10-Q/A 1 c62906ae10-qa.txt AMENDMENT TO QUARTERLY REPORT 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 June 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 7,944,558 shares of common stock outstanding on June 30, 1999. ================================================================================ 2 FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES QUARTERLY REPORT ON FORM 10-Q
Index Page ----- ---- PART I. FINANCIAL INFORMATION Restatement Explanatory Note 3 Item 1 - Financial Statements Consolidated Balance Sheets June 30, 1999 (unaudited) and December 31, 1998 4 Consolidated Statements of Income Three and six months ended June 30, 1999 and 1998 (unaudited) 5 Consolidated Statements of Comprehensive Income Three and six months ended June 30, 1999 and 1998 (unaudited) 6 Consolidated Statements of Cash Flows Six months ended June 30, 1999 and 1998 (unaudited) 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 June 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 to 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) (Unaudited)
June 30, December 31, Assets 1999 1998 ------ ---------- ------------ (Restated) (Restated) Cash and due from banks $ 138,403 154,527 Federal funds sold 23,580 31,930 Interest bearing deposits in banks 10,165 17,562 Investment securities: Available-for-sale 379,414 379,393 Held-to-maturity 262,205 299,285 ------------- ------------ 641,619 678,678 Loans 1,593,710 1,484,459 Less allowance for loan losses 29,509 28,803 ------------- ------------ Net loans 1,564,201 1,455,656 Premises and equipment, net 65,251 63,382 Accrued interest receivable 23,004 22,433 Goodwill, net of accumulated amortization of $12,137 at June 30, 1999 (unaudited) and $10,950 at December 31, 1998 28,387 29,337 Other real estate owned, net 544 1,113 Deferred tax asset 10,350 6,657 Other assets 21,193 18,719 ------------- ------------ Total assets $ 2,526,697 2,479,994 ============= ============ Liabilities and Stockholders' Equity ------------------------------------ Deposits: Noninterest bearing $ 380,534 390,998 Interest bearing 1,631,648 1,650,934 ------------- ------------ Total deposits 2,012,182 2,041,932 Federal funds purchased 43,380 1,675 Securities sold under repurchase agreements 155,475 173,593 Accrued interest payable 10,213 13,364 Accounts payable and accrued expenses 14,163 13,039 Other borrowed funds 66,751 9,828 Long-term debt 20,277 24,288 ------------- ------------ Total liabilities 2,322,441 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 7,944,558 shares as of June 30, 1999 (unaudited) and 7,988,573 shares as of December 31, 1998 8,874 10,468 Retained earnings 158,998 149,639 Accumulated other comprehensive income(loss) (3,616) 2,168 ------------- ------------ Total stockholders' equity 164,256 162,275 ------------- ------------ Total liabilities and stockholders' equity $ 2,526,697 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) (Unaudited)
For the three months For the six months ended June 30, ended June 30, --------------------- -------------------- 1999 1998 1999 1998 (Restated) (Restated) (Restated) (Restated) ---------- ---------- ---------- ---------- Interest income: Interest and fees on loans $ 36,160 36,107 70,783 71,297 Interest and dividends on investment securities: Taxable 8,635 6,971 17,406 13,294 Exempt from Federal taxes 823 458 1,618 784 Interest on deposit with banks 124 123 182 318 Interest on Federal funds sold 137 832 429 1,798 -------- -------- -------- -------- Total interest income 45,879 44,491 90,418 87,491 -------- -------- -------- -------- Interest expense: Interest on deposits 16,305 16,910 32,884 33,147 Interest on Federal funds purchased 590 6 606 44 Interest on securities sold under repurchase agreements 1,485 1,748 2,953 3,522 Interest on other borrowed funds 284 114 367 222 Interest on long-term debt 494 622 996 1,283 Interest on mandatorily redeemable securities of subsidiary trust 882 882 1,764 1,770 -------- -------- -------- -------- Total interest expense 20,040 20,282 39,570 39,988 -------- -------- -------- -------- Net interest income 25,839 24,209 50,848 47,503 Provision for loan losses 786 1,028 1,572 2,093 -------- -------- -------- -------- Net interest income after provision for loan losses 25,053 23,181 49,276 45,410 Other operating income: Income from fiduciary activities 1,125 1,027 2,304 2,128 Service charges on deposit accounts 2,882 2,607 5,444 5,097 Data processing 1,696 1,753 3,405 3,831 Other service charges, commissions, and fees 1,368 1,234 2,752 2,477 Net investment securities gains (losses) -- (33) 1 9 Other real estate income (expense), net 3 (14) 383 171 Other income 645 624 1,075 995 -------- -------- -------- -------- Total