FIRST INTERSTATE BANCSYSTEM INC - FORM 10-Q - August 5, 2015

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
________________________________________________________________________________________________________ 
FORM 10-Q
________________________________________________________________________________________________________ 
ý
Quarterly report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended June 30, 2015
OR
 
¨
Transition report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from                   to                   
COMMISSION FILE NUMBER 001-34653
________________________________________________________________________________________________________ 
First Interstate BancSystem, Inc.
(Exact name of registrant as specified in its charter)
________________________________________________________________________________________________________ 
Montana
 
81-0331430
(State or other jurisdiction of
incorporation or organization)
 
(IRS Employer
Identification No.)
 
 
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  ý    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files.)     Yes  ý    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
¨
  
Accelerated filer
ý
 
 
 
 
Non-accelerated filer
¨
  
Smaller reporting company
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  ¨ No  ý
Indicate the number of shares outstanding of each of the Registrant’s classes of common stock:
 
June 30, 2015 – Class A common stock
 
21,720,287

 
 
June 30, 2015 – Class B common stock
 
23,786,296

 
 



FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
Quarterly Report on Form 10-Q
Index
 
 
Page
Part I.
Financial Information
 
 
 
 
Item 1.
Financial Statements (unaudited)
 
 
 
 
 
Consolidated Balance Sheets - June 30, 2015 and December 31, 2014
3

 
 
 
 
Consolidated Statements of Income - Three and Six Months Ended June 30, 2015 and 2014
4

 
 
 
 
Consolidated Statements of Comprehensive Income - Three and Six Months Ended June 30, 2015 and 2014
5

 
 
 
 
Consolidated Statements of Changes in Stockholders’ Equity - Six Months Ended June 30, 2015 and 2014
6

 
 
 
 
Consolidated Statements of Cash Flows - Six Months Ended June 30, 2015 and 2014
7

 
 
 
 
9

 
 
 
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
35

 
 
 
Item 3.
51

 
 
 
Item 4.
51

 
 
Part II.
 
 
 
 
Item 1.
51

 
 
 
Item 1A .
51

 
 
 
Item  2.
51

 
 
 
Item 3.
52

 
 
 
Item 4.
Mine Safety Disclosures
52

 
 
 
Item 5.
52

 
 
 
Item 6.
52

 
 
54








2

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
(Unaudited)

 
June 30,
2015
 
December 31,
2014
Assets
 
 
 
Cash and due from banks
$
163,057

 
$
147,894

Federal funds sold
2,763

 
543

Interest bearing deposits in banks
340,614

 
650,233

Total cash and cash equivalents
506,434

 
798,670

Investment securities:
 
 
 
Available-for-sale
1,592,743

 
1,711,924

Held-to-maturity (estimated fair values of $553,323 and $584,533 at June 30, 2015 and December 31, 2014, respectively)
546,690

 
575,186

Total investment securities
2,139,433

 
2,287,110

Loans held for investment
5,028,624

 
4,856,615

Mortgage loans held for sale
75,322

 
40,828

Total loans
5,103,946

 
4,897,443

Less allowance for loan losses
76,552

 
74,200

Net loans
5,027,394

 
4,823,243

Goodwill
204,375

 
205,574

Premises and equipment, net of accumulated depreciation
189,488

 
195,212

Company-owned life insurance
177,625

 
153,821

Other real estate owned (“OREO”)
11,773

 
13,554

Accrued interest receivable
29,008

 
27,063

Core deposit intangibles, net of accumulated amortization
11,573

 
13,282

Mortgage servicing rights, net of accumulated amortization and impairment reserve
14,654

 
14,038

Deferred tax asset, net
—

 
4,874

Other assets
74,461

 
73,495

Total assets
$
8,386,218

 
$
8,609,936

Liabilities and Stockholders’ Equity
 
 
 
Deposits:
 
 
 
Non-interest bearing
$
1,757,641

 
$
1,791,364

Interest bearing
5,046,760

 
5,214,848

Total deposits
6,804,401

 
7,006,212

Securities sold under repurchase agreements
469,145

 
502,250

Accounts payable and accrued expenses
53,879

 
66,164

Accrued interest payable
5,366

 
5,833

Deferred tax liability
3,024

 
—

Long-term debt
43,068

 
38,067

Other borrowed funds
3

 
9

Subordinated debentures held by subsidiary trusts
82,477

 
82,477

Total liabilities
7,461,363

 
7,701,012

Stockholders’ equity:
 
 
 
Nonvoting noncumulative preferred stock without par value; authorized 100,000 shares; no shares issued and outstanding as of June 30, 2015 or December 31, 2014
—

 
—

Common stock
313,125

 
323,596

Retained earnings
612,875

 
587,862

Accumulated other comprehensive loss, net
(1,145
)
 
(2,534
)
Total stockholders’ equity
924,855

 
908,924

Total liabilities and stockholders’ equity
$
8,386,218

 
$
8,609,936

See accompanying notes to unaudited consolidated financial statements.

3

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
(Unaudited)
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
Interest income:
 
 
 
 
 
 
 
Interest and fees on loans
$
60,402

 
$
55,565

 
$
119,773

 
$
109,283

Interest and dividends on investment securities:
 
 
 
 
 
 
 
Taxable
8,000

 
7,309

 
15,971

 
14,949

Exempt from federal taxes
1,040

 
1,083

 
2,099

 
2,180

Interest on deposits in banks
271

 
225

 
660

 
456

Interest on federal funds sold
5

 
3

 
7

 
4

Total interest income
69,718

 
64,185

 
138,510

 
126,872

Interest expense:
 
 
 
 
 
 
 
Interest on deposits
3,239

 
3,327

 
6,548

 
6,751

Interest on securities sold under repurchase agreements
53

 
63

 
107

 
129

Interest on long-term debt
538

 
476

 
1,052

 
949

Interest on subordinated debentures held by subsidiary trusts
600

 
592

 
1,190

 
1,180

Total interest expense
4,430

 
4,458

 
8,897

 
9,009

Net interest income
65,288

 
59,727

 
129,613

 
117,863

Provision for loan losses
1,340

 
(2,001
)
 
2,435

 
(7,001
)
Net interest income after provision for loan losses
63,948

 
61,728

 
127,178

 
124,864

Non-interest income:
 
 
 
 
 
 
 
Other service charges, commissions and fees
11,173

 
9,699

 
21,040

 
18,855

Income from the origination and sale of loans
8,802

 
6,380

 
14,708

 
11,040

Wealth management revenues
4,897

 
4,609

 
9,834

 
9,064

Service charges on deposit accounts
4,053

 
3,929

 
7,997

 
7,804

Investment securities gains, net
46

 
17

 
52

 
88

Other income
2,799

 
1,937

 
5,921

 
3,826

Total non-interest income
31,770

 
26,571

 
59,552

 
50,677

Non-interest expense:
 
 
 
 
 
 
 
Salaries and wages
26,093

 
24,440

 
51,442

 
46,882

Employee benefits
8,070

 
7,164

 
15,850

 
15,477

Occupancy, net
4,529

 
4,253

 
9,021

 
8,492

Furniture and equipment
3,703

 
3,157

 
7,496

 
6,358

Outsourced technology services
2,593

 
2,309

 
5,056

 
4,609

OREO expense, net of income
(823
)
 
(134
)
 
(884
)
 
(153
)
Professional fees
1,514

 
1,278

 
2,815

 
2,648

FDIC insurance premiums
1,304

 
1,093

 
2,446

 
2,209

Mortgage servicing rights amortization
627

 
583

 
1,246

 
1,183

Mortgage servicing rights impairment recovery
(56
)
 
(11
)
 
(71
)
 
(56
)
Core deposit intangibles amortization
854

 
354

 
1,709

 
708

Other expenses
13,577

 
10,837

 
25,381

 
21,304

Acquisition expenses
(7
)
 
597

 
63

 
597

Total non-interest expense
61,978

 
55,920

 
121,570

 
110,258

Income before income tax expense
33,740

 
32,379

 
65,160

 
65,283

Income tax expense
11,518

 
11,302

 
21,958

 
22,813

Net income
$
22,222

 
$
21,077

 
$
43,202

 
$
42,470

 
 
 
 
 
 
 
 
Basic earnings per common share
$
0.49

 
$
0.48

 
$
0.95

 
$
0.96

Diluted earnings per common share
$
0.49

 
$
0.47

 
$
0.94

 
$
0.95

See accompanying notes to unaudited consolidated financial statements.

4

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
(Unaudited)

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2015
2014
 
2015
2014
Net income
$
22,222

$
21,077

 
$
43,202

$
42,470

Other comprehensive income, before tax:
 
 
 
 
 
Investment securities available-for sale:
 
 
 
 
 
Change in net unrealized gains (losses) during period
(9,196
)
2,816

 
1,412

17,167

Reclassification adjustment for net gains included in income
(46
)
(17
)
 
(52
)
(88
)
Change in unamortized loss on available-for-sale securities transferred into held-to-maturity
451

—

 
902

—

Defined benefit post-retirement benefits plans:
 
 
 
 
 
Change in net actuarial loss
13

35

 
28

70

Other comprehensive income (loss), before tax
(8,778
)
2,834

 
2,290

17,149

Deferred tax benefit (expense) related to other comprehensive income
3,454

(1,115
)
 
(901
)
(6,748
)
Other comprehensive income (loss), net of tax
(5,324
)
1,719

 
1,389

10,401

Comprehensive income, net of tax
$
16,898

$
22,796

 
$
44,591

$
52,871

See accompanying notes to unaudited consolidated financial statements.


5

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(In thousands, except share and per share data)
(Unaudited)

 
Common
stock
 
Retained
earnings
 
Accumulated
other
comprehensive
income (loss)
 
Total
stockholders’
equity
Balance at December 31, 2014
$
323,596

 
$
587,862

 
$
(2,534
)
 
$
908,924

Net income
—

 
43,202

 
—

 
43,202

Other comprehensive income, net of tax expense
—

 
—

 
1,389

 
1,389

Common stock transactions:
 
 
 
 
 
 
 
588,409 common shares purchased and retired
(15,264
)
 
—

 
—

 
(15,264
)
21,414 common shares issued
—

 
—

 
—

 
—

156,956 non-vested common shares issued
—

 
—

 
—

 
—

1,678 non-vested common shares forfeited
—

 
—

 
—

 
—

129,885 stock options exercised, net of 37,357 shares tendered in payment of option price and income tax withholding amounts
1,670

 
—

 
—

 
1,670

Tax benefit of stock-based compensation
804

 
—

 
—

 
804

Stock-based compensation expense
2,319

 
—

 
—

 
2,319

Common cash dividend declared ($0.40 per share)
—

 
(18,189
)
 
—

 
(18,189
)
Balance at June 30, 2015
$
313,125

 
$
612,875

 
$
(1,145
)
 
$
924,855

 
 
 
 
 
 
 
 
Balance at December 31, 2013
$
285,535

 
$
532,087

 
$
(16,041
)
 
$
801,581

Net income
—

 
42,470

 
—

 
42,470

Other comprehensive income, net of tax expense
—

 
—

 
10,401

 
10,401

Common stock transactions:
 
 
 
 
 
 
 
349,930 common shares purchased and retired
(8,764
)
 
—

 
—

 
(8,764
)
24,581 common shares issued
—

 
—

 
—

 
—

147,876 non-vested common shares issued
—

 
—

 
—

 
—

8,647 non-vested common shares forfeited
—

 
—

 
—

 
—

286,069 stock options exercised, net of 160,377 shares tendered in payment of option price and income tax withholding amounts
3,547

 
—

 
—

 
3,547

Tax benefit of stock-based compensation
1,225

 
—

 
—

 
1,225

Stock-based compensation expense
2,154

 
—

 
—

 
2,154

Common cash dividend declared ($0.32 per share)
—

 
(14,088
)
 
—

 
(14,088
)
Balance at June 30, 2014
$
283,697

 
$
560,469

 
$
(5,640
)
 
$
838,526

See accompanying notes to unaudited consolidated financial statements.

6

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)

 
Six Months Ended June 30,
 
2015
 
2014
Cash flows from operating activities:
 
 
 
Net income
$
43,202

 
$
42,470

Adjustments to reconcile net income to net cash provided by (used in) operating activities:
 
 
 
Provision for loan losses
2,435

 
(7,001
)
Net gain on disposal of premises and equipment
(856
)
 
(79
)
Depreciation and amortization
9,090

 
7,786

Net premium amortization on investment securities
7,021

 
7,088

Net gain on investment securities transactions
(52
)
 
(88
)
Net gain on sale of mortgage loans held for sale
(10,759
)
 
(7,601
)
Net gain on sale of OREO
(1,736
)
 
(766
)
Write-downs of OREO and other assets pending disposal
106

 
10

Net reversal of impairment of mortgage servicing rights
(71
)
 
(56
)
Deferred income tax expense
9,108

 
3,760

Net increase in cash surrender value of company-owned life insurance
(1,304
)
 
(1,724
)
Stock-based compensation expense
2,319

 
2,154

Tax benefits from stock-based compensation expense
804

 
1,225

Excess tax benefits from stock-based compensation expense
(530
)
 
(1,211
)
Originations of mortgage loans held for sale
(561,779
)
 
(412,050
)
Proceeds from sales of mortgage loans held for sale
546,871

 
402,825

Changes in operating assets and liabilities:
 
 
 
Increase in interest receivable
(1,945
)
 
(47
)
Increase in other assets
(1,034
)
 
(1,929
)
Increase (decrease) in accrued interest payable
(467
)
 
353

Decrease in accounts payable and accrued expenses
(12,268
)
 
(4,788
)
Net cash provided by operating activities
28,155

 
30,331

Cash flows from investing activities:
 
 
 
Purchases of investment securities:
 
 
 
Held-to-maturity
(27,640
)
 
(4,141
)
Available-for-sale
(223,483
)
 
(175,823
)
Proceeds from maturities, pay-downs and sales of investment securities:
 
 
 
Held-to-maturity
55,654

 
9,347

Available-for-sale
337,538

 
243,355

Purchases of company-owned life insurance
(22,500
)
 
(15,000
)
Proceeds from sales of mortgage servicing rights
—

 
266

Extensions of credit to customers, net of repayments
(190,392
)
 
(155,523
)
Recoveries of loans charged-off
3,285

 
5,345

Proceeds from sales of OREO
7,807

 
4,234

Capital expenditures, net of sales
514

 
(6,309
)
Net cash used in investing activities
$
(59,217
)
 
$
(94,249
)

7

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)

 
Six Months Ended June 30,
 
2015
 
2014
Cash flows from financing activities:
 
 
 
Net increase (decrease) in deposits
$
(201,811
)
 
$
45,292

Net increase (decrease) in securities sold under repurchase agreements
(33,105
)
 
5,548

Net increase (decrease) in other borrowed funds
(6
)
 
17

Repayments of long-term debt
(30
)
 
(24
)
Advances on long-term debt
5,031

 
—

Proceeds from issuance of common stock
1,670

 
3,547

Excess tax benefits from stock-based compensation expense
530

 
1,211

Purchase and retirement of common stock
(15,264
)
 
(8,764
)
Dividends paid to common stockholders
(18,189
)
 
(14,088
)
Net cash provided by (used in) financing activities
(261,174
)
 
32,739

Net decrease in cash and cash equivalents
(292,236
)
 
(31,179
)
Cash and cash equivalents at beginning of period
798,670

 
534,827

Cash and cash equivalents at end of period
$
506,434

 
$
503,648

 
 
 
 
Supplemental disclosures of cash flow information:
 
 
 
Cash paid during the period for income taxes
$
18,450

 
$
16,190

Cash paid during the period for interest expense
9,364

 
8,656

See accompanying notes to unaudited consolidated financial statements.


