10-Q/A 1 c62905ae10-qa.txt AMENDMENT TO QUARTERLY REPORT DATED 9/30/99 1 ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q/A [ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 1999 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transaction period from _______ to _______ COMMISSION FILE NUMBER 333-3250 -------- FIRST INTERSTATE BANCSYSTEM, INC. ------------------------------------------------------ (Exact name of registrant as specified in its charter) Montana 81-0331430 ------------------------------- ------------------- (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) PO Box 30918, 401 North 31st Street, Billings, MT 59116-0918 -------------------------------------------------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: 406/255-5390 ------------ Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days Yes X No ---- ---- The Registrant had 8,001,869 shares of common stock outstanding on October 31, 1999. ================================================================================ 2 FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES QUARTERLY REPORT ON FORM 10-Q
Index Page ----- ---- PART I. FINANCIAL INFORMATION Item 1 - Financial Statements Restatement Explanatory Note 3 Consolidated Balance Sheets September 30, 1999 and December 31, 1998 4 Consolidated Statements of Income Three and nine months ended September 30, 1999 and 1998 5 Consolidated Statements of Comprehensive Income Three and nine months ended September 30, 1999 and 1998 6 Consolidated Statements of Cash Flows Nine months ended September 30, 1999 and 1998 7 Notes to Unaudited Consolidated Financial Statements 8 As more fully described in "Notes to Unaudited Consolidated Financial Statements," the Company has restated its 1999 and 1998 consolidated financial statements Item 2 - Management's Discussion and Analysis of Financial Condition And Results of Operations 11 Item 3 - Quantitative and Qualitative Disclosures about Market Risk 16 PART II. OTHER INFORMATION Item 1 - Legal Proceedings 17 Item 2 - Changes in Securities 17 Item 3 - Defaults on Senior Securities 17 Item 4 - Submission of Matters to a Vote of Security Holders 17 Item 5 - Other Information 17 Item 6 - Exhibits and Reports on Form 8-K 17 SIGNATURES 18
2 3 RESTATEMENT EXPLANATORY NOTE In 2000, the Company determined it was necessary to restate the Company's 2000, 1999, 1998 and 1997 consolidated quarterly financial statements to change the accounting treatment for awards made pursuant to its Nonqualified Stock Option and Stock Appreciation Rights Plan ("Stock Option Plan") from fixed to variable plan accounting. This Amendment No. 1 to the Company's Quarterly Report on Form 10-Q for the quarterly period ended September 30, 1999 amends and restates the previously filed Form 10-Q in its entirety. In order to preserve the nature and character of the disclosures set forth in the Form 10-Q as originally filed, no attempt has been made in this Amendment No. 1 to modify or update such disclosures except as required to reflect the effects of the restatement and make nonsubstantial revisions to the notes to the unaudited consolidated financial statements. For additional information regarding the restatement, see "Notes to Unaudited Consolidated Financial Statements - Restatement" included in Part I, Item 1. 3 4 FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES Consolidated Balance Sheets (Dollars in thousands, except share data)
Assets September 30, December 31, 1999 1998 (Restated) (Restated) ------------- ----------- Cash and due from banks $ 164,451 154,527 Federal funds sold 25,210 31,930 Interest bearing deposits in banks 3,843 17,562 Investment securities: Available-for-sale 374,610 379,393 Held-to-maturity 259,986 299,285 ------------ ---------- 634,596 678,678 Loans 1,684,201 1,484,459 Less allowance for loan losses 30,143 28,803 ------------ ---------- Net loans 1,654,058 1,455,656 Premises and equipment, net 69,964 63,382 Accrued interest receivable 27,597 22,433 Goodwill and core deposit intangibles, net of accumulated amortization of $12,910 at September 30, 1999 and $10,950 at December 31, 1998 33,080 29,337 Other real estate owned, net 1,819 1,113 Deferred tax asset 10,275 6,657 Other assets 20,483 18,719 ------------ ---------- Total assets $ 2,645,376 2,479,994 ============ ========== Liabilities and Stockholders' Equity Deposits: Noninterest bearing $ 405,534 390,998 Interest bearing 1,693,169 1,650,934 ------------ ---------- Total deposits 2,098,703 2,041,932 Federal funds purchased 61,605 1,675 Securities sold under repurchase agreements 177,295 173,593 Accrued interest payable 13,745 13,364 Accounts payable and accrued expenses 15,093 13,039 Other borrowed funds 44,850 9,828 Long-term debt 23,530 24,288 ------------ ---------- Total liabilities 2,434,821 2,277,719 Mandatorily redeemable securities of subsidiary trust 40,000 40,000 Stockholders' equity: Common stock without par value; authorized 20,000,000 shares; issued and outstanding 7,974,273 shares as of September 30, 1999 and 7,988,573 shares as of December 31, 1998 10,072 10,468 Retained earnings 164,038 149,639 Accumulated other comprehensive income (loss) (3,555) 2,168 ------------ ---------- Total stockholders' equity 170,555 162,275 ------------ ---------- Total liabilities and stockholders' equity $ 2,645,376 2,479,994 ============ ==========