other operating income 7,719 7,198 15,364 14,708 -------- -------- -------- -------- Other operating expenses: Salaries and wages 9,014 8,141 17,975 15,938 Employee benefits 2,759 2,839 6,133 6,278 Occupancy expense, net 1,674 1,569 3,412 3,238 Furniture and equipment expense 2,391 2,070 4,652 4,064 FDIC insurance 58 54 116 108 Goodwill amortization 595 579 1,187 1,273 Other expenses 5,208 5,556 10,264 10,492 -------- -------- -------- -------- Total other operating expenses 21,699 20,808 43,739 41,391 -------- -------- -------- -------- Income before income taxes 11,073 9,571 20,901 18,727 Income tax expense 3,984 3,611 7,476 7,077 -------- -------- -------- -------- Net income $ 7,089 5,960 13,425 11,650 ======== ======== ======== ======== Basic earnings per common share $ 0.89 0.74 1.69 1.45 Diluted earning per common share $ 0.87 0.74 1.66 1.44 Dividends per common share $ 0.27 0.23 0.51 0.45
See accompanying notes to unaudited consolidated financial statements. 5 6 FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES Consolidated Statements of Comprehensive Income (Dollars in thousands) (Unaudited)
For the three months For the six months ended June 30, ended June 30, -------------------- --------------------- 1999 1998 1999 1998 (Restated) (Restated) (Restated) (Restated) ---------- ---------- ---------- ---------- Net income $ 7,089 5,960 13,425 11,650 Other comprehensive income (loss): Unrealized gains (losses) on investment securities: Realized and unrealized holding gains (losses) arising during period (6,461) 147 (9,481) (4) Add: reclassification adjustment for (gains) losses included in net income (1) 33 (1) (9) ------- ------- ------ ------- Other comprehensive income (loss), before tax (6,462) 180 (9,482) (13) Income tax benefit (expense) related to items of other comprehensive income 2,520 (70) 3,698 5 ------- ------- ------ ------- Other comprehensive income (loss), after tax (3,942) 110 (5,784) (8) ------- ------- ------ ------- Comprehensive income $ 3,147 6,070 7,641 11,642 ======= ======= ====== =======
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) (Unaudited)
For the six months ended June 30, -------------------------- 1999 1998 (Restated) (Restated) ---------- ---------- Cash flows from operating activities: Net income $ 13,425 11,650 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan loss 1,572 2,093 Depreciation and amortization 4,901 4,622 Net premium amortization on investment securities 147 208 Gain on sales of investments (1) (9) Gain on sales of other real estate owned (415) (240) Loss (gain) on sales of property and equipment (20) 127 Provision for deferred income taxes (180) (2,547) Increase in interest receivable (566) (1,859) Increase in other assets (2,479) (1,224) Increase (decrease) in accrued interest payable (3,122) 267 Increase in accounts payable and accrued expenses 1,339 2,701 ---------- ---------- Net cash provided by operating activities 14,601 15,789 ---------- ---------- Cash flows from investing activities: Purchases of investment securities: Held-to-maturity (49,859) (42,894) Available-for-sale (38,117) (168,663) Proceeds from maturities and paydowns of investment securities: Held-to-maturity 86,898 52,960 Available-for-sale 28,694 35,449 Proceeds from sales of available-for-sale investment securities -- 28,191 Extensions of credit to customers, net of repayments (110,590) (17,837) Recoveries of loans charged-off 1,238 1,240 Proceeds from sales of other real estate 1,258 731 Acquisition of branch banks (5,833) -- Capital distributions from joint venture 125 200 Capital expenditures, net (5,332) (3,297) ---------- ---------- Net cash used in investing activities (91,518) (113,920) ---------- ---------- Cash flows from financing activities: Net increase (decrease) in deposits (25,626) 89,559 Net increase (decrease) in Federal funds and repurchase agreements 23,587 (16,780) Net increase in other borrowed funds 56,923 311 Proceeds from long-term borrowings -- 1,428 Repayment of long-term borrowings (4,011) (8,373) Net decrease in debt issuance costs 48 21 Proceeds from issuance of common stock 213 40 Payments to retire common stock (2,022) (687) Dividends paid on common stock (4,066) (3,609) ---------- ---------- Net cash provided by financing activities 45,046 61,910 ---------- ---------- Net decrease in cash and cash equivalents (31,871) (36,221) Cash and cash equivalents at beginning of period 204,019 229,147 ---------- ---------- Cash and cash equivalents at end of period $ 172,148 192,926 ========== ========== Supplemental disclosure of cash flow information: Cash paid during period for taxes $ 8,012 8,770 Cash paid during period for interest 42,901 39,721 ========== ==========