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 of First Interstate BancSystem, Inc. and subsidiaries (the “Company”) contain all adjustments (all of which are of a normal recurring nature) necessary to present fairly the financial position of the Company at June 30, 2015 and December 31, 2014, and the results of operations for each of the three and six month periods ended and cash flows for each of the six month periods ended June 30, 2015 and 2014 in conformity with U.S. generally accepted accounting principles. The balance sheet information at December 31, 2014 is derived from audited consolidated financial statements. Certain reclassifications, none of which were material, have been made to conform prior year financial statements to the June 30, 2015 presentation. These reclassifications did not change previously reported net income or stockholders’ equity.

These unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014. Operating results for the three and six months ended June 30, 2015 are not necessarily indicative of the results that may be expected for the year ending December 31, 2015.

(2)
Acquisitions

Absarokee Bancorporation, Inc. On March 26, 2015, the Company entered into an agreement and plan of merger to acquire all of the outstanding stock of Absarokee Bancorporation, Inc. ("Absarokee"), a Montana-based bank holding company that operates one subsidiary bank, United Bank, with branches located in three Montana communities adjacent to the Company's existing market areas.

The acquisition was completed on July 24, 2015 for cash consideration of $7,234. Immediately subsequent to the acquisition, United Bank was merged with and into the Company's existing bank subsidiary, First Interstate Bank ("FIB"). As of the date of the acquisition, Absarokee has total assets of approximately $73,272, loans of approximately $37,520 and deposits of approximately $63,580.

Mountain West Financial Corp. On July 31, 2014, the Company acquired all of the outstanding stock of Mountain West Financial Corp ("MWFC"), a Montana-based bank holding company operating one subsidiary bank, Mountain West Bank, NA ("MWB"). MWB was merged with and into FIB in October 2014. During March 2015, the Company completed its review of MWFC tax items and finalized the fair value of acquired deferred tax assets. Finalization of provisional estimates resulted in a $1,199 decrease in goodwill.


9

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share data)


(3)
Investment Securities

The amortized cost and approximate fair values of investment securities are summarized as follows:
June 30, 2015
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Estimated
Fair
Value
Available-for-Sale:
 
 
 
 
Obligations of U.S. government agencies
$
622,237

$
1,087

$
(2,304
)
$
621,020

U.S. agency residential mortgage-backed securities & collateralized mortgage obligations
965,430

10,468

(4,463
)
971,435

Private mortgage-backed securities
286

4

(2
)
288

Total
$
1,587,953

$
11,559

$
(6,769
)
$
1,592,743

June 30, 2015
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Estimated
Fair
Value
Held-to-Maturity:
 
 
 
 
State, county and municipal securities
$
181,642

$
4,644

$
(524
)
$
185,762

Corporate securities
50,310

59

(204
)
50,165

U.S agency residential mortgage-backed securities &
    collateralized mortgage obligations
314,326

5,945

(3,288
)
316,983

Other investments
412

1

—

413

Total
$
546,690

$
10,649

$
(4,016
)
$
553,323

December 31, 2014
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Estimated
Fair
Value
Available-for-Sale:
 
 
 
 
Obligations of U.S. government agencies
$
725,408

$
895

$
(5,370
)
$
720,933

U.S. agency residential mortgage-backed securities & collateralized mortgage obligations
982,764

11,526

(3,624
)
990,666

Private mortgage-backed securities
322

5

(2
)
325

Total
$
1,708,494

$
12,426

$
(8,996
)
$
1,711,924

December 31, 2014
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Estimated
Fair
Value
Held-to-Maturity:
 
 
 
 
State, county and municipal securities
$
188,941

$
5,949

$
(386
)
$
194,504

Corporate securities
32,565

54

(75
)
32,544

U.S. agency residential mortgage-backed securities & collateralized mortgage obligations
353,176

5,563

(1,758
)
356,981

Other Investments
504

—

—

504

Total
$
575,186

$
11,566

$
(2,219
)
$
584,533


Gross realized gains and losses from the disposition of investment securities are summarized in the following table:
    
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
Gross realized gains
$
46

 
$
18

 
$
52

 
$
243

Gross realized losses
—

 
1

 
—

 
155

 



10

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share data)



The following tables show the gross unrealized losses and fair values of investment securities, aggregated by investment category, and the length of time individual investment securities have been in a continuous unrealized loss position, as of June 30, 2015 and December 31, 2014.
 
Less than 12 Months
 
12 Months or More
 
Total
June 30, 2015
Fair
Value
Gross
Unrealized
Losses
 
Fair
Value
Gross
Unrealized
Losses
 
Fair
Value
Gross
Unrealized
Losses
Available-for-Sale:
 
 
 
 
 
 
 
 
Obligations of U.S. government agencies
$
106,516

$
(460
)
 
$
239,339

$
(1,844
)
 
$
345,855

$
(2,304
)
U.S. agency residential mortgage-backed securities & collateralized mortgage obligations
254,399

(1,480
)
 
133,709

(2,983
)
 
388,108

(4,463
)
Private mortgage-backed securities
—

—

 
83

(2
)
 
83

(2
)
Total
$
360,915

$
(1,940
)
 
$
373,131

$
(4,829
)
 
$
734,046

$
(6,769
)
 
Less than 12 Months
 
12 Months or More
 
Total
June 30, 2015
Fair
Value
Gross
Unrealized
Losses
 
Fair
Value
Gross
Unrealized
Losses
 
Fair
Value
Gross
Unrealized
Losses
Held-to-Maturity:
 
 
 
 
 
 
 
 
State, county and municipal securities
$
19,427

$
(165
)
 
$
13,513

$
(359
)
 
$
32,940

$
(524
)
U.S. agency residential mortgage-backed securities & collateralized mortgage obligations
85,286

(3,288
)
 
—

—

 
85,286

(3,288
)
Corporate securities
31,291

(204
)
 
—

—

 
31,291

(204
)
Total
$
136,004

$
(3,657
)
 
$
13,513

$
(359
)
 
$
149,517

$
(4,016
)

 
Less than 12 Months
 
12 Months or More
 
Total
December 31, 2014
Fair
Value
Gross
Unrealized
Losses
 
Fair
Value
Gross
Unrealized
Losses
 
Fair
Value
Gross
Unrealized
Losses
Available-for-Sale:
 
 
 
 
 
 
 
 
Obligations of U.S. government agencies
$
135,888

$
(702
)
 
$
309,283

$
(4,668
)
 
$
445,171

$
(5,370
)
U.S. agency residential mortgage-backed securities & collateralized mortgage obligations
219,214

(887
)
 
151,380

(2,737
)
 
370,594

(3,624
)
Private mortgage-backed securities
—

—

 
90

(2
)
 
90

(2
)
Total
$
355,102

$
(1,589
)
 
$
460,753

$
(7,407
)
 
$
815,855

$
(8,996
)
 
Less than 12 Months
 
12 Months or More
 
Total
December 31, 2014
Fair
Value
Gross
Unrealized
Losses
 
Fair
Value
Gross
Unrealized
Losses
 
Fair
Value
Gross
Unrealized
Losses
Held-to-Maturity:
 
 
 
 
 
 
 
 
State, county and municipal securities
$
7,979

$
(13
)
 
$
20,097

$
(373
)
 
$
28,076

$
(386
)
U.S. agency residential mortgage-backed securities & collateralized mortgage obligations
61,201

(1,758
)
 
—

—

 
61,201

(1,758
)
Corporate securities
14,755

(75
)
 
—

—

 
14,755

(75
)
Total
$
83,935

$
(1,846
)
 
$
20,097

$
(373
)
 
$
104,032

$
(2,219
)
    

11

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share data)


The investment portfolio is evaluated quarterly for other-than-temporary declines in the market value of each individual investment security. The Company had 190 and 154 individual investment securities that were in an unrealized loss position as of June 30, 2015 and December 31, 2014, respectively. Unrealized losses as of June 30, 2015 and December 31, 2014 related primarily to fluctuations in the current interest rates. The Company does not have the intent to sell any of the available-for-sale securities in the above table and it is not likely that the Company will have to sell any such securities before a recovery in cost. No impairment losses were recorded during the three and six months ended June 30, 2015 and 2014.

Maturities of investment securities at June 30, 2015 are shown below. Maturities of mortgage-backed securities have been adjusted to reflect shorter maturities based upon estimated prepayments of principal. All other investment securities maturities are shown at contractual maturity dates.
 
Available-for-Sale
 
Held-to-Maturity
June 30, 2015
Amortized
Cost
Estimated
Fair Value
 
Amortized
Cost
Estimated
Fair Value
Within one year
$
321,079

$
322,976

 
$
97,639

$
98,594

After one year but within five years
1,189,454

1,192,101

 
273,778

276,390

After five years but within ten years
58,106

58,232

 
125,446

127,706

After ten years
19,314

19,434

 
49,827

50,633

Total
$
1,587,953

$
1,592,743

 
$
546,690

$
553,323

    
As of June 30, 2015, the Company had investment securities callable within one year with amortized costs and estimated fair values of $104,832 and $104,923, respectively, including callable structured notes with amortized costs and estimated fair values of $4,996 and $5,004, respectively. These investment securities are primarily classified as available-for-sale and included in the after one year but within five years category in the table above.


12

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share data)


(4)
Loans
    
The following table presents loans by class as of the dates indicated:
 
June 30,
2015
 
December 31,
2014
Real estate loans:
 
 
 
Commercial
$
1,704,073

 
$
1,639,422

Construction:
 
 
 
Land acquisition & development
211,889

 
220,443

Residential
101,023

 
96,580

Commercial
90,316

 
101,246

Total construction loans
403,228

 
418,269

Residential
999,038

 
999,903

Agricultural
158,506

 
167,659

Total real estate loans
3,264,845

 
3,225,253

Consumer:
 
 
 
Indirect consumer
589,479

 
552,863

Other consumer
144,919

 
144,141

Credit card
64,728

 
65,467

Total consumer loans
799,126

 
762,471

Commercial
819,119

 
740,073

Agricultural
142,629

 
124,859

Other, including overdrafts
2,905

 
3,959

Loans held for investment
5,028,624

 
4,856,615

Mortgage loans held for sale
75,322

 
40,828

Total loans
$
5,103,946

 
$
4,897,443

    
Loans from business combinations included in the table above include certain loans that had evidence of deterioration in credit quality since origination and for which it was probable, at acquisition, that all contractually required payments would not be collected.

The following table displays the outstanding unpaid principal balance, accrued interest receivable and accrual status of loans acquired with credit impairment as of June 30, 2015 and 2014:    
As of June 30,
2015
 
2014
 
 
 
 
Outstanding balance
$
35,555

 
$
—

 
 
 
 
Carrying value
 
 
 
Loans on accrual status
22,293

 
—

Loans on non-accrual status
—

 
—

Total carrying value
$
22,293

 
$
—

    

13

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share data)


The following table summarizes changes in the accretable yield for loans acquired credit impaired for the three and six ended June 30, 2015 and 2014:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2015
2014
 
2015
2014
 
 
 
 
 
 
Beginning balance
$
6,980

$
—

 
$
5,781

$
—

Accretion income
(807
)
—

 
(1,355
)
—

Reductions due to exit events
—

—

 
(396
)
—

Reclassifications from (to) nonaccretable differences
1,309

—

 
3,452

—

Ending balance
$
7,482

$
—

 
$
7,482

$
—

    
Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. The following tables present the contractual aging of the Company’s recorded investment in past due loans by class as of the dates indicated:
 
 
 
 
Total Loans
 
 
 
 
30 - 59
60 - 89
> 90
30 or More
 
 
 
 
Days
Days
Days
Days
Current
Non-accrual
Total
As of June 30, 2015
Past Due
Past Due
Past Due
Past Due
Loans
Loans
Loans
Real estate
 
 
 
 
 
 
 
Commercial
$
5,123

$
2,803

$
111

$
8,037

$
1,669,445

$
26,591

$
1,704,073

Construction:
 
 
 
 
 
 

 

Land acquisition & development
1,075

276

156

1,507

202,620

7,762

211,889

Residential
417

—

—

417

100,274

332

101,023

Commercial
—

—

—

—

86,874

3,442

90,316

Total construction loans
1,492

276

156

1,924

389,768

11,536

403,228

Residential
3,563

1,524

929

6,016

990,453

2,569

999,038

Agricultural
875

261

—

1,136

150,586

6,784

158,506

Total real estate loans
11,053

4,864

1,196

17,113

3,200,252

47,480

3,264,845

Consumer:
 
 
 
 
 
 
 

Indirect consumer
3,382

507

26

3,915

585,200

364

589,479

Other consumer
785

121

29

935

143,241

743

144,919

Credit card
415

224

391

1,030

63,684

14

64,728

Total consumer loans
4,582

852

446

5,880

792,125

1,121

799,126

Commercial
8,285

812

190

9,287

788,210

21,622

819,119

Agricultural
700

30

10

740

141,264

625

142,629

Other, including overdrafts
—

—

311

311

2,594

—

2,905

Loans held for investment
24,620

6,558

2,153

33,331

4,924,445

70,848

5,028,624

Mortgage loans originated for sale
—

—

—

—

75,322

—

75,322

Total loans
$
24,620

$
6,558

$
2,153

$
33,331

$
4,999,767

$
70,848

$
5,103,946





14

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share data)


 
 
 
 
Total Loans
 
 
 
 
30 - 59
60 - 89
> 90
30 or More
 
 
 
 
Days
Days
Days
Days
Current
Non-accrual
Total
As of December 31, 2014
Past Due
Past Due
Past Due
Past Due
Loans
Loans
Loans
Real estate
 
 
 
 
 
 
 
Commercial
$
4,692

$
1,609

$
331

$
6,632

$
1,605,421

$
27,369

$
1,639,422

Construction:
 
 
 
 
 
 

 

Land acquisition & development
839

383

—

1,222

210,969

8,252

220,443

Residential
—

475

—

475

95,833

272

96,580

Commercial
100

—

—

100

98,582

2,564

101,246

Total construction loans
939

858

—

1,797

405,384

11,088

418,269

Residential
6,969

645

1,762

9,376

987,735

2,792

999,903

Agricultural
1,624

236

—

1,860

158,957

6,842

167,659

Total real estate loans
14,224

3,348

2,093

19,665

3,157,497

48,091

3,225,253

Consumer:
 
 
 
 
 
 
 

Indirect consumer
3,235

482

6

3,723

548,757

383

552,863

Other consumer
988

140

32

1,160

142,432

549

144,141

Credit card
369

284

315

968

64,484

15

65,467

Total consumer loans
4,592

906

353

5,851

755,673

947

762,471

Commercial
3,659

994

147

4,800

722,575

12,698

740,073

Agricultural
1,125

—

—

1,125

123,288

446

124,859

Other, including overdrafts
—

—

—

—

3,959

—

3,959

Loans held for investment
23,600

5,248

2,593

31,441

4,762,992

62,182

4,856,615

Mortgage loans originated for sale
—

—

—

—

40,828

—

40,828

Total loans
$
23,600

$
5,248

$
2,593

$
31,441

$
4,803,820

$
62,182

$
4,897,443


Acquired loans that met the criteria for nonaccrual of interest prior to the acquisition were considered performing upon acquisition. If interest on non-accrual loans had been accrued, such income would have been approximately $875 and $1,061 for the three months ended June 30, 2015 and 2014, respectively, and approximately $1,613 and $2,182 for the six months ended June 30, 2015 and 2014 respectively.
        

