitations on use of hybrid capital instruments do not apply to our outstanding instruments.
Federal law requires the federal banking agencies to take “prompt corrective action” in respect of depository institutions that do not meet minimum capital requirements. The law sets forth the following five capital tiers: “well capitalized,” “adequately capitalized,” “under-capitalized,” “significantly under-capitalized” and “critically under-capitalized.” A depository institution's capital tier will depend upon how its capital levels compare with various relevant capital measures and certain other factors, as established by regulation. The relevant capital measures are the common equity tier 1 capital ratio, total capital ratio, the tier 1 capital ratio and the leverage ratio.
A depository institution is generally prohibited from making any capital distributions (including payment of a dividend) or paying any management fee to its parent holding company if the depository institution would thereafter be under-capitalized. Under-capitalized institutions may be subject to growth limitations and other restrictions and are required to submit a capital restoration plan. If a depository institution fails to submit an acceptable plan, it is treated as if it is “significantly under-capitalized.”
“Significantly under-capitalized” depository institutions are subject to additional requirements and restrictions, such as orders to sell sufficient stock to become “adequately capitalized,” to reduce total assets, restrict interest rates paid, remove management and directors and cease receipt of deposits from correspondent banks. “Critically under-capitalized” institutions are subject to the appointment of a receiver or conservator.
The capital stock of banks organized under Montana law, such as the Bank, may be subject to assessment upon the direction of the Montana Department of Administration under the Montana Bank Act. Under the Montana Bank Act, if the Department of Administration determines an impairment of a bank's capital exists, it may notify the bank's board of directors of the impairment and require payment of an assessment on the bank stock. If the bank fails to do so, the Department of Administration may, among other things, take charge of the bank and proceed to liquidate the bank.
Safety and Soundness Standards and Other Supervisory and Enforcement Mechanisms
The federal banking agencies have adopted guidelines establishing standards for safety and soundness, asset quality and earnings, internal controls and audit systems. These standards are designed to identify potential concerns and ensure that action is taken to address those concerns before they pose a risk to the DIF. If a federal banking agency determines that an institution fails to meet any of these standards, the agency may require the institution to submit an acceptable plan to achieve compliance with the standard. If the institution fails to submit an acceptable plan within the time allowed by the agency or fails in any material respect to implement an accepted plan, the agency must, by order, require the institution to correct the deficiency and may take other supervisory action.
Pursuant to the Dodd-Frank Act, federal banking regulators impose additional supervisory measures on banking organizations when they exceed $10 billion in assets. These include enhanced risk management and corporate governance processes and stress-testing requirements based on scenarios specified by the regulators. We currently have less than $10 billion in assets, but would exceed that threshold upon consummation of the pending Cascade Bancorp acquisition.
The Federal Reserve has authority to bring enforcement action against a bank or bank holding company and all “institution-affiliated parties” of a bank or bank holding company, including directors, officers, stockholders and, under certain circumstances, attorneys, appraisers and accountants for the bank or holding company. Formal enforcement actions may include measures such as the issuance of a capital directive or cease and desist order to removal of officers and/or directors or the appointment of a receiver or conservator. Civil money penalties cover a wide range of violations and actions, and can range up to $25,000 per day, unless a finding of reckless disregard is made, in which case penalties may be as high as $1 million per day. The FDIC also has the authority to terminate deposit insurance or recommend to the Federal Reserve that enforcement action be taken with respect to a particular bank. If such action is not taken, the FDIC has authority to take the action under specified circumstances. Montana law also provides the Montana Division with various enforcement mechanisms and, ultimately, authority to appoint a receiver or conservator for a Montana bank.
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Deposit Insurance
The FDIC insures our customer deposits through the DIF up to $250,000 per depositor. The amount of FDIC assessments paid by each DIF member institution is based on financial measures and supervisory ratings derived from a statistical model estimating the probability of failure within a three-year period, with banks deemed more risky paying higher assessment.
The FDIC was required by the Dodd-Frank Act to take actions necessary to cause the DIF to reach a reserve ratio of 1.35% of total estimated insured deposits by September 30, 2020. However, under the Dodd-Frank Act, the effects of any increases in deposit insurance premium assessments necessary to achieve the 1.35% reserve ratio are to be offset for the benefit of depository institutions with total consolidated assets of less than $10 billion, once the ratio reaches 1.15%. The 1.15% ratio was achieved on or about June 30, 2016. Consequently, effective July 1, 2016, the FDIC revised its system to impose surcharges on institutions with $10 billion or more in assets and credit smaller institutions for any future payments toward reaching the 1.35% ratio. This system will remain in place until the earlier of the DIF reaching the 1.35% ratio or December 31, 2018. If the ratio has not been achieved by that date, a shortfall assessment would be applied. The Bank currently has total consolidated assets of less than $10 billion, but would reach that threshold upon consummation of the pending Cascade Bancorp acquisition.
All FDIC-insured institutions are also required to pay assessments to the FDIC to fund interest payments on bonds issued by the Financing Corporation, or the FICO, an agency of the Federal government established to recapitalize the predecessor to the DIF. The FICO assessment rates are set at 0.00056% of total assets and will continue until the FICO bonds mature in 2017 through 2019.
Customer Privacy and Other Consumer Protections
Federal law imposes customer privacy requirements on any company engaged in financial activities, including the Bank and us. Under these requirements, a financial company is required to protect the security and confidentiality of customer nonpublic personal information. In addition, for customers who obtain a financial product such as a loan for personal, family or household purposes, a financial holding company is required to disclose its privacy policy to the customer at the time the relationship is established and annually thereafter. The financial company must also disclose its policies concerning the sharing of the customer's nonpublic personal information with affiliates and third parties. Finally, a financial company is prohibited from disclosing an account number or similar item to a third party for use in telemarketing, direct mail marketing or marketing through electronic mail.
The Bank is subject to a variety of federal and state laws, regulations and reporting obligations aimed at protecting consumers and Bank customers. Failure to comply with these laws and regulations may, among other things, impair the collection of loans made in violation of the laws and regulations, provide borrowers or other customers certain rights and remedies or result in the imposition of penalties on the Bank. Certain of these laws and regulations are described below.
The Equal Credit Opportunity Act generally prohibits discrimination in credit transactions on, among other things, the basis of race, color, religion, national origin, sex, marital status or age and, in certain circumstances, limits the Bank's ability to require co-obligors or guarantors as a condition of the extension of credit to an individual.
The Real Estate Settlement Procedures Act, or RESPA, requires certain disclosures be provided to borrowers in real estate loan closings or other real estate settlements. In addition, RESPA limits or prohibits certain settlement practices, fee sharing, kickbacks and similar practices that are considered to be abusive.
The Truth in Lending Act, or TILA, requires disclosures to borrowers and other parties in consumer loans including, among other things, disclosures relating to interest rates and other finance charges, payments and payment schedules and annual percentage rates. TILA provides remedies to borrowers upon certain failures in compliance by a lender.
The Fair Housing Act regulates, among other things, lending practices in residential lending and prohibits discrimination in housing-related lending activities on the basis of race, color, religion, national origin, sex, handicap, disability or familial status.
The Home Mortgage Disclosure Act requires certain lenders and other firms engaged in the home mortgage industry to collect and report information relating to applicants, borrowers and home mortgage lending activities in which they engage in their market areas or communities. The information is used for, among other purposes, evaluation of discrimination or other impermissible acts in home mortgage lending.
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The Home Ownership and Equity Protection Act regulates terms and disclosures of certain closed-end home mortgage loans that are not purchase money loans and includes loans classified as “high-cost loans.”
The Fair Credit Reporting Act, as amended by the Fair and Accurate Credit Transactions Act, generally limits lenders and other financial firms in their collection, use or dissemination of customer credit information, gives customers some access to, and control over, their credit information and requires financial firms to establish policies and procedures intended to deter identity theft and related frauds.
The Fair Debt Collection Practices Act regulates actions that may be taken in the collection of consumer debts and provides consumers with certain rights of access to information related to collection actions.
The Electronic Fund Transfer Act regulates fees and other terms on electronic funds transactions.
The Federal Reserve has issued regulations relating to fees and charges in debit card transactions to implement provisions of the Dodd-Frank Act. Card issuers with consolidated assets of less than $10 billion are exempt from the interchange fee standards but are subject to other rules addressing exclusivity and other requirements. The Bank is not currently subject to the interchange fee standards, since its consolidated assets are less than $10 billion. However, if the pending Cascade Bancorp acquisition if consummated, it would put us over $10 billion in assets. Based on our 2016 debit card transaction volume, we estimate interchange fee caps prescribed under the Dodd-Frank Act for issuers with consolidated assets in excess of $10 billion would have reduced our debit card interchange fee income by approximately $8 million.
The federal consumer protection scheme was revised by the Dodd-Frank Act. Among other things, the CFPB was created with authority to regulate consumer financial products and services and implement and enforce federal consumer financial laws. Although the CFPB is accorded examination and enforcement authority, the CFPB's authority does not generally extend to depository institutions with total assets of less than $10 billion. The Bank currently has total assets of less than $10 billion and therefore has continued to be examined by the Federal Reserve for compliance with federal consumer protection laws. However, the Bank will become subject to CFPB examination and enforcement authority when it exceeds $10 billion in assets, which will occur if the pending Cascade Bancorp acquisition is consummated.
The Community Reinvestment Act, or CRA, generally requires the federal banking agencies to evaluate the record of a financial institution in meeting the credit needs of its local communities, including low and moderate income neighborhoods. In addition to substantial penalties and corrective measures that may be assessed for a violation of fair lending laws, the federal banking agencies may take compliance with such laws and the CRA into account when evaluating applications for such transactions as mergers and new branches.
In connection with its assessment of CRA performance, the appropriate bank regulatory agency assigns a rating of “outstanding,” “satisfactory,” “needs to improve” or “substantial noncompliance.” The Bank received an “outstanding” rating on its most recent published examination. Although the Bank's policies and procedures are designed to achieve compliance with all fair lending and CRA requirements, instances of non-compliance are occasionally identified through normal operational activities. Management responds pro-actively to correct all instances of non-compliance and implement procedures to prevent further violations from occurring.
USA PATRIOT Act
The USA PATRIOT Act of 2001 amended the Bank Secrecy Act of 1970 and the Money Laundering Control Act of 1986 and adopted additional measures requiring insured depository institutions, broker-dealers and certain other financial institutions to have policies, procedures and controls to detect, prevent and report money laundering and terrorist financing. The laws and related regulations also provide for information sharing, subject to conditions, between federal law enforcement agencies and financial institutions, as well as among financial institutions, for counter-terrorism purposes. Federal banking regulators are required, when reviewing bank holding company acquisition or merger applications, to take into account the effectiveness of the anti-money laundering activities of the applicants.
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Office of Foreign Asset Control
The United States Treasury Office of Foreign Asset Control enforces economic and trade sanctions imposed by the United States on foreign persons and governments. Among other authorities, the Office of Foreign Asset Control may require United States financial institutions to block or “freeze” assets of identified foreign persons or governments which come within the control of the financial institution. Financial institutions are required to adopt procedures for identification of new and existing deposit accounts and other relationships with persons or governments identified by the Office of Foreign Asset Control and to timely report the accounts or relationships to the Office of Foreign Asset Control.
Incentive Compensation
In May 2016, the Federal Reserve Board, other federal banking agencies and the SEC jointly published re-proposed rule-making designed to implement provisions of the Dodd-Frank Act prohibiting incentive compensation arrangements that would encourage inappropriate risk taking at a covered institution, which includes a bank or bank holding company with $1 billion or more of assets, such as us. The proposed rule (i) prohibits incentive-based compensation arrangements that encourage executive officers, employees, directors or principal shareholders to expose the institution to inappropriate risks by providing excessive compensation (based on the standards for excessive compensation adopted pursuant to the FDIA) and (ii) prohibits incentive-based compensation arrangements for executive officers, employees, directors or principal shareholders that could lead to a material financial loss for the institution. The proposed rule requires covered institutions to establish policies and procedures for monitoring and evaluating their compensation practices. The comment period ended in July 2016. Although final rules had not been adopted as of February 2017, if these or other regulations are adopted in a form similar to the proposed rule-making, they will impose limitations on the manner in which we may structure compensation for our executives.
Cyber-security
In March 2015, federal regulators issued two related statements regarding cyber-security. One statement indicates that financial institutions should design multiple layers of security controls to establish lines of defense and to ensure that their risk management processes also address the risk posed by compromised customer credentials, including security measures to reliably authenticate customers accessing internet-based services of the financial institution. The other statement indicates that a financial institution’s management is expected to maintain sufficient business continuity planning processes to ensure the rapid recovery, resumption and maintenance of the institution’s operations after a cyber-attack involving destructive malware. A financial institution is also expected to develop appropriate processes to enable recovery of data and business operations and address rebuilding network capabilities and restoring data if the institution or its critical service providers fall victim to this type of cyber-attack. If we fail to observe the regulatory guidance, we could be subject to various regulatory sanctions, including financial penalties.
In the ordinary course of business, we rely on electronic communications and information systems to conduct our operations and to store sensitive data. We employ a variety of preventative and detective tools to monitor, block, and provide alerts regarding suspicious activity, as well as to report on any suspected advanced persistent threats. Notwithstanding the strength of our defensive measures, the threat from cyber attacks is severe, attacks are sophisticated and increasing in volume, and attackers respond rapidly to changes in defensive measures. While to date, we have not experienced a significant compromise, significant data loss or any material financial losses related to cyber-security attacks, our systems and those of our customers and third-party service providers are under constant threat and it is possible that we could experience a significant event in the future. Risks and exposures related to cyber-security attacks are expected to remain high for the foreseeable future due to the rapidly evolving nature and sophistication of these threats, as well as due to the expanding use of Internet banking, mobile banking and other technology-based products and services by us and our customers. See Item 1A. Risk Factors for a further discussion of risks related to cyber-security.
Website Access to SEC Filings
All of our reports and statements filed or furnished electronically with the SEC, including Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and Proxy Statements, as well as amendments to these reports and statements filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, are accessible at no cost through our website at www.FIBK.com as soon as reasonably practicable after they have been filed with the SEC. These reports are also accessible on the SEC’s website at www.sec.gov. The public may read and copy materials we file with the SEC at the public reference facilities maintained by the SEC at Room 1580, 100 F Street N.E., Washington, DC 20549. The public may obtain information on the operation of the public reference room by calling the SEC at 1-800-SEC-0330. Our website and the information contained therein or connected thereto is not intended to be incorporated into this report and should not be considered a part of this report.
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Item 1A. Risk Factors
Like other financial and bank holding companies, we are subject to a number of risks, many of which are outside of our control. If any of the events or circumstances described in the following risk factors actually occurs, our business, financial condition, results of operations and prospects could be harmed. These risks are not the only ones that we may face. Other risks of which we are not aware, including those which relate to the banking and financial services industry in general and us in particular, or those which we do not currently believe are material, may harm our future business, financial condition, results of operations and prospects. Readers should consider carefully the following important factors in evaluating us, our business and an investment in our securities.
Risks Relating to the Market and Our Business
A worsening of economic conditions could reduce demand for our products and services and/or result in increases in our level of non-performing loans, which could have an adverse effect on our results of operations.
Our customers are located predominantly in Montana, Wyoming and South Dakota. Our profitability depends primarily on the general economic conditions in these areas. Local economic conditions have a significant impact on our commercial real estate and construction and consumer loans, the ability of the borrowers to repay these loans and the value of the collateral securing these loans.
Deterioration in economic conditions could result in the following consequences, any of which could have a material adverse effect on our business, financial condition, liquidity and results of operations:
• | demand for our products and services may decline; |
• | loan delinquencies, problem assets and foreclosures may increase; |
• | collateral for loans, especially real estate, may decline in value, in turn reducing customers’ future borrowing power, and reducing the value of assets and collateral associated with existing loans; |
• | the value of our securities portfolio may decline; and |
• | the net worth and liquidity of loan guarantors may decline, impairing their ability to honor commitments to us. |
Moreover, a significant decline in general economic conditions, caused by inflation, recession, acts of terrorism, an outbreak of hostilities or other international or domestic calamities, unemployment or other factors beyond our control could further impact these local economic conditions and could further negatively affect the financial results of our banking operations. In addition, deflationary pressures, while possibly lowering our operating costs, could have a significant negative effect on our borrowers, especially our business borrowers, and the values of underlying collateral securing loans, which could negatively affect our financial performance.
We are subject to lending risks.
We take on credit risk by virtue of making loans and extending loan commitments and letters of credit. Our credit standards, procedures and policies may not prevent us from incurring substantial credit losses, particularly in light of market developments. Our lending is affected by increases in interest rates and/or weakening economic conditions, each of which could adversely impact the ability of borrowers to repay outstanding loans or impact the value of the collateral securing these loans, resulting in higher delinquencies, repossessions and losses, which would have an adverse impact on our business, financial condition, results of operations and prospects. We are also subject to various laws and regulations that affect our lending activities. Failure to comply with applicable laws and regulations could subject us to regulatory enforcement action.