Noncash Investing and Financing Activities: The Company transferred loans of $274 and $458 to other real estate owned during the six months ended June 30, 1999 and 1998, respectively. In conjunction with the exercise of stock options, the Company transferred $215 and $51 from accrued liabilities to common stock during the six month periods ended June 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, restated consolidated financial statements contain all adjustments (all of which are of a normal recurring nature) necessary to present fairly the consolidated financial position at June 30, 1999 and December 31, 1998, and the results of operations and cash flows for each of the periods ended June 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 June 30, 1999 presentation. For additional information regarding the restatement, see Note 5. 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 June 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 six month periods ended June 30, 1999 and 1998.
Three months ended Six months ended -------------------- -------------------- 6/30/99 6/30/98 6/30/99 6/30/98 ------- ------- ------- ------- Weighted average common shares 7,953,548 8,014,509 7,968,030 8,019,154 Weighted average potential common shares 149,797 69,191 142,571 59,021
(3) Cash Dividends On July 14, 1999, the Company declared and paid a cash dividend on second 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 July 1999 dividend represents 30% of the Company's net income for the quarter ended June 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 $1.6 million as of June 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 $9.7 million as of June 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) 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. The following is a summary of the effect of such restatement on the Company's consolidated financial statements:
June 30, 1999 December 31, 1998 --------------------- --------------------- Originally Originally Reported Restated Reported Restated ---------- -------- ---------- -------- Consolidated Balance Sheets Deferred tax asset $ 8,444 10,350 5,498 6,657 Other assets 20,631 21,193 18,717 18,719 Total assets 2,524,229 2,526,697 2,478,833 2,479,994 Accounts payable and accrued expenses 8,272 14,163 10,622 13,039 Common stock 9,260 8,874 10,001 10,468 Retained earnings 162,035 158,998 151,362 149,639 =========== ========= ========= =========
9 10 FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES Notes to Unaudited Consolidated Financial Statements (Dollars in thousands, except share and per share data)
For the three months ended ------------------------------------------------------- June 30, 1999 June 30, 1998 ------------------------- -------------------------- Originally Originally Reported Restated Reported Restated ------------ ----------- ----------- ----------- Consolidated Statements of Income Employee benefits $ 2,037 2,759 2,393 2,839 =========== =========== =========== =========== Income before income taxes $ 11,795 11,073 10,017 9,571 Income tax expense 4,269 3,984 3,787 3,611 ----------- ----------- ----------- ----------- Net income $ 7,526 7,089 6,230 5,960 =========== =========== =========== =========== Basic earnings per common share $ 0.95 0.89 0.78 0.74 Diluted earnings per common share 0.93 0.87 0.77 0.74 =========== =========== =========== ===========
For the six months ended ------------------------------------------------------- June 30, 1999 June 30, 1998 ------------------------- -------------------------- Originally Originally Reported Restated Reported Restated ------------ ----------- ----------- ----------- Consolidated Statements of Income Employee benefits $ 3,966 6,133 5,200 6,278 =========== =========== =========== =========== Income before income taxes $ 23,068 20,901 19,805 18,727 Income tax expense 8,329 7,476 7,502 7,077 ----------- ----------- ----------- ----------- Net income $ 14,739 13,425 12,303 11,650 =========== =========== =========== =========== Basic earnings per common share $ 1.85 1.69 1.53 1.45 Diluted earnings per common share 1.82 1.66 1.52 1.44 =========== =========== =========== ===========