15

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share data)


The Company considers impaired loans to include all loans, except consumer loans, that are risk rated as doubtful, or have been placed on non-accrual status or renegotiated in troubled debt restructurings. The following tables present information on the Company’s recorded investment in impaired loans as of dates indicated:
As of June 30, 2015
Unpaid
Total
Principal
Balance
Recorded
Investment
With No
Allowance
Recorded
Investment
With
Allowance
Total
Recorded
Investment
Related
Allowance
Real estate:
 
 
 
 
 
Commercial
$
60,786

$
31,201

$
17,201

$
48,402

$
1,810

Construction:
 
 
 
 
 
Land acquisition & development
22,630

6,452

5,915

12,367

569

Residential
969

332

—

332

—

Commercial
3,796

426

1,590

2,016

1,606

Total construction loans
27,395

7,210

7,505

14,715

2,175

Residential
5,442

2,291

1,429

3,720

127

Agricultural
9,094

6,396

2,202

8,598

712

Total real estate loans
102,717

47,098

28,337

75,435

4,824

Commercial
28,472

11,275

12,298

23,573

3,279

Agricultural
2,110

427

1,058

1,485

618

Total
$
133,299

$
58,800

$
41,693

$
100,493

$
8,721

As of December 31, 2014
Unpaid
Total
Principal
Balance
Recorded
Investment
With No
Allowance
Recorded
Investment
With
Allowance
Total
Recorded
Investment
Related
Allowance
Real estate:
 
 
 
 
 
Commercial
$
41,603

$
28,143

$
11,246

$
39,389

$
1,608

Construction:
 
 
 
 
 
Land acquisition & development
12,511

7,262

1,615

8,877

574

Residential
459

272

—

272

—

Commercial
2,729

253

2,442

2,695

904

Total construction loans
15,699

7,787

4,057

11,844

1,478

Residential
2,959

2,452

341

2,793

143

Agricultural
8,844

6,444

2,305

8,749

732

Total real estate loans
69,105

44,826

17,949

62,775

3,961

Commercial
16,904

11,882

2,644

14,526

1,190

Agricultural
1,231

342

837

1,179

641

Total
$
87,240

$
57,050

$
21,430

$
78,480

$
5,792



16

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share data)


The following table presents the average recorded investment in and income recognized on impaired loans for the periods indicated:
 
Three Months Ended June 30,
 
2015
 
2014
 
 Average Recorded Investment
 
 Income Recognized
 
 Average Recorded Investment
 
 Income Recognized
 
 
 
 
 
 
Real estate:
 
 
 
 
 
 
 
Commercial
$
39,513

 
$
211

 
$
57,588

 
$
241

Construction:
 
 
 
 
 
 
 
Land acquisition & development
8,664

 
12

 
13,563

 
11

Residential
338

 
—

 
785

 
—

Commercial
3,492

 
—

 
1,471

 
2

Total construction loans
12,494

 
12

 
15,819

 
13

Residential
3,014

 
1

 
5,852

 
1

Agricultural
8,572

 
13

 
9,747

 
25

Total real estate loans
63,593

 
237

 
89,006

 
280

Commercial
21,841

 
112

 
14,162

 
14

Agricultural
1,004

 
8

 
742

 
6

Total
$
86,438

 
$
357

 
$
103,910

 
$
300

 
Six Months Ended June 30,
 
2015
 
2014
 
 Average Recorded Investment
 
 Income Recognized
 
 Average Recorded Investment
 
 Income Recognized
 
 
Real estate:
 
 
 
 
 
 
 
Commercial
$
40,652

 
$
361

 
$
60,870

 
$
457

Construction:
 
 
 
 
 
 
 
Land acquisition & development
8,720

 
22

 
14,554

 
22

Residential
302

 
—

 
1,051

 
—

Commercial
3,133

 
2

 
918

 
4

Total construction loans
12,155

 
24

 
16,523

 
26

Residential
2,719

 
2

 
5,969

 
3

Agricultural
8,666

 
35

 
9,830

 
29

Total real estate loans
64,192

 
422

 
93,192

 
515

Commercial
17,874

 
120

 
14,231

 
28

Agricultural
857

 
13

 
538

 
12

Total
$
82,923

 
$
555

 
$
107,961

 
$
555


The amount of interest income recognized by the Company within the period that the loans were impaired was primarily related to loans modified in a troubled debt restructuring that remained on accrual status. Interest payments received on non-accrual impaired loans are applied to principal. Interest income is subsequently recognized only to the extent cash payments are received in excess of principal due. If interest on impaired loans had been accrued, interest income on impaired loans would have been approximately $1,045 and $1,301 for the three months ended June 30, 2015 and 2014, respectively, and approximately $2,011 and $2,412 for the six months ended June 30, 2015 and 2014 respectively.
            
Collateralized impaired loans are generally recorded at the fair value of the underlying collateral using discounted cash flows, independent appraisals and management estimates based upon current market conditions. For loans measured under the present value of cash flows method, the change in present value attributable to the passage of time, if applicable, is recognized in the provision for loan losses and thus no interest income is recognized.
    

17

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share data)


Modifications of performing loans are made in the ordinary course of business and are completed on a case-by-case basis as negotiated with the borrower. Loan modifications typically include interest rate concessions, interest only periods of less than twelve months, short-term payment deferrals and extension of amortization periods to provide payment relief. A loan modification is considered a troubled debt restructuring if the borrower is experiencing financial difficulties and the Company, for economic or legal reasons, grants a concession to the borrower that it would not otherwise consider. Certain troubled debt restructurings are on non-accrual status at the time of restructuring and are typically returned to accrual status after considering the borrower's sustained repayment performance in accordance with the restructuring agreement for a period of at least six months and management is reasonably assured of future performance. If the troubled debt restructuring meets these performance criteria and the interest rate granted at the modification is equal to or greater than the rate that the Company was willing to accept at the time of the restructuring for a new loan with comparable risk, then the loan will return to performing status and the accrual of interest will resume.
    
The Company had loans renegotiated in troubled debt restructurings of $37,363 as of June 30, 2015, of which $22,236 were included in non-accrual loans and $15,127 were on accrual status. The Company had loans renegotiated in troubled debt restructurings of $44,227 as of December 31, 2014, of which $23,275 were included in non-accrual loans and $20,952 were on accrual status.

No troubled debt restructurings occurred during the three months ended June 30, 2015. The following table presents information on the Company's troubled debt restructurings that occurred during the six months ended June 30, 2015:    
 
 
 
 
 
 
 
 
 
 
 
Number of Notes
 
Type of Concession
Principal Balance at Restructure Date
Six Months Ended June 30, 2015
 
 
Interest only period
Extension of terms or maturity
Interest rate adjustment
Other
Commercial
 
1
 
$
—

$
10

$
—

$
—

$
10

Total loans restructured during period
 
1
 
$
—

$
10

$
—

$
—

$
10


For troubled debt restructurings that were on non-accrual status or otherwise deemed impaired before the modification, a specific reserve may already be recorded. In periods subsequent to modification, the Company continues to evaluate all troubled debt restructurings for possible impairment and recognizes impairment through the allowance. Additionally these loans continue to work their way through the credit cycle through charge-off, pay-off or foreclosure. Financial effects of modifications of troubled debt restructurings may include principal loan forgiveness or other charge-offs directly related to the restructuring. The Company had no charge-offs directly related to modifying troubled debt restructurings during the three or six months ended June 30, 2015 or 2014.
    
The following table presents information on the Company's troubled debt restructurings during the previous 12 months for which there was a payment default during the periods indicated. The Company considers a payment default to occur on troubled debt restructurings when the loan is 90 days or more past due or was placed on non-accrual status after the modification.
 
Three Months Ended June 30, 2015
 
Six Months Ended June 30, 2015
 
Number of Notes
 
Balance
 
Number of Notes
 
Balance
Commercial Real Estate
—
 
$
—

 
1
 
$
1,822


At June 30, 2015, there were no material commitments to lend additional funds to borrowers whose existing loans have been renegotiated or are classified as non-accrual.
    
As part of the on-going and continuous monitoring of the credit quality of the Company’s loan portfolio, management tracks internally assigned risk classifications of loans. The Company adheres to a Uniform Classification System developed jointly by the various bank regulatory agencies to internally risk rate loans. The Uniform Classification System defines three broad categories of criticized assets, which the Company uses as credit quality indicators:
    

18

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share data)


Other Assets Especially Mentioned — includes loans that exhibit weaknesses in financial condition, loan structure or documentation, which if not promptly corrected, may lead to the development of abnormal risk elements.
    
Substandard — includes loans that are inadequately protected by the current sound worth and paying capacity of the borrower. Although the primary source of repayment for a substandard loan is not currently sufficient; collateral or other sources of repayment are sufficient to satisfy the debt. Continuance of a substandard loan is not warranted unless positive steps are taken to improve the worthiness of the credit.
    
Doubtful — includes loans that exhibit pronounced weaknesses to a point where collection or liquidation in full, on the basis of currently existing facts, conditions and values, is highly questionable and improbable. Doubtful loans are required to be placed on non-accrual status and are assigned specific loss exposure.

Company management undertakes the same process for assigning risk ratings to acquired loans as it does for originated loans. Acquired loans rated as substandard or lower or that were on non-accrual status or designated as troubled debt restructurings at the time of acquisition are deemed to be acquired credit impaired loans accounted for under ASC Topic 310-30, regardless of whether they are classified as performing or non-performing loans.

The following tables present the Company’s recorded investment in criticized loans by class and credit quality indicator based on the most recent analysis performed as of the dates indicated:
As of June 30, 2015
Other Assets
Especially
Mentioned
Substandard
Doubtful
Total
Criticized
Loans
Real estate:
 
 
 
 
Commercial
$
83,194

$
85,323

$
7,952

$
176,469

Construction:
 
 
 
 
Land acquisition & development
13,426

14,190

2,031

29,647

Residential
857

2,165

29

3,051

Commercial
—

409

3,161

3,570

Total construction loans
14,283

16,764

5,221

36,268

Residential
8,434

9,387

1,002

18,823

Agricultural
9,826

14,838

595

25,259

Total real estate loans
115,737

126,312

14,770

256,819

Consumer:
 
 
 
 
Indirect consumer
843

1,454

161

2,458

Other consumer
557

930

349

1,836

Credit card
—

—

—

—

Total consumer loans
1,400

2,384

510

4,294

Commercial
34,776

24,519

15,691

74,986

Agricultural
3,794

6,684

730

11,208

Total
$
155,707

$
159,899

$
31,701

$
347,307


19

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share data)


As of December 31, 2014
Other Assets
Especially
Mentioned
Substandard
Doubtful
Total
Criticized
Loans
Real estate:
 
 
 
 
Commercial
$
84,533

$
83,448

$
15,246

$
183,227

Construction:
 
 
 
 
Land acquisition & development
11,826

15,016

2,507

29,349

Residential
2,029

2,666

—

4,695

Commercial
39

253

2,442

2,734

Total construction loans
13,894

17,935

4,949

36,778

Residential
10,473

10,848

1,121

22,442

Agricultural
10,122

12,328

612

23,062

Total real estate loans
119,022

124,559

21,928

265,509

Consumer:
 
 
 
 
Indirect consumer
916

1,590

121

2,627

Other consumer
553

1,085

432

2,070

Credit card
—

348

1,263

1,611

Total consumer loans
1,469

3,023

1,816

6,308

Commercial
25,766

32,433

10,273

68,472

Agricultural
7,827

3,660

837

12,324

Total
$
154,084

$
163,675

$
34,854

$
352,613


The Company maintains a credit review function, which is independent of the credit approval process, to assess assigned internal risk classifications and monitor compliance with internal lending policies and procedures. Written action plans with firm target dates for resolution of identified problems are maintained and reviewed on a quarterly basis for all categories of criticized loans.


20

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share data)


(5)
Allowance for Loan Losses
    
The following tables present a summary of changes in the allowance for loan losses by portfolio segment for the periods indicated. 
Three Months Ended June 30, 2015
Real Estate
Consumer
Commercial
Agriculture
Other
Total
Allowance for loan losses:
 
 
 
 
 
 
Beginning balance
$
53,659

$
5,499

$
15,196

$
982

$
—

$
75,336

Provision charged to operating expense
461

646

224

9

—

1,340

Less loans charged-off
(610
)
(837
)
(61
)
—

—

(1,508
)
Add back recoveries of loans previously
   charged-off
425

520

438

1

—

1,384

Ending balance
$
53,935

$
5,828

$
15,797

$
992

$
—

$
76,552

 
 
 
 
 
 
 
Six Months Ended June 30, 2015
Real Estate
Consumer
Commercial
Agriculture
Other
Total
Allowance for loan losses:
 
 
 
 
 
 
Beginning balance
$
53,884

$
5,035

$
14,307

$
974

$
—

$
74,200

Provision charged to operating expense
(570
)
1,771

1,217

17

—

2,435

Less loans charged-off
(795
)
(2,138
)
(435
)
—

—

(3,368
)
Add back recoveries of loans previously
   charged-off
1,416

1,160

708

1

—

3,285

Ending balance
$
53,935

$
5,828

$
15,797

$
992

$
—

$
76,552

 
 
 
 
 
 
 
As of June 30, 2015
Real Estate
Consumer
Commercial
Agriculture
Other
Total
Allowance for loan losses:
 
 
 
 
 
 
Loans individually evaluated for impairment
$
4,824

$
—

$
3,279

$
618

$
—

$
8,721

Loans collectively evaluated for impairment
49,111

5,828

12,518

374

—

67,831

Allowance for loan losses
$
53,935

$
5,828

$
15,797

$
992

$
—

$
76,552

 
 
 
 
 
 
 
Total loans:
 
 
 
 
 
 
Individually evaluated for impairment
$
75,435

$
—

$
23,573

$
1,485

$
—

$
100,493

Collectively evaluated for impairment
3,264,732

799,126

795,546

141,144

2,905

5,003,453

Total loans
$
3,340,167

$
799,126

$
819,119

$
142,629

$
2,905

$
5,103,946

Three Months Ended June 30, 2014
Real Estate
Consumer
Commercial
Agriculture
Other
Total
Allowance for loan losses:
 

 

 

 

 

 

Beginning balance
$
59,830

$
5,377

$
15,701

$
463

$
—

$
81,371

Provision charged to operating expense
(2,011
)
346

(494
)
158

—

(2,001
)
Less loans charged-off
(1,158
)
(934
)
(534
)
—

—

(2,626
)
Add back recoveries of loans previously
   charged-off
651

558

313

—

—

1,522

Ending balance
$
57,312

$
5,347

$
14,986

$
621

$
—

$
78,266


21

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share data)


Six Months Ended June 30, 2014
Real Estate

Consumer

Commercial

Agriculture

Other

Total

Allowance for loan losses:
 

 

 

 

 

 

Beginning balance
$
63,923

$
6,193

$
14,747

$
476

$
—

$
85,339

Provision charged to operating expense
(5,386
)
(232
)
(1,566
)
183

—

(7,001
)
Less loans charged-off
(2,243
)
(1,780
)
(1,330
)
(64
)
—

(5,417
)
Add back recoveries of loans previously
   charged-off
1,018

1,166

3,135

26

—

5,345

Ending balance
$
57,312

$
5,347

$
14,986

$
621

$
—

$
78,266

 
 
 
 
 
 
 
As of December 31, 2014
Real Estate

Consumer

Commercial

Agriculture

Other

Total

Allowance for loan losses:
 
 
 
 
 
 
Loans individually evaluated for impairment
$
3,961

$
—

$
1,190

$
641

$
—

$
5,792

Loans collectively evaluated for impairment
49,923

5,035

13,117

333

—

68,408

Allowance for loan losses
$
53,884

$
5,035

$
14,307

$
974

$
—

$
74,200

 
 
 
 
 
 
 
Total loans:
 

 

 

 

 

 

Individually evaluated for impairment
$
62,775

$
—

$
14,526

$
1,179

$
—

$
78,480

Collectively evaluated for impairment
3,203,306

762,471

725,547

123,680

3,959

4,818,963

Total loans
$
3,266,081

$
762,471

$
740,073

$
124,859

$
3,959

$
4,897,443

    
The Company performs a quarterly assessment of the adequacy of its allowance for loan losses in accordance with generally accepted accounting principles. The methodology used to assess the adequacy is consistently applied to the Company's loan portfolio and consists of three elements: (1) specific valuation allowances based on probable losses on impaired loans; (2) historical valuation allowances based on loan loss experience for similar loans with similar characteristics and trends; and (3) general valuation allowances determined based on changes in the nature of the loan portfolio, overall portfolio quality, industry concentrations, delinquency trends, general economic conditions and other qualitative risk factors both internal and external to the Company.
    