At December 31, 2016, we had $2.6 billion of commercial loans, including $1.8 billion of commercial real estate loans, representing approximately 48% of our total loan portfolio. These loans may involve greater risks than other types of lending. Because payments on such loans are often dependent on the successful operation or development of the property or business involved, repayment of such loans is more sensitive than other types of loans to adverse conditions in the real estate market or the general economy. Commercial loans typically are made on the basis of the borrowers' ability to make repayment from the cash flow of the commercial venture. If the cash flow from business operations is reduced, the borrower's ability to repay the loan may be impaired. Due to the larger average size of each commercial loan as compared with other loans, as well as the collateral that is generally less readily-marketable, losses incurred on commercial loans could have a material adverse impact on our business, financial condition and results of operations.
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In addition, at December 31, 2016, we had $1.7 billion of agricultural, construction, residential and other real estate loans, representing approximately 31% of our total loan portfolio. Deterioration in economic conditions or in the real estate market could result in increased delinquencies and foreclosures and could have an adverse effect on the collateral value for many of these loans and on the repayment ability of many of our borrowers. Deterioration in economic conditions or in the real estate market could also reduce the number of loans we make to businesses in the construction and real estate industry, which could negatively impact our interest income and results of operations. Similarly, the occurrence of a natural or manmade disaster in our market areas could impair the value of the collateral we hold for real estate secured loans. Any one or a combination of the factors identified above could negatively impact our business, financial condition, results of operations and prospects.
Changes in interest rates could negatively impact our net interest income, may weaken demand for our products and services or harm our results of operations and cash flows.
Our earnings and cash flows are largely dependent upon net interest income, which is the difference between interest income earned on interest-earning assets such as loans and securities and interest expense paid on interest-bearing liabilities such as deposits and borrowed funds. Interest rates are highly sensitive to many factors that are beyond our control, including general economic conditions and policies of various governmental and regulatory agencies, particularly the Federal Reserve. Changes in monetary policy, including changes in interest rates, could influence not only the interest we receive on loans and securities and the amount of interest we pay on deposits and borrowings, but such changes could also adversely affect (1) our ability to originate loans and obtain deposits, (2) the fair value of our financial assets and liabilities, including mortgage servicing rights, (3) our ability to realize gains on the sale of assets and (4) the average duration of our mortgage-backed securities and collateralized mortgage obligations portfolios. An increase in interest rates may reduce customers' desire to borrow money from us as it increases their borrowing costs and may adversely affect the ability of borrowers to pay the principal or interest on loans, which may lead to an increase in non-performing assets and a reduction of income recognized. Any substantial, unexpected or prolonged change in market interest rates could have a material adverse effect on our cash flows, financial condition and results of operations.
If we experience loan losses in excess of estimated amounts, our earnings will be adversely affected.
The risk of credit losses on loans varies with, among other things, general economic conditions, the composition of our loan portfolio, the creditworthiness of the borrower over the term of the loan and, in the case of a collateralized loan, the value and marketability of the collateral for the loan. We maintain an allowance for loan losses based upon, among other things, historical experience, an evaluation of economic conditions and regular reviews of loan portfolio quality. Based upon such factors, our management makes various assumptions and judgments about the ultimate collectability of our loan portfolio and provides an allowance for loan losses. These assumptions and judgments are complex and difficult to determine given the significant uncertainty surrounding future conditions in the general economy and banking industry. If management's assumptions and judgments prove to be incorrect and the allowance for loan losses is inadequate, or if the banking authorities or regulations require us to increase the allowance for loan losses, our earnings, financial condition, results of operations and prospects could be significantly and adversely affected.
We may be adversely affected by declining oil and gas prices, and declining demand for coal.
Oil and gas drilling and production in Wyoming and in the Bakken Formation in Montana and North Dakota have been important contributors to our region's economic growth over the years. As of December 31, 2016, our direct exposure to the oil and gas industry was approximately $59 million in outstanding loans, including approximately $43 million related to drilling and extraction activity and approximately $16 million advanced to oil and gas service companies. As of December 31, 2016, we also had commitments to lend an additional $25 million to oil and gas borrowers. These borrowers may be significantly affected by volatility in oil and gas prices and declines in the level of drilling and production activity. A prolonged period of low oil and gas prices or other events that result in a decline in drilling activity could have a negative impact on the economies of our market areas and on our customers. We carefully monitor the impact of volatility in oil and gas prices on our loan portfolio. As of December 31, 2016, 76.3% of our outstanding oil and gas loans were criticized.
Additionally, adverse developments in the demand for coal due to tightening environmental regulations, the suspension of new coal leasing on federal lands, slower growth in electricity demand and fuel competition from low natural gas prices, may impact the economies of the Powder River Basin in Montana and Wyoming.
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Adverse developments in the energy sector could have spillover effects on the broader economies of our market areas, including commercial and residential real estate values and the general level of economic activity. The State of Wyoming derives a significant portion of its operating budget from energy extraction and related industries. As such, reductions in oil, gas and coal related revenues may have additional negative economic implications for the State of Wyoming. There is no assurance that our business, financial condition, results of operations and cash flows will not be adversely impacted by increases in non-performing oil and gas loans, or by the direct and indirect effects of current and future conditions in the energy industry.
We will become subject to additional regulatory requirements if our total assets exceed $10 billion, which could have an adverse effect on our financial condition or results of operations.
Various federal banking laws and regulations, including rules adopted by the Federal Reserve pursuant to the requirements of the Dodd-Frank Act, impose heightened requirements on certain large banks and bank holding companies. Most of these rules apply primarily to bank holding companies with at least $50 billion in total consolidated assets, but certain rules also apply to banks and bank holding companies with at least $10 billion in total consolidated assets.
Following the fourth consecutive quarter (and any applicable phase-in period) where our or the Bank’s total consolidated assets equal or exceed $10 billion, we or the Bank, as applicable, will be subject to the following Dodd-Frank Act provisions, among others:
• | The Dodd-Frank Act created the CFPB, which has broad powers to supervise and enforce consumer protection laws. The CFPB has broad rule-making authority for a wide range of consumer protection laws that apply to all banks, including the authority to prohibit “unfair, deceptive or abusive” acts and practices. Currently, the Federal Reserve Board and the Montana Division examine the Bank for compliance with consumer protection laws. However, the CFPB has examination and enforcement authority over all banks with more than $10 billion in assets, and accordingly will assume examination and enforcement authority over us should we exceed $10 billion in total assets. |
• | The Dodd-Frank Act has limited the interchange fees for electronic debt transactions by a payment card issuer to $0.21 plus five basis points times the value of the transaction, plus up to $0.01 for fraud prevention costs. Should we exceed $10 billion in total assets, our interchange revenue will be significantly lower. |
• | The Dodd-Frank Act established 1.35% as the minimum DIF reserve ratio and has adopted a plan under which it will meet the statutory minimum fund reserve ratio of 1.35% by September 30, 2020. The Dodd-Frank Act requires the FDIC to offset the effect of the increase in the statutory minimum fund reserve ratio to 1.35% from the former statutory minimum of 1.15% on institutions with assets less than $10 billion. Should we exceed $10 billion in total assets, we will not be entitled to benefit from the offset. |
• | The Dodd-Frank Act requires a publicly traded bank holding company with $10 billion or more in assets to establish and maintain a risk committee responsible for oversight of enterprise-wide risk management practices, which must be commensurate with the bank’s structure, risk profile, complexity, activities and size. |
• | A bank holding company with more than $10 billion in assets is required under the Dodd-Frank Act to conduct annual stress tests to determine whether the capital planning of the combined company, assessment of its capital adequacy and risk management practices adequately protect it and its affiliates in the event of an economic downturn. The results of the annual stress tests are reported to the Federal Reserve Board, and it will be required to consider the results of the company’s stress tests as part of its capital planning and risk management practices. |
While we do not currently have $10 billion or more in total consolidated assets, if our announced acquisition of Cascade Bancorp is completed as expected, our total consolidated assets will exceed $10 billion during the third quarter of 2017. Assuming the merger is consummated, we anticipated we will become subject to the Dodd-Frank Act stress testing requirements commencing on January 1, 2019.
It is difficult to predict the overall cost of complying with the Dodd-Frank Act. Compliance with the Dodd-Frank Act requirements may necessitate that we hire additional compliance or other personnel, design and implement additional internal controls, engage external consultants or incur other significant expenses, any of which could have a material adverse effect on our business, financial condition or results of operations. Compliance with the annual stress testing requirements, part of which must be publicly disclosed, may be misinterpreted by the market generally or our customers and, as a result, may adversely affect our stock price or our ability to retain our customers or effectively compete for new business opportunities.
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We may be unable to successfully integrate or profitably operate acquired organizations, which could have an adverse effect on our financial condition or results of operations.
Acquisitions of other banks and financial institutions involves the integration of two companies that have previously operated independently. The difficulties of combining the operations of the two companies include, among other things: integrating personnel with diverse business backgrounds; combining different corporate cultures; and retaining key employees. The process of integrating operations could cause an interruption of, or loss of momentum in, the activities of the business and the loss of key personnel. The integration of the two companies may require the experience and expertise of certain key employees of the target company that we expect to retain. We may not be successful in retaining these employees for the time period necessary to successfully integrate the acquired company’s operations with ours. The diversion of management’s attention and any delays or difficulties encountered in connection with the merger and the integration of the two companies’ operations could have an adverse effect on our business and results of operations following the merger.
Additionally, we may not be able to successfully achieve the level of cost savings, revenue enhancements, and other synergies that we expect, and may not be able to capitalize upon the existing customer relationships of the acquired company to the extent anticipated, or it may take longer, or be more difficult or expensive than expected, to achieve these goals. This could have an adverse effect on our business, results of operation and stock price.
We may not continue to have access to low-cost funding sources.
We depend on checking and savings, negotiable order of withdrawal, or NOW, and money market deposit account balances and other forms of customer deposits as our primary source of funding. Such account and deposit balances can decrease when customers perceive alternative investments, such as the stock market, as providing a better risk/return trade-off. Additionally, the availability of internet banking products has increased the mobility of customer deposits. If customers move money out of bank deposits and into other investments or internet banking products, we could lose a relatively low cost source of funds, increasing our funding costs and reducing our net interest income and net income.
Our goodwill may become impaired, which may adversely impact our results of operations and financial condition and may limit our Bank's ability to pay dividends to us, thereby causing liquidity issues.
The excess purchase price over the fair value of net assets from acquisitions, or goodwill, is evaluated for impairment at least annually and on an interim basis if an event or circumstance indicates that it is likely impairment has occurred. In testing for impairment, the fair value of net assets is estimated based on analyses of our market value, discounted cash flows and peer values. Consequently, the determination of the fair value of goodwill is sensitive to market-based economics and other key assumptions. Variability in market conditions or in key assumptions could result in impairment of goodwill, which is recorded as a non-cash adjustment to income. An impairment of goodwill could have a material adverse effect on our business, financial condition and results of operations. As of December 31, 2016, we had goodwill of $213 million, or 22% of our total stockholders' equity. Further, the acquisition of Cascade Bancorp may significantly increase the amount of our goodwill, which could increase impairment losses.
Changes in accounting standards could materially impact our financial statements.
From time to time, the Financial Accounting Standards Board, or FASB and the SEC change the financial accounting and reporting standards that govern the preparation of our financial statements. These changes can materially impact how we record and report our financial condition and results of operations. The FASB proposed amendments to its guidance on the credit impairment of financial instruments. The proposed amendments, which will be effective for our first fiscal year after December 15, 2019, would introduce a new impairment model based on current expected credit losses, or CECL rather than incurred losses. The CECL model would apply to most debt instruments, including loan receivables and loan commitments.
Unlike the incurred loss models in existing generally accepted accounting principles, the CECL model does not specify a threshold for the recognition of an impairment allowance. Rather, we would recognize an impairment allowance equal to our current estimate of expected credit losses for financial instruments as of the end of the reporting period. This will change the current method of providing allowances for credit losses that are probable, which may require us to increase our allowance for loan losses, and may greatly increase the types of data we would need to collect and review to determine the appropriate level of the allowance for credit losses.
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We are dependent upon the services of our management team and directors.
Our future success and profitability is substantially dependent upon the management skills of our executive officers and directors, many of whom have held officer and director positions with us for many years. We do not currently have employment agreements or non-competition agreements with any of our key executives, other than an employment agreement with our president and chief executive officer, Kevin P. Riley. The unanticipated loss or unavailability of key employees could harm our ability to operate our business or execute our business strategy. We may not be successful in retaining these key employees or finding and integrating suitable successors in the event of their loss or unavailability.
We may not be able to attract and retain qualified employees to operate our business effectively.
As a result of low unemployment rates in Montana, Wyoming, South Dakota and the surrounding region, there is substantial competition for qualified personnel in our markets. It may be difficult for us to attract and retain qualified employees at all management and staffing levels. Failure to attract and retain employees and maintain adequate staffing of qualified personnel could adversely impact our operations and our ability to execute our business strategy. Furthermore, relatively low unemployment rates in certain of our markets may lead to significant increases in salaries, wages and employee benefits expenses as we compete for qualified, skilled employees, which could negatively impact our results of operations and prospects.
We are subject to significant governmental regulation and new or changes in existing regulatory, tax and accounting rules and interpretations could significantly harm our business.
The financial services industry is extensively regulated. Federal and state banking regulations are designed primarily to protect the deposit insurance funds and consumers, not to benefit a financial company's stockholders. These regulations may impose significant limitations on operations. The significant federal and state banking regulations that affect us are described in this report under the heading “Regulation and Supervision.” These regulations, along with the currently existing tax, accounting, securities, insurance, employment, monetary and other laws and regulations, rules, standards, policies and interpretations control the methods by which we conduct business, implement strategic initiatives and tax compliance and govern financial reporting and disclosures. These laws, regulations, rules, standards, policies and interpretations are undergoing significant review and changes, particularly given the recent market developments in the banking and financial services industries and the enactment of the Dodd-Frank Act in July 2010.
Other changes to statutes, regulations or regulatory policies or supervisory guidance, including changes in interpretation or implementation of statutes, regulations, policies, or supervisory guidance, could affect us in substantial and unpredictable ways. Such changes could subject us to additional costs, limit the types of financial services and products we may offer and/or increase the ability of non-banks to offer competing financial services and products, among other things. Failure to comply with laws, regulations, policies or supervisory guidance could result in enforcement and other legal actions by Federal or state authorities. In this regard, government authorities, including the bank regulatory agencies, often pursue aggressive enforcement actions with respect to compliance and other legal matters involving financial activities, which heightens the risks associated with actual and perceived compliance failures. Any of the foregoing could have a material adverse effect on our business, financial condition and results of operations.
We have become subject to more stringent capital requirements, which may adversely impact our return on equity, or constrain us from paying dividends or repurchasing shares.
In July 2013, the FDIC and the federal banking agencies approved a new rule that substantially amended the regulatory risk-based capital rules applicable to us. The final rule implements the “Basel III” regulatory capital reforms and changes required by the Dodd-Frank Act.
The final rule included new minimum risk-based capital and leverage ratios, which became effective for us on January 1, 2015, and refined the definition of what constitutes “capital” for calculating these ratios. The new minimum capital requirements are: (1) a common equity Tier 1 capital ratio of 4.5%; (2) a Tier 1 to risk-based assets capital ratio of 6% (increased from 4%); (3) a total capital ratio of 8% (unchanged from prior rules); and (4) a Tier 1 leverage ratio of 4%. The final rule also required unrealized gains and losses on certain “available-for-sale” securities holdings to be included for calculating regulatory capital requirements unless a one-time opt-out is exercised. The final rule also established a “capital conservation buffer” of 2.5%, that, when fully phased in, will result in the following minimum ratios: (1) a common equity Tier 1 capital ratio of 7.0%, (2) a Tier 1 to risk-based assets capital ratio of 8.5%, and (3) a total capital ratio of 10.5%. Phase in of the new capital conservation buffer requirement began in January 2016 at 0.625% of risk-weighted assets and will increase each year until fully implemented in January 2019. An institution will be subject to limitations on paying dividends, engaging in share repurchases and paying discretionary bonuses if its capital level falls below the buffer amount. These limitations will establish a maximum percentage of eligible retained income that can be utilized for such actions.
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The application of more stringent capital requirements could, among other things, result in lower returns on equity, require the raising of additional capital, and result in regulatory actions constraining us from paying dividends or repurchasing shares if we were to be unable to comply with such requirements.
The FDIC has adopted a plan to increase the federal DIF, including additional future premium increases and special assessments.
The Dodd-Frank Act broadened the base for FDIC insurance assessments and assessments are now based on the average consolidated total assets less average tangible equity capital of a financial institution. In addition, the Dodd-Frank Act established 1.35% as the minimum DIF reserve ratio and has adopted a plan under which it will meet the statutory minimum fund reserve ratio of 1.35% by September 30, 2020. The Dodd-Frank Act requires the FDIC to offset the effect on institutions with assets less than $10 billion of the increase in the statutory minimum fund reserve ratio to 1.35% from the former statutory minimum of 1.15%. As a result, the deposit insurance assessments to be paid by the Bank could increase. Any additional future premium increases or special assessments could have a material adverse effect on our business, financial condition, and results of operations.