See accompanying notes to unaudited consolidated financial statements. 4 5 FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES Consolidated Statements of Income (Dollars in thousands, except share data)
For the three months For the nine months ended September 30, ended September 30, --------------------- ---------------------- 1999 1998 1999 1998 (Restated) (Restated) (Restated) (Restated) ---------- ---------- ---------- ---------- Interest income: Interest and fees on loans $38,301 36,464 109,084 107,761 Interest and dividends on investment securities: Taxable 8,558 7,859 25,964 21,153 Exempt from Federal taxes 859 575 2,477 1,359 Interest on deposit with banks 34 179 216 497 Interest on Federal funds sold 437 790 866 2,588 ------- -------- -------- -------- Total interest income 48,189 45,867 138,607 133,358 ------- -------- -------- -------- Interest expense: Interest on deposits 17,002 17,600 49,886 50,747 Interest on Federal funds purchased 697 1 1,303 45 Interest on securities sold under repurchase agreements 1,798 1,788 4,751 5,310 Interest on other borrowed funds 432 130 799 352 Interest on long-term debt 572 532 1,568 1,815 Interest on mandatorily redeemable securities of subsidiary trust 883 882 2,647 2,652 ------- -------- -------- -------- Total interest expense 21,384 20,933 60,954 60,921 ------- -------- -------- -------- Net interest income 26,805 24,934 77,653 72,437 Provision for loan losses 931 1,101 2,503 3,194 ------- -------- -------- -------- Net interest income after provision for loan losses 25,874 23,833 75,150 69,243 Other operating income: Income from fiduciary activities 1,002 808 3,306 2,936 Service charges on deposit accounts 2,971 2,646 8,415 7,743 Data processing 1,924 1,747 5,329 5,578 Other service charges, commissions, and fees 1,982 1,776 4,890 4,346 Net investment securities gains 16 43 17 52 Other real estate income (expense), net (24) 58 359 229 Other income 816 466 1,891 1,461 ------- -------- -------- -------- Total other operating income 8,687 7,544 24,207 22,345 ------- -------- -------- -------- Other operating expenses Salaries, wages and employee benefits 11,910 11,195 36,018 33,411 Occupancy expense, net 1,833 1,731 5,245 4,851 Furniture and equipment expense 2,692 1,995 7,344 6,177 FDIC insurance 57 54 173 162 Goodwill and core deposit intangible amortization 774 661 1,960 1,848 Other expenses 5,956 5,117 16,377 15,788 ------- -------- -------- -------- Total other operating expenses 23,222 20,753 67,117 62,237 ------- -------- -------- -------- Income before income taxes 11,339 10,624 32,240 29,351 Income tax expense 4,076 3,928 11,552 11,005 ------- -------- -------- -------- Net income $ 7,263 6,696 20,688 18,346 ======= ======== ======== ======== Basic earnings per common share $ 0.91 0.83 2.60 2.29 Diluted earning per common share $ 0.90 0.83 2.55 2.27 Dividends per common share $ 0.28 0.23 0.79 0.68
See accompanying notes to unaudited consolidated financial statements. 5 6 FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES Consolidated Statements of Comprehensive Income (Dollars in thousands)
For the three months For the nine months ended September 30, ended September 30, --------------------- --------------------- 1999 1998 1999 1998 (Restated) (Restated) (Restated) (Restated) ---------- ---------- ---------- ---------- Net income $ 7,263 6,696 20,688 18,346 Other comprehensive income (loss): Unrealized gains (losses) on investment securities: Realized and unrealized holding gains (losses) arising during period 116 4,305 (9,365) 4,301 Add: reclassification adjustment for gains included in net income (16) (43) (17) (52) ------- ------ ------- ------- Other comprehensive income (loss), before tax 100 4,262 (9,382) 4,249 Income tax benefit (expense) related to items of other comprehensive income (39) (1,662) 3,659 (1,657) ------- ------- ------- ------- Other comprehensive income (loss), after tax 61 2,600 (5,723) 2,592 ------- ------- ------- ------- Comprehensive income $ 7,324 9,296 14,965 20,938 ======= ======= ======= =======
See accompanying notes to unaudited consolidated financial statements. 6 7 FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows (Dollars in thousands, except per share data)