Specific allowances are established for loans where management has determined that probability of a loss exists by analyzing the borrower’s ability to repay amounts owed, collateral deficiencies and any relevant qualitative or economic factors impacting the loan. Historical valuation allowances are determined by applying percentage loss factors to the credit exposures from outstanding loans. For commercial, agricultural and real estate loans, loss factors are applied based on the internal risk classifications of these loans. For consumer loans, loss factors are applied on a portfolio basis. For commercial, agriculture and real estate loans, loss factor percentages are based on a migration analysis of our historical loss experience, designed to account for credit deterioration. For consumer loans, loss factor percentages are based on a one-year loss history. General valuation allowances are determined by evaluating, on a quarterly basis, changes in the nature and volume of the loan portfolio, overall portfolio quality, industry concentrations, current economic and regulatory conditions and the estimated impact of these factors on historical loss rates.    

An allowance for loan losses is established for loans acquired credit impaired and for which the Company projects a decrease in the expected cash flows in periods subsequent to the acquisition of such loans. As of June 30, 2015 and December 31, 2014, the Company's allowance for loan losses included $501 and $287, respectively, related to acquired loans.


22

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share data)


(6)
Other Real Estate Owned
    
Information with respect to the Company's other real estate owned follows:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
Beginning balance
$
15,134

 
$
16,594

 
$
13,554

 
$
15,504

Additions
1,139

 
984

 
4,396

 
4,399

Valuation adjustments
—

 
(10
)
 
(106
)
 
(10
)
Dispositions
(4,500
)
 
(1,143
)
 
(6,071
)
 
(3,468
)
Ending balance
$
11,773

 
$
16,425

 
$
11,773

 
$
16,425


Foreclosed residential real estate properties of $3,708 were included in other real estate owned as of June 30, 2015. Consumer mortgage loans collateralized by residential real estate property of $65 were in the process of foreclosure as of June 30, 2015.

(7)
Long-Term Debt

On January 29, 2015, the Company borrowed $4,960 on a 2.28% note payable maturing July 29, 2022, with interest payable monthly and principal due at maturity. The note is collateralized by the Company's equity interest in Universal Sub CDE, LLC, a community development entity owned 99.9% by the Company.

(8)
Capital Stock
    
The Company had 21,720,287 shares of Class A common stock and 23,786,296 shares of Class B common stock outstanding as of June 30, 2015. The Company had 21,928,932 shares of Class A common stock and 23,859,483 shares of Class B common stock outstanding as of December 31, 2014.
    
During the six months ended June 30, 2015, the Company repurchased and retired 565,875 shares of its Class A common stock in open market transactions at an aggregate purchase price of $14,674. During the six months ended June 30, 2014, the Company repurchased and retired 325,418 shares of its Class A common stock in a privately negotiated transaction at an aggregate purchase price of $8,143. The repurchases were made pursuant to stock repurchase programs approved by the Company's Board of Directors. Under the terms of the current stock repurchase program, the Company may repurchase up to an additional 434,125 shares of its Class A common stock. All other stock repurchases during the three and six months ended June 30, 2015 and 2014 were redemptions of vested restricted shares tendered in lieu of cash for payment of income tax withholding amounts by participants of the Company's 2006 Equity Compensation Plan.

On April 3, 2015, the Company filed a Registration Statement on Form S-8 to register an additional 2,000,000 shares of Class A common stock to be issued pursuant to the Company's 2015 Equity and Incentive Plan.
    
(9)
Earnings per Common Share
    
Basic earnings per common share is calculated by dividing net income by the weighted average number of common shares outstanding during the period presented, excluding unvested restricted stock. Diluted earnings per share is calculated by dividing net income by the weighted average number of common shares determined for the basic earnings per share computation plus the dilutive effects of stock-based compensation using the treasury stock method.

23

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share data)


    
The following table sets forth the computation of basic and diluted earnings per share for the three and six month periods ended June 30, 2015 and 2014.
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2015
2014
 
2015
2014
Net income
$
22,222

$
21,077

 
$
43,202

$
42,470

Weighted average common shares outstanding for basic earnings per share computation
45,143,122

44,044,260

 
45,260,104

44,021,166

Dilutive effects of stock-based compensation
463,564

531,703

 
582,935

573,689

Weighted average common shares outstanding for diluted earnings per common share computation
45,606,686

44,575,963

 
45,843,039

44,594,855

 
 
 
 
 
 
Basic earnings per common share
$
0.49

$
0.48

 
$
0.95

$
0.96

Diluted earnings per common share
$
0.49

$
0.47

 
$
0.94

$
0.95

        
The Company had 166,362 and 107,651 shares of unvested restricted stock as of June 30, 2015 and 2014, respectively, that were not included in the computation of diluted earnings per common share because performance conditions for vesting had not been met. The Company had no anti-dilutive stock options outstanding as of June 30, 2015 or June 30, 2014.
 
(10)
Regulatory Capital

On July 2, 2013, the Board of Governors of the Federal Reserve Bank issued a final rule implementing a revised regulatory capital framework for U.S. banks in accordance with the Basel III international accord and satisfying related mandates under the Dodd-Frank Wall Street Reform and Consumer Protection Act . The revised regulatory capital framework ("Basel III ") includes a more stringent definition of capital and introduces a new common equity tier 1, or CET1, capital requirement, sets forth a comprehensive methodology for calculating risk-weighted assets, introduces a conservation buffer and sets out minimum capital ratios and overall capital adequacy standards. As a banking organization subject to the standardized approach, Basel III became effective for us on January 1, 2015. Certain deductions and adjustments to regulatory capital began to phase in starting January 1, 2015 and will be fully implemented on January 1, 2018. The capital conservation buffer phases in beginning January 1, 2016 and will be fully implemented on January 1, 2019.

CET1 capital predominantly includes common shareholders’ equity, less certain deductions for goodwill, intangible assets and deferred tax assets that arise from net operating losses and tax credit carry-forwards. We have elected to permanently exclude capital in accumulated other comprehensive income related to debt and equity securities classified as available-for-sale as well as for defined benefit post-retirement plans from CET1. Certain deductions and adjustments to CET1 capital, tier 1 capital and tier 2 capital are subject to phase-in through December 31, 2017.


24

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share data)


As of June 30, 2015 and December 31, 2014, the Company exceeded all capital adequacy requirements to which it is subject. Actual capital amounts and ratios for the Company and its bank subsidiary, as of June 30, 2015 and December 31, 2014 are presented in the following tables: 
 
Actual
 
Adequately Capitalized
 
Well Capitalized (1)
 
Amount
 Ratio
 
Amount
 Ratio
 
Amount
 Ratio
June 30, 2015
 
 
 
 
 
 
 
 
Total risk-based capital:
 
 
 
 
 
 
 
 
Consolidated
$
924,408

15.4
%
 
$
481,244

8.0
%
 
$
601,555

10.0
%
FIB
857,522

14.3

 
479,416

8.0

 
599,270

10.0

Tier 1 risk-based capital:
 
 
 
 
 
 
 
 
Consolidated
835,198

13.9

 
360,933

6.0

 
481,244

8.0

FIB
776,594

13.0

 
359,562

6.0

 
479,416

8.0

Common equity tier 1 risk-based capital:
 
 
 
 
 
 
 
 
Consolidated
755,198

12.6

 
270,700

4.5

 
391,011

6.5

FIB
776,594

13.0

 
269,671

4.5

 
389,525

6.5

Leverage capital ratio:
 
 
 
 
 
 
 
 
Consolidated
835,198

10.1

 
330,350

4.0

 
412,938

5.0

FIB
776,594

9.4

 
329,180

4.0

 
411,475

5.0

 
Actual
 
Adequately Capitalized
 
Well Capitalized (1)
 
Amount
 Ratio
 
Amount
 Ratio
 
Amount
 Ratio
December 31, 2014
 
 
 
 
 
 
 
 
Total risk-based capital:
 
 
 
 
 
 
 
 
Consolidated
$
897,769

16.2
%
 
$
444,685

8.0
%
 
$
555,856

10.0
%
FIB
832,907

15.1

 
442,468

8.0

 
553,085

10.0

Tier 1 risk-based capital:
 
 
 
 
 
 
 
 
Consolidated
807,229

14.5

 
222,343

4.0

 
333,514

6.0

FIB
754,708

13.7

 
221,234

4.0

 
331,851

6.0

Leverage capital ratio:
 
 
 
 
 
 
 
 
Consolidated
807,229

9.6

 
335,897

4.0

 
419,871

5.0

FIB
754,708

9.2

 
330,006

4.0

 
412,507

5.0


(1)
The ratios for the well-capitalized requirement are only applicable to FIB. However, the Company manages its capital position as if the requirement applies to the consolidated entity and has presented the ratios as if they also applied on a consolidated basis.

(11)
Commitments and Contingencies
    
Legal Proceedings. First Interstate Bank ("the Bank"), a wholly owned banking subsidiary of the Company, was a defendant in a lender liability lawsuit , Kelly Logging Inc. v. First Interstate Bank ("the case"). The case was tried in August 2014 in the Montana Fourth Judicial District, Missoula County in Missoula, Montana ("the court"). On August, 2014, a jury awarded damages to Kelly Logging of $17,047, which included $287 in compensatory damages and $16,760 in punitive damages. On October 1, 2014, a non-final judgment was entered in this matter in the amount of $17,047 plus reasonable attorney fees and interest, subject to the court's mandatory review of the jury's punitive damages award and rulings on pending post-trial motions. On April 21, 2015, the court ruled on the post-trial motions and issued an order upholding the jury's punitive damage award. The order also awarded plaintiff attorney's fees of $7,500 and costs of $91, for a final judgment amount of $24,638 plus interest.

25

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share data)



The Company believes it has meritorious grounds for appeal of the final judgment and, in the event mandatory mediation of the case scheduled for third quarter 2015 is unsuccessful, intends to appeal to the Montana Supreme Court to set aside or substantially reduce the punitive damages award and grant the Bank a new trial. In recent appellate cases, the Montana Supreme Court has reduced excessive punitive damage awards to comply with the upper limit of the federal due process guidelines, or to an amount equal to less than ten times the compensatory damages awarded, in even the most egregious cases. Although the Company believes it has meritorious defenses and appellate issues for this litigation, these proceedings are subject to many uncertainties and, given their complexity and scope, the final outcome cannot be predicted and could have a material adverse effect on the consolidated financial condition, results of operations or liquidity of the Company. During third quarter 2014, the Company accrued $4,000 of litigation-related expense, which takes into consideration the federal due process guidelines related to punitive damage awards and the plaintiff's attorneys fees.

In the normal course of business, the Company is involved in various other claims and litigation. In the opinion of management, following consultation with legal counsel, the ultimate liability or disposition thereof of all other claims and litigation is not expected to have a material adverse effect on the consolidated financial condition, results of operations or liquidity of the Company.
    
Other Commitments. As of June 30, 2015, the Company had commitments under construction agreements of $2,433.
    
(12)
Financial Instruments with Off-Balance Sheet Risk
    
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. 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. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. At June 30, 2015, commitments to extend credit to existing and new borrowers approximated $995,388, which included $528,943 on unused credit card lines and $357,999 with commitment maturities beyond one year.
    
Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. At June 30, 2015, the Company had outstanding standby letters of credit of $58,105. The estimated fair value of the obligation undertaken by the Company in issuing the standby letters of credit is included in other liabilities in the Company’s consolidated balance sheet.
    
(13)
Supplemental Disclosures to Consolidated Statement of Cash Flows
        
The Company transferred loans of $4,396 and $4,399 to OREO during the six months ended June 30, 2015 and 2014, respectively.
        
The Company transferred internally originated mortgage servicing rights of $1,792 and $1,024 from loans to mortgage servicing assets during the six months ended June 30, 2015 and 2014, respectively.

The Company transferred loans of $10,619 to loans held for sale during the six months ended June 30, 2015.

    

26

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share data)



(14)
Other Comprehensive Income/Loss
    
The gross amounts of each component of other comprehensive income (loss) and the related tax effects are as follows:
 
Pre-tax
 
Tax Expense (Benefit)
 
Net of Tax
Three Months Ended June 30,
2015
 
2014
 
2015
 
2014
 
2015
 
2014
Investment securities available-for sale:
 
 
 
 
 
 
 
 
 
 
 
Change in net unrealized gains/losses
during period
$
(9,196
)
 
$
2,816

 
$
(3,618
)
 
$
1,108

 
$
(5,578
)
 
$
1,708

Reclassification adjustment for net gains
 included in net income
(46
)
 
(17
)
 
(18
)
 
(7
)
 
(28
)
 
(10
)
Change in unamortized loss on available-
 for-sale securities transferred into held-to-
 maturity
451

 
—

 
177

 
—

 
274

 
—

Defined benefits post-retirement benefit plan:
 
 
 
 
 
 
 
 
 
 
 
Change in net actuarial loss
13

 
35

 
5

 
14

 
8

 
21

Total other comprehensive income (loss)
$
(8,778
)
 
$
2,834

 
$
(3,454
)
 
$
1,115

 
$
(5,324
)
 
$
1,719


 
Pre-tax
 
Tax Expense (Benefit)
 
Net of Tax
Six Months Ended June 30,
2015
 
2014
 
2015
 
2014
 
2015
 
2014
Investment securities available-for sale:
 
 
 
 
 
 
 
 
 
 
 
Change in net unrealized gains/losses
during period
$
1,412

 
$
17,167

 
$
555

 
$
6,755

 
$
857

 
$
10,412

Reclassification adjustment for net gains
 included in net income
(52
)
 
(88
)
 
(20
)
 
(35
)
 
(32
)
 
(53
)
Change in unamortized loss on available-
 for-sale securities transferred into held-to-
 maturity
902

 
—

 
355

 
—

 
547

 
—

Defined benefits post-retirement benefit plan:
 
 
 
 
 
 
 
 
 
 
 
Change in net actuarial loss
28

 
70

 
11

 
28

 
17

 
42

Total other comprehensive income
$
2,290

 
$
17,149

 
$
901

 
$
6,748

 
$
1,389

 
$
10,401


The components of accumulated other comprehensive loss, net of income tax benefits, are as follows:
 
June 30,
2015
 
December 31,
2014
Net unrealized loss on investment securities available-for-sale
$
(749
)
 
$
(2,121
)
Net actuarial loss on defined benefit post-retirement benefit plans
(396
)
 
(413
)
Net accumulated other comprehensive loss
$
(1,145
)
 
$
(2,534
)



27

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share data)


(15)
Fair Value Measurements
            
Financial assets and financial liabilities measured at fair value on a recurring basis are as follows:
 
 
Fair Value Measurements at Reporting Date Using
As of June 30, 2015
Balance
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
Significant Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Investment securities available-for-sale:
 
 
 
 
 
 
Obligations of U.S. government agencies
$
621,020

$
—
$
621,020

$
—
U.S. agencies mortgage-backed securities & collateralized mortgage obligations
971,435

 
—
971,435

 
—
Private mortgage-backed securities
288

 
—
288

 
—
 
 
Fair Value Measurements at Reporting Date Using
As of December 31, 2014
Balance
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
Significant Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Investment securities available-for-sale:
 
 
 
 
 
 
Obligations of U.S. government agencies
$
720,933

$
—
$
720,933

$
—
U.S. agencies mortgage-backed securities & collateralized mortgage obligations
990,666

 
—
990,666

 
—
Private mortgage-backed securities
325

 
—
325

 
—
    
There were no changes in valuation methodologies or transfers between levels of the fair value hierarchy during the six months ended June 30, 2015 or 2014.
    