Final CFPB regulations could restrict our ability to originate and sell mortgage loans.
The CFPB has issued a rule designed to clarify for lenders how they can avoid monetary damages under the Dodd-Frank Act, which would hold lenders accountable for ensuring a borrower’s ability to repay a mortgage. Loans that meet this “qualified mortgage” definition will be presumed to have complied with the new ability-to-repay standard. Under the CFPB’s rule, a “qualified mortgage” loan must not contain certain specified features, including:
• | excessive upfront points and fees (those exceeding 3% of the total loan amount, less “bona fide discount points” for prime loans); |
• | interest-only payments; |
• | negative-amortization; and |
• | terms longer than 30 years. |
Also, to qualify as a “qualified mortgage,” a borrower’s total debt-to-income ratio may not exceed 43%. Lenders must also verify and document the income and financial resources relied upon to qualify the borrower for the loan and underwrite the loan based on a fully amortizing payment schedule and maximum interest rate during the first five years, taking into account all applicable taxes, insurance and assessments. The CFPB’s rule on qualified mortgages could limit our ability or desire to make certain types of loans or loans to certain borrowers, or could make it more expensive/and or time consuming to make these loans, which could limit our growth or profitability.
We are dependent on our information technology and telecommunications systems and third-party servicers, and systems failures or interruptions could have a material adverse effect on us.
Our business is highly dependent on the successful and uninterrupted functioning of our information technology and telecommunications systems and third-party servicers. We outsource many of our major systems, such as certain data processing, loan servicing and deposit processing systems. The failure of these systems, or the termination of a third-party software license or service agreement on which any of these systems is based, could interrupt our operations. Because our information technology and telecommunications systems interface with and depend on third-party systems, we could experience disruptions if demand for such services exceeds capacity or such third-party systems fail or experience interruptions. If significant, sustained or repeated, a system failure or disruption could compromise our ability to operate effectively, damage our reputation, result in a loss of customer business, and/or subject us to additional regulatory scrutiny and possible financial liability, any of which could have a material adverse effect on us, our financial condition, results of operations, cash flows and prospects.
We are exposed to risks related to cyber-security.
Our computer systems and network infrastructure could be susceptible to cyber-attacks, such as denial of service attacks, hacking, terrorist activities or identity theft. Financial services institutions and companies engaged in data processing have reported breaches in the security of their websites or other systems, some of which have involved sophisticated and targeted attacks intended to obtain unauthorized access to confidential information, destroy data, disable or degrade service, or sabotage systems, often through the introduction of computer viruses, malware, cyber-attacks and other means.
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In addition, we provide our customers with the ability to bank remotely, including online, through their mobile device and over the telephone. The secure transmission of confidential information over the internet and other remote channels is a critical element of remote banking. Our network could be vulnerable to unauthorized access, computer viruses, phishing schemes and other internal and external security breaches. We may be required to spend significant capital and other resources to protect against the threat of security breaches and computer viruses, or to alleviate problems caused by security breaches or viruses. To the extent that our activities or the activities of our customers involve the storage and transmission of confidential information, security breaches and viruses could expose us to claims, regulatory scrutiny, litigation and other possible liabilities.
Despite efforts to ensure the integrity of our systems, cyber threats are rapidly evolving and we may not be able to anticipate or prevent all such attacks, nor may we be able to implement guaranteed preventive measures against such security breaches. The techniques used by cyber criminals change frequently, may not be recognized until launched and can originate from a wide variety of sources, including outside groups such as external service providers. These risks may increase in the future as we continue to increase our mobile payment and other internet-based product offerings and expand our internal usage of web-based products and applications.
Further, targeted social engineering attacks may be sophisticated and difficult to prevent and our employees, customers or other users of our systems may be fraudulently induced to disclose sensitive information, allowing cyber criminals to gain access to our data or data of our customers.
A successful penetration or circumvention of system security could cause us serious negative consequences, including significant disruption of operations, misappropriation of confidential information, or damage to our computers or systems or those of our customers and counterparties. A successful security breach could result in violations of applicable privacy and other laws, financial loss to us or to our customers, loss of confidence in our security measures, significant litigation exposure, and harm to our reputation, all of which could have a material adverse effect on us.
The resolution of litigation, if unfavorable, could have a material adverse effect on our results of operations for a particular period.
We face legal risks in our businesses, and the volume of claims and amount of damages and penalties claimed in litigation and regulatory proceedings against financial institutions remains high. Legal liability against us could have material adverse financial effects or cause harm to our reputation, which in turn could adversely impact our business prospects.
Additionally, some of the services we provide, such as trust and investment services, require us to act as fiduciaries for our customers and others. From time to time, third parties make claims and take legal action against us pertaining to the performance of our fiduciary responsibilities. If these claims and legal actions are not resolved in a manner favorable to us, we may be exposed to significant financial liability and/or our reputation could be damaged. Either of these results may adversely impact demand for our products and services or otherwise have a harmful effect on our business and, in turn, on our financial condition, results of operations and prospects.
We are subject to liquidity risks.
Liquidity is the ability to meet current and future cash flow needs on a timely basis at a reasonable cost. Our liquidity is used to make loans and to repay deposit liabilities as they become due or are demanded by customers. Potential alternative sources of liquidity include federal funds purchased and securities sold under repurchase agreements. We maintain a portfolio of investment securities and hold overnight funds that may be used as a secondary source of liquidity to the extent the securities are not pledged for collateral. Other potential sources of liquidity include the sale of loans, the utilization of available government and regulatory assistance programs, the ability to acquire brokered deposits, the issuance of additional collateralized borrowings such as Federal Home Loan Bank, or FHLB, advances, the issuance of debt or equity securities and borrowings through the Federal Reserve's discount window. Without sufficient liquidity from these potential sources, we may not be able to meet the cash flow requirements of our depositors and borrowers.
Additionally, our access to funding sources in amounts adequate to finance our activities or on terms that are acceptable to us could be impaired by factors specific to us, the financial services industry or the economy in general. Factors that could reduce our access to liquidity sources include a downturn in our local or national economies, difficult or illiquid credit markets or adverse regulatory actions against us. A failure to maintain adequate liquidity could have a material adverse effect on our regulatory standing, business, financial condition or results of operations.
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We may become liable for environmental remediation and other costs on repossessed properties, which could adversely impact our results of operations, cash flows and financial condition.
A significant portion of our loan portfolio is secured by real property. During the ordinary course of business, we may foreclose on and take title to properties securing certain loans. If hazardous or toxic substances are found on these properties, we may be liable for remediation costs, as well as for personal injury and property damage. Environmental laws may require us to incur substantial expenses and may materially reduce the affected property's value or limit our ability to use or sell the affected property. In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase our exposure to environmental liability. The remediation costs and any other financial liabilities associated with an environmental hazard could have a material adverse effect on our cash flows, financial condition and results of operations.
Our systems of internal operating controls may not be effective.
We establish and maintain systems of internal operational controls that provide us with critical information used to manage our business. These systems are subject to various inherent limitations, including cost, judgments used in decision-making, assumptions about the likelihood of future events, the soundness of our systems, the possibility of human error and the risk of fraud. Moreover, controls may become inadequate because of changes in conditions or processes and the risk that the degree of compliance with policies or procedures may deteriorate over time. Because of these limitations, any system of internal operating controls may not be successful in preventing all errors or fraud or in making all material information known in a timely manner to the appropriate levels of management. From time to time, control deficiencies and losses from operational malfunctions or fraud have occurred and may occur in the future. Any future deficiencies, weaknesses or losses related to internal operating control systems could have an adverse effect on our business and, in turn, on our financial condition, results of operations and prospects, as well as how we are perceived by our customers, regulators and investors.
We face significant competition from other financial institutions and financial services providers.
We face substantial competition in all areas of our operations from a variety of different competitors, many of which are larger and may have more financial resources, higher lending limits and larger branch networks. Such competitors primarily include national and regional banks within the various markets we serve. We also face competition from many other types of financial institutions, including, savings and loans, credit unions, finance companies, brokerage firms, insurance companies, factoring companies, financial technology firms and other financial intermediaries. The financial services industry could become even more competitive as a result of legislative, regulatory and technological changes and continued consolidation. Banks, securities firms and insurance companies can merge under the umbrella of a financial holding company, which can offer virtually any type of financial service, including banking, securities underwriting, insurance (both agency and underwriting) and merchant banking. Increased competition among financial services companies due to the recent consolidation of certain competing financial institutions and the conversion of certain investment banks to bank holding companies may adversely affect our ability to market our products and services. Also, technology has lowered barriers to entry and made it possible for nonbanks to offer products and services traditionally provided by banks, such as automatic funds transfer and automatic payment systems. Many of our competitors have fewer regulatory constraints and may have lower cost structures. Additionally, due to their size, some competitors may offer a broader range of products and services as well as better pricing for those products and services than we can.
Our ability to compete successfully depends on a number of factors, including, among other things:
• | the ability to develop, maintain and build upon customer relationships based on quality service, high ethical standards and safe, sound assets; |
• | the ability to expand our market position; |
• | the scope, relevance and pricing of products and services offered to meet customer needs and demands; |
• | the rate at which we introduce new products and services relative to our competitors; |
• | customer satisfaction with our level of service; and |
• | industry and general economic trends. |
Failure to perform in any of these areas could significantly weaken our competitive position, which could adversely affect our growth and profitability, which, in turn, could harm our business, financial condition, results of operations and cash flows.
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Our operations rely on certain external vendors.
We are reliant upon certain external vendors to provide products and services necessary to maintain our day-to-day operations. Failure of certain external vendors to perform in accordance with contractual arrangements could be disruptive to our operations and limit our ability to provide certain products and services demanded by our customers, which could have material adverse impact on our financial condition or results of operations.
We may be adversely affected by the soundness of other financial institutions.
Financial services companies are interrelated as a result of trading, clearing, counterparty or other relationships. We have exposure to many different industries and counterparties. For example, we execute transactions with counterparties in the financial services industry, including brokers and dealers, commercial banks, investment banks and other institutional clients. As a result, defaults by, or even rumors or questions about, one or more financial services companies or the financial services industry generally, have led to market-wide liquidity problems and could lead to losses or defaults by us or by other institutions. Many of these transactions expose us to increased credit risk in the event of default of a counterparty or client.
We may not effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers.
The financial services industry is continually undergoing rapid technological change with frequent introductions of new technology-driven products and services. The effective use of technology enables financial institutions to better serve customers and to perform more efficiently. Our future success depends, in part, upon our ability to use technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements. We may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers. Failure to successfully keep pace with technological change affecting the financial services industry could have a material adverse impact on our business and, in turn, on our financial condition, results of operations and prospects.
Our Bank's ability to pay dividends to us is subject to regulatory limitations, which, to the extent we are not able to receive such dividends, may impair our ability to grow, pay dividends, cover operating expenses and meet debt service requirements.
We are a legal entity separate and distinct from the Bank, our only bank subsidiary. Since we are a holding company with no significant assets other than the capital stock of our subsidiaries, we depend upon dividends from the Bank for a substantial part of our revenue. Accordingly, our ability to pay dividends, cover operating expenses and acquire other institutions depends primarily upon the receipt of dividends or other capital distributions from the Bank. The Bank's ability to pay dividends to us is subject to, among other things, its earnings, financial condition and need for funds, as well as federal and state governmental policies and regulations applicable to us and the Bank, which limit the amount that may be paid as dividends without prior approval. For example, in general, the Bank is limited to paying dividends that do not exceed the current year net profits together with retained earnings from the two preceding calendar years unless the prior consent of the Federal Reserve is obtained. In addition, the Bank may not pay dividends in excess of the previous two years' net earnings without providing notice to the Montana Division.
New lines of business or new products and services may subject us to additional risks.
From time to time, we may implement new lines of business or offer new products and services within existing lines of business. There are substantial risks and uncertainties associated with these efforts, particularly in instances where the markets are not fully developed. In developing and marketing new lines of business and/or new products and services we may invest significant time and resources. Initial timetables for the introduction and development of new lines of business and/or new products or services may not be achieved and price and profitability targets may not prove feasible. External factors, such as compliance with regulations, competitive alternatives, and shifting market preferences, may also impact the successful implementation of a new line of business or a new product or service. Furthermore, any new line of business and/or new product or service could have a significant impact on the effectiveness of our system of internal controls. Failure to successfully manage these risks in the development and implementation of new lines of business or new products or services could have a material adverse effect on our business, results of operations and financial condition.
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Risks Relating to Our Pending Acquisition of Cascade Bancorp
The success of the merger and integration of Cascade Bancorp will depend on a number of uncertain factors that could materially and adversely affect the financial condition and results of our operations and that of the combined company or prevent the combined company from realizing the anticipated benefits of the merger.
The success of the merger and the ability to realize the its anticipated benefits will depend on a number of factors, including:
• | our ability to integrate the branches acquired from Cascade Bancorp into our current operations; |
• | our ability to limit the outflow of deposits held by customers of the acquired branches and to successfully retain and manage interest-earning assets acquired in the merger; |
• | our ability to control the incremental non-interest expense of the acquired branches in a manner that enables us to maintain a favorable overall efficiency ratio; |
• | our ability to retain and attract the appropriate personnel to staff the acquired branches; and |
• | our ability to earn acceptable levels of interest and non-interest income, including fee income, from the acquired branches. |
Integrating the acquired branches will be an operation of substantial size and expense, and may be affected by general market and economic conditions or government actions affecting the financial industry generally. Integration efforts will also likely divert our management’s attention and resources. We may not be able to integrate the acquired branches successfully, and the integration process could result in the loss of key employees, the disruption of ongoing business, or inconsistencies in standards, controls, procedures and policies that adversely affect our ability to maintain relationships with clients, customers, depositors and employees or to achieve the anticipated benefits of the merger. We may also encounter unexpected difficulties or costs during the integration that could adversely affect our earnings and financial condition, perhaps materially. Additionally, the operation of the acquired branches may adversely affect our existing profitability, we may not be able to achieve results in the future similar to those achieved by the existing banking business or we may not be able to manage growth resulting from the merger effectively.
Failure to complete the merger could negatively impact our stock prices, future business and financial results.
There can be no assurance that our announced merger with Cascade Bancorp will be completed. If the merger is not completed, our ongoing business may be adversely affected and we will be subject to a number of risks, including the following:
• | We will be required to pay certain costs relating to the merger, whether or not the merger is completed, such as legal, accounting, financial advisor, proxy solicitation and printing fees; |
• | Under the merger agreement, we are subject to certain restrictions on the conduct of business before completing the merger, which may adversely affect our ability to execute certain of our business strategies if the merger is terminated; and |
• | matters relating to the merger may require substantial commitments of time and resources by our management, which could otherwise have been devoted to other opportunities that may have been beneficial to us as an independent company. |
In addition, if the merger is not completed, we may experience negative reactions from the financial markets and from customers and employees. We also could be subject to litigation related to any failure to complete the merger or to proceedings commenced by us against Cascade Bancorp seeking damages or to compel Cascade Bancorp to perform its obligations under the merger agreement. These factors and similar risks could have an adverse effect on our results of operation, business and stock price.
Our shareholders will have a reduced ownership and voting interest after the merger and will exercise less influence over the combined organization.
Our shareholders currently have the right to vote in the election of members for our board of directors and on various other matters affecting us. Upon the completion of the merger, our Class A common stockholders will have their ownership interests diluted by approximately 9.7% and voting interests diluted by approximately 1.2%; and, the holders of our Class B common stock will have their ownership interests diluted by approximately 10.4% and voting interests diluted by approximately 6.4%.
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Risks Relating to Our Common Stock
Our common stock share price could be volatile and could decline.
The market price of our Class A common stock is volatile and could be subject to wide fluctuations in price in response to various factors, some of which are beyond our control. These factors include:
• | prevailing market conditions; |
• | our historical performance and capital structure; |
• | estimates of our business potential and earnings prospects; |
• | an overall assessment of our management; |
• | conversion by our Class B shareholders of their shares into Class A common stock to liquidate their holdings; |
• | our performance relative to our peers; |
• | market demand for our shares; |
• | perceptions of the banking industry in general; |
• | political influences on investor sentiment; and, |
• | consumer confidence. |
At times the stock markets, including the NASDAQ Stock Market, on which our Class A common stock is listed, may experience significant price and volume fluctuations. As a result, the market price of our Class A common stock is likely to be similarly volatile and investors in our Class A common stock may experience a decrease in the value of their shares, including decreases unrelated to our operating performance or prospects. Further, because our Class B common stock is convertible on a share-for-share basis into Class A common stock and the share price of our Class B common stock is based upon the share price of our Class A common stock, our Class B stock price is similarly impacted by the factors listed above.
In addition, following periods of volatility in the overall market and the market price of a company's securities, securities class action litigation has often been instituted against these companies. This litigation, if instituted against us, could result in substantial costs and a diversion of our management's attention and resources.
Our dividend policy may change.
Although we have historically paid dividends to our stockholders, we have no obligation to continue doing so and may change our dividend policy at any time without notice to our stockholders. Holders of our common stock are only entitled to receive such cash dividends as our board of directors may declare out of funds legally available for such payments. The amount of any dividend declaration is subject to our evaluation of our strategic plans, growth initiatives, capital availability, projected liquidity needs and other factors.