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 six month periods ended June 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. 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 $7.1 million, or $0.89 per share, during the second quarter of 1999, as compared to $6.0 million, or $0.74 per share, recorded during the same period in 1998. Year-to-date through June 30, 1999, the Company reported net income of $13.4 million, or $1.69 per share, as compared to $11.7 million, or $1.45 per share, for the same period in 1998. Increases in earnings are largely the result of net interest income generated through internal loan and deposit growth. EARNING ASSETS Loans. Total loans increased $110 million, or 7.4%, to $1,594 million as of June 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 growth, in part, to expansion of its market presence through new branch openings and marketing activities; and, in part, to a renewed focus on opportunities in the indirect consumer lending area. 11 12 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 $37 million, or 5.5%, to $642 million as of June 30, 1999, from $679 million as of December 31, 1998. Proceeds from maturities, sales and principal payments during the first six months of 1999 were 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 $15 million, in aggregate, to $34 million as of June 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 $2.9 million, or 3.3%, to $90.4 million for the six months ended June 30, 1999 from $87.5 million for the same period in 1998. Interest income of $45.9 million in the second quarter of 1999 increased $1.4 million, or 3.1%, from the same period in the prior year. These increases are due to greater volumes of interest earning assets generated through internal growth. On a fully-taxable equivalent basis, average earning assets for the six months ended June 30, 1999 of $2,196 million yielded 8.39% while average earning assets of $2,015 million for the six months ended June 30, 1998 yielded 8.81%. This decrease in yield is due to shifts in the mix of earning assets from higher yielding loans to investment securities which produce a lower yield as well as overall rate reductions resulting from 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 decreased $30 million, or 1.5%, to $2,012 million as of June 30, 1999 from $2,042 million as of December 31, 1998. This decrease in deposits is a typical seasonal decrease that historically occurs during the first half of the year. Long-Term Debt. Long-term debt decreased $4.0 million, or 16.5%, to $20 million as of June 30, 1999 from $24 million as of December 31, 1998 due primarily to the prepayment of two Federal Home Loan Bank notes scheduled to mature in 2006 and 2016. 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 $81 million, or 43.5%, to $266 million as of June 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 June 30, 1999 of $20.0 million decreased $242,000, or 1.2%, from the same period in 1998. Year-to-date interest expense through June 30, 1999 of $39.6 million decreased $418,000, or 1.0%, from the same period in 1998. Average interest bearing liabilities and trust preferred securities of $1,890 million increased $161.9 million, or 9.4%, from $1,728 million for the same period in 1998. The rate on average interest bearing liabilities and trust preferred securities decreased 45 basis points to 4.22% for the six months ended June 30, 1999 from 4.67% for the same period in 1998. EQUITY 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 $25.8 million during the second quarter of 1999 increased $1.6 million, or 6.7%, from $24.2 million during the same period in the prior year. Year-to-date net interest income of $50.8 million through June 30, 1999 increased $3.3 million, or 7.0%, from $47.5 million for the same period in the prior year. On a fully-taxable equivalent basis, the net interest margin ratio of 4.76% for the six months ended June 30, 1999 decreased 5 basis points from 4.81% 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 1.24% at June 30, 1999 declined 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 protected by the current sound worth and paying 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 3.05% at June 30, 1999 declined from 3.37% at December 31, 1998. Subsequent to June 30, 1999, the Company downgraded one commercial loan causing the ratio of non-performing assets to total loans and other real estate owned to increase to 1.89% and the ratio of classified loans to total loans to increase to 3.70%. 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 loss 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 may vary from current provision estimates. The provision for loan losses decreased $242,000, or 23.5%, to $786,000 for the three months ended June 30, 1999 from $1 million for the same period in the prior year. During the six months ended June 30, 1999, the provision for loan losses decreased $521,000, or 24.9%, 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 fees, income from fiduciary activities, comprised principally of fees earned on trust assets, and other fee income. Other operating income increased $521,000, or 7.2%, to $7.7 million for the quarter ended June 30, 1999 from $7.2 million for