The methodologies used by the Company in determining the fair values of each class of financial instruments are based primarily on the use of independent, market-based data to reflect a value that would be reasonably expected in an orderly transaction between market participants at the measurement date. The Company obtains fair value measurements for investment securities from an independent pricing service. The vendors chosen by the Company are widely recognized vendors whose evaluations support the pricing functions of financial institutions, investment and mutual funds, and portfolio managers. The Company has documented and evaluated the pricing methodologies used by the vendors and maintains internal processes that regularly test valuations. These internal processes include obtaining and reviewing available reports on internal controls, evaluating the prices for reasonableness given market changes, obtaining and evaluating the inputs used in the model for a sample of securities, investigating anomalies and confirming determinations through discussions with the vendor. For investment securities, if needed, a broker may be utilized to determine the reported fair value. Further details on the methods used to estimate the fair value of each class of financial instruments above are discussed below.
            
Investment Securities Available-for-Sale. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the investment's terms and conditions, among other things.
  
Additionally, from time to time, certain assets are measured at fair value on a non-recurring basis. Adjustments to fair value generally result from the application of lower-of-cost-or-market accounting or write-downs of individual assets due to impairment.


28

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share data)


The following table presents information about the Company’s assets and liabilities measured at fair value on a non-recurring basis.
 
 
 
Fair Value Measurements at Reporting Date Using
As of June 30, 2015
Balance
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
Significant Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Impaired loans
$
50,131

$
—
$
—
$
50,131

Other real estate owned
5,623

 
—
 
—
5,623

Long-lived assets to be disposed of by sale
1,083

 
—
 
—
1,083

 
 
 
 
 
 
 
 
 
 
Fair Value Measurements at Reporting Date Using
As of December 31, 2014
Balance
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
Significant Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Impaired loans
$
30,494

$
—
$
—
$
30,494

Other real estate owned
4,554

 
—
 
—
4,554

Long-lived assets to be disposed of by sale
1,083

 
—
 
—
1,083

    
Impaired Loans. Collateralized impaired loans are reported at the fair value of the underlying collateral if repayment is expected solely from collateral. The impaired loans are reported at fair value through specific valuation allowance allocations. In addition, when it is determined that the fair value of an impaired loan is less than the recorded investment in the loan, the carrying value of the loan is adjusted to fair value through a charge to the allowance for loan losses. Collateral values are estimated using independent appraisals and management estimates of current market conditions. As of June 30, 2015, certain impaired loans with a carrying value of $70,827 were reduced by specific valuation allowance allocations of $8,721 and partial loan charge-offs of $11,975 resulting in a reported fair value of $50,131. As of December 31, 2014, certain impaired loans with a carrying value of $45,046 were reduced by specific valuation allowance allocations of $5,792 and partial loan charge-offs of $8,760 resulting in a reported fair value of $30,494.
        
OREO.The fair values of OREO are estimated using independent appraisals and management estimates of current market conditions. Upon initial recognition, write-downs based on the foreclosed asset's fair value at foreclosure are reported through charges to the allowance for loan losses. Periodically, the fair value of foreclosed assets is remeasured with any subsequent write-downs charged to OREO expense in the period in which they are identified. Write-downs of $106 and $10 during the six months ended June 30, 2015 and 2014, respectively, were based on management's estimate of the current fair value of the properties.
    
Long-lived Assets to be Disposed of by Sale. Long-lived assets to be disposed of by sale are carried at the lower of carrying value or fair value less estimated costs to sell. The fair values of long-lived assets to be disposed of by sale are based upon observable market data and management estimates of current market conditions. As of June 30, 2015 and December 31, 2014, the Company had long-lived assets to be disposed of by sale with carrying values aggregating $1,785 that were reduced by write-downs of $702 resulting in an aggregate fair value of $1,083.
    
In addition, mortgage loans held for sale are required to be measured at the lower of cost or fair value. The fair value of mortgage loans held for sale is based upon binding contracts or quotes or bids from third party investors. As of June 30, 2015 and December 31, 2014, all mortgage loans held for sale were recorded at cost.


29

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share data)


The following table presents additional quantitative information about assets measured at fair value on a non-recurring basis and for which the Company has utilized Level 3 inputs to determine fair values:
As of June 30, 2015
Fair
Value
Valuation
Technique
Unobservable
Inputs
Range
(Weighted Average)
Impaired loans
$
50,131

Appraisal
Appraisal adjustment
0%
-
51%
(19%)
Other real estate owned
5,623

Appraisal
Appraisal adjustment
0%
-
50%
(15%)
Long-lived assets to be disposed of by sale
1,083

Appraisal
Appraisal adjustment
0%
-
9%
(5%)
 
 
 
 
 
 
 
 
As of December 31, 2014
Fair
Value
Valuation
Technique
Unobservable
Inputs
Range
(Weighted Average)
Impaired loans
$
30,494

Appraisal
Appraisal adjustment
0%
-
51%
(19%)
Other real estate owned
4,554

Appraisal
Appraisal adjustment
0%
-
50%
(15%)
Long-lived assets to be disposed of by sale
1,083

Appraisal
Appraisal adjustment
0%
-
9%
(5%)
 
 
 
 
 
 
 
 
The Company is required to disclose the fair value of financial instruments for which it is practical to estimate fair value. The methodologies for estimating the fair value of financial instruments that are measured at fair value on a recurring or non-recurring basis are discussed above. The methodologies for estimating the fair value of other financial instruments are discussed below. For financial instruments bearing a variable interest rate where no credit risk exists, it is presumed that recorded book values are reasonable estimates of fair value.
        
Financial Assets. Carrying values of cash, cash equivalents and accrued interest receivable approximate fair values due to the liquid and/or short-term nature of these instruments. Fair values for investment securities held-to-maturity are obtained from an independent pricing service, which considers observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the investment’s terms and conditions, among other things. Fair values of fixed rate loans and variable rate loans that reprice on an infrequent basis are estimated by discounting future cash flows using current interest rates at which similar loans with similar terms would be made to borrowers of similar credit quality. Carrying values of variable rate loans that reprice frequently, and with no change in credit risk, approximate the fair values of these instruments.
        
Financial Liabilities. The fair values of demand deposits, savings accounts, securities sold under repurchase agreements and accrued interest payable are the amounts payable on demand at the reporting date. The fair values of fixed-maturity certificates of deposit are estimated using external market rates currently offered for deposits with similar remaining maturities. The carrying values of the interest bearing demand notes to the United States Treasury are deemed an approximation of fair values due to the frequent repayment and repricing at market rates. The fixed and floating rate subordinated debentures, floating rate subordinated term loan, notes payable to the FHLB, fixed rate subordinated term debt, and capital lease obligation are estimated by discounting future cash flows using current rates for advances with similar characteristics.

Commitments to Extend Credit and Standby Letters of Credit. The fair value of commitments to extend credit and standby letters of credit, based on fees currently charged to enter into similar agreements, is not significant.


30

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share data)


The estimated fair values of financial instruments that are reported in the Company's consolidated balance sheets, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value, are as follows:
 
 
 
Fair Value Measurements at Reporting Date Using
As of June 30, 2015
Carrying Amount
Estimated
Fair Value
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
Significant Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Financial assets:
 
 
 
 
 
Cash and cash equivalents
$
506,434

$
506,434

$
506,434

$
—

$
—

Investment securities available-for-sale
1,592,743

1,592,743

—

1,592,743

—

Investment securities held-to-maturity
546,690

553,323

—

553,323

—

Accrued interest receivable
29,008

29,008

—

29,008

—

Mortgage servicing rights, net
14,654

28,320

—

28,320

—

Net loans
5,027,394

5,000,935

—

4,950,804

50,131

Total financial assets
$
7,716,923

$
7,710,763

$
506,434

$
7,154,198

$
50,131

 
 
 
 
 
 
Financial liabilities:
 
 
 
 
 
Total deposits, excluding time deposits
$
5,655,166

$
5,655,166

$
5,655,166

$
—

$
—

Time deposits
1,149,235

1,153,809

—

1,153,809

—

Securities sold under repurchase agreements
469,145

469,145

—

469,145

—

Other borrowed funds
3

3

—

3

—

Accrued interest payable
5,366

5,366

—

5,366

—

Long-term debt
43,068

41,584

—

41,584

—

Subordinated debentures held by subsidiary
   trusts
82,477

76,393

—

76,393

—

Total financial liabilities
$
7,404,460

$
7,401,466

$
5,655,166

$
1,746,300

$
—

 
 
 
Fair Value Measurements at Reporting Date Using
As of December 31, 2014
Carrying Amount
Estimated
Fair Value
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
Significant Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Financial assets:
 
 
 
 
 
Cash and cash equivalents
$
798,670

$
798,670

$
798,670

$
—

$
—

Investment securities available-for-sale
1,711,924

1,711,924

—

1,711,924

—

Investment securities held-to-maturity
575,186

584,533

—

584,533

—

Accrued interest receivable
27,063

27,063

—

27,063

—

Mortgage servicing rights, net
14,038

21,434

—

21,434

—

Net loans
4,823,243

4,800,725

—

4,770,231

30,494

Total financial assets
$
7,950,124

$
7,944,349

$
798,670

$
7,115,185

$
30,494

 
 
 
 
 
 
Financial liabilities:
 
 
 
 
 
Total deposits, excluding time deposits
$
5,767,992

$
5,767,992

$
5,767,992

$
—

$
—

Time deposits
1,238,220

1,244,324

—

1,244,324

—

Securities sold under repurchase agreements
502,250

502,250

—

502,250

—

Other borrowed funds
9

9

—

9

—

Accrued interest payable
5,833

5,833

—

5,833

—

Long-term debt
38,067

37,781

—

37,781

—

Subordinated debentures held by subsidiary
   trusts
82,477

75,734

—

75,734

—

Total financial liabilities
$
7,634,848

$
7,633,923

$
5,767,992

$
1,865,931

$
—



31

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share data)


(16)
Recent Authoritative Accounting Guidance            
    
ASU 2014-04 “Receivables-Troubled Debt Restructurings by Creditors (Subtopic 310-40): Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure.” The amendments in ASU 2014-04 clarify that an in-substance repossession or foreclosures occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (i) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (ii) the borrower conveying all interest in the residential real estate property to the creditor to satisfy the loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. The amendments in ASU 2014-04 also require interim and annual disclosure of both (i) the amount of foreclosed residential real estate property held by the creditor and (ii) the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure. The Company adopted the amendments in ASU 2014-04 effective January 1, 2015 using a prospective transition method. Adoption of the amendments in ASU 2014-04 did not have a material impact on the Company’s consolidated financial statements, results of operations or liquidity.
    
ASU 2014-09 "Revenue from Contracts with Customers." The amendments in ASU 2014-09 introduce a new five-step revenue recognition model in which an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2014-09 also requires disclosures sufficient to enable users to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers, including qualitative and quantitative disclosures about contracts with customers, significant judgments and changes in judgments, and assets recognized from the costs to obtain or fulfill a contract. The amendments in ASU 2014-09 are effective for the Company for fiscal years beginning after December 15, 2016, including interim periods within that reporting period, and may be adopted retrospectively to each prior reporting period presented or retrospectively with the cumulative effect of initial adoption recognized at the date of initial application. The Company is currently evaluating the new guidance to determine the impact it will have on its consolidated financial statements, results of operations or liquidity.
    
ASU 2014-11 "Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures." The amendments in ASU 2014-11 expand secured borrowing treatment for certain repurchase agreements. Under the amendments in ASU 2014-11, repurchase-to-maturity transactions and repurchase agreements executed as repurchase financing transactions are required to be accounted for as secured borrowings. ASU 2014-11 requires additional disclosures about certain transactions accounted for as a sale in which the transferor retains substantially all of the exposure to the economic return on the transferred financial assets through an agreement with the same counterparty. ASU 2014-11 also requires disclosure of the types of collateral pledged and liabilities associated with an entity's repurchase agreements, securities lending transactions and repurchase-to-maturity transactions accounted for as secured borrowings. The Company adopted the amendments in ASU 2014-11 are effective January 1, 2015. The adoption did not have a material impact on the Company’s consolidated financial statements, results of operations or liquidity.
    
ASU 2014-12 "Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could be Achieved after the Requisite Service Period." ASU 2014-12 amends Accounting Standards Codification ("ASC") Topic 718, Compensation-Stock Compensation, to clarify that a performance target that affects the vesting of a share-based payment award and that could be achieved after the requisite service period should be treated as a performance condition that affects the vesting of the award. ASU 2014-12 further clarifies that the requisite service period ends when the employees can cease rendering service and still be eligible to vest in the award if the performance target is achieved. The amendments in ASU 2014-12 are effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. The amendments in ASU 2014-12 may be applied prospectively to all awards granted or modified after the effective date or retrospectively to all awards with performance targets that are outstanding as of the beginning of the earliest annual period presented in the financial statements and to all new or modified awards thereafter. The amendments in ASU 2014-12 will not have a material impact on the Company’s consolidated financial statements, results of operations or liquidity.
    
ASU 2014-14 "Classification of Certain Government-Guaranteed Mortgage Loans upon Foreclosure." ASU 2014-14 updates ASC Subtopic 310-40, Receivables-Troubled Debt Restructurings by Creditors, to require that a mortgage loan be derecognized and that a separate other receivable be recognized upon foreclosure if (i) the loan has a government guarantee that is not separable from the loan before foreclosure; (ii) at the time of foreclosure, the creditor

32

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share data)


has the intent to convey the real estate property to the guarantor and make a claim on the guarantee, and the creditor has the ability to recover under that claim; and, (iii) any amount of the claim that is determined on the basis of the fair value of the real estate is fixed at the time of foreclosure. ASU 2014-14 provides that, upon foreclosure, the separate other receivable should be measured based on the amount of the loan balance (principal and interest) expected to be recovered from the guarantor. The Company adopted the amendments in ASU 2014-14 effective January 1, 2015, using a prospective transition method. Adoption of the amendments in ASU 2014-12 did not have a material impact on the Company’s consolidated financial statements, results of operations or liquidity.

ASU 2014-16 "Determining Whether the Host Contract in a Hybrid Financial Instrument Issued in the Form of a Share is More Akin to Debt or to Equity." The amendments in ASU 2014-16 clarify that an entity should consider all relevant terms and features-including the embedded derivative feature being evaluated for bifurcation-in evaluating the nature of the host contract within a hybrid financial instrument. The amendments further clarify that no single term or feature would necessarily determine the economic characteristics and risk of the host contract. Rather, the nature of the host contract depends upon the economic characteristics and risk of the entire hybrid financial instrument. The amendments in ASU 2014-16 are effective for the Company for annual periods, and interim periods within those annual periods, beginning after December 15, 2015. The effects of initially adopting the amendments in ASU 2014-16 should be applied on a modified retrospective basis to existing hybrid financial instruments issued in the form of a share as of the beginning of the fiscal year for which the amendments are effective. Retrospective application is permitted to all relevant prior periods. The amendments in ASU 2014-16 will not have a material impact on the Company’s consolidated financial statements, results of operations or liquidity.

ASU 2015-02 "Amendments to the Consolidation Analysis." The amendments in ASU 2015-02 (i) modify the evaluation of whether limited partnerships and similar legal entities are variable interest entities or voting interest entities, (ii) eliminate the presumption that a general partner should consolidate a limited partnership, (iii) affect the consolidation analysis of reporting entities that are involved with variable interest entities, particularly those that have fee arrangements and related party relationships, and (iv) provide scope exceptions from consolidation guidance for reporting entities with interest in legal entities that are required to comply or operate in accordance with requirements of the Investment Company Act of 1940 for registered market funds. The amendments in ASU 2015-02 are effective for public entities for fiscal years, and interim periods within those years, beginning after December 15, 2015, with early adoption permitted. The amendments in ASU 2015-02, which may be adopted using a retrospective or modified retrospective approach, will not have a material impact on the Company’s consolidated financial statements, results of operations or liquidity.