An investment in our common stock is not an insured deposit.
Our Class A and Class B common stock is not a bank savings account or deposit and, therefore, is not insured against loss by the FDIC, any other deposit insurance fund or any other public or private entity. As a result, holders of our common stock could lose some or all of their investment.
Holders of the Class B common stock have voting control of our company and are able to determine virtually all matters submitted to stockholders, including potential change in control transactions.
Members of the Scott family control in excess of 77% of the voting power of our outstanding common stock. Due to their holdings of common stock, members of the Scott family are able to determine the outcome of virtually all matters submitted to stockholders for approval, including the election of directors, amendment of our articles of incorporation (except when a class vote is required by law), any merger or consolidation requiring common stockholder approval and the sale of all or substantially all of our assets. Accordingly, such holders have the ability to prevent change in control transactions as long as they maintain voting control of the company.
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In addition, because these holders have the ability to elect all of our directors they are able to control our policies and operations, including the appointment of management, future issuances of our common stock or other securities, the payments of dividends on our common stock and entering into extraordinary transactions, and their interests may not in all cases be aligned with the interests of all stockholders. The Scott family members have entered into a stockholder agreement giving family members a right of first refusal to purchase shares of Class B common stock that are intended to be sold or transferred, subject to certain exceptions, by other family members. This agreement may have the effect of continuing ownership of the Class B common stock and control within the Scott family. This concentrated control limits stockholders' ability to influence corporate matters. As a result, the market price of our Class A common stock could be adversely affected.
“Anti-takeover” provisions and the regulations to which we are subject also may make it more difficult for a third party to acquire control of us, even if the change in control would be beneficial to stockholders.
We are a financial and bank holding company incorporated in the State of Montana. Anti-takeover provisions in Montana law and our articles of incorporation and bylaws, as well as regulatory approvals that would be required under federal law, could make it more difficult for a third party to acquire control of us and may prevent stockholders from receiving a premium for their shares of our Class A common stock. These provisions could adversely affect the market price of our Class A common stock and could reduce the amount that Class A and Class B stockholders might receive if we are sold.
Our articles of incorporation provide that our Board may issue up to 100,000 shares of preferred stock, in one or more series, without stockholder approval and with such terms, conditions, rights, privileges and preferences as the Board may deem appropriate. In addition, our articles of incorporation provide for staggered terms for our Board and limitations on persons authorized to call a special meeting of stockholders. In addition, certain provisions of Montana law may have the effect of inhibiting a third party from making a proposal to acquire us or of impeding a change of control under circumstances that otherwise could provide the holders of our Class A and Class B common stock with the opportunity to realize a premium over the then-prevailing market price of such Class A common stock.
Further, the acquisition of specified amounts of our common stock (in some cases, the acquisition or control of more than 5% of our voting stock) may require certain regulatory approvals, including the approval of the Federal Reserve and one or more of our state banking regulatory agencies. The filing of applications with these agencies and the accompanying review process can take several months. Additionally, as discussed above, the holders of the Class B common stock will have voting control of our company. This and the other factors described above may hinder or even prevent a change in control of us, even if a change in control would be beneficial to our stockholders.
We qualify as a “controlled company” under the NASDAQ Marketplace Rules and may rely on exemptions from certain corporate governance requirements.
As a result of the combined voting power of the members of the Scott family described above, we qualify as a “controlled company” under the NASDAQ Marketplace Rules. As a controlled company, we may rely on exemptions from certain NASDAQ corporate governance standards that are available to controlled companies, including the requirements that:
• | a majority of the board of directors consist of independent directors; |
• | the compensation of officers be determined, or recommended to the board of directors for determination, by a majority of the independent directors or a compensation committee comprised solely of independent directors; and |
• | director nominees be selected, or recommended for the board of directors' selection, by a majority of the independent directors or a nominating committee comprised solely of independent directors with a written charter or board resolution addressing the nomination process. |
As a result, in the future, our compensation and governance and nominating committees may not consist entirely of independent directors. As long as we choose to rely on these exemptions from NASDAQ Marketplace Rules in the future, you will not have the same protections afforded to stockholders of companies that are subject to all of the NASDAQ corporate governance requirements.
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Future equity issuances could result in dilution, which could cause our common stock price to decline.
We are not restricted from issuing additional Class A common stock, including any securities that are convertible into or exchangeable for, or that represent the right to receive, Class A common stock. We may issue additional Class A common stock in the future pursuant to current or future employee equity compensation plans or in connection with future acquisitions or financings. Should we choose to raise capital by selling shares of Class A common stock for any reason, the issuance would have a dilutive effect on the holders of our Class A and Class B common stock and could have a material negative effect on the market price of our Class A common stock.
The common stock is equity and is subordinate to our existing and future indebtedness.
Shares of our Class A and Class B common stock are equity interests and do not constitute indebtedness. As such, shares of our Class A and Class B common stock rank junior to all our indebtedness, including any subordinated term loans, subordinated debentures held by trusts that have issued trust preferred securities other non-equity claims on us with respect to assets available to satisfy claims on us. In the future, we may make additional offerings of debt or equity securities or, we may issue additional debt or equity securities as consideration for future mergers and acquisitions.
Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
Our principal executive offices and one of our banking offices are anchor tenants in an eighteen story commercial building located in Billings, Montana. The building is owned by a joint venture limited liability company in which FIB owns a 50% interest. We lease approximately 102,609 square feet of office space in the building. We also own a 65,226 square foot building that houses our operations center in Billings, Montana. We provide banking services at an additional 79 locations in Montana, Wyoming and South Dakota, of which 13 properties are leased from independent third parties and 66 properties are owned by us. We believe each of our facilities is suitable and adequate to meet our current operational needs.
Item 3. Legal Proceedings
In the normal course of business, we are named or threatened to be named as a defendant in various lawsuits. Management, following consultation with legal counsel, does not expect the ultimate disposition of one or a combination of these matters to have a material adverse effect on our business.
Item 4. Mine Safety Disclosures
Not applicable.
PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Description of Our Capital Stock
Our articles provide for two classes of common stock: Class A common stock, which has one vote per share, and Class B common stock, which has five votes per share. Class B common stock is convertible into Class A common stock as described below. Our common stock is uncertificated.
Our authorized capital stock consists of 200,100,000 shares, each with no par value per share, of which:
• | 100,000,000 shares are designated as Class A common stock; |
• | 100,000,000 shares are designated as Class B common stock; and |
• | 100,000 shares are designated as preferred stock. |
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At December 31, 2016, we had issued and outstanding 21,613,885 shares of Class A common stock and 23,312,291 shares of Class B common stock. At December 31, 2016, we also had outstanding stock options to purchase an aggregate of 529,562 shares of our Class A common stock and 411,281 shares of our Class B common stock.
Members of the Scott family control in excess of 77% of the voting power of our outstanding common stock. The Scott family members have entered into a stockholder agreement giving family members a right of first refusal to purchase shares of Class B common stock that are intended to be sold or transferred, subject to certain exceptions, by other family members. This agreement may have the effect of continuing ownership of the Class B common stock and control of our Company within the Scott family.
Due to the ownership and control of our Company by members of the Scott family, we are a “controlled company” as that term is used under the NASDAQ Marketplace Rules. As a “controlled company,” we may rely on exemptions from certain NASDAQ corporate governance requirements, including those regarding independent director requirements for the Board and committees of the Board.
Preferred Stock
Our Board is authorized, without approval of the holders of Class A common stock or Class B common stock, to provide for the issuance of preferred stock from time to time in one or more series in such number and with such designations, preferences, powers and other special rights as may be stated in the resolution or resolutions providing for such preferred stock. Our Board may cause us to issue preferred stock with voting, conversion and other rights that could adversely affect the holders of Class A common stock or Class B common stock or make it more difficult to effect a change in control.
Common Stock
The holders of our Class A common stock are entitled to one vote per share and the holders of our Class B common stock are entitled to five votes per share on any matter to be voted upon by the stockholders. Holders of Class A common stock and Class B common stock vote together as a single class on all matters (including the election of directors) submitted to a vote of stockholders, unless otherwise required by law.
The holders of common stock are not entitled to cumulative voting rights with respect to the election of directors, which means that the holders of a majority of the shares voted can elect all of the directors then standing for election. Directors are elected by a majority of the voting power present in person or represented by proxy at a shareholder meeting rather than by a plurality vote.
The holders of our Class A common stock and Class B common stock are entitled to share equally in any dividends that our Board may declare from time to time from legally available funds and assets, subject to limitations under Montana law and the preferential rights of holders of any outstanding shares of preferred stock. If a dividend is paid in the form of shares of common stock or rights to acquire shares of common stock, the holders of Class A common stock will be entitled to receive Class A common stock, or rights to acquire Class A common stock, as the case may be and the holders of Class B common stock will be entitled to receive Class B common stock, or rights to acquire Class B common stock, as the case may be.
Upon any voluntary or involuntary liquidation, dissolution, distribution of assets or winding up of our company, the holders of our Class A common stock and Class B common stock are entitled to share equally, on a per share basis, in all our assets available for distribution, after payment to creditors and subject to any prior distribution rights granted to holders of any outstanding shares of preferred stock.
Our Class A common stock is not convertible into any other shares of our capital stock. Any holder of Class B common stock may at any time convert his or her shares into shares of Class A common stock on a share-for-share basis. The shares of Class B common stock will automatically convert into shares of Class A common stock on a share-for-share basis:
• | when the aggregate number of shares of our Class B common stock is less than 20% of the aggregate number of shares of our Class A common stock and Class B common stock then outstanding; or |
• | upon any transfer, whether or not for value, except for transfers to the holder’s spouse, certain of the holder’s relatives, the trustees of certain trusts established for their benefit, corporations and partnerships wholly-owned by the holders and their relatives, the holder’s estate and other holders of Class B common stock. |
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Once converted into Class A common stock, the Class B common stock cannot be reissued. No class of common stock may be subdivided or combined unless the other class of common stock concurrently is subdivided or combined in the same proportion and in the same manner.
Other than in connection with dividends and distributions, subdivisions or combinations, the exercise of stock options for Class B shares or certain other circumstances, we are not authorized to issue additional shares of Class B common stock.
Class A and Class B common stock do not have any preemptive rights.
The Class B common stock is not and will not be listed on the NASDAQ Stock Market or any other exchange. Therefore, no trading market is expected to develop in the Class B common stock. Class A common stock is listed on the NASDAQ Stock Market under the symbol “FIBK.”
The table below sets forth, for each quarter in the past two years, the quarterly high and low closing sales prices per share of the Class A common stock, as reported by the NASDAQ Stock Market.
Quarter Ended | High | Low | ||
March 31, 2015 | $27.82 | $23.90 | ||
June 30, 2015 | 28.79 | 26.83 | ||
September 30, 2015 | 28.50 | 25.68 | ||
December 31, 2015 | 30.64 | 26.84 | ||
March 31, 2016 | 28.92 | 24.92 | ||
June 30, 2016 | 29.55 | 26.44 | ||
September 30, 2016 | 32.56 | 26.89 | ||
December 31, 2016 | 43.10 | 30.70 | ||
As of December 31, 2016, we had 687 record shareholders, including the Wealth Management division of FIB as trustee for 888,665 shares of Class A common stock held on behalf of 744 individual participants in the Savings and Profit Sharing Plan for Employees of First Interstate BancSystem, Inc., or the Savings Plan. The Savings Plan Trustee votes the shares based on the instructions of each participant. In the event the participant does not provide the Savings Plan Trustee with instructions, the Savings Plan Trustee votes those shares in accordance with voting instructions received from a majority of the participants in the plan.
Dividends
It is our policy to pay a dividend to all common shareholders quarterly. We currently intend to continue paying quarterly dividends; however, the Board may change or eliminate the payment of future dividends.
Recent quarterly dividends follow:
Dividend Payment | Amount Per Share | Total Cash Dividends | ||
First quarter 2015 | $0.20 | $9,114,216 | ||
Second quarter 2015 | 0.20 | 9,073,574 | ||
Third quarter 2015 | 0.20 | 9,071,305 | ||
Fourth quarter 2015 | 0.20 | 9,030,775 | ||
First quarter 2016 | 0.22 | 9,859,940 | ||
Second quarter 2016 | 0.22 | 9,847,205 | ||
Third quarter 2016 | 0.22 | 9,808,340 | ||
Fourth quarter 2016 | 0.22 | 9,838,816 | ||
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Dividend Restrictions
For a description of restrictions on the payment of dividends, see Part I, Item 1, “Business — Regulation and Supervision — Restrictions on Transfers of Funds to Us and the Bank,” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Capital Resources and Liquidity Management” included in Part II, Item 7 herein.
Sales of Unregistered Securities
There were no issuances of unregistered securities during the three months ended December 31, 2016.
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
The following table provides information with respect to purchases made by or on behalf of us or any "affiliated purchasers" (as defined in Rule 10b-18(a)(3) under the Exchange Act), of our common stock during the three months ended December 31, 2016.
Total Number of | Maximum Number | |||||||||
Shares Purchased | of Shares That | |||||||||
Total Number | Average | as Part of Publicly | May Yet Be | |||||||
of Shares | Price Paid | Announced Plans | Purchased Under the | |||||||
Period | Purchased (1) | Per Share | or Programs | Plans or Programs | ||||||
October 2016 | — | $ | — | — | 24,123 | |||||
November 2016 | — | — | — | 24,123 | ||||||
December 2016 | 17,254 | 42.55 | — | 24,123 | ||||||
Total | 17,254 | $ | 42.55 | — | 24,123 | |||||
(1) | Stock repurchases were redemptions of vested restricted shares tendered in lieu of cash for payment of income tax withholding amounts by participants of the Company's 2006 Equity Compensation Plan. |
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Performance Graph
The performance graph below compares the cumulative total shareholder return on our Class A common stock with the cumulative total return on equity securities of companies included in the NASDAQ Composite Index, the NASDAQ Bank Index and the SNL U.S. Bank NASDAQ index, measured on the last trading day of each year shown. The NASDAQ Bank Index and the SNL U.S. Bank Nasdaq index are comparative peer indexes comprised of financial companies, including banks, savings institutions and related holding companies that perform banking-related functions, listed on the NASDAQ Stock Market. The NASDAQ Composite Index is a comparative broad market index comprised of all domestic and international common stocks listed on the NASDAQ Stock Market. This graph assumes a $100 investment in our Class A common stock on December 31, 2011, and reinvestment of dividends on the date of payment without commissions. The plot points on the graph were provided by SNL Financial LC, Charlottesville, VA. The performance graph represents past performance, which may not be indicative of the future performance of our common stock.
Index | 12/31/11 | 12/31/12 | 12/31/13 | 12/31/14 | 12/31/15 | 12/31/16 | ||||||||||||
First Interstate BancSystem, Inc. | $ | 100.00 | $ | 122.41 | $ | 229.16 | $ | 230.28 | $ | 247.82 | $ | 374.06 | ||||||
NASDAQ Composite | 100.00 | 117.45 | 164.57 | 188.84 | 201.98 | 219.89 | ||||||||||||
SNL U.S. Bank NASDAQ | 100.00 | 119.19 | 168.21 | 176.48 | 192.08 | 265.02 | ||||||||||||
NASDAQ Bank | 100.00 | 118.69 | 168.21 | 176.48 | 192.08 | 265.02 | ||||||||||||
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Item 6. Selected Consolidated Financial Data
The following selected consolidated financial data with respect to our consolidated financial position as of December 31, 2016 and 2015, and the results of our operations for the fiscal years ended December 31, 2016, 2015 and 2014, has been derived from our audited consolidated financial statements included in Part IV, Item 15. This data should be read in conjunction with Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and such consolidated financial statements, including the notes thereto. The selected consolidated financial data with respect to our consolidated financial position as of December 31, 2013, 2012 and 2011, and the results of our operations for the fiscal years ended December 31, 2012 and 2011, has been derived from our audited consolidated financial statements not included herein.