For the nine months ended September 30, -------------------------- 1999 1998 (Restated) (Restated) ---------- ---------- Cash flows from operating activities: Net income $ 20,688 18,346 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 2,503 3,194 Depreciation and amortization 7,939 6,616 Net premium amortization on investment securities 308 316 Gain on sales of investments (17) (52) Gain on sales of other real estate owned (415) (240) Loss (gain) on sales of property and equipment (17) 135 Provision for deferred income taxes (140) (2,503) Increase in interest receivable (5,159) (4,030) Decrease in other assets (424) (1,234) Increase in accrued interest payable 352 2,363 Increase in accounts payable and accrued expenses 1,516 3,369 --------- -------- Net cash provided by operating activities 27,134 26,280 --------- -------- Cash flows from investing activities: Purchases of investment securities: Held-to-maturity (61,560) (67,159) Available-for-sale (40,460) (280,997) Proceeds from maturities and paydowns of investment securities: Held-to-maturity 98,381 77,989 Available-for-sale 42,473 93,863 Proceeds from sales of available-for-sale investment securities -- 15,038 Proceeds from sales of held-to-maturity investment securities 7,009 -- Extensions of credit to customers, net of repayments (169,327) (3,047) Recoveries of loans charged-off 2,125 2,318 Proceeds from sales of other real estate 1,258 990 Acquisition of branch banks, net of cash and cash equivalents acquired 9,469 -- Capital distributions from joint venture 125 200 Capital expenditures, net (10,990) (5,998) --------- -------- Net cash used in investing activities (121,497) (166,803) --------- -------- Cash flows from financing activities: Net increase (decrease) in deposits (3,810) 138,355 Net increase (decrease) in Federal funds and repurchase agreements 63,632 (22,264) Net increase (decrease) in other borrowed funds 35,022 (213) Proceeds from long-term borrowings 5,500 2,428 Repayment of long-term borrowings (9,557) (9,391) Net decrease in debt issuance costs 71 45 Proceeds from issuance of common stock 2,043 2,222 Payments to retire common stock (2,763) (1,389) Dividends paid on common stock (6,290) (5,458) --------- -------- Net cash provided by financing activities 83,848 104,335 --------- -------- Net decrease in cash and cash equivalents (10,515) (36,188) Cash and cash equivalents at beginning of period 204,019 229,147 --------- -------- Cash and cash equivalents at end of period $ 193,504 192,959 ========= ======== Supplemental disclosure of cash flow information: Cash paid during period for taxes $ 12,402 12,520 Cash paid during period for interest 60,573 58,558 ========= ========
Noncash Investing and Financing Activities: The Company transferred loans of $459 and $734 to other real estate owned during the nine months ended September 30, 1999 and 1998, respectively. In conjunction with the exercise of stock options, the Company transferred $324 and $51 from accrued liabilities to common stock during the nine month periods ended September 30, 1999 and 1998, respectively. See accompanying notes to unaudited consolidated financial statements. 7 8 FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES Notes to Unaudited Consolidated Financial Statements (Dollars in thousands, except share and per share data) (1) Basis of Presentation In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments (all of which are of a normal recurring nature) necessary to present fairly the consolidated financial position at September 30, 1999 and December 31, 1998, and the results of operations and cash flows for each of the periods ended September 30, 1999 and 1998 in conformity with generally accepted accounting principles. The balance sheet information at December 31, 1998 is derived from audited consolidated financial statements, however, certain reclassifications have been made to conform to the September 30, 1999 presentation. In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standard ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities." This statement establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. In June, 1999, FASB issued SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities Deferral of the Effective Date of FASB Statement No. 133 - an amendment of FASB Statement No. 133", deferring the effective date of SFAS No. 133 to all fiscal quarters or fiscal years beginning after June 15, 2000. As of September 30, 1999, the Company was not engaged in hedging activities nor did it hold any derivative instruments. (2) Computation of Earnings per Share Basic earnings per common share (EPS) is calculated by dividing net income by the weighted average number of common shares outstanding during the period presented. Diluted earnings per common share is calculated by dividing net income by the weighted average number of common shares and potential common shares outstanding during the period. The following table shows weighted average common shares and weighted average potential common shares for the three and nine month periods ended September 30, 1999 and 1998.