ASU 2015-03 "Simplifying the Presentation of Debt Issuance Costs." The amendments in ASU 2015-03 require that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, rather than as a deferred charge. The amendments in ASU 2015-03 are effective for public entities for fiscal years, and interim periods within those years, beginning after December 15, 2015, and should be applied on a retrospective basis. The amendments in ASU 2015-03 will not have a material impact on the Company’s consolidated financial statements, results of operations or liquidity.

ASU 2015-05 "Intangibles-Goodwill and Other Internal-Use Software." The amendments in ASU 2015-05 (i) provide guidance about whether a cloud computing arrangement includes a software license. Under the guidance in ASU 2015-05, if a cloud computing arrangement includes a software license, the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract. The guidance in ASU 2015-05 does not change generally accepted accounting principles for a customer's accounting for service contracts. The amendments in ASU 2015-05 are effective for public entities for annual periods, including interim periods within those annual periods, beginning after December 15, 2015, with early adoption permitted. The amendments in ASU 2015-05, which may be adopted retrospectively or prospectively to all arrangements entered into or materially modified after the effective date. Adoption of the amendments in ASU 2015-05 will not have a material impact on the Company’s consolidated financial statements, results of operations or liquidity.


33

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share data)


ASU 2015-10 "Technical Corrections and Improvements." The amendments in ASU 2015-10 represent changes to clarify the codification, correct unintended application of guidance, or make minor improvements to the codification that are not expected to have a significant effect on current accounting practice or create a significant administrative cost to most entities. The amendments in ASU 2015-10 that require transition guidance are effective for all entities for fiscal years, and interim periods within those years, beginning after December 15, 2015, with early adoption permitted. All other amendments in ASU 2015-10 became effective in June 2015. The amendments in ASU 2015-03 will not have a material impact on the Company’s consolidated financial statements, results of operations or liquidity.
    
(17)
Subsequent Events
    
Subsequent events have been evaluated for potential recognition and disclosure through the date financial statements were filed with the Securities and Exchange Commission. On July 23, 2015, the Company declared a quarterly dividend to common shareholders of $0.20 per share, to be paid on August 14, 2015 to shareholders of record as of August 3, 2015.     

On July 24, 2015, the Company completed the acquisition of Absarokee, parent company of United Bank, and the subsequent merger of United Bank with and into FIB. For additional information regarding the acquisition and subsequent bank merger, see "Note 2 - Acquisitions."
    
No other events requiring recognition or disclosure were identified.

34

Item 2.
                    
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
                    
The following discussion should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2014, including the audited financial statements contained therein, filed with the Securities and Exchange Commission, or SEC.
            
When we refer to “we,” “our,” and “us” in this report, we mean First Interstate BancSystem, Inc. and our consolidated subsidiaries, unless the context indicates that we refer only to the parent company, First Interstate BancSystem, Inc.
    
Cautionary Note Regarding Forward-Looking Statements and Factors that Could Affect Future Results
    
“Forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Rule 175 promulgated thereunder, and Section 21E of the Securities Exchange Act of 1934, as amended, and Rule 3b-6 promulgated thereunder, that involve inherent risks and uncertainties. Any statements about our plans, objectives, expectations, strategies, beliefs, or future performance or events constitute forward-looking statements. Such statements are identified as those that include words or phrases such as “believes,” “expects,” “anticipates,” “plans,” “trend,” “objective,” “continue” or similar expressions or future or conditional verbs such as “will,” “would,” “should,” “could,” “might,” “may” or similar expressions. Forward-looking statements involve known and unknown risks, uncertainties, assumptions, estimates and other important factors that could cause actual results to differ materially from any results, performance or events expressed or implied by such forward-looking statements. The following factors, among others, may cause actual results to differ materially from current expectations in the forward-looking statements, including those set forth in this report: continuing or worsening business and economic conditions, adverse economic conditions affecting Montana, Wyoming and western South Dakota, credit losses, lending risk, adequacy of the allowance for loan losses, impairment of goodwill, failure to manage growth, access to low-cost funding sources, changes in interest rates, dependence on the Company’s management team, ability to attract and retain qualified employees, governmental regulation and changes in regulatory, tax and accounting rules and interpretations, failure of technology, cyber-security, unfavorable resolution of pending litigation, inability to meet liquidity requirements, environmental remediation and other costs, ineffective internal operational controls, competition, reliance on external vendors, litigation pertaining to fiduciary responsibilities, failure to effectively implement technology-driven products and services, soundness of other financial institutions, inability of our bank subsidiary to pay dividends, implementation of new lines of business or new product or service offerings, change in dividend policy, volatility of Class A common stock, decline in market price of Class A common stock, dilution as a result of future equity issuances, uninsured nature of any investment in Class A common stock, voting control of Class B stockholders, anti-takeover provisions, controlled company status, and, subordination of common stock to Company debt.
    
A more detailed discussion of each of the foregoing risks is included in the Company's Annual Report on Form 10-K for the year ended December 31, 2014, filed February 27, 2015. These factors and the other risk factors described in the Company's periodic and current reports filed with the SEC from time to time, however, are not necessarily all of the important factors that could cause the Company's actual results, performance or achievements to differ materially from those expressed in or implied by any of the Company's forward-looking statements. Other unknown or unpredictable factors also could harm the Company's results. Investors and others are encouraged to read the more detailed discussion of the Company's risks contained in the Company's Annual Report on Form 10-K for the year ended December 31, 2014.
    
All forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements set forth above. Forward-looking statements speak only as of the date they are made and we do not undertake or assume any obligation to update publicly any of these statements to reflect actual results, new information or future events, changes in assumptions or changes in other factors affecting forward-looking statements, except to the extent required by applicable laws. If we update one or more forward-looking statements, no inference should be drawn that we will make additional updates with respect to those or other forward-looking statements.
    
Executive Overview
    
We are a financial holding company headquartered in Billings, Montana. As of June 30, 2015, we had consolidated assets of $8,386 million, deposits of $6,804 million, loans of $5,104 million and total stockholders’ equity of $925 million. We currently operate 83 banking offices, including detached drive-up facilities, in 45 communities located in Montana, Wyoming and western South Dakota. Through our bank subsidiary, First Interstate Bank, or FIB, we deliver a comprehensive range of banking products and services to individuals, businesses, municipalities and other entities throughout our market areas. Our customers participate in a wide variety of industries, including energy, tourism, agriculture, healthcare, professional services, education, governmental services, construction, mining, retail and wholesale trade.

35

Our Business
            
Our principal business activity is lending to and accepting deposits from individuals, businesses, municipalities and other entities. We derive our income principally from interest charged on loans and, to a lesser extent, from interest and dividends earned on investments. We also derive income from non-interest sources such as fees received in connection with various lending and deposit services; trust, employee benefit, investment and insurance services; mortgage loan originations, sales and servicing; merchant and electronic banking services; and from time to time, gains on sales of assets. Our principal expenses include interest expense on deposits and borrowings, operating expenses, provisions for loan losses and income tax expense.
    
Our loan portfolio consists of a mix of real estate, consumer, commercial, agricultural and other loans, including fixed and variable rate loans. Our real estate loans comprise commercial real estate, construction (including residential, commercial and land development loans), residential, agricultural and other real estate loans. Fluctuations in the loan portfolio are directly related to the economies of the communities we serve. While each loan originated generally must meet minimum underwriting standards established in our credit policies, lending officers are granted discretion within pre-approved limits in approving and pricing loans to assure that the banking offices are responsive to competitive issues and community needs in each market area. We fund our loan portfolio primarily with the core deposits from our customers, generally without utilizing brokered deposits and with minimal reliance on wholesale funding sources.
    
Recent Developments
    
On March 26, 2015, the Company entered into an agreement and plan of merger to acquire all of the outstanding stock of Absarokee Bancorporation, Inc., or Absarokee, a Montana-based bank holding company that operates one wholly-owned subsidiary bank, United Bank, with branches located in three Montana communities adjacent to the Company's existing market areas. The acquisition was completed on July 24, 2015. Pursuant to the terms of the Agreement and Plan of Merger to acquire Absarokee, the Company paid cash consideration of $7.2 million. As of the acquisition date, Absarokee had total assets of $73 million, loans of $38 million and deposits of $64 million. Immediately subsequent to the acquisition, the Company merged United Bank with and into its existing banking subsidiary, FIB. For additional information regarding the acquisition, see “Note 2 – Acquisitions” and "Note 17 – Subsequent Events" in the accompanying “Notes to Unaudited Consolidated Financial Statements” included in this report.
    
On July 2, 2013, the Board of Governors of the Federal Reserve Bank issued a final rule implementing a revised regulatory capital framework for U.S. banks in accordance with the Basel III international accord. As a banking organization subject to the standardized approach, the revised regulatory capital framework, or Basel III, became effective for us on January 1, 2015. Basel III includes a more stringent definition of capital and introduces a new common equity tier 1, or CET1, capital requirement, sets forth a comprehensive methodology for calculating risk-weighted assets, introduces a conservation buffer and sets out minimum capital ratios and overall capital adequacy standards. Certain deductions and adjustments to regulatory capital phase in starting January 1, 2015 and will be fully implemented on January 1, 2018. The capital conservation buffer phases in beginning January 1, 2016 and will be fully implemented on January 1, 2019. As of June 30, 2015 and December 31, 2014, we had capital levels that, in all cases, exceeded the well-capitalized guidelines. For additional information regarding our capital levels, see "Capital Resources and Liquidity Management" included herein and “Note 10 – Regulatory Capital” in the accompanying “Notes to Unaudited Consolidated Financial Statements” included in this report.
    
Primary Factors Used in Evaluating Our Business
            
As a banking institution, we manage and evaluate various aspects of both our financial condition and our results of operations. We monitor our financial condition and performance on a monthly basis at our holding company, at the Bank and at each banking office. We evaluate the levels and trends of the line items included in our balance sheet and statements of income, as well as various financial ratios that are commonly used in our industry. We analyze these ratios and financial trends against both our own historical levels and the financial condition and performance of comparable banking institutions in our region and nationally.
    
Results of Operations
        
Principal factors used in managing and evaluating our results of operations include return on average equity, net interest income, non-interest income, non-interest expense and net income. Net interest income is affected by the level of interest rates, changes in interest rates and changes in the volume and composition of interest earning assets and interest bearing liabilities. The most significant impact on our net interest income between periods is derived from the interaction of changes in the rates earned or paid on interest earning assets and interest bearing liabilities, which we refer to as interest rate spread. The volume of loans, investment securities and other interest earning assets, compared to the volume of interest bearing deposits and indebtedness, combined with the interest rate spread, produces changes in our net interest income between periods. Non-interest bearing sources of funds, such as demand deposits and stockholders’ equity, also support earning assets.
    

36

The impact of free funding sources is captured in the net interest margin, which is calculated as net interest income divided by average earning assets. We evaluate our net interest income on factors that include the yields on our loans and other earning assets, the costs of our deposits and other funding sources, the levels of our net interest spread and net interest margin and the provisions for loan losses required to maintain our allowance for loan losses at an adequate level.
        
We seek to increase our non-interest income over time and we evaluate our non-interest income relative to the trends of the individual types of non-interest income in view of prevailing market conditions.
    
We manage our non-interest expenses in consideration of growth opportunities and our community banking model that emphasizes customer service and responsiveness. We evaluate our non-interest expense on factors that include our non-interest expense relative to our average assets, our efficiency ratio and the trends of the individual categories of non-interest expense.
    
Finally, we seek to increase our net income and provide favorable shareholder returns over time, and we evaluate our net income relative to the performance of other bank holding companies on factors that include return on average assets, return on average equity, total shareholder return and growth in earnings.
    
Financial Condition
            
Principal areas of focus in managing and evaluating our financial condition include liquidity, the diversification and quality of our loans, the adequacy of our allowance for loan losses, the diversification and terms of our deposits and other funding sources, the re-pricing characteristics and maturities of our assets and liabilities, including potential interest rate exposure and the adequacy of our capital levels. We seek to maintain sufficient levels of cash and investment securities to meet potential payment and funding obligations, and we evaluate our liquidity on factors that include the levels of cash and highly liquid assets relative to our liabilities, the quality and maturities of our investment securities, the ratio of loans to deposits and any reliance on brokered certificates of deposit or other wholesale funding sources.
        
We seek to maintain a diverse and high quality loan portfolio and evaluate our asset quality on factors that include the allocation of our loans among loan types, credit exposure to any single borrower or industry type, non-performing assets as a percentage of total loans and OREO, and loan charge-offs as a percentage of average loans. We seek to maintain our allowance for loan losses at a level adequate to absorb probable losses inherent in our loan portfolio at each balance sheet date, and we evaluate the level of our allowance for loan losses relative to our overall loan portfolio and the level of non-performing loans and potential charge-offs.
        
We seek to fund our assets primarily using core customer deposits spread among various deposit categories, and we evaluate our deposit and funding mix on factors that include the allocation of our deposits among deposit types, the level of our non-interest bearing deposits, the ratio of our core deposits (i.e. excluding time deposits above $100,000) to our total deposits and our reliance on brokered deposits or other wholesale funding sources, such as borrowings from other banks or agencies. We seek to manage the mix, maturities and re-pricing characteristics of our assets and liabilities to maintain relative stability of our net interest rate margin in a changing interest rate environment, and we evaluate our asset-liability management using models to evaluate the changes to our net interest income under different interest rate scenarios.
    
Finally, we seek to maintain adequate capital levels to absorb unforeseen operating losses and to help support the growth of our balance sheet. We evaluate our capital adequacy using the regulatory and financial capital ratios including leverage capital ratio, tier 1 risk-based capital ratio, total risk-based capital ratio, common equity tier 1 risk-based capital ratio and tangible common equity to tangible assets.
    
Critical Accounting Estimates and Significant Accounting Policies
        
Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States and follow general practices within the industries in which we operate. Application of these principles requires management to make estimates, assumptions and judgments that affect the amounts reported in the consolidated financial statements and accompanying notes. The most significant accounting policies we follow are summarized in Note 1 of the Notes to Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2014.
        
Our critical accounting estimates are summarized below. Management considers an accounting estimate to be critical if: (1) the accounting estimate requires management to make particularly difficult, subjective and/or complex judgments about matters that are inherently uncertain and (2) changes in the estimate that are reasonably likely to occur from period to period, or the use of different estimates that management could have reasonably used in the current period, would have a material impact on our consolidated financial statements, results of operations or liquidity.

37

Allowance for Loan Losses
            
The provision for loan losses creates an allowance for loan losses known and inherent in the loan portfolio at each balance sheet date. The allowance for loan losses represents management’s estimate of probable credit losses inherent in the loan portfolio.
                
We perform a quarterly assessment of the risks inherent in our loan portfolio, as well as a detailed review of each significant loan with identified weaknesses. Based on this analysis, we record a provision for loan losses in order to maintain the allowance for loan losses at appropriate levels. In determining the allowance for loan losses, we estimate losses on specific loans, or groups of loans, where the probable loss can be identified and reasonably determined. Determining the amount of the allowance for loan losses is considered a critical accounting estimate because it requires significant judgment and the use of subjective measurements, including management’s assessment of the internal risk classifications of loans, historical loan loss rates, changes in the nature of the loan portfolio, overall portfolio quality, industry concentrations, delinquency trends and the impact of current local, regional and national economic factors on the quality of the loan portfolio. Changes in these estimates and assumptions are possible and may have a material impact on our allowance, and therefore our consolidated financial statements or results of operations. The allowance for loan losses is maintained at an amount we believe is sufficient to provide for estimated losses inherent in our loan portfolio at each balance sheet date, and fluctuations in the provision for loan losses result from management’s assessment of the adequacy of the allowance for loan losses. Management monitors qualitative and quantitative trends in the loan portfolio, including changes in the levels of past due, internally classified and non-performing loans. Note 1 of the Notes to Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended December 31, 2014 describes the methodology used to determine the allowance for loan losses. A discussion of the factors driving changes in the amount of the allowance for loan losses is included herein under the heading “Asset Quality."
            