Five Year Summary (Dollars in thousands except share and per share data) | |||||||||||||||
As of or for the year ended December 31, | 2016 | 2015 | 2014 | 2013 | 2012 | ||||||||||
Selected Balance Sheet Data: | |||||||||||||||
Net loans | $ | 5,402,330 | $ | 5,169,379 | $ | 4,823,243 | $ | 4,259,514 | $ | 4,123,401 | |||||
Investment securities | 2,124,468 | 2,057,505 | 2,287,110 | 2,151,543 | 2,203,481 | ||||||||||
Total assets | 9,063,895 | 8,728,196 | 8,609,936 | 7,564,651 | 7,721,761 | ||||||||||
Deposits | 7,376,110 | 7,088,937 | 7,006,212 | 6,133,750 | 6,240,411 | ||||||||||
Securities sold under repurchase agreements | 537,556 | 510,635 | 502,250 | 457,437 | 505,785 | ||||||||||
Long-term debt | 27,970 | 27,885 | 38,067 | 36,917 | 37,160 | ||||||||||
Preferred stock pending redemption (1) | — | — | — | — | 50,000 | ||||||||||
Subordinated debentures held by subsidiary trusts | 82,477 | 82,477 | 82,477 | 82,477 | 82,477 | ||||||||||
Preferred stockholders’ equity (1) | — | — | — | — | — | ||||||||||
Common stockholders’ equity | 982,593 | 950,493 | 908,924 | 801,581 | 751,186 | ||||||||||
Selected Income Statement Data: | |||||||||||||||
Interest income | $ | 297,426 | $ | 282,423 | $ | 267,067 | $ | 257,662 | $ | 273,900 | |||||
Interest expense | 17,661 | 18,060 | 18,606 | 20,695 | 30,114 | ||||||||||
Net interest income | 279,765 | 264,363 | 248,461 | 236,967 | 243,786 | ||||||||||
Provision for loan losses | 9,991 | 6,822 | (6,622 | ) | (6,125 | ) | 40,750 | ||||||||
Net interest income after provision for loan losses | 269,774 | 257,541 | 255,083 | 243,092 | 203,036 | ||||||||||
Non-interest income | 136,496 | 121,515 | 111,835 | 113,024 | 115,509 | ||||||||||
Non-interest expense | 261,011 | 248,599 | 237,303 | 223,414 | 230,283 | ||||||||||
Income before income taxes | 145,259 | 130,457 | 129,615 | 132,702 | 88,262 | ||||||||||
Income tax expense | 49,623 | 43,662 | 45,214 | 46,566 | 30,038 | ||||||||||
Net income | 95,636 | 86,795 | 84,401 | 86,136 | 58,224 | ||||||||||
Preferred stock dividends | — | — | — | — | 3,300 | ||||||||||
Net income available to common shareholders | $ | 95,636 | $ | 86,795 | $ | 84,401 | $ | 86,136 | $ | 54,924 | |||||
Common Share Data: | |||||||||||||||
Earnings per share: | |||||||||||||||
Basic | $ | 2.15 | $ | 1.92 | $ | 1.89 | $ | 1.98 | $ | 1.28 | |||||
Diluted | 2.13 | 1.90 | 1.87 | 1.96 | 1.27 | ||||||||||
Dividends per share | 0.88 | 0.80 | 0.64 | 0.41 | 0.61 | ||||||||||
Book value per share (2) | 21.87 | 20.92 | 19.85 | 18.15 | 17.35 | ||||||||||
Tangible book value per share (3) | 16.91 | 16.19 | 15.07 | 13.89 | 12.97 | ||||||||||
Weighted average shares outstanding: | |||||||||||||||
Basic | 44,511,774 | 45,184,091 | 44,615,060 | 43,566,681 | 42,965,987 | ||||||||||
Diluted | 44,910,396 | 45,646,418 | 45,210,561 | 44,044,602 | 43,092,978 | ||||||||||
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Five Year Summary (continued) (Dollars in thousands except share and per share data) | |||||||||||||||
As of or for the year ended December 31, | 2016 | 2015 | 2014 | 2013 | 2012 | ||||||||||
Financial Ratios: | |||||||||||||||
Return on average assets | 1.10 | % | 1.02 | % | 1.06 | % | 1.16 | % | 0.79 | % | |||||
Return on average common equity | 9.93 | 9.37 | 9.86 | 11.05 | 7.46 | ||||||||||
Return on average tangible common equity (4) | 12.81 | 12.23 | 12.88 | 14.59 | 10.07 | ||||||||||
Average stockholders’ equity to average assets | 11.04 | 10.87 | 10.77 | 10.49 | 10.57 | ||||||||||
Yield on average earning assets | 3.80 | 3.70 | 3.75 | 3.84 | 4.10 | ||||||||||
Cost of average interest bearing liabilities | 0.30 | 0.31 | 0.34 | 0.40 | 0.58 | ||||||||||
Interest rate spread | 3.50 | 3.39 | 3.41 | 3.44 | 3.52 | ||||||||||
Net interest margin (5) | 3.57 | 3.46 | 3.49 | 3.54 | 3.66 | ||||||||||
Efficiency ratio (6) | 62.70 | 64.42 | 65.86 | 63.83 | 64.09 | ||||||||||
Common stock dividend payout ratio (7) | 40.93 | 41.65 | 33.83 | 20.71 | 47.66 | ||||||||||
Loan to deposit ratio | 74.27 | 74.01 | 69.90 | 70.84 | 67.69 | ||||||||||
Asset Quality Ratios: | |||||||||||||||
Non-performing loans to total loans (8) | 1.40 | % | 1.37 | % | 1.32 | % | 2.22 | % | 2.61 | % | |||||
Non-performing assets to total loans and other real estate owned (OREO) (9) | 1.58 | 1.49 | 1.59 | 2.57 | 3.35 | ||||||||||
Non-performing assets to total assets | 0.96 | 0.90 | 0.91 | 1.48 | 1.85 | ||||||||||
Allowance for loan losses to total loans | 1.39 | 1.46 | 1.52 | 1.96 | 2.38 | ||||||||||
Allowance for loan losses to non-performing loans | 99.52 | 106.71 | 114.58 | 88.28 | 91.31 | ||||||||||
Net charge-offs to average loans | 0.20 | 0.08 | 0.10 | 0.21 | 1.26 | ||||||||||
Capital Ratios: | |||||||||||||||
Tangible common equity to tangible assets (10) | 8.60 | % | 8.64 | % | 8.22 | % | 8.32 | % | 7.46 | % | |||||
Net tangible common equity to tangible assets (11) | 9.28 | 9.35 | 8.94 | 9.14 | 8.26 | ||||||||||
Tier 1 common capital to total risk weighted assets (12) | 12.65 | 12.69 | 13.08 | 13.31 | 11.94 | ||||||||||
Leverage ratio | 10.11 | 10.12 | 9.61 | 10.08 | 8.81 | ||||||||||
Tier 1 risk-based capital | 13.89 | 13.99 | 14.52 | 14.93 | 13.60 | ||||||||||
Total risk-based capital | 15.13 | 15.36 | 16.15 | 16.75 | 15.59 | ||||||||||
(1) | On December 18, 2012, we provided notice to preferred stockholders of our intention to redeem the preferred stock on January 18, 2013. Upon notice to holders of the redemption, all preferred stock outstanding was reclassified from stockholder's equity to a liability. |
(2) | For purposes of computing book value per share, book value equals common stockholders’ equity. |
(3) | Tangible book value per share is a non-GAAP financial measure that management uses to evaluate our capital adequacy. For purposes of computing tangible book value per share, tangible book value equals common stockholders’ equity less goodwill, core deposit intangibles and other intangible assets (except mortgage servicing rights). Tangible book value per share is calculated as tangible common stockholders’ equity divided by common shares outstanding, and its most directly comparable GAAP financial measure is book value per share. See below our reconciliation of non-GAAP financial measures to their most directly comparable GAAP financial measures under the caption “—Non-GAAP Financial Measures” in this Part II, Item 6. |
(4) | Return on average tangible common equity is a non-GAAP financial measure that management uses to evaluate our capital adequacy. For purposes of computing return on average tangible common equity, average tangible common equity equals average stockholders' equity less average goodwill, average core deposit intangibles and average other intangible assets (except mortgage servicing rights). Return on average tangible common equity is calculated as net income available to common shareholders divided by average tangible common equity, and its most comparable GAAP financial measure is return on average common stockholders' equity. See below our reconciliation of non-GAAP financial measures to their most directly comparable GAAP financial measures under the caption “—Non-GAAP Financial Measures” in this Part II, Item 6. |
(5) | Net interest margin ratio is presented on a fully taxable equivalent, or FTE, basis. |
(6) | Efficiency ratio represents non-interest expense, excluding loan loss provision, divided by the aggregate of net interest income and non-interest income. |
(7) | Common stock dividend payout ratio represents dividends per common share divided by basic earnings per common share. |
(8) | Non-performing loans include non-accrual loans and loans past due 90 days or more and still accruing interest. |
(9) | Non-performing assets include non-accrual loans, loans past due 90 days or more and still accruing interest and OREO. |
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(10) | Tangible common equity to tangible assets is a non-GAAP financial measure that management uses to evaluate our capital adequacy. For purposes of computing tangible common equity to tangible assets, tangible common equity is calculated as common stockholders’ equity less goodwill and other intangible assets (except mortgage servicing assets), and tangible assets is calculated as total assets less goodwill and other intangible assets (except mortgage servicing rights). See below our reconciliation of non-GAAP financial measures to their most directly comparable GAAP financial measures under the caption “—Non-GAAP Financial Measures” in this Part II, Item 6. |
(11) | Net tangible common equity to tangible assets is a non-GAAP financial measure that management uses to evaluate our capital adequacy. For purposes of computing net tangible common equity to tangible assets, net tangible common equity is calculated as common stockholders’ equity less goodwill (adjusted for associated deferred tax liability) and other intangible assets (except mortgage servicing assets), and tangible assets is calculated as total assets less goodwill and other intangible assets (except mortgage servicing rights). See below our reconciliation of non-GAAP financial measures to their most directly comparable GAAP financial measures under the caption “—Non-GAAP Financial Measures” in this Part II, Item 6. |
(12) | For purposes of computing tier 1 common capital to total risk-weighted assets, tier 1 common capital excludes preferred stock and trust preferred securities. |
Non-GAAP Financial Measures
In addition to results presented in accordance with generally accepted accounting principals in the United States of America, or GAAP, this annual report contains the following non-GAAP financial measures that management uses to evaluate our capital adequacy: return on average tangible common equity, tangible book value per share, tangible common equity to tangible assets and net tangible common equity to tangible assets. Return on average tangible equity is calculated as net income available to common shareholders divided by average tangible common stockholders' equity. Tangible book value per share is calculated as tangible common stockholders’ equity divided by common shares outstanding. Tangible assets is calculated as total assets less goodwill and other intangible assets (excluding mortgage servicing assets). Tangible common equity to tangible assets is calculated as tangible common stockholders’ equity divided by tangible assets. Net tangible common equity to tangible assets is calculated as net tangible common stockholders’ equity divided by tangible assets. These non-GAAP financial measures may not be comparable to similarly titled measures reported by other companies because other companies may not calculate these non-GAAP measures in the same manner. They also should not be considered in isolation or as a substitute for measures prepared in accordance with GAAP.
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The following table shows a reconciliation from ending stockholders’ equity (GAAP) to ending tangible common stockholders’ equity (non-GAAP) and ending net tangible common stockholders’ equity (non-GAAP) and ending assets (GAAP) to ending tangible assets (non-GAAP), their most directly comparable GAAP financial measures, in each instance as of the periods presented.
Non-GAAP Financial Measures - Five Year Summary (Dollars in thousands except share and per share data) | |||||||||||||||
As of December 31, | 2016 | 2015 | 2014 | 2013 | 2012 | ||||||||||
Total common stockholders' equity (GAAP) | $ | 982,593 | $ | 950,493 | $ | 908,924 | $ | 801,581 | $ | 751,186 | |||||
Less goodwill and other intangible assets (excluding mortgage servicing rights) | 222,468 | 215,119 | 218,870 | 188,214 | 189,637 | ||||||||||
Tangible common stockholders' equity (Non-GAAP) | 760,125 | 735,374 | 690,054 | 613,367 | 561,549 | ||||||||||
Add deferred tax liability for deductible goodwill | 60,499 | 60,499 | 60,499 | 60,499 | 60,499 | ||||||||||
Net tangible common stockholders' equity (Non-GAAP) | $ | 820,624 | $ | 795,873 | $ | 750,553 | $ | 673,866 | $ | 622,048 | |||||
Total Assets (GAAP) | $ | 9,063,895 | $ | 8,728,196 | $ | 8,609,936 | $ | 7,564,651 | $ | 7,721,761 | |||||
Less goodwill and other intangible assets (excluding mortgage servicing rights) | 222,468 | 215,119 | 218,870 | 188,214 | 189,637 | ||||||||||
Tangible assets (Non-GAAP) | $ | 8,841,427 | $ | 8,513,077 | $ | 8,391,066 | $ | 7,376,437 | $ | 7,532,124 | |||||
Average Balances: | |||||||||||||||
Total common stockholders' equity (GAAP) | $ | 963,530 | $ | 926,050 | $ | 855,862 | $ | 779,530 | $ | 735,984 | |||||
Less goodwill and other intangible assets (excluding mortgage servicing rights) | 216,726 | 216,494 | 200,740 | 188,954 | 190,381 | ||||||||||
Average tangible common stockholders' equity (Non-GAAP) | $ | 746,804 | $ | 709,556 | $ | 655,122 | $ | 590,576 | $ | 545,603 | |||||
Common shares outstanding | 44,926,176 | 45,458,255 | 45,788,415 | 44,155,063 | 43,290,323 | ||||||||||
Net income available to common shareholders | $ | 95,636 | $ | 86,795 | $ | 84,401 | $ | 86,136 | $ | 54,924 | |||||
Book value per common share (GAAP) | $ | 21.87 | $ | 20.92 | $ | 19.85 | $ | 18.15 | $ | 17.35 | |||||
Tangible book value per common share (Non-GAAP) | 16.92 | 16.19 | 15.07 | 13.89 | 12.97 | ||||||||||
Tangible common equity to tangible assets (Non-GAAP) | 8.60 | % | 8.64 | % | 8.22 | % | 8.32 | % | 7.46 | % | |||||
Net tangible common equity to tangible assets (Non-GAAP) | 9.28 | 9.35 | 8.94 | 9.14 | 8.26 | ||||||||||
Return on average common tangible equity (Non-GAAP) | 12.81 | 12.23 | 12.88 | 14.59 | 10.07 | ||||||||||
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Cautionary Note Regarding Forward-Looking Statements and Factors that Could Affect Future Results
This report contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Rule 175 promulgated thereunder, and Section 21E of the Securities Exchange Act of 1934, as amended, and Rule 3b-6 promulgated thereunder, that involve inherent risks and uncertainties. Any statements about our plans, objectives, expectations, strategies, beliefs, or future performance or events constitute forward-looking statements. Such statements are identified as those that include words or phrases such as “believes,” “expects,” “anticipates,” “plans,” “trend,” “objective,” “continue” or similar expressions or future or conditional verbs such as “will,” “would,” “should,” “could,” “might,” “may” or similar expressions. Forward-looking statements involve known and unknown risks, uncertainties, assumptions, estimates and other important factors that could cause actual results to differ materially from any results, performance or events expressed or implied by such forward-looking statements.
The following factors, among others, may cause actual results to differ materially from current expectations in the forward-looking statements, including those set forth in this report:
• | declining business and economic conditions; |
• | adverse economic conditions affecting Montana, Wyoming and South Dakota; |
• | lending risk; |
• | changes in interest rates; |
• | credit losses; |
• | adequacy of the allowance for loan losses; |
• | declining oil and gas prices and declining demand for coal; |
• | additional regulatory requirements if our assets exceed $10 billion; |
• | failure to integrate or profitably operate acquired organizations; |
• | access to low-cost funding sources; |
• | impairment of goodwill; |
• | changes in accounting standards; |
• | dependence on the Company’s management team; |
• | ability to attract and retain qualified employees; |
• | governmental regulation and changes in regulatory, tax and accounting rules and interpretations; |
• | stringent capital requirements; |
• | future FDIC insurance premium increases; |
• | CFPB restrictions on our ability to originate and sell mortgage loans; |
• | failure of technology; |
• | cyber-security; |
• | unfavorable resolution of litigation; |
• | litigation pertaining to fiduciary responsibilities; |
• | inability to meet liquidity requirements; |
• | environmental remediation and other costs; |
• | ineffective internal operational controls; |
• | competition; |
• | reliance on external vendors; |
• | soundness of other financial institutions; |
• | failure to effectively implement technology-driven products and services; |
• | inability of our bank subsidiary to pay dividends; |
• | risks associated with introducing new lines of business, products or services; |
• | implementation of new lines of business or new product or service offerings; |
• | successful completion of the merger and integration of Cascade Bancorp; |
• | uninsured nature of any investment in Class A and Class B common stock; |
• | volatility of Class A and Class B common stock; |
• | decline in market price of Class A and Class B common stock; |
• | voting control of Class B stockholders; |
• | anti-takeover provisions; |
• | dilution as a result of future equity issuances; |
• | change in dividend policy; |
• | controlled company status; and, |
• | subordination of common stock to Company debt. |
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These factors are not necessarily all of the factors that could cause our actual results, performance or achievements to differ materially from those expressed in or implied by any of our forward-looking statements. Other unknown or unpredictable factors also could harm our results.
All forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements set forth above. Forward-looking statements speak only as of the date they are made and we do not undertake or assume any obligation to update publicly any of these statements to reflect actual results, new information or future events, changes in assumptions or changes in other factors affecting forward-looking statements, except to the extent required by applicable laws. If we update one or more forward-looking statements, no inference should be drawn that we will make additional updates with respect to those or other forward-looking statements.
Executive Overview
We are a financial and bank holding company headquartered in Billings, Montana. As of December 31, 2016, we had consolidated assets of $9.1 billion, deposits of $7.4 billion, loans of $5.5 billion and total stockholders’ equity of $983 million.