Three months ended Nine months ended ---------------------- ---------------------- 9/30/99 9/30/98 9/30/99 9/30/98 --------- --------- --------- --------- Weighted average common shares 7,953,331 8,024,038 7,957,010 8,024,016 Weighted average potential common shares 147,442 73,400 144,021 65,455
(3) Cash Dividends In October 1999, the Company declared and paid a cash dividend on third quarter earnings of $0.28 per share to stockholders of record on that date. It has been the Company's practice to pay quarterly dividends based upon earnings. The October 1999 dividend represents 30% of the Company's net income for the quarter ended September 30, 1999 without taking into effect compensation expense related to stock options. (4) Commitments and Contingencies In the normal course of business, the Company is involved in various claims and litigation. In the opinion of management, following consultation with legal counsel, the ultimate liability or disposition thereof will not have a material adverse effect on the consolidated financial condition, results of operations or liquidity. 8 9 FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES Notes to Unaudited Consolidated Financial Statements (Dollars in thousands, except share and per share data) The Company owns a 50% ownership interest in an aircraft and is jointly and severally liable for aircraft indebtedness of $1.5 million as of September 30, 1999. The Company is an anchor tenant in a building owned by a joint venture partnership in which the Company owns a 50% partnership interest. The Company is jointly and severally liable for joint venture partnership indebtedness of $9.6 million as of September 30, 1999. The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, in varying degrees, elements of credit and interest rate risk in excess of amounts recorded in the consolidated balance sheet. Standby letters of credit and financial guarantees written are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Most commitments extend for no more than two years. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Company holds various collateral supporting those commitments for which collateral is deemed necessary. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the commitment contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management's credit evaluation of the customer. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment and income-producing commercial properties. (5) Acquisitions On May 7, 1999, First Interstate Bank in Montana purchased the net assets of the Helena and Belgrade branches of First National Bank of Montana at a premium of $236,000. At the purchase date, the acquired branches had loans and deposits of approximately $1 million and $4 million, respectively. On July 9, 1999, the Company purchased all of the outstanding stock of Security State Bank Shares, a one-bank holding company with three branch offices located in Polson, Montana ("Polson acquisition"). The total cash purchase price paid at closing was $11.9 million. The purchase was funded through available cash on hand and a $2.5 million advance on the Company's revolving term note. At the purchase date, Security State Bank Shares had total loans of approximately $35 million and total deposits of approximately $53 million. Excess purchase price over the fair value of identifiable net assets is being amortized using the straight-line method over a period of 25 years. The intangible value of depositor relationships is being amortized using an accelerated method based on an estimated runoff of the related deposits, not exceeding 10 years. (6) Restatement In 2000, the Company determined that fixed plan accounting treatment historically afforded its Stock Option Plan was not consistent with certain elements of the Stock Option Plan's operations and accounting guidance contained in APB Opinion 25 and related interpretations. Accordingly, the Company has restated the accompanying unaudited 1999 and 1998 consolidated financial statements to reflect variable plan accounting treatment for awards made pursuant to its Stock Option Plan. 9 10 FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES Notes to Unaudited Consolidated Financial Statements (Dollars in thousands, except share and per share data) The following is a summary of the effect of such restatement on the Company's consolidated financial statements:
September 30, 1999 December 31, 1998 ----------------------- ---------------------- Originally Originally Reported Restated Reported Restated ---------- --------- ---------- -------- Consolidated Balance Sheets Deferred tax asset $ 8,297 10,275 5,498 6,657 Other assets 19,995 20,483 18,717 18,719 Total assets 2,642,910 2,645,376 2,478,833 2,479,994 Accounts payable and accrued expenses 9,260 15,093 10,622 13,039 Common stock 10,198 10,072 10,001 10,468 Retained earnings 167,279 164,038 151,362 149,639 ========== ========= ========= =========
For the three months ended --------------------------------------------------- September 30, 1999 September 30, 1998 -------------------- ------------------------ Originally Originally Reported Restated Reported Restated ---------- -------- ---------- --------- Consolidated Statements of Income Salaries, wages and employee benefits $ 11,572 11,910 10,686 11,195 ========= ======= ======= ======= Income before income taxes $ 11,677 11,339 11,133 10,624 Income tax expense 4,209 4,076 4,128 3,928 --------- ------- ------- ------- Net income $ 7,468 7,263 7,005 6,696 ========= ======= ======= ======= Basic earnings per common share $ 0.94 0.91 0.87 0.83 Diluted earnings per common share 0.92 0.90 0.87 0.83 ========= ======= ======= =======
For the nine months ended --------------------------------------------------- September 30, 1999 September 30, 1998 -------------------- ------------------------ Originally Originally Reported Restated Reported Restated ---------- -------- ---------- --------- Consolidated Statements of Income Salaries, wages and employee benefits $ 33,513 36,018 31,824 33,411 ========= ======= ======= ======= Income before income taxes $ 34,745 32,240 30,938 29,351 Income tax expense 12,538 11,552 11,630 11,005 --------- ------- ------- ------- Net income $ 22,207 20,688 19,308 18,346 ========= ======= ======= ======= Basic earnings per common share $ 2.79 2.60 2.41 2.29 Diluted earnings per common share 2.74 2.55 2.39 2.27 ========= ======= ======= =======