Goodwill
                
The excess purchase price over the fair value of net assets from acquisitions, or goodwill, is evaluated for impairment at least annually and on an interim basis if an event or circumstance indicates that it is likely impairment has occurred. In any given year, the Company may elect to perform a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is in excess of its carrying value. If it is not more likely than not that the fair value of the reporting unit is in excess of the carrying value, or if the Company elects to bypass the qualitative assessment, a two-step quantitative impairment test is performed. In performing a quantitative test for impairment, the fair value of net assets is estimated based on an analysis of our market value, discounted cash flows and peer values. Determining the fair value of goodwill is considered a critical accounting estimate because of its sensitivity to market-based economics. In addition, any allocation of the fair value of goodwill to assets and liabilities requires significant management judgment and the use of subjective measurements. Variability in market conditions and key assumptions or subjective measurements used to estimate and allocate fair value are reasonably possible and could have a material impact on our consolidated financial statements or results of operations. Note 1 of the Notes to the Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended December 31, 2014 describes our accounting policy with regard to goodwill.
                
Our annual evaluation of goodwill for impairment is performed as of July 1st each year. Upon completion of the most recent evaluation, it was determined that the estimated fair value of net assets was greater than the carrying value of the Company. We will continue to monitor our performance and evaluate our goodwill for impairment annually or more frequently as needed.
    
Fair Values of Loans Acquired in Business Combinations
    
Loans acquired in business combinations are initially recorded at fair value with no carryover of the related allowance for credit losses. Determining the fair value of the loans involves estimating the amount and timing of principal and interest cash flows initially expected to be collected on the loans and discounting those cash flows at an appropriate market rate of interest. Going forward, the Company continues to evaluate reasonableness of expectations for the timing and the amount of cash to be collected. Subsequent decreases in expected cash flows may result in changes in the amortization or accretion of fair market value adjustments, and in some cases may result in the loan being considered impaired.  For collateral dependent loans with deteriorated credit quality, the Company estimates the fair value of the underlying collateral of the loans. These values are discounted using market derived rates of return, with consideration given to the period of time and costs associated with the foreclosure and disposition of the collateral. Note 1 of the Notes to the Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended December 31, 2014 describes our accounting policy with regard to acquired loans.
        

38

Results of Operations
        
The following discussion and analysis is intended to provide greater details of the results of our operations and financial condition.
    
Net Interest Income. Our net interest income on a fully taxable equivalent, or FTE, basis increased $5.6 million, or 9.2%, to $66.4 million during the three months ended June 30, 2015, as compared to $60.8 million for the same period in 2014, and $11.8 million, or 9.8%, to $131.8 million during the six months ended June 30, 2015, as compared to $120.0 million for the same period in 2014. These increases were primarily attributable to growth in average interest earning assets as a result of the July 2014 acquisition of Mountain West Financial Corp, or Mountain West, in which we acquired cash and cash equivalents totaling $74 million, loans totaling $360 million and investment securities totaling $105 million. In addition,we experienced organic growth in total loans of approximately 5.3% from June 30, 2014 through June 30, 2015, which also positively impacted our quarter-to-date and year-to-date net FTE interest income.
    
Also positively impacting our net interest income during the three and six months ended June 30, 2015, as compared to the same periods in the prior year, was interest accretion related to the fair valuation of acquired loans. Interest accretion related to the fair valuation of acquired loans was $1.6 million during the three months ended June 30, 2015, of which $470 thousand was the result of early loan payoffs. For the six months ended June 30, 2015, interest accretion related to the fair valuation of acquired loans was $2.7 million, of which $821 thousand was the result of early loan payoffs.
    
Despite increases in our net interest income, our net FTE interest margin ratio decreased 7 basis points to 3.47% for the three months ended June 30, 2015, as compared to 3.54% for the same period in 2014, and 8 basis points to 3.45% for the six months ended June 30, 2015, as compared to 3.53% during the same period in 2014. Decreases in net FTE interest margin ratio during the three and six months ended June 30, 2015, as compared to the same periods in 2014, were primarily due to lower yields earned on loans and investment securities, which were partially offset by increases in the average outstanding interest earning assets and reductions in funding costs. Exclusive of the fair value accretion resulting from the early payoff of acquired loans and recoveries of previously charged-off interest, our net interest margin ratio was 3.40% during the three months ended June 30, 2015, as compared to 3.46% for the same period in 2014, and 3.39% during the six months ended June 30, 2015, as compared to 3.48% during the same period in 2014.
        

39

The following tables present, for the periods indicated, condensed average balance sheet information, together with interest income and yields earned on average interest earning assets and interest expense and rates paid on average interest bearing liabilities.
Average Balance Sheets, Yields and Rates
 
 
 
 
 
 
 
(Dollars in thousands)
Three Months Ended June 30,
 
2015
 
2014
 
Average
Balance
Interest
Average
Rate
 
Average
Balance
Interest
Average
Rate
Interest earning assets:
 
 
 
 
 
 
 
Loans (1) (2)
$
4,991,416

$
60,911

4.89
%
 
$
4,436,786

$
56,019

5.06
%
Investment securities (2)
2,319,636

9,642

1.67

 
2,091,438

9,017

1.73

Interest bearing deposits in banks
369,345

271

0.29

 
356,911

225

0.25

Federal funds sold
3,168

5

0.63

 
1,958

3

0.61

Total interest earnings assets
7,683,565

70,829

3.70

 
6,887,093

65,264

3.80

Non-earning assets
743,545

 
 
 
669,029

 
 
Total assets
$
8,427,110

 
 
 
$
7,556,122

 
 
Interest bearing liabilities:
 
 
 
 
 
 
 
Demand deposits
$
2,086,443

$
524

0.10
%
 
$
1,878,483

$
513

0.11
%
Savings deposits
1,874,508

624

0.13

 
1,653,034

598

0.15

Time deposits
1,175,753

2,091

0.71

 
1,148,832

2,216

0.77

Repurchase agreements
448,810

53

0.05

 
438,744

63

0.06

Other borrowed funds
7

—

—

 
8

—

—

Long-term debt
43,039

538

5.01

 
36,897

476

5.17

Subordinated debentures held by subsidiary trusts
82,477

600

2.92

 
82,477

592

2.88

Total interest bearing liabilities
5,711,037

4,430

0.31

 
5,238,475

4,458

0.34

Non-interest bearing deposits
1,739,329

 
 
 
1,443,239

 
 
Other non-interest bearing liabilities
55,515

 
 
 
44,291

 
 
Stockholders’ equity
921,229

 
 
 
830,117

 
 
Total liabilities and stockholders’ equity
$
8,427,110

 

 
 
$
7,556,122

 

 
Net FTE interest income
 
66,399

 
 
 
60,806

 
Less FTE adjustments (2)
 
(1,111
)
 
 
 
(1,079
)
 
Net interest income from consolidated statements of income
 
$
65,288

 

 
 
$
59,727

 

Interest rate spread
 
 
3.39
%
 
 
 
3.46
%
Net FTE interest margin (3)
 
 
3.47
%
 
 
 
3.54
%
Cost of funds, including non-interest bearing demand deposits (4)
 
 
0.24
%
 
 
 
0.27
%
    
(1)
Average loan balances include non-accrual loans. Interest income on loans includes amortization of deferred loan fees net of deferred loan costs, which is not material.
(2)
Interest income and average rates for tax exempt loans and securities are presented on a FTE basis.
(3)
Net FTE interest margin during the period equals (i) the difference between annualized interest income on interest earning assets and the annualized interest expense on interest bearing liabilities, divided by (ii) average interest earning assets for the period.
(4)
Calculated by dividing total annualized interest on interest bearing liabilities by the sum of total interest bearing liabilities plus non-interest bearing deposits.
    

40

Average Balance Sheets, Yields and Rates
 
 
 
 
 
 
 
(Dollars in thousands)
Six Months Ended June 30,
 
2015
 
2014
 
Average
Balance
Interest
Average
Rate
 
Average
Balance
Interest
Average
Rate
Interest earning assets:
 
 
 
 
 
 
 
Loans (1) (2)
$
4,943,547

$
120,727

4.92
%
 
$
4,391,143

$
110,211

5.06
%
Investment securities (2)
2,307,104

19,283

1.69

 
2,099,993

18,387

1.77

Interest bearing deposits in banks
457,475

660

0.29

 
362,815

456

0.25

Federal funds sold
2,176

7

0.65

 
1,531

4

0.53

Total interest earnings assets
7,710,302

140,677

3.68

 
6,855,482

129,058

3.80

Non-earning assets
747,788

 
 
 
666,748

 
 
Total assets
$
8,458,090

 
 
 
$
7,522,230

 
 
Interest bearing liabilities:
 
 
 
 
 
 
 
Demand deposits
$
2,087,815

$
1,030

0.10
%
 
$
1,858,211

$
1,025

0.11
%
Savings deposits
1,878,640

1,252

0.13

 
1,646,296

1,193

0.15

Time deposits
1,198,048

4,266

0.72

 
1,160,783

4,533

0.79

Repurchase agreements
464,083

107

0.05

 
447,601

129

0.06

Other borrowed funds
5

—

—

 
7

—

—

Long-term debt
40,589

1,052

5.23

 
36,903

949

5.19

Subordinated debentures held by subsidiary trusts
82,477

1,190

2.91

 
82,477

1,180

2.89

Total interest bearing liabilities
5,751,657

8,897

0.31

 
5,232,278

9,009

0.35

Non-interest bearing deposits
1,731,210

 
 
 
1,423,639

 
 
Other non-interest bearing liabilities
60,924

 
 
 
47,223

 
 
Stockholders’ equity
914,299

 
 
 
819,090

 
 
Total liabilities and stockholders’ equity
$
8,458,090

 

 
 
$
7,522,230

 

 
Net FTE interest income
 
131,780

 
 
 
120,049

 
Less FTE adjustments (2)
 
(2,167
)
 
 
 
(2,186
)
 
Net interest income from consolidated statements of income
 
$
129,613

 

 
 
$
117,863

 

Interest rate spread
 
 
3.37
%
 
 
 
3.45
%
Net FTE interest margin (3)
 
 
3.45
%
 
 
 
3.53
%
Cost of funds, including non-interest bearing demand deposits (4)
 
 
0.24
%
 
 
 
0.27
%
    
(1)
Average loan balances include non-accrual loans. Interest income on loans includes amortization of deferred loan fees net of deferred loan costs, which is not material.
(2)
Interest income and average rates for tax exempt loans and securities are presented on a FTE basis.
(3)
Net FTE interest margin during the period equals (i) the difference between annualized interest income on interest earning assets and the annualized interest expense on interest bearing liabilities, divided by (ii) average interest earning assets for the period.
(4)
Calculated by dividing total annualized interest on interest bearing liabilities by the sum of total interest bearing liabilities plus non-interest bearing deposits.


41

The table below sets forth, for the periods indicated, a summary of the changes in interest income and interest expense resulting from estimated changes in average asset and liability balances (volume) and estimated changes in average interest rates (rate). Changes which are not due solely to volume or rate have been allocated to these categories based on the respective percent changes in average volume and average rate as they compare to each other.    
Analysis of Interest Changes Due to Volume and Rates
 
 
 
 
 
 
 
 
(Dollars in thousands)
Three Months Ended June 30, 2015
compared with
Three Months Ended June 30, 2014
 
Six Months Ended June 30, 2015
compared with
Six Months Ended June 30, 2014
 
Volume
 
Rate
 
Net
 
Volume
 
Rate
 
Net
Interest earning assets:
 
 
 
 
 
 
 
 
 
 
 
Loans (1)
$
7,002

 
$
(2,110
)
 
$
4,892

 
$
13,864

 
$
(3,348
)
 
$
10,516

Investment securities (1)
984

 
(359
)
 
625

 
1,814

 
(919
)
 
895

Interest bearing deposits in banks
8

 
38

 
46

 
119

 
85

 
204

Federal funds sold
2

 
—

 
2

 
2

 
1

 
3

Total change
7,996

 
(2,431
)
 
5,565

 
15,799

 
(4,181
)
 
11,618

Interest bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
Demand deposits
57

 
(46
)
 
11

 
127

 
(122
)
 
5

Savings deposits
80

 
(54
)
 
26

 
168

 
(109
)
 
59

Time deposits
52

 
(177
)
 
(125
)
 
146

 
(413
)
 
(267
)
Repurchase agreements
1

 
(11
)
 
(10
)
 
5

 
(27
)
 
(22
)
Long-term debt
79

 
(17
)
 
62

 
95

 
8

 
103

Subordinated debentures held by subsidiary trusts
—

 
8

 
8

 
—

 
10

 
10

Total change
269

 
(297
)
 
(28
)
 
541

 
(653
)
 
(112
)
Increase (decrease) in FTE net interest income
$
7,727

 
$
(2,134
)
 
$
5,593

 
$
15,258

 
$
(3,528
)
 
$
11,730

            
(1)Interest income for tax exempt loans and securities are presented on a FTE basis.
        
Provision for Loan Losses. During the three and six months ended June 30, 2015, we recorded a provision for loan losses of $1.3 million and $2.4 million, as compared to the reversal of provision for loan losses of $2.0 million and $7.0 million recorded during the same respective periods in 2014. The increase in provision is reflective of loan growth, increases in specific reserves on impaired loans and lower levels of recoveries of previously charged-off loans. For information regarding our non-performing loans, see “Non-Performing Assets” included herein.
                
Non-interest Income. Our principal sources of non-interest income include other service charges, commissions and fees; income from the origination and sale of loans; wealth management revenues; and, service charges on deposit accounts. Non-interest income increased $5.2 million, or 19.6%, to $31.8 million for the three months ended June 30, 2015, as compared to $26.6 million for the same period in 2014, and $8.9 million, or 17.5%, to $59.6 million for the six months ended June 30, 2015, as compared to $50.7 million during the same period in 2014. Significant components of these increases are discussed below.
        
Other service charges, commissions and fees primarily include debit and credit card interchange income, mortgage loan servicing fee income, insurance and other commissions and ATM service charge revenues. Other service charges, commissions and fees increased $1.5 million, or 15.2%, to $11.2 million during the three months ended June 30, 2015, as compared to $9.7 million for the same period in 2014, and $2.2 million, or 11.6%, to $21.0 million for the six months ended June 30, 2015, as compared to $18.9 million during the same period in 2014. These increases were primarily due to additional interchange revenue resulting from higher debit and credit card transaction volumes.
    
Income from the origination and sale of loans increased $2.4 million, or 38.0%, to $8.8 million during the three months ended June 30, 2015, as compared to $6.4 million during the same period in 2014, and $3.7 million, or 33.2%, to $14.7 million during the six months ended June 30, 2015, as compared to $11.0 million during the same period in 2014. During second quarter 2015, we sold $10.6 million of seasoned portfolio loans at an aggregate gain of $410 thousand. The remaining quarter-to-date and year-to-date increases in income from the origination and sale of loans, as compared to the same periods in 2014, were primarily the result of increased demand in our market areas for both refinancing loans and loans for home purchases. Our total mortgage loans production increased approximately 39% during the six months ended June 30, 2015, as compared to the same period in 2014, with loans originated for home purchases accounting for approximately 62% of our mortgage loan production, as compared to approximately 73% during the same period in 2014.
            