We currently operate 80 banking offices, including detached drive-up facilities, in 45 communities located in Montana, Wyoming and South Dakota. We also offer internet and mobile banking services. Through our wholly-owned subsidiary, FIB, we deliver a comprehensive range of banking products and services to individuals, businesses, municipalities and other entities throughout our market areas. Our customers participate in a wide variety of industries, including energy, healthcare and professional services, education and governmental services, construction, mining, agriculture, retail and wholesale trade and tourism.
Our Business
Our principal business activity is lending to, accepting deposits from and conducting financial transactions for individuals, businesses, municipalities and other entities. We derive our income principally from interest charged on loans and, to a lesser extent, from interest and dividends earned on investments. We also derive income from non-interest sources such as fees received in connection with various lending and deposit services; trust, employee benefit, investment and insurance services; mortgage loan originations, sales and servicing; merchant and electronic banking services; and from time to time, gains on sales of assets. Our principal expenses include interest expense on deposits and borrowings, operating expenses, provisions for loan losses and income tax expense.
Our loan portfolio consists of a mix of real estate, consumer, commercial, agricultural and other loans, including fixed and variable rate loans. Our real estate loans comprise commercial real estate, construction (including residential, commercial and land development loans), residential, agricultural and other real estate loans. Fluctuations in the loan portfolio are directly related to the economies of the communities we serve. While each loan originated generally must meet minimum underwriting standards established in our credit policies, lending officers are granted discretion within pre-approved limits in approving and pricing loans to assure that the banking offices are responsive to competitive issues and community needs in each market area. We fund our loan portfolio primarily with the core deposits from our customers, generally without utilizing brokered deposits and with minimal reliance on wholesale funding sources. For additional information about our underwriting standards and loan approval process, see "Business—Lending Activities," included in Part I, Item 1 of this report.
Recent Trends and Developments
On January 12, 2017, the Company acquired for cash all right, title and interest in and to all First Interstate-related U.S. trademark registrations owned by Wells Fargo & Company (the "Trademarks"); all common law rights and goodwill associated with the Trademarks; and all First Interstate-related domain names, which will enable the Company to use the the Trademarks throughout the U.S.
On November 17, 2016, we entered into an agreement and plan of merger, the Agreement, to acquire all of the outstanding stock of Cascade Bancorp, parent company of Bank of the Cascades, an Oregon-based community bank with 50 banking offices across Oregon, Idaho and Washington. Under the terms of the Agreement, each outstanding share of Cascade Bancorp will convert into the right to receive 0.14864 shares of our Class A common stock and $1.91 in cash. Based on the closing price of the our Class A common stock on December 31, 2016, the merger consideration represents an aggregate purchase price of approximately $628 million. Upon completion of the merger, which is expected to close during third quarter 2017 subject to regulatory and shareholder approvals, we will become a regional community bank with over $12 billion in total assets with a geographic footprint that will span Montana, Wyoming, South Dakota, Idaho, Oregon and Washington.
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On April 6, 2016, our bank subsidiary entered into a stock purchase agreement to acquire all of the outstanding stock of Flathead Bank of Bigfork, or Flathead Bank, a wholly-owned subsidiary of Flathead Holding Company of Bigfork, with branches located in western and northwestern Montana. The acquisition was completed on August 12, 2016 for cash consideration of $34 million. As of the date of the acquisition, Flathead Bank had total assets of $254 million, loans of $83 million and deposits of $210 million. For additional information regarding the acquisition, “Notes to Consolidated Financial Statements—Acquisitions,” included in Part IV, Item 15 of this report.
Effective January 1, 2016, we elected to account for our loans held for sale using the fair value option. Under the fair value option, unrealized gains and losses on loans held for sale are included in mortgage banking revenues in our consolidated statements of income. Changes in the fair value of mortgage loans increased mortgage banking revenues by $760 thousand during 2016.
In prior periods, we recorded net gains or losses attributable to deferred compensation plan assets as other income, and the corresponding compensation expense or benefit related to these net gains or losses as employee benefits expense in our consolidated statements of income. However, because we pass all gains or losses on deferred compensation plan assets through to plan participants, these income and expense amounts offset and do not impact our consolidated net income. To eliminate fluctuations in other income and employee benefits expense caused by changes in the market values of deferred compensation plan assets, during second quarter 2016 we began recording these gains or losses in other income net of the directly offsetting employee compensation expense or benefit. All prior periods presented in this report have been revised to reflect this change.
On July 2, 2013, the Board of Governors of the Federal Reserve Bank issued a final rule implementing a revised regulatory capital framework for U.S. banks in accordance with the Basel III international accord. The revised regulatory capital framework, or Basel III, became effective for us on January 1, 2015. Basel III includes a more stringent definition of capital and introduces a new common equity tier 1, or CET1, capital requirement, sets forth a comprehensive methodology for calculating risk-weighted assets, introduces a conservation buffer and sets out minimum capital ratios and overall capital adequacy standards. Certain deductions and adjustments to regulatory capital phased in starting January 1, 2015 and will be fully implemented on January 1, 2018. The capital conservation buffer phased in beginning January 1, 2016 and will be fully
implemented on January 1, 2019. As of December 31, 2015, we had capital levels that, in all cases, exceeded the well capitalized guidelines. For additional information regarding our capital levels, see "Capital Resources and Liquidity Management" included herein and “Notes to Consolidated Financial Statements—Regulatory Capital,” included in Part IV, Item 15 of this report.
Primary Factors Used in Evaluating Our Business
As a banking institution, we manage and evaluate various aspects of both our financial condition and our results of operations. We monitor our financial condition and performance and evaluate the levels and trends of the line items included in our balance sheet and statements of income, as well as various financial ratios that are commonly used in our industry. We analyze these ratios and financial trends against both our own historical levels and the financial condition and performance of comparable banking institutions in our region and nationally.
Results of Operations
Principal factors used in managing and evaluating our results of operations include return on average equity, net interest income, non-interest income, non-interest expense and net income. Net interest income is affected by the level of interest rates, changes in interest rates and changes in the volume and composition of interest earning assets and interest bearing liabilities. The most significant impact on our net interest income between periods is derived from the interaction of changes in the rates earned or paid on interest earning assets and interest bearing liabilities, which we refer to as interest rate 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 interest rate spread, produces changes in our net interest income between periods. Non-interest bearing sources of funds, such as demand deposits and stockholders’ equity, also support earning assets.
The impact of free funding sources is captured in the net interest margin, which is calculated as net interest income divided by average earning assets. We evaluate our net interest income on factors that include the yields on our loans and other earning assets, the costs of our deposits and other funding sources, the levels of our net interest spread and net interest margin.
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We seek to increase our non-interest income over time and we evaluate our non-interest income relative to the trends of the individual types of non-interest income in view of prevailing market conditions.
We manage our non-interest expenses in consideration of growth opportunities and our community banking model that emphasizes customer service and responsiveness. We evaluate our non-interest expense on factors that include our non-interest expense relative to our average assets, our efficiency ratio and the trends of the individual categories of non-interest expense.
Finally, we seek to increase our net income and provide favorable shareholder returns over time, and we evaluate our net income relative to the performance of other bank holding companies on factors that include return on average assets, return on average equity, total shareholder return and growth in earnings.
Financial Condition
Principal areas of focus in managing and evaluating our financial condition include liquidity, the diversification and quality of our loans, the adequacy of our allowance for loan losses, the diversification and terms of our deposits and other funding sources, the re-pricing characteristics and maturities of our assets and liabilities, including potential interest rate exposure and the adequacy of our capital levels. We seek to maintain sufficient levels of cash and investment securities to meet potential payment and funding obligations, and we evaluate our liquidity on factors that include the levels of cash and highly liquid assets relative to our liabilities, the quality and maturities of our investment securities, the ratio of loans to deposits and any reliance on brokered certificates of deposit or other wholesale funding sources.
We seek to maintain a diverse and high quality loan portfolio and evaluate our asset quality on factors that include the allocation of our loans among loan types, credit exposure to any single borrower or industry type, non-performing assets as a percentage of total loans and OREO, and loan charge-offs as a percentage of average loans. We seek to maintain our allowance for loan losses at a level adequate to absorb probable losses inherent in our loan portfolio at each balance sheet date, and we evaluate the level of our allowance for loan losses relative to our overall loan portfolio and the level of non-performing loans and potential charge-offs.
We seek to fund our assets primarily using core customer deposits spread among various deposit categories, and we evaluate our deposit and funding mix on factors that include the allocation of our deposits among deposit types, the level of our non-interest bearing deposits, the ratio of our core deposits (i.e. excluding time deposits above $100,000) to our total deposits and our reliance on brokered deposits or other wholesale funding sources, such as borrowings from other banks or agencies. We seek to manage the mix, maturities and re-pricing characteristics of our assets and liabilities to maintain relative stability of our net interest rate margin in a changing interest rate environment, and we evaluate our asset-liability management using models to evaluate the changes to our net interest income under different interest rate scenarios.
Finally, we seek to maintain adequate capital levels to absorb unforeseen operating losses and to help support the growth of our balance sheet. We evaluate our capital adequacy using the regulatory and financial capital ratios including leverage capital ratio, tier 1 risk-based capital ratio, total risk-based capital ratio, tangible common equity to tangible assets and tier 1 common capital to total risk-weighted assets.
Critical Accounting Estimates and Significant Accounting Policies
Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States and follow general practices within the industries in which we operate. Application of these principles requires management to make estimates, assumptions and judgments that affect the amounts reported in the consolidated financial statements and accompanying notes. Our significant accounting policies are summarized in “Notes to Consolidated Financial Statements—Summary of Significant Accounting Policies” included in financial statements included Part IV, Item 15 of this report.
Our critical accounting estimates are summarized below. Management considers an accounting estimate to be critical if: (1) the accounting estimate requires management to make particularly difficult, subjective and/or complex judgments about matters that are inherently uncertain and (2) changes in the estimate that are reasonably likely to occur from period to period, or the use of different estimates that management could have reasonably used in the current period, would have a material impact on our consolidated financial statements, results of operations or liquidity.
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Allowance for Loan Losses
The provision for loan losses creates an allowance for loan losses known and inherent in the loan portfolio at each balance sheet date. The allowance for loan losses represents management’s estimate of probable credit losses inherent in the loan portfolio.
We perform a quarterly assessment of the risks inherent in our loan portfolio, as well as a detailed review of each significant loan with identified weaknesses. Based on this analysis, we record a provision for loan losses in order to maintain the allowance for loan losses at appropriate levels. In determining the allowance for loan losses, we estimate losses on specific loans, or groups of loans, where the probable loss can be identified and reasonably determined. Determining the amount of the allowance for loan losses is considered a critical accounting estimate because it requires significant judgment and the use of subjective measurements, including management’s assessment of the internal risk classifications of loans, historical loan loss rates, changes in the nature of the loan portfolio, overall portfolio quality, industry concentrations, delinquency trends and the impact of current local, regional and national economic factors on the quality of the loan portfolio. Changes in these estimates and assumptions are possible and may have a material impact on our allowance, and therefore our consolidated financial statements or results of operations. The allowance for loan losses is maintained at an amount we believe is sufficient to provide for estimated losses inherent in our loan portfolio at each balance sheet date, and fluctuations in the provision for loan losses result from management’s assessment of the adequacy of the allowance for loan losses. Management monitors qualitative and quantitative trends in the loan portfolio, including changes in the levels of past due, internally classified and non-performing loans. See “Notes to Consolidated Financial Statements — Summary of Significant Accounting Policies” for a description of the methodology used to determine the allowance for loan losses. A discussion of the factors driving changes in the amount of the allowance for loan losses is included herein under the heading “—Financial Condition—Allowance for Loan Losses.” See also Part I, Item 1A, “Risk Factors—Risks Relating to the Market and Our Business.”
Goodwill
The excess purchase price over the fair value of net assets from acquisitions, or goodwill, is evaluated for impairment at least annually and on an interim basis if an event or circumstance indicates that it is likely impairment has occurred. In any given year, the Company may elect to perform a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is in excess of its carrying value. If it is not more likely than not that the fair value of the reporting unit is in excess of the carrying value, or if the Company elects to bypass the qualitative assessment, a two-step quantitative impairment test is performed. In performing a quantitative test for impairment, the fair value of net assets is estimated based on an analysis of our market value, discounted cash flows and peer values. Determining the fair value of goodwill is considered a critical accounting estimate because of its sensitivity to market-based economics. In addition, any allocation of the fair value of goodwill to assets and liabilities requires significant management judgment and the use of subjective measurements. Variability in market conditions and key assumptions or subjective measurements used to estimate and allocate fair value are reasonably possible and could have a material impact on our consolidated financial statements or results of operations.
Our annual goodwill impairment test is performed each year as of July 1st. Upon completion of this year's test, the estimated fair value of net assets was greater than carrying value of the Company. We will continue to monitor our performance and evaluate our goodwill for impairment annually or more frequently as needed.
For additional information regarding goodwill, see “Notes to Consolidated Financial Statements—Summary of Significant Accounting Policies,” included in Part IV, Item 15 of this report and “Risk Factors—Risks Relating to the Market and Our Business,” included in Part I, Item 1A of this report.
Fair Values of Loans Acquired in Business Combinations
Loans acquired in business combinations are initially recorded at fair value with no carryover of the related allowance for credit losses. Determining the fair value of the loans involves estimating the amount and timing of principal and interest cash flows initially expected to be collected on the loans and discounting those cash flows at an appropriate market rate of interest. Going forward, the Company continues to evaluate reasonableness of expectations for the timing and the amount of cash to be collected. Subsequent decreases in expected cash flows may result in changes in the amortization or accretion of fair market value adjustments, and in some cases may result in the loan being considered impaired. For collateral dependent loans with deteriorated credit quality, the Company estimates the fair value of the underlying collateral of the loans. These values are discounted using market derived rates of return, with consideration given to the period of time and costs associated with the foreclosure and disposition of the collateral.
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For additional information regarding acquired loans, see “Notes to Consolidated Financial Statements—Summary of Significant Accounting Policies,” “Notes to Consolidated Financial Statements—Acquisitions” and “Notes to Consolidated Financial Statements—Loans,” included in Part IV, Item 15 of this report.
Results of Operations
The following discussion of our results of operations compares the years ended December 31, 2016 to December 31, 2015 and the years ended December 31, 2015 to December 31, 2014.
Net Interest Income
Net interest income, the largest source of our operating income, is derived from interest, dividends and fees received on interest earning assets, less interest expense incurred on interest bearing liabilities. Interest earning assets primarily include loans and investment securities. Interest bearing liabilities include deposits and various forms of indebtedness. Net interest income is affected by the level of interest rates, changes in interest rates and changes in the composition of interest earning assets and interest bearing liabilities.
The most significant impact on our 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 interest rate spread, produces changes in the net interest income between periods.
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The following table presents, for the periods indicated, condensed average balance sheet information, together with interest income and yields earned on average interest earning assets and interest expense and rates paid on average interest bearing liabilities.