10 11 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion focuses on significant factors affecting the financial condition and results of operations of First Interstate BancSystem, Inc. and subsidiaries ("the Company") during the three and nine month periods ended September 30, 1999, with comparisons to 1998 as applicable. All earnings per share figures presented are basic and do not account for the dilutive effect of potential common shares. FORWARD LOOKING STATEMENTS Certain statements contained in this review are "forward looking statements" that involve risk and uncertainties. The Company wishes to caution readers that the following factors, among others, may cause the actual results, performance or achievements of the Company to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include general economic and business conditions in those areas in which the Company operates, credit quality, demographic changes, competition, fluctuations in interest rates, changes in business strategy or development plans and changes in governmental regulations. ASSET LIABILITY MANAGEMENT Interest Rate Sensitivity. The primary objective of the Company's asset liability management process is to optimize net interest income while prudently managing balance sheet risks by understanding the levels of risk accompanying its decisions and monitoring and managing these risks. The ability to optimize net interest margin is largely dependent on the achievement of an interest rate spread that can be managed during fluctuations of interest rates. Interest sensitivity is a measure of the extent to which net interest income will be affected by market interest rates over a period of time. Management monitors the sensitivity of net interest margin by utilizing income simulation models and traditional gap analysis. Liquidity. The objective of liquidity management is to maintain the Company's ability to meet the day-to-day cash flow requirements of its customers who either wish to withdraw funds or require funds to meet their credit needs. The Company manages its liquidity position to meet the needs of its customers, while maintaining an appropriate balance between assets and liabilities to meet the return on investment objectives of its stockholders. The Company monitors the sources and uses of funds on a daily basis to maintain an acceptable liquidity position, principally through deposit receipts and check payments; loan originations, extensions, and repayments; and management of investment securities. Additional sources of liquidity include Federal funds lines, other borrowings and access to the capital markets. First Interstate BancSystem, Inc. (the "Holding Company") is a legal entity separate and distinct from the bank subsidiaries. Statutes, regulations and loan covenants limit the amount of dividends that may be paid to the Holding Company by the subsidiary banks. Additional sources of Holding Company liquidity include borrowing lines and access to capital markets. Capital Adequacy. The objective of capital adequacy is to provide adequate capitalization to assure depositor, investor and regulatory confidence. The intent is to provide sufficient capital funds to support growth and to absorb fluctuations in income so that operations can continue in periods of uncertainty while at the same time ensuring investable funds are available to foster expansion. OVERVIEW The Company reported net income of $7.3 million, or $0.91 per share, during the third quarter of 1999, as compared to $6.7 million, or $0.83 per share, recorded during the same period in 1998. Year-to-date through September 30, 1999, the Company reported net income of $20.7 million, or $2.60 per share, as compared to $18.3 million, or $2.29 per share, for the same period in 1998. Increases in earnings are largely the result of internal growth. EARNING ASSETS Loans. Total loans increased $200 million, or 13.5%, to $1,684 million as of September 30, 1999 from $1,484 million as of December 31, 1998. All major categories of loans increased from December 31, 1998 with the most significant growth occurring in commercial and indirect consumer lending. Management attributes this 11 12 growth, in part, to expansion of its market presence through acquisitions, new branch openings and marketing activities; and, in part, to a renewed focus on opportunities in the indirect consumer lending area. Investment Securities. The Company's investment portfolio is managed to result in the highest yield while meeting the Company's liquidity needs and meeting pledging requirements for public funds deposits and securities sold under repurchase agreements. The portfolio is comprised of U.S. Treasury securities, U.S. government agency securities, tax exempt securities, corporate securities, other mortgage-backed securities and other equity securities. Investment securities decreased $44 million, or 6.5%, to $635 million as of September 30, 1999, from $679 million as of December 31, 1998. Proceeds from maturities, sales and principal payments during the first nine months of 1999 were reinvested or used to fund increases in loans. Interest Bearing Deposits in Banks and Federal Funds Sold. Interest bearing deposits in banks consist of funds on deposit with the Federal Home Loan Bank. These deposits, along with Federal funds sold, are used by the Company's banking subsidiaries to fund the daily liquidity needs of the Company. Interest bearing deposits in banks and Federal funds sold decreased $20 million, in aggregate, to $29 million as of September 30, 1999 from $49 million as of December 31, 1998. Funds temporarily invested in interest bearing deposits in banks and Federal funds sold at December 31, 1998 were invested in higher yielding assets, principally loans. Income from Earning Assets. Interest income increased $5.2 million, or 3.9%, to $138.6 million for the nine months ended September 30, 1999 from $133.4 million for the same period in 1998. Interest income of $48.2 million in the third quarter of 1999 increased $2.3 million, or 