the same period in 1998. Year-to-date other operating income of $15.4 million through June 30, 1999 increased $656,000, or 4.5%, 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 Fees. Data processing fees of $1.7 million for the three months ended June 30, 1999 decreased $57,000, or 3.3%, from the same period in the prior year. For the six month period ended June 30, 1999, data processing fees of $3.4 million decreased $426,000, or 11.1%, from $3.8 million for the same period in the prior year. These decreases are primarily 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 increased 9.5% and 8.3% for the three and six month periods ended June 30, 1999 from the same periods in the prior year due to increases in the value of assets under trust management. Other Service Charges, Commissions and Fees. Other service charges, commissions and fees of $1.4 million for the three months ended June 30, 1999 increased $134,000, or 10.9%, from the same period in the prior year. For the six months ended June 30, 1999, other service charges, commission and fees increased $275,000, or 11.1% to $2.8 million from $2.5 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. Net other real estate (OREO) income increased $212,000 to $383,000 for the six months ended June 30, 1999 as compared to $171,000 during the same period in 1998. Variations in net OREO income during the periods resulted principally from fluctuations in gains and losses on sales of OREO. Net OREO income 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 OPERATING EXPENSE Other operating expenses increased $891,000, or 4.3%, to $21.7 million for the quarter ended June 30, 1999 from $20.8 million for the same period in 1998. Year-to-date other operating expenses through June 30, 1999 of $43.7 million increased $2.3 million, or 5.6%, from the same period in 1998. Significant components of the increased are discussed below: Salaries and Wages Expense. Salaries and wages expense of $9.0 million during the second quarter of 1999, increased $873,000, or 10.7%, from the second quarter of 1998. Year-to-date salaries and wages expense increased $2.1 million, or 12.8%, to $18.0 million for the six months ended June 30, 1999 as compared to $15.9 million for the same period in the prior year. Increases are primarily attributable to inflationary wage increases and the additional staffing requirements of new branch banks opened or acquired since June 1998. Furniture and Equipment. Furniture and equipment expenses for the second quarter of 1999 increased $321,000, or 15.5% to $2.4 million from $2.1 million for the same period in 1998. Furniture and equipment expense increased $588,000, or 14.5%, to $4.7 million for the six months ended June 30, 1999 from $4.1 million for the same period in 1998. The increases are due to new branch additions since June 30, 1998 and continued investment in technology. 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. 14 15 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 business systems. Validation will continue through 1999 as new software releases and hardware upgrades are received and implemented. Validation of all secondary systems is expected to be completed by September 30, 1999. 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. The Company completed development of a Business Resumption Contingency Plan ("Plan") during the second 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 $200,000 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 system 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. 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. 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, respectively. 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. 15 16 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK As of June 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 The following matter was submitted to a vote of security holders at the Annual Meeting of Shareholders of First Interstate BancSystem, Inc. on May 20, 1999:
Matter For Against Not Voted ------------------------- --------- ------- --------- Election of all directors 7,818,208 1,152 136,692
ITEM 5. OTHER INFORMATION Not applicable or required. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 27. Financial Data Schedule. (b) No reports were filed on Form 8-K during the quarter ended June 30, 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 16, 2001 /s/ Thomas W. Scott ------------------------ ----------------------------------------- Thomas W. Scott Chief Executive Officer Date May 16, 2001 /s/ Terrill R. Moore ------------------------ ----------------------------------------- Terrill R. Moore Senior Vice President and Chief Financial Officer 18