Average Balance Sheets, Yields and Rates
(Dollars in thousands)
Year Ended December 31, | ||||||||||||||||||||||||||
2016 | 2015 | 2014 | ||||||||||||||||||||||||
Average Balance | Interest | Average Rate | Average Balance | Interest | Average Rate | Average Balance | Interest | Average Rate | ||||||||||||||||||
Interest earning assets: | ||||||||||||||||||||||||||
Loans (1) (2) | $ | 5,378,298 | $ | 261,681 | 4.87 | % | $ | 5,056,810 | $ | 248,015 | 4.90 | % | $ | 4,602,907 | $ | 233,273 | 5.07 | % | ||||||||
Investment securities (2) | 2,093,549 | 37,597 | 1.80 | 2,191,968 | 37,167 | 1.70 | 2,122,587 | 36,755 | 1.73 | |||||||||||||||||
Federal funds sold | 1,575 | 11 | 0.70 | 2,079 | 12 | 0.58 | 1,391 | 7 | 0.50 | |||||||||||||||||
Interest bearing deposits in banks | 478,909 | 2,589 | 0.54 | 508,314 | 1,537 | 0.30 | 506,067 | 1,334 | 0.26 | |||||||||||||||||
Total interest earnings assets | 7,952,331 | 301,878 | 3.80 | 7,759,171 | 286,731 | 3.70 | 7,232,952 | 271,369 | 3.75 | |||||||||||||||||
Non-earning assets | 772,064 | 762,535 | 715,846 | |||||||||||||||||||||||
Total assets | $ | 8,724,395 | $ | 8,521,706 | $ | 7,948,798 | ||||||||||||||||||||
Interest bearing liabilities: | ||||||||||||||||||||||||||
Demand deposits | $ | 2,162,571 | $ | 2,182 | 0.10 | % | $ | 2,101,988 | $ | 2,105 | 0.10 | % | $ | 1,992,565 | $ | 2,094 | 0.11 | % | ||||||||
Savings deposits | 2,037,351 | 2,677 | 0.13 | 1,908,091 | 2,541 | 0.13 | 1,723,073 | 2,444 | 0.14 | |||||||||||||||||
Time deposits | 1,094,190 | 7,803 | 0.71 | 1,171,952 | 8,461 | 0.72 | 1,198,053 | 9,241 | 0.77 | |||||||||||||||||
Repurchase agreements | 481,014 | 429 | 0.09 | 456,255 | 231 | 0.05 | 454,265 | 237 | 0.05 | |||||||||||||||||
Other borrowed funds (3) | 8 | — | — | 6 | — | — | 8 | — | — | |||||||||||||||||
Long-term debt | 28,219 | 1,815 | 6.43 | 44,654 | 2,300 | 5.15 | 37,442 | 2,016 | 5.38 | |||||||||||||||||
Subordinated debentures held by subsidiary trusts | 82,477 | 2,755 | 3.34 | 82,477 | 2,422 | 2.94 | 88,304 | 2,574 | 2.91 | |||||||||||||||||
Total interest bearing liabilities | 5,885,830 | 17,661 | 0.30 | 5,765,423 | 18,060 | 0.31 | 5,493,710 | 18,606 | 0.34 | |||||||||||||||||
Non-interest bearing deposits | 1,812,589 | 1,774,696 | 1,543,079 | |||||||||||||||||||||||
Other non-interest bearing liabilities | 62,446 | 55,537 | 56,147 | |||||||||||||||||||||||
Stockholders’ equity | 963,530 | 926,050 | 855,862 | |||||||||||||||||||||||
Total liabilities and stockholders’ equity | $ | 8,724,395 | $ | 8,521,706 | $ | 7,948,798 | ||||||||||||||||||||
Net FTE interest income | $ | 284,217 | $ | 268,671 | $ | 252,763 | ||||||||||||||||||||
Less FTE adjustments (2) | (4,452 | ) | (4,308 | ) | (4,302 | ) | ||||||||||||||||||||
Net interest income from consolidated statements of income | $ | 279,765 | $ | 264,363 | $ | 248,461 | ||||||||||||||||||||
Interest rate spread | 3.50 | % | 3.39 | % | 3.41 | % | ||||||||||||||||||||
Net FTE interest margin (4) | 3.57 | % | 3.46 | % | 3.49 | % | ||||||||||||||||||||
Cost of funds, including non-interest bearing demand deposits (5) | 0.23 | % | 0.24 | % | 0.26 | % | ||||||||||||||||||||
(1) | Average loan balances include non-accrual loans. Interest income on loans includes amortization of deferred loan fees net of deferred loan costs, which is not material. |
(2) | Interest income and average rates for tax exempt loans and securities are presented on a fully taxable equivalent, or FTE, basis. |
(3) | Includes interest on federal funds purchased and other borrowed funds. Excludes long-term debt. |
(4) | Net FTE interest margin during the period equals (i) the difference between interest income on interest earning assets and the interest expense on interest bearing liabilities, divided by (ii) average interest earning assets for the period. |
(5) | Cost of funds including non-interest bearing demand deposits equals (i) interest expense on interest bearing liabilities, divided by (ii) the sum of average interest bearing liabilities and average non-interest bearing demand deposits. |
Net FTE interest income increased $15.5 million to $284.2 million during 2016, as compared to $268.7 million in 2015, primarily due to growth in average loans combined with increases in yields earned on interest earning assets and a shift in the mix of interest earning assets from lower-yielding cash deposits in banks and investment securities into higher-yielding loans. Also contributing to the increase in net FTE interest income during 2016, as compared to 2015, was a shift in the mix of deposits away from higher costing time deposits into lower costing demand and savings deposits. Interest accretion related
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to the fair valuation of acquired loans contributed $6.3 million of interest income during 2016. Net FTE interest income was also positively impacted by recoveries of previously charged-off interest of $2.6 million in 2016, as compared to $2.1 million in 2015. The Company's net interest margin ratio increased 11 basis points to 3.57% during 2016, as compared to 3.46% in 2015. Exclusive of interest accretion related to acquired loans and the impact of recoveries of charged-off interest, the Company's net interest margin ratio was 3.46% during 2016, as compared to 3.35% during 2015.
During 2015, deposit growth combined with corresponding increases in interest earning assets and a 3 basis point reduction in our funding costs resulted in an increase in our net interest income on an FTE basis. Our FTE net interest income increased $15.9 million, or 6.3%, to $268.7 million in 2015, compared to $252.8 million in 2014. Interest accretion related to the fair valuation of acquired loans contributed $5.4 million of interest income during 2015. Net FTE interest income was also positively impacted by recoveries of previously charged-off interest of $2.1 million in 2015, as compared to $3.6 million in 2014. Despite increases in our net FTE interest income, our net interest margin ratio decreased 3 basis points to 3.46% in 2015, compared to 3.49% in 2014. Declines in yields earned on the Company's loan and investment portfolios were partially offset by increases in average interest earning assets, primarily loans and investment securities, and reductions in funding costs. Exclusive of interest accretion related to acquired loans and the impact of recoveries of charged-off interest, our net interest margin ratio was 3.35% during 2015 and 3.41% during 2014.
The table below sets forth, for the periods indicated, a summary of the changes in interest income and interest expense resulting from estimated changes in average asset and liability balances (volume) and estimated changes in average interest rates (rate). Changes which are not due solely to volume or rate have been allocated to these categories based on the respective percent changes in average volume and average rate as they compare to each other.
Analysis of Interest Changes Due To Volume and Rates (Dollars in thousands) | |||||||||||||||||||||||||||||
Year Ended December 31, 2016 compared with December 31, 2015 | Year Ended December 31, 2015 compared with December 31, 2014 | Year Ended December 31, 2014 compared with December 31, 2013 | |||||||||||||||||||||||||||
Volume | Rate | Net | Volume | Rate | Net | Volume | Rate | Net | |||||||||||||||||||||
Interest earning assets: | |||||||||||||||||||||||||||||
Loans (1) | $ | 15,767 | $ | (2,101 | ) | $ | 13,666 | $ | 23,004 | $ | (8,262 | ) | $ | 14,742 | $ | 16,689 | $ | (5,866 | ) | $ | 10,823 | ||||||||
Investment Securities (1) | (1,669 | ) | 2,099 | 430 | 1,201 | (789 | ) | 412 | (520 | ) | (1,420 | ) | (1,940 | ) | |||||||||||||||
Federal funds sold | — | (1 | ) | (1 | ) | 6 | 197 | 203 | (9 | ) | (2 | ) | (11 | ) | |||||||||||||||
Interest bearing deposits in banks | (89 | ) | 1,141 | 1,052 | — | 5 | 5 | 290 | 52 | 342 | |||||||||||||||||||
Total change | 14,009 | 1,138 | 15,147 | 24,211 | (8,849 | ) | 15,362 | 16,450 | (7,236 | ) | 9,214 | ||||||||||||||||||
Interest bearing liabilities: | |||||||||||||||||||||||||||||
Demand deposits | 61 | 16 | 77 | 115 | (104 | ) | 11 | 270 | (139 | ) | 131 | ||||||||||||||||||
Savings deposits | 172 | (36 | ) | 136 | 262 | (165 | ) | 97 | 245 | (246 | ) | (1 | ) | ||||||||||||||||
Time deposits | (561 | ) | (97 | ) | (658 | ) | (201 | ) | (579 | ) | (780 | ) | (805 | ) | (1,346 | ) | (2,151 | ) | |||||||||||
Repurchase agreements | 13 | 185 | 198 | 1 | (7 | ) | (6 | ) | (2 | ) | (55 | ) | (57 | ) | |||||||||||||||
Long-term debt | (847 | ) | 362 | (485 | ) | 388 | (104 | ) | 284 | 18 | 62 | 80 | |||||||||||||||||
Preferred stock pending redemption | — | — | — | — | — | — | (159 | ) | — | (159 | ) | ||||||||||||||||||
Subordinated debentures held by subsidiary trusts | — | 333 | 333 | (170 | ) | 18 | (152 | ) | 177 | (109 | ) | 68 | |||||||||||||||||
Total change | (1,162 | ) | 763 | (399 | ) | 395 | (941 | ) | (546 | ) | (256 | ) | (1,833 | ) | (2,089 | ) | |||||||||||||
Increase (decrease) in FTE net interest income (1) | $ | 15,171 | $ | 375 | $ | 15,546 | $ | 23,816 | $ | (7,908 | ) | $ | 15,908 | $ | 16,706 | $ | (5,403 | ) | $ | 11,303 | |||||||||
(1) | Interest income and average rates for tax exempt loans and securities are presented on a FTE basis. |
Provision for Loan Losses
The provision for loan losses supports the allowance for loan losses known and inherent in the loan portfolio at each balance sheet date. We perform a quarterly assessment of the risks inherent in our loan portfolio, as well as a detailed review of each significant loan with identified weaknesses. Based on this analysis, we record a provision for loan losses in order to maintain the allowance for loan losses at appropriate levels. In determining the allowance for loan losses, we estimate losses on specific loans, or groups of loans, where the probable loss can be identified and reasonably determined. The balance of
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the allowance for loan losses is based on internally assigned risk classifications of loans, historical loan loss rates, changes in the nature of the loan portfolio, overall portfolio quality, industry concentrations, delinquency trends, current economic factors and the estimated impact of current economic conditions on certain historical loan loss rates. Fluctuations in the provision for loan losses result from management’s assessment of the adequacy of the allowance for loan losses. Ultimate loan losses may vary from current estimates. For additional information concerning the provision for loan losses, see “—Critical Accounting Estimates and Significant Accounting Policies” included herein.
Fluctuations in the provision for loan losses reflect management's estimate of possible loan losses based upon evaluation of the borrowers' ability to repay, collateral value underlying loans, loan loss trends and estimated effects of current economic conditions on our loan portfolio. During 2016, we recorded a provision for loan losses of $10.0 million, as compared to $6.8 million in 2015. The increase in provision for loan losses recorded in 2016 was primarily attributable to the application of historical loan loss rates to loan growth combined with increases in net loan charge-offs.
During second quarter 2016, we performed an in-depth review of the qualitative factors used in determining the appropriate level of the allowance for loan losses utilizing our loss experience subsequent to the financial crisis. This review resulted in the adjustment of certain qualitative factors. The adjustment of qualitative factors combined with the management's assessment of losses on specific loans with identified weaknesses did not result in a material impact to the overall level of our allowance for loan losses. For information regarding our non-performing loans, see “Non-Performing Assets” included herein. For information regarding our allowance for losses and the second quarter 2016 adjustment of certain qualitative factors, see "Financial Condition - Allowance for Loan Losses" included herein.
During 2015, we recorded a provision for loan losses of $6.8 million, as compared to a reversal of provision for loan losses of $6.6 million in 2014. The provision for loans losses recorded in 2015 was attributable to increases in specific reserves on impaired loans and the application of historical loan loss rates to loan growth. During 2014, reductions in specific reserves on impaired loans and lower general reserves reflective of continued improvement in economic conditions in our market areas, combined with improvement in loss history trends used to estimate required reserves and decreases in the level of criticized real estate and construction loans, which typically require higher reserves based on loss history, resulted in a $6.6 million reversal of provision for loan losses. For additional information concerning non-performing assets, see “—Financial Condition—Non-Performing Assets” herein.
Non-interest Income
Our principal sources of non-interest income include mortgage banking revenues; payment services revenues; wealth management revenues; service charges on deposit accounts; and, other service charges, commissions and fees. Non-interest income increased $15.0 million, or 12.3%, to $136.5 million in 2016, as compared to $121.5 million in 2015, and $9.7 million, or 8.7%, to $121.5 million in 2015 as compared to $111.8 million in 2014. Significant components of these fluctuations are discussed below.
Mortgage banking revenues include origination and processing fees on residential real estate loans held for sale and gains on residential real estate loans sold to third parties. Fluctuations in market interest rates have a significant impact on mortgage banking revenues. Higher interest rates can reduce the demand for home loans and loans to refinance existing mortgages. Conversely, lower interest rates generally stimulate refinancing and home loan origination. Mortgage banking revenues increased $7.2 million, or 24.2%, to $37.2 million in 2016, as compared to $30.0 million in 2015. Mortgage loan production was relatively flat in 2016, as compared to 2015, with most of the increase a result of gains on loan sale margins. Our margin on loan sales increased by approximately 40 basis points beginning in the second quarter of 2016, which contributed to year-over-year growth in revenues. In addition, effective January 1, 2016, we elected to carry our loans held for sale at fair value. Changes in the fair value of mortgage loans increased mortgage banking revenues by $760 thousand in 2016. These increases were partially offset by a $410 thousand gain on the sale of $10.6 million of seasoned portfolio loans recorded during second quarter 2015. Loans originated for home purchases accounted for approximately 58% of 2016 loan production, as compared to approximately 66% in 2015, and 75% in 2014.
Mortgage banking revenues increased $6.0 million, or 25.2%, to $30.0 million during 2015, as compared to $23.9 million during 2014, primarily due to higher volume. Our 2015 mortgage loan production volume increased 25% as compared to 2014.
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Payment services revenues consist of interchange fees paid by merchants for processing electronic payment transactions and ATM service fees. Payment services revenues increased $1.6 million, or 5.0%, to $34.4 million in 2016, as compared to $32.8 million for the same period in 2015, and increased $2.1 million, or 6.7%, to $32.8 million in 2015, as compared to $30.7 million in 2014. These increases were attributable to additional interchange income due to higher credit card transaction volumes each year, primarily the result of our business credit card initiative.
Service charges on deposit accounts increased $1.4 million, or 8.2%, to $18.4 million in 2016, as compared to $17.0 million in 2015, primarily due to increases in overdraft charges on consumer accounts. Management attributes this increase to a focused effort on educating depositors on the benefits of overdraft protection for one-time debit and ATM card transactions. As of December 31, 2016, approximately 8% of our depositors have opted for overdraft protection. Service charges on deposit accounts increased $464 thousand, or 2.8%, to $17.0 million in 2015, as compared to $16.6 million in 2014.
Other service charges, commissions and fees primarily include mortgage servicing fees, fees earned on certain derivative interest rate contracts and insurance commissions. Other service charges, commissions and fees increased $1.1 million, or 10.6%, to $11.5 million in 2016, as compared to $10.4 million in 2015, primarily due to increases in mortgage loan servicing fee income, the result of an increase in the number of loans serviced, and additional fees earned on derivative interest rate swap contracts. Other service charges, commissions and fees increased $357 thousand, or 3.6%, to $10.4 million in 2015 as compared to $10.0 million in 2014, primarily due to increases in mortgage loan servicing fee income resulting from an increase in the number of loans serviced.
Other income primarily includes company-owned life insurance revenues, check printing income, agency stock dividends and gains on sales of miscellaneous assets. Other income decreased $1.3 million, or 11.4%, to $10.0 million in 2016, as compared to $11.3 million in 2015. During 2015, other income included a one-time gain of $863 thousand on the sale of land and the reversal of a $1.0 million expense accrual due to final settlement of secondary investor claims assumed as part of the Mountain West Financial Corp, or MWFC, acquisition in 2014.
Other income decreased $216 thousand, or 1.9%, to $11.3 million in 2015, as compared to $11.5 million in 2014. One-time gains of $863 thousand on the sale of land and the reversal of a $1.0 million expense accrual due to final settlement of secondary investor claims discussed above were offset by by significant one-time other income items recorded in 2014. During 2014, other income included one-time net gains of $1.2 million related to the sale of two FIB bank buildings and insurance death benefits of $921 thousand.
During 2016, we recorded non-recurring litigation recoveries of $4.2 million related to a lender liability lawsuit originally settled in 2015. For additional information regarding the lawsuit or the non-recurring litigation recovery, see “Notes to Consolidated Financial Statements—Commitments and Contingencies,” included in Part IV, Item 15 of this report.
Non-interest Expense
Non-interest expense increased $12.4 million, or 5.0%, to $261.0 million in 2016, as compared to $248.6 million in 2015, and increased $11.3 million, or 4.8%, to $248.6 million in 2015, as compared to $237.3 million in 2014. Non-interest expense for 2016, 2015 and 2014 includes $2.8 million, $5.8 million and $8.0 million, respectively, of acquisition and loss contingency expenses. Exclusive of these acquisition and loss contingency expenses, non-interest expense increased $15.4 million, or 6.3%, to $258.2 million in 2016, as compared to $242.8 million in 2015, and $13.5 million, or 5.9%, to $242.8 million in 2015 as compared to $229.3 million 2014. Significant components of these increases are discussed in more detail below.
Salaries and wages expense increased $7.2 million, or 7.1%, to $108.7 million in 2016, as compared to $101.5 million in 2015. Approximately 47% of this increase was due to higher incentive bonus accruals reflective of our 2016 performance against our 2016 performance targets. The remaining increase was primarily due to inflationary wage increases, one-time separation and special bonus expenses recorded during the first quarter of 2016 and increased personnel costs associated with the Flathead acquisition in August 2016 and the Absarokee acquisition in July 2015.
Higher incentive compensation during 2016, as compared to 2015, was the result of our improved performance against pre-determined performance metrics. During 2016, we achieved pre-set performance metrics established by our board of directors that resulted in incentive compensation funding at 100% of targeted amounts. During 2015, our performance against established performance metrics resulted in incentive compensation funding at approximately 70% of targeted amounts.