5.1%, from the same period in the prior year. These increases are due to greater volumes of interest earning assets generated primarily through internal growth. On a fully-taxable equivalent basis, average earning assets for the nine months ended September 30, 1999 of $2,243 million yielded 8.36% while average earning assets of $2,047 million for the nine months ended September 30, 1998 yielded 8.77%. The decrease in yield is due to decreases in prime rate during the last half of 1998. FUNDING SOURCES The Company utilizes traditional funding sources to support its earning asset portfolio including deposits, borrowings, Federal funds purchased and repurchase agreements. Deposits. Total deposits increased $57 million, or 2.8%, to $2,099 million as of September 30, 1999 from $2,042 million as of December 31, 1998 primarily due to bank acquisitions. Total deposits averaged $2,037 million during the nine month period ended September 30, 1999, a $172 million, or 9.2%, increase from the same period in 1998. Other Funding Sources. Other funding sources include Federal funds purchased for one day periods, other borrowed funds consisting primarily of short-term borrowings from the Federal Home Loan Bank and repurchase agreements with primarily commercial depositors. Other funding sources increased $99 million, or 53.3%, to $284 million as of September 30, 1999 from $185 million as of December 31, 1998. Increases in other funding sources were used to support loan growth. Cost of Other Funding Sources. Interest expense for the three months ended September 30, 1999 of $21.4 million increased $451,000, or 2.2%, from the same period in 1998. Year-to-date interest expense through September 30, 1999 of $61.0 million increased $33,000, or 0.5%, from the same period in 1998. Average interest bearing liabilities and trust preferred securities of $1,928 million during the nine months ended September 30, 1999 increased $177 million, or 10.1%, from $1,751 million for the same period in 1998. The rate on average interest bearing liabilities and trust preferred securities decreased 43 basis points to 4.23% for the nine months ended September 30, 1999 from 4.66% for the same period in 1998 primarily due to decreases in prime rate during the last half of 1998. EQUITY AND ACCRUED EXPENSES During 1998, the Company determined that future grants of stock options would no longer include stock appreciation rights (SARs). Grantees with outstanding SARs were given an election to convert their SARs to stock options with similar terms in a one-for-one exchange. In January 1999, 106,300 SARs were exchanged for stock options. 12 13 NET INTEREST INCOME The most significant impact on the Company's net interest income between periods is derived from the interaction of changes in the volume of and rates earned or paid on interest earning assets and interest bearing liabilities. The volume of loans, investment securities and other earning assets, compared to the volume of interest bearing deposits and indebtedness, combined with the spread, produces the changes in net interest income between periods. Net interest income of $26.8 million during the third quarter of 1999 increased $1.9 million, or 7.5%, from $24.9 million during the same period in the prior year. Year-to-date net interest income of $77.7 million through September 30, 1999 increased $5.3 million, or 7.2%, from $72.4 million for the same period in the prior year. On a fully-taxable equivalent basis, the net interest margin ratio of 4.72% for the nine months ended September 30, 1999 decreased 8 basis points from 4.80% for the same period in the prior year. NON-PERFORMING AND CLASSIFIED ASSETS Non-performing assets include non-performing loans and real property acquired through foreclosure. Non-performing loans include loans on a non-accrual status, loans past due 90 days or more and still accruing interest and loans restructured due to financial difficulties of the borrower. The ratio of non-performing assets to total loans and other real estate owned of 2.06% at September 30, 1999 increased from 1.29% at December 31, 1998. The Company classifies its loans on a regular basis as substandard, doubtful and loss. Substandard loans are inadequately supported by the current financial capacity of the obligor or the collateral pledged. Doubtful loans have the weaknesses of substandard loans with the additional characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. Loans classified as loss are considered uncollectible and of such little value that their continuance as bankable assets is not warranted. The ratio of classified loans to total loans of 3.99% at September 30, 1999 increased from 3.37% at December 31, 1998. Increases in the ratios of non-performing assets to total loans and classified loans to total loans from December 31, 1998 are principally due to the downgrade of one commercial loan. Management does not anticipate a significant direct impact to earnings as a result of this commercial loan downgrade. It is management's opinion that the allowance for loan losses is adequate to absorb any potential loss. PROVISION FOR LOAN LOSS The loan loss provision is dependent on many factors, including loan growth, net charge-offs, changes in the composition of the loan portfolio, delinquencies, management's assessment of the quality of the loan portfolio, the value of the underlying collateral on problem loans and the general economic conditions in the Company's markets. The Company performs a quarterly assessment of risks inherent in its loan portfolio, as well as a detailed review of each asset determined to have identified weaknesses. The allowance for loan losses is maintained at a level that is, in management's judgment, adequate to absorb losses inherent in the loan portfolio. Fluctuations in the provision for loan losses result from management's assessment of the adequacy of the allowance for loan losses. Actual loan losses vary from current provision estimates. The provision for loan losses decreased $170,000, or 15.4%, to $931,000 for the three months ended September 30, 1999 from $1.1 million for the same period in the prior year. During the nine months ended September 30, 1999, the provision for loan losses