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Salaries and wages expense increased $4.9 million, or 5.1%, to $101.5 million in 2015, from $96.5 million in 2014, primarily due to increased personnel costs associated with the MWFC acquisition in July 2014 and the Absarokee acquisition in July 2015, inflationary wage increases and higher commissions paid to mortgage loan originators due to higher loan production volumes. These increases were partially offset by a decrease of $1.5 million in incentive bonus accruals reflective of our 2015 performance against our 2015 performance targets.
Employee benefits expense increased $3.9 million, or 12.4%, to $35.2 million in 2016, as compared to $31.3 million in 2015. Approximately 50% of the increase was due to due to higher profit sharing accruals. During 2016, our performance supported profit sharing funding at 2.34% of our 2016 net income, as compared to 1.50% of net income in 2015. Also contributing to the increase in employee benefits expense in 2016, as compared to 2015, were increases in stock based compensation expense and additional benefits costs resulting from the Flathead Bank acquisition in August 2016 and the Absarokee acquisition in July 2015. Partially offsetting these increases was a decrease of $267 thousand in net periodic benefit costs related to our an amendment to our post-retirement healthcare plan. For additional information regarding the amendment of our post-retirement healthcare plan, see “Notes to Consolidated Financial Statements—Employee Benefit Plans—Post-Retirement Healthcare Plan,” included in Part IV, Item 15 of this report.
Employee benefits increased $760 thousand, or 2.5%, to $31.3 million in 2015, as compared to $30.6 million in 2014, primarily due to the increases in group health insurance expense reflective of higher claims experience in 2015 and increased benefits costs resulting from the MWFC acquisition in July 2014 and the Absarokee acquisition in July 2015.
Furniture and equipment expense decreased $5.9 million or 38.3%, to $9.6 million in 2016, as compared to $15.5 million in 2015. Effective January 1, 2016, we began capturing certain software costs separately from equipment costs, resulting in decreases in furniture and equipment expense and corresponding increases in outsourced technology expenses.
Furniture and equipment expense increased $1.7 million, or 12.4%, to $15.5 million in 2015, as compared to $13.8 million in 2014, primarily due to costs associated with the implementation of new software systems placed into service during the last half of 2014, the continued upgrade of systems during 2015 and increased maintenance costs resulting from the MWFC acquisition in July 2014 and the Absarokee acquisition in July 2015.
Outsourced technology services expense increased $10.4 million or 103.0%, to $20.5 million in 2016, as compared to $10.1 million in 2015. Approximately $5.9 million of the 2016 increase was the result of the classification of certain software costs as outsourced technology services expenses in the current year versus classification as furniture and equipment expense in the prior year. The remaining increase in 2016, as compared to 2015, was primarily due to the continued enhancement of our technology systems and processes to improve scalability and support our future growth.
Outsourced technology services expense increased $701 thousand, or 7.4%, to $10.1 million in 2015, as compared to $9.4 million in 2014. This increase was primarily due to the enhancement of our technology systems and processes to improve scalability and support our future growth.
OREO expense is recorded net of OREO income. Variations in net OREO expense between periods are primarily due to fluctuations in write-downs of the estimated fair value of properties, net gains and losses recorded on the sale of properties and carrying costs and/or operating expenses and income. Net OREO income decreased $1.4 million, or 97.0%, to $44 thousand in 2016, as compared to $1.5 million in 2015, primarily due to lower net gains on the sale of OREO properties and lower net income from income-producing OREO properties. During 2016, we recorded net gains on the sale of OREO of $925 thousand, write-downs in the fair value of OREO properties of $603 thousand and net OREO income of $278 thousand. This compares to net gains on the sale of OREO of $3.0 million, write-downs in the fair value of OREO properties of $207 thousand and net OREO income of $1.3 million in 2015.
Net OREO income increased $1.2 million, or 442.3%, to $1.5 million in 2015, as compared to $272 thousand in 2014, primarily due to higher net gains recorded on the sale of properties. During 2015, we recorded net gains of $3.0 million, as compared to net gains of $1.8 million in 2014.
Professional fees decreased $1.5 million, or 22.7%, to $5.0 million during in 2016, as compared to $6.5 million in 2015, and increased $1.6 million, or 32.3%, to $6.5 million in 2015, as compared to $4.9 million in 2014. During 2015, we incurred professional fees in conjunction with identifying and executing strategies for revenue enhancement and changing our wealth management data platform.
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Mortgage servicing rights are amortized in proportion to and over the period of estimated net servicing income. Mortgage servicing rights amortization expense increased $523 thousand, or 21.5%, to $3.0 million in 2016, as compared to $2.4 million in 2015, and increased $73 thousand, or 3.1%, to $2.4 million in 2015, as compared to $2.4 million in 2014, primarily due to higher volumes of loans serviced.
Core deposit intangibles represent the intangible value of depositor relationships resulting from deposit liabilities assumed and are amortized based on the estimated useful lives of the related deposits. Core deposit intangibles amortization expense increased $39 thousand or 1.2%, to $3.4 million in 2016, as compared to $3.4 million in 2015, and increased $1.1 million, or 50.5%, to $3.4 million in 2015, as compared to $2.3 million in 2014, due to additional amortization of core deposit intangibles recorded in conjunction with recent acquisitions. We acquired core deposit intangibles of $2.5 million in conjunction with our acquisition of Flathead in August 2016, $695 thousand in conjunction with our acquisition of Absarokee in July 2015 and $11.0 million in conjunction with our acquisition of MWFC in July 2014. For additional information regarding acquired core deposit intangibles, see “Notes to Consolidated Financial Statements—Acquisitions,” included in Part IV, Item 15 of this report.
Other expenses primarily include advertising and public relations costs; office supply, postage, freight, telephone and travel expenses; donations expense; debit and credit card expenses; board of director fees; legal expenses; and, other losses. Other expenses decreased $311 thousand, or less than 1.0%, to $50.6 million in 2016, as compared to $50.9 million in 2015. Increases in other expense due to the additional operating expenses resulting from the Flathead Bank acquisition in August 2016 and the Absarokee acquisition in July 2015, were partially offset by one-time expenses of $806 thousand associated with the write-down of the fair values of two vacated bank buildings held for sale and a one-time contract termination fee of $867 thousand recorded in 2015. Also contributing to the decrease in other expenses in 2016, as compared to 2015, was a reduction of $697 thousand in fraud losses.
Other expenses increased $3.5 million, or 7.3%, to $50.9 million in 2015, as compared to $47.5 million in 2014. During 2015, the Company recorded write-downs aggregating $806 thousand in the fair value of two vacated bank buildings held for sale; recorded a one-time contract termination fee of $876 thousand related to a change in payment service provider; and incurred an additional legal expense of approximately $1.0 million in conjunction with legal settlements reached in 2015. In addition, the Company recorded fraud losses of $1.7 million in 2015, as compared to $1.2 million in 2014, due to unusually high fraudulent credit card activity during the first half of 2015. The remaining increase in other expense in 2015, as compared to 2014, is reflective of additional operating expenses resulting from the MWFC acquisition in July 2014 and the Absarokee acquisition in July 2015.
During 2015 and 2014, we recorded loss contingency expense of $5.0 million and $4.0 million, respectively related to a legal and settlement costs associated with a lender liability lawsuit against FIB. The lawsuit was settled in 2015. For additional information regarding this pending litigation, see “Notes to Consolidated Financial Statements—Commitments and Contingencies,” included in Part IV, Item 15 of this report.
During 2016, 2015 and 2014, we recorded acquisition expenses of $2.8 million, $795 thousand and $4.0 million, respectively. Acquisition expenses primarily include legal and professional fees, employee retention payments and travel expenses. For additional information regarding our acquisitions, see "Recent Developments" included herein and “Notes to Consolidated Financial Statements—Acquisitions,” included in Part IV, Item 15 of this report.
Income Tax Expense
Our effective federal tax rate was 29.7% for the year ended December 31, 2016, 29.0% for the year ended December 31, 2015 and 30.7% for the year ended December 31, 2014. Fluctuations in effective federal income tax rates are primarily due to the timing of of federal tax credits resulting from our participation in the New Markets Tax Credits Program. For additional information about our participation in the New Markets Tax Credits Program, see “Notes to Consolidated Financial Statements—Summary of Significant Accounting Policies,” included in Part IV, Item 15 of this report.
State income tax applies primarily to pretax earnings generated within Montana and South Dakota. Our effective state tax rate was 4.4% for the year ended December 31, 2016, 4.5% for the year ended December 31, 2015 and 4.2% for the year ended December 31, 2014.
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Net Income
Net income was $95.6 million, or $2.13 per diluted share, in 2016, compared to $86.8 million, or $1.90 per diluted share, in 2015 and $84.4 million, or $1.87 per diluted share, in 2014.
Summary of Quarterly Results
The following tables present unaudited quarterly results of operations for the fiscal years ended December 31, 2016 and 2015.
Quarterly Results (Dollars in thousands except per share data) | |||||||||||||||
First Quarter | Second Quarter | Third Quarter | Fourth Quarter | Full Year | |||||||||||
Year Ended December 31, 2016: | |||||||||||||||
Interest income | $ | 72,380 | $ | 71,959 | $ | 74,935 | $ | 78,152 | $ | 297,426 | |||||
Interest expense | 4,430 | 4,326 | 4,354 | 4,551 | 17,661 | ||||||||||
Net interest income | 67,950 | 67,633 | 70,581 | 73,601 | 279,765 | ||||||||||
Provision for loan losses | 4,000 | 2,550 | 2,363 | 1,078 | 9,991 | ||||||||||
Net interest income after provision for loan losses | 63,950 | 65,083 | 68,218 | 72,523 | 269,774 | ||||||||||
Non-interest income(1) | 28,636 | 37,881 | 35,161 | 34,818 | 136,496 | ||||||||||
Non-interest expense(1) | 62,255 | 63,767 | 65,403 | 69,586 | 261,011 | ||||||||||
Income before income taxes | 30,331 | 39,197 | 37,976 | 37,755 | 145,259 | ||||||||||
Income tax expense | 10,207 | 13,643 | 12,783 | 12,990 | 49,623 | ||||||||||
Net income | $ | 20,124 | $ | 25,554 | $ | 25,193 | $ | 24,765 | $ | 95,636 | |||||
Basic earnings per common share | $ | 0.45 | $ | 0.58 | $ | 0.57 | $ | 0.56 | $ | 2.15 | |||||
Diluted earnings per common share | 0.45 | 0.57 | 0.56 | 0.55 | 2.13 | ||||||||||
Dividends paid per common share | 0.22 | 0.22 | 0.22 | 0.22 | 0.88 | ||||||||||
(1) | To improve comparability between periods presented above, we have included the standard costs of originating residential mortgage loans sold to secondary investors in salaries and wages expense, rather than as an offset to mortgage banking revenues. This reclassification resulted in an increase in mortgage banking revenues for each of the first three quarters of 2016 and an offsetting increase in salaries and wages expense during the same periods. This reclassification had no impact on previously reported net income. |
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Quarterly Results (Dollars in thousands except per share data) | |||||||||||||||
First Quarter | Second Quarter | Third Quarter | Fourth Quarter | Full Year | |||||||||||
Year Ended December 31, 2015: | |||||||||||||||
Interest income | $ | 68,792 | $ | 69,718 | $ | 70,780 | $ | 73,133 | $ | 282,423 | |||||
Interest expense | 4,467 | 4,430 | 4,450 | 4,713 | 18,060 | ||||||||||
Net interest income | 64,325 | 65,288 | 66,330 | 68,420 | 264,363 | ||||||||||
Provision for loan losses | 1,095 | 1,340 | 1,098 | 3,289 | 6,822 | ||||||||||
Net interest income after provision for loan losses | 63,230 | 63,948 | 65,232 | 65,131 | 257,541 | ||||||||||
Non-interest income | 27,918 | 31,763 | 31,178 | 30,656 | 121,515 | ||||||||||
Non-interest expense | 59,728 | 61,971 | 66,198 | 60,702 | 248,599 | ||||||||||
Income before income taxes | 31,420 | 33,740 | 30,212 | 35,085 | 130,457 | ||||||||||
Income tax expense | 10,440 | 11,518 | 10,050 | 11,654 | 43,662 | ||||||||||
Net income | $ | 20,980 | $ | 22,222 | $ | 20,162 | $ | 23,431 | $ | 86,795 | |||||
Basic earnings per common share | $ | 0.46 | $ | 0.49 | $ | 0.45 | $ | 0.52 | $ | 1.92 | |||||
Diluted earnings per common share | 0.46 | 0.49 | 0.44 | 0.51 | 1.90 | ||||||||||
Dividends paid per common share | 0.20 | 0.20 | 0.20 | 0.20 | 0.80 | ||||||||||
Financial Condition
Total assets increased $336 million, or 3.8%, to $9,064 million as of December 31, 2016, from $8,728 million as of December 31, 2015, with $254 million of the increase attributable to the Flathead acquisition. The remaining increase was primarily due to the deployment of funds generated primarily through organic deposit growth into interest earning assets.
Total assets increased $118 million, or 1.4%, to $8,728 million as of December 31, 2015, from $8,610 million as of December 31, 2014, with $75 million of the increase attributable to the Absarokee acquisition. During 2015, deposit growth combined with proceeds from maturities and paydowns of investment securities were used to fund loan growth.
Loans
Our loan portfolio consists of a mix of real estate, consumer, commercial, agricultural and other loans, including fixed and variable rate loans. Fluctuations in the loan portfolio are directly related to the economies of the communities we serve. While each loan originated generally must meet minimum underwriting standards established in our credit policies, lending officers are granted certain levels of authority in approving and pricing loans to assure that the banking offices are responsive to competitive issues and community needs in each market area. For additional information regarding our underwriting standards and loan approval policies, see "Community Banking—Lending Activities," included in Part I, Item 1 of this report.
Total loans increased $232 million, or 4.4%, to $5,479 million as of December 31, 2016, from $5,246 million as of December 31, 2015. Approximately $83 million of this increase was attributable to the acquisition of Flathead Bank in August 2016. Exclusive of the Flathead Bank acquisition, total loans grew organically $149 million, or 2.8%, with the most notable growth occurring in construction and consumer loans. These increases were partially offset by declines in residential real estate and agricultural loans. Total loans increased $349 million, or 7.1%, to $5,246 million as of December 31, 2015, from $4,897 million as of December 31, 2014, with all major categories of loans, except agricultural real estate loans, showing growth. Approximately $37 million of the increase in total loans in 2015, as compared to 2014, was attributable to the Absarokee acquisition.
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The following table presents the composition of our loan portfolio as of the dates indicated:
Loans Outstanding (Dollars in thousands) | |||||||||||||||||||||||||||||
As of December 31, | |||||||||||||||||||||||||||||
2016 | Percent | 2015 | Percent | 2014 | Percent | 2013 | Percent | 2012 | Percent | ||||||||||||||||||||
Loans | |||||||||||||||||||||||||||||
Real estate: | |||||||||||||||||||||||||||||
Commercial | $ | 1,834,445 | 33.5 | % | $ | 1,793,258 | 34.2 | % | $ | 1,639,422 | 33.6 | % | $ | 1,449,174 | 33.3 | % | $ | 1,497,272 | 35.6 | % | |||||||||
Construction | 481,997 | 8.8 | 430,719 | 8.2 | 418,269 | 8.5 | 351,635 | 8.1 | 334,529 | 7.9 | |||||||||||||||||||
Residential | 1,027,393 | 18.8 | 1,032,851 | 19.7 | 999,903 | 20.4 | 867,912 | 20.0 | 708,339 | 16.8 | |||||||||||||||||||
Agricultural | 170,248 | 3.1 | 156,234 | 3.0 | 167,659 | 3.4 | 173,534 | 4.0 | 177,244 | 4.2 | |||||||||||||||||||
Consumer | 970,266 | 17.7 | 844,353 | 16.1 | 762,471 | 15.6 | 671,587 | 15.5 | 636,794 | 15.1 | |||||||||||||||||||
Commercial | 797,942 | 14.6 | 792,416 | 15.1 | 740,073 | 15.1 | 676,544 | 15.6 | 688,753 | 16.3 | |||||||||||||||||||
Agricultural | 132,858 | 2.4 | 142,151 | 2.7 | 124,859 | 2.5 | 111,872 | 2.6 | 113,627 | 2.8 | |||||||||||||||||||
Other loans | 1,601 | — | 1,339 | — | 3,959 | 0.1 | 1,734 | — | 912 | — | |||||||||||||||||||
Mortgage loans held for sale | 61,794 | 1.1 | 52,875 | 1.0 | 40,828 | 0.8 | 40,861 | 0.9 | 66,442 | 1.3 | |||||||||||||||||||
Total loans | 5,478,544 | 100.0 | % | 5,246,196 | 100.0 | % | 4,897,443 | 100.0 | % | 4,344,853 | 100.0 | % | 4,223,912 | 100.0 | % | ||||||||||||||
Less allowance for loan losses | 76,214 | 76,817 | 74,200 | 85,339 | 100,511 | ||||||||||||||||||||||||
Net loans | $ | 5,402,330 | </ | ||||||||||||||||||||||||||