decreased $691,000, or 21.2%, from the same period in the prior year. OTHER OPERATING INCOME The Company's principal sources of other operating income include service charges on deposit accounts, data processing fee income, income from fiduciary activities, comprised principally of fees earned on trust assets, and other fee income. Other operating income increased $1.1 million, or 15.2%, to $8.7 million for the quarter ended September 30, 1999 from $7.5 million for the same period in 1998. Year-to-date other operating income of $24.2 million through September 30, 1999 increased $1.9 million, or 8.3%, from the same period in 1998. All four principal categories showed increases over the prior year except data processing fees. Significant fluctuations are discussed below: 13 14 Data Processing Fee Income. Data processing fee income of $1.9 million was recorded during the third quarter of 1999, a $177,000, or 10.1%, increase from $1.7 million for the same period in 1998. This increase is primarily due to a greater number of data processing customers using the Company's ATM network and increases in core processing transaction volumes. The Company serviced approximately 1,270 locations in its ATM network at September 30,1999 compared to approximately 820 locations at September 30, 1998. Year-to-date through September 30, 1999, data processing fee income of $5.3 million decreased $249,000, or 4.5%, from $5.6 million for the same period in 1998. This decrease is due to a non-recurring termination fee of $300,000 received during the first quarter of the prior year. Income from Fiduciary Activities. Revenues from fiduciary activities of $1.0 million during the third quarter of 1999 increased $194,000, or 24.0%, from $808,000 for the same period in 1998. Revenues from fiduciary activities increased $370,000, or 12.6%, to $3.3 million for the nine months ended September 30, 1999 from $2.9 million for the same period in 1998. These increases are primarily attributable to increases in the value of assets under trust management combined with growth in customer assets under trust management. Other Service Charges, Commissions and Fees. Other service charges, commissions and fees of $2.0 million for the three months ended September 30, 1999 increased $206,000, or 11.6%, from $1.8 million for the same period in the prior year. For the nine months ended September 30, 1999, other service charges, commission and fees increased $544,000, or 12.5% to $4.9 million from $4.3 million for the same period in the prior year. Increases are primarily due to loan servicing income resulting from strong loan demands combined with the acquisition of mortgage servicing rights in January 1999. Other Real Estate Income/Expense. Net other real estate (OREO) income/expense for the three months ended September 30, 1999 showed a $24,000 net expense compared to $58,000 net income for the same period in the prior year. For the nine month period ended September 30, 1999, net OREO income/expense showed net income of $359,000, a $130,000 increase compared to $229,000 during the same period in 1998. Variations in net OREO income/expense result principally from fluctuations in gains and losses on sales. Net OREO income/expense is directly related to prevailing economic conditions, and such income could decrease significantly should an unfavorable shift occur in the economic conditions of the Company's markets. Other Income. Other income, which primarily includes brokerage service fees, check printing income and other miscellaneous income, increased $350,000, or 75.1%, to $816,000 for the quarter ended September 30, 1999 from $466,000 for the same period in the prior year. Year-to-date through September 30, 1999, other income increased $430,000, or 29.4%, to $1.9 million from $1.5 million for the same period in the prior year. The increases are primarily due to growth in brokerage service fee income and a $94,000 distribution of policyholders' membership interests in the demutualization of an insurance company recorded during the third quarter of 1999. OTHER OPERATING EXPENSE Other operating expenses increased $2.4 million, or 11.5%, to $23.2 million for the quarter ended September 30, 1999 from $20.8 million for the same period in 1998. Year-to-date other operating expenses through September 30, 1999 of $67.1 million increased $4.9 million, or 7.9%, from $62.2 million for the same period in 1998. Significant components of the increased are discussed below: Salaries, Wages and Employee Benefits Expense. Salaries, wages and employee benefits expense of $11.9 million during the third quarter of 1999, increased $715,000, or 6.3%, from $11.2 million during the third quarter of 1998. Year-to-date salaries and wages expense increased $2.6 million, or 7.8%, to $36.0 million for the nine months ended September 30, 1999 as compared to $33.4 million for the same period in the prior year. Increases of approximately $918,000 are attributable to the remeasurement of compensation expense related to outstanding stock options. The remaining increase is primarily attributable to inflationary wage increases and the additional staffing requirements of eight new branch banks opened or acquired since September 1998. 14 15 Occupancy Expense. Occupancy expense of $1.8 million for the third quarter of 1999 increased $102,000, or 5.9%, from $1.7 million for the same period in 1998. Occupancy expense for the nine months ended September 30, 1999 increased $394,000, or 8.1%, to $5.2 million from $4.9 million for the same period in the prior year. These increases are primarily due to additional depreciation and rent expenses associated with the addition of new facilities and the remodeling of existing facilities. Furniture and Equipment. Furniture and equipment expenses for the third quarter of 1999 increased $697,000, or 34.9% to $2.7 million from $2.0 million for the same period in 1998. Furniture and equipment expense increased $1.2 million, or 18.9%, to $7.3 million for the nine months ended September 30, 1999 from $6.2 million for the same period in 1998. The increases are due in part to a change in the estimated useful life of a mainframe computer resulting in additional depreciation expense of $494,000, $300,000 of which was recorded during the third quarter of 1999. The remaining increase is attributable to the eight branches opened or acquired since September 30, 1998 and the Company's continuing investment in technology. Goodwill and Core Deposit Intangibles Amortization Expense. Goodwill and core deposit intangibles amortization expense for the three and nine month periods ended September 30, 1999 increased 17.1% and 6.1%, respectively. The increase is due to amortization of goodwill and core deposit intangibles associated with the bank acquisitions. Other Expenses. Other expenses primarily include advertising and public relations costs, legal and other professional fees, and office supply, postage and telephone expenses. Other expenses of $6.0 million during the third quarter of 1999 increased $839,000, or 16.4%, from $5.1 million for the same period in 1998. During the nine month period ended September 30, 1999, other expenses increased $589,000, or 3.7%, to $16.4 million from $15.8 million for the same period in 1998. These increases are due, in large part, to amortization of mortgage servicing rights purchased in January 1999 and to the direct and indirect expenses associated with the eight new branches opened or acquired since September 30, 1998. YEAR 2000 During 1997 the Company established a Year 2000 Taskforce charged with the responsibility of ensuring all internal and external information and non-information technology systems critical to business functions are Year 2000 compliant. The taskforce developed a five phase "key step plan". Each phase is identified and described below: o Education - during this phase Year 2000 issues relating to the Company are identified, resources are committed and an overall strategy is developed. o Assessment - during the assessment phase three areas of concern are identified: internal computing systems and programs consisting of hardware, software, networks, processing platforms and computer programs; environmental and non-information technology systems including security systems, heating, ventilation and air conditioning systems, elevators, and vault systems; and, external vendors and suppliers including entities providing the Company with hardware, software, and office equipment. o Renovation - code enhancements, hardware and software upgrades, system replacements, vendor certifications are completed during the renovation phase. o Validation - in this phase, systems will be tested to ensure they will function properly in the Year 2000. Any errors noted during the validation phase will be corrected and the systems will be retested. This phase will continue until all systems are compliant. o Special Support - the Company will provide staffing support to monitor all systems as the new century approaches and develop contingency plans in the event a system fails. Currently, the Company has completed the education, assessment and renovation phases of the key step plan and the validation phase is substantially complete for all critical and secondary business systems. Validation will continue through 1999 as new software releases and hardware upgrades are received and implemented. To date, the validation phase has not revealed any material Year 2000 issues in any of the Company's internal systems or programs. The Company's internal audit department has been reviewing validation results. 15 16 The Company completed development of a Business Resumption Contingency Plan ("Plan") during the third quarter of 1999. The Plan addresses mitigation of risks associated with system failures at critical dates including staffing issues security concerns, customer communication, utility failures, hot-site identification and backup system identification. Management currently estimates total costs of the Company's Year 2000 compliance to be less than $300,000, of which $240,000 has already been incurred. Of the 39 critical business systems identified, only one system is an internally developed system. The cost of renovation of external systems is generally included in the annual maintenance fees paid to suppliers and has not been included in the cost estimates presented. All Year 2000 costs are expensed as incurred. There are many risks associated with the Year 2000 issue, including the possibility of a failure of third parties to remediate their own Year 2000 issues. The failure of third parties with which the Company has financial or operational relationships such as clearing organizations, regulatory agencies, business customers, suppliers and utilities, to remediate their technology systems in a timely manner could result in a material financial risk to the Company. While the Company exercises no control over such third parties, the Company's Year 2000 project plan includes a survey assessment of critical third parties response and remediation plans and their potential impact to the Company. The Company's expectations about future costs and the timely completion of its Year 2000 modifications are subject to uncertainties that could cause actual results to differ materially from what has been discussed above. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK As of September 30, 1999, there have been no material changes in the quantitative and qualitative information about market risk provided pursuant to Item 305 of Regulation S-K as presented in the Company's December 31, 1998 Form 10-K. 16 17 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS None. ITEM 2. CHANGES IN SECURITIES None. ITEM 3. DEFAULTS UPON SENIOR INDEBTEDNESS None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None ITEM 5. OTHER INFORMATION Not applicable or required. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 27. Financial Data Schedule. (b) No reports were filed on Form 8-K during the quarter ended September 30, 1999. 17 18 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized: FIRST INTERSTATE BANCSYSTEM, INC. Date May 15, 2001 /s/ THOMAS W. SCOTT ------------------------ ----------------------------------------- Thomas W. Scott Chief Executive Officer Date May 15, 2001 /s/ TERRILL R. MOORE ------------------------ ----------------------------------------- Terrill R. Moore Senior Vice President and Chief Financial Officer 18