42

Wealth management revenues are comprised principally of fees earned for management of trust assets and investment services revenues. Fees earned for management of trust assets are generally based on the market value of assets managed. Wealth management revenues increased $288 thousand, or 6.2%, to $4.9 million during the three months ended June 30, 2015, as compared to $4.6 million during the same period in 2014, and $770 thousand, or 8.5%, to $9.8 million during the six months ended June 30, 2015, as compared to $9.1 million during the same period in 2014. Increases in wealth management revenues during the three and six months ended June 30, 2015, as compared to the same periods in 2014, were due to the combined effects of the addition of new wealth management customers and increases in the market values of assets under trust management.
        
Other income increased $862 thousand, or 44.5%, to $2.8 million during the three months ended June 30, 2015, as compared to $1.9 million during the same period in 2014, and $2.1 million, or 54.8%, to $5.9 million during the six months ended June 30, 2015, as compared to $3.8 million during the same period in 2014. During second quarter 2015, we recorded a gain of $863 thousand on the sale of land. In addition, during first quarter 2015, we reached a settlement on and reversed a $1.0 million accrual related to secondary investor claims assumed as part of the July 2014 acquisition of Mountain West.
    
Non-interest Expense. Non-interest expense increased $6.1 million, or 10.8%, to $62.0 million for the three months ended June 30, 2015, as compared to $55.9 million for the same period in 2014, and $11.3 million, or 10.3%, to $121.6 million during the six months ended June 30, 2015, as compared to $110.3 million in the same period in 2014. Significant components of these increases are discussed below.
    
Salaries and wages expense increased $1.7 million, or 6.8%, to $26.1 million during the three months ended June 30, 2015, as compared to $24.4 million during the same period in 2014, and $4.6 million, or 9.7%, to $51.4 million during the six months ended June 30, 2015, as compared to $46.9 million during the same period in 2014. Quarter-to-date and year-to-date increases in salaries and wages expense, as compared to the prior year, were primarily the result of increased personnel costs associated with the Mountain West acquisition in July 2014, inflationary wage increases and higher commissioned pay reflective of increased mortgage loan origination during the first half of 2015.
    
Employee benefits expense increased $906 thousand, or12.6%, to $8.1 million for the three months ended June 30, 2015, as compared to $7.2 million during the same period in 2014, and $373 thousand, or 2.4%, to $15.9 million during the six months ended June 30, 2015, as compared to $15.5 million during the same period in 2014. Increases in employee benefits expense during the three and six months ended June 30, 2015, as compared to the same periods in 2014, were reflective of increased benefits costs associated with the Mountain West acquisition in July 2014 and increases in group health insurance expense.
    
Furniture and equipment expense increased $546 thousand, or 17.3%, to $3.7 million for the three months ended June 30, 2015, as compared to $3.2 million during the same period in 2014, and $1.1 million, or 17.9%, to $7.5 million during the six months ended June 30, 2015, as compared to $6.4 million during the same period in the prior year. These increases were primarily due to additional software costs associated with the implementation of new systems placed into service during the last half of 2014 to assist in accounting for acquired loans, process mortgage loans and automate certain reconciliation functions.
    
Net OREO income increased $689 thousand, or 514.2%, to $823 thousand during the three months ended June 30, 2015, as compared to $134 thousand during the same period in 2014, and $731 thousand, or 477.8%, to $884 thousand during the six months ended June 30, 2015, as compared to $153 thousand in the same period in 2014, primarily due to increases in net gains recognized on the sale of OREO properties. During the three and six months ended June 30, 2015, we recorded net gains on the sale of OREO properties of $986 thousand and $1.7 million, respectively, as compared to net gains on the sale of OREO properties of $331 thousand and $766 thousand recorded during the same respective periods in 2014.
    
Core deposit intangible amortization expense increased $500 thousand, or 141.2%, to $854 thousand during the three months ended June 30, 2015, as compared to $354 thousand during the same period in 2014, and $1.0 million, or 141.4%, to $1.7 million during the six months ended June 30, 2015, as compared to $708 thousand during the same period in 2014. Increases in core deposit amortization expense were due to the amortization of core deposit intangible assets recorded in conjunction with the acquisition of Mountain West in July 2014.
    
Other expense increased $2.7 million, or 25.3%, to $13.6 million during the three months ended June 30, 2015, as compared to $10.8 million during the same period in 2014, and $4.1 million, or 19.1%, to $25.4 million during the six months ended June 30, 2015, as compared to $21.3 million for the same period in 2014. During second quarter 2015, we recorded a one-time contract termination fee of $876 thousand related to a change in payment service provider. In addition, fraud loses increased $416 thousand, or 137.3%, to $719 thousand during second quarter 2015, as compared to $303 thousand the same period in 2014, and $456 thousand, or 98.7%, to $918 thousand during the six months ended June 30, 2015, as compared to $462 thousand during the same period in 2014, primarily due to unusually high fraudulent credit card activity. The remaining quarter-to-date and year-to-date increases in other expense, were primarily due to the additional operating costs associated with branches acquired in the July 2014 acquisition of Mountain West, increases in advertising costs due to fluctuations in the timing of advertising campaigns and higher travel and legal costs.

43


During the six months ended June 30, 2015 and 2014, we recorded $63 thousand and $597 thousand, respectively, of acquisition-related expenses. These acquisition-related expenses primarily include legal and professional fees and travel expenses. For additional information regarding acquisitions, see "Recent Developments" included herein and “Note 2 – Acquisitions” in the accompanying “Notes to Unaudited Consolidated Financial Statements” included in this report.
 
Income Tax Expense. Our effective federal income tax rate was 29.5% for the six months ended June 30, 2015 and 30.7% for the six months ended June 30, 2014. State income tax applies primarily to pretax earnings generated within Montana and South Dakota. Our effective state tax rate was 4.2% for the six months ended June, 2015 and 2014. Decreases in effective federal income tax rates are primarily due to tax credits received on investments in new markets tax credit and low income housing projects during 2015 and the last half of 2014.
    
Financial Condition
        
Total assets decreased $224 million, or 2.6%, to $8,386 million as of June 30, 2015, from $8,610 million as of December 31, 2014. Absent deposit growth during the first six months of 2015, loan growth was funded through available funds resulting in decreases in cash and cash equivalents and investment securities from December 31, 2014 to June 30, 2015. Significant fluctuations in balance sheet accounts are discussed below.
        
Loans. Total loans increased $207 million, or 4.2%, to $5,104 million as of June 30, 2015, as compared to $4,897 million December 31, 2014, with the most notable growth occurring in commercial, commercial real estate, indirect consumer and agricultural loans.

Continuing business expansion in our market areas and the movement of completed commercial construction projects from construction loans to permanent financing resulted in increases in the commercial and commercial real estate loan portfolios. Commercial loans increased $79 million, or 10.7%, to $819 million as of June 30, 2015, from $740 million as of December 31, 2014, and commercial real estate loans increased $65 million, or 3.9%, to $1.7 billion as of June 30, 2015, from $1.6 billion as of December 31, 2014.

Indirect consumer loans grew $37 million or 6.6%, to $589 million as of June 30, 2015, from $553 million as of December 31, 2014. Management attributes this increase to the combined impact of heightened consumer demand for recreational vehicles and increased dealer volume resulting from the our historical expansion efforts within our existing market areas.

Agricultural loans increased $18 million, or 14.2%, to $143 million as of June 30, 2015, from $125 million as of December 31, 2014. Management attributes this increase to seasonal increases in agricultural credit lines that typically occur during the second and third quarters of each year. Agricultural real estate loans decreased $9 million, or 5.5%, to $159 million as of June 30, 2015, from $168 million as of December 31, 2014, primarily due to scheduled loan repayments.


44

Non-performing Assets. Non-performing assets include non-accrual loans, loans contractually past due 90 days or more and still accruing interest and OREO. The following table sets forth information regarding non-performing assets as of the dates indicated:    
Nonperforming Assets and Troubled Debt Restructurings
 
 
 
 
 
 
 
 
(Dollars in thousands)
June 30,
2015
 
March 31,
2015
 
December 31,
2014
 
September 30,
2014
 
June 30,
2014
Non-performing loans:
 
 
 
 
 
 
 
 
 
Non-accrual loans
$
70,848

 
$
73,941

 
$
62,182

 
$
71,915

 
$
79,166

Accruing loans past due 90 days or more
2,153

 
5,175

 
2,576

 
1,348

 
1,494

 
 
 
 
 
 
 
 
 
 
Total non-performing loans
73,001

 
79,116

 
64,758

 
73,263

 
80,660

OREO
11,773

 
15,134

 
13,554

 
18,496

 
16,425

 
 
 
 
 
 
 
 
 
 
Total non-performing assets
$
84,774

 
$
94,250

 
$
78,312

 
$
91,759

 
$
97,085

 
 
 
 
 
 
 
 
 
 
Troubled debt restructurings not included above
$
15,127

 
$
16,070

 
$
20,952

 
$
20,956

 
$
23,531

 
 
 
 
 
 
 
 
 
 
Non-performing loans to total loans
1.43
%
 
1.61
%
 
1.32
%
 
1.51
%
 
1.79
%
Non-performing assets to total loans and OREO
1.66
%
 
1.91
%
 
1.59
%
 
1.88
%
 
2.15
%
Non-performing assets to total assets
1.01
%
 
1.11
%
 
0.91
%
 
1.08
%
 
1.27
%
    
Non-performing loans. Non-performing loans include non-accrual loans and loans contractually past due 90 days or more. We monitor and evaluate collateral values on non-performing loans quarterly. Appraisals are required on all non-performing loans every 18-24 months, or sooner as conditions necessitate. We monitor real estate values by market for our larger market areas. Based on trends in real estate values, adjustments may be made to the appraised value based on time elapsed between the appraisal date and the impairment analysis or a new appraisal may be ordered. Appraised values in our smaller market areas may be adjusted based on trends identified through discussions with local realtors and appraisers. Appraisals are also adjusted for selling costs. The adjusted appraised value is then compared to the loan balance and any resulting shortfall is recorded in the allowance for loan losses as a specific valuation allowance. Overall increases in specific valuation allowances will result in higher provisions for loan losses. Provisions for loan losses are also impacted by changes in the historical or general valuation elements of the allowance for loan losses.
    
The following table sets forth the allocation of our non-performing loans among our various loan categories as of the dates indicated:
Non-Performing Loans by Loan Type
 
 
 
 
 
 
 
(Dollars in thousands)
June 30,
2015
 
Percent
of Total
 
December 31,
2014
 
Percent
of Total
Real estate:
 
 
 
 
 
 
 
Commercial
$
26,700

 
36.6
%
 
$
27,700

 
42.9
%
Construction:
 
 
.
 
 
 
 
Land acquisition and development
7,919

 
10.8
%
 
8,252

 
12.7
%
Commercial
3,443

 
4.7
%
 
2,564

 
4.0
%
Residential
332

 
0.5
%
 
272

 
0.4
%
Total construction
11,694

 
16.0
%
 
11,088

 
17.1
%
Residential
3,497

 
4.8
%
 
4,554

 
7.0
%
Agricultural
6,784

 
9.3
%
 
6,842

 
10.6
%
Total real estate
48,675

 
66.7
%
 
50,184

 
77.5
%
Consumer
1,568

 
2.1
%
 
1,282

 
2.0
%
Commercial
21,812

 
29.9
%
 
12,846

 
19.8
%
Agricultural
635

 
0.9
%
 
446

 
0.7
%
Other
311

 
0.4
%
 
—

 
—
%
Total non-performing loans
$
73,001

 
100.0
%
 
$
64,758

 
100.0
%
        

45

Non-accrual loans. We generally place loans, excluding acquired credit impaired loans, on non-accrual when they become 90 days past due, unless they are well secured and in the process of collection. When a loan is placed on non-accrual status, any interest previously accrued but not collected is reversed from income. If all loans on non-accrual had been current in accordance with their original terms, gross income of approximately $1.6 million and $2.2 million would have been accrued for the six months ended June 30, 2015 and 2014, respectively.
                
Non-accrual loans, the largest component of non-performing loans, increased $9 million, or 13.9%, to $71 million as of June 30, 2015, from $62 million as of December 31, 2014, primarily due to the placement of the loans of one commercial and one commercial real estate borrower on non-accrual status.
            
OREO. OREO consists of real property acquired through foreclosure on the collateral underlying defaulted loans. We initially record OREO at fair value less estimated selling costs. Any excess of loan carrying value over the fair value of the real estate acquired is recorded as a charge against the allowance for loan losses. Estimated losses that result from the ongoing periodic valuation of these properties are charged to earnings in the period in which they are identified. The fair values of OREO properties are estimated using appraisals and management estimates of current market conditions. OREO properties are appraised every 18-24 months unless deterioration in local market conditions indicates the need to obtain new appraisals sooner. OREO properties are evaluated by management quarterly to determine if additional write-downs are appropriate or necessary based on current market conditions. Quarterly evaluations include a review of the most recent appraisal of the property and reviews of recent appraisals and comparable sales data for similar properties in the same or adjacent market areas. Commercial and agricultural OREO properties are listed with unrelated third party professional real estate agents or brokers local to the areas where the marketed properties are located. Residential properties are typically listed with local realtors, after any redemption period has expired. We rely on these local real estate agents and/or brokers to list the properties on the local multiple listing system, to provide marketing materials and advertisements for the properties and to conduct open houses.        
        
OREO decreased $2 million, or 13.1%, to $12 million as of June 30, 2015, from $14 million as of December 31, 2014. During the six months ended June 30, 2015, we recorded OREO additions of $4 million and sold OREO with a book value of $6 million at a net gain of $1.7 million. As of June 30, 2015, the composition of OREO properties was 34% land and land development, 29% commercial, 31% residential real estate, 3% construction and 3% agricultural.
                    
Allowance for Loan Losses. The Company performs a quarterly assessment of the adequacy of its allowance for loan losses in accordance with generally accepted accounting principles. The methodology used to assess the adequacy is consistently applied to the Company's loan portfolio. The allowance for loan losses is established through a provision for loan losses based on our evaluation of known and inherent risk in our loan portfolio at each balance sheet date. In determining the allowance for loan losses, we estimate losses on specific loans, or groups of loans, where the probable loss can be identified and reasonably determined. The balance of the allowance for loan losses is based on internally assigned risk classifications of loans, historical loan loss rates, changes in the nature of the loan portfolio, overall portfolio quality, industry concentrations, delinquency trends, current economic factors and the estimated impact of current economic conditions on certain historical loan loss rates. See the discussion under “Critical Accounting Estimates and Significant Accounting Policies — Allowance for Loan Losses."
        
The allowance for loan losses is increased by provisions charged against earnings and net recoveries of charged-off loans and is reduced by negative provisions credited to earnings and net loan charge-offs. The allowance for loan losses consists of three elements:
        
(1)
Specific valuation allowances associated with impaired loans. Specific valuation allowances are determined based on assessment of the fair value of the collateral underlying the loans as determined through independent appraisals, the present value of future cash flows, observable market prices and any relevant qualitative or environmental factors impacting the loan. No specific valuation allowances are recorded for impaired loans that are adequately secured.
        
(2)
Historical valuation allowances based on loan loss experience for similar loans with similar characteristics and trends. Historical valuation allowances are determined by applying percentage loss factors to the credit exposures from outstanding loans. For commercial, agricultural and real estate loans, loss factors are applied based on the internal risk classifications of these loans. For consumer loans, loss factors are applied on a portfolio basis. For commercial, agriculture and real estate loans, loss factor percentages are based on a migration analysis of our historical loss experience, designed to account for credit deterioration. For consumer loans, loss factor percentages are based on a one-year loss history.
        
(3)
General valuation allowances determined based on changes in the nature of the loan portfolio, overall portfolio quality, industry concentrations, delinquency trends, general economic conditions and other qualitative risk factors both internal and external to us.

46


Based on the assessment of the adequacy of the allowance for loan losses, management records provisions for loan losses to maintain the allowance for loan losses at appropriate levels.
    
Loans acquired in business combinations are recorded at fair value with no allowance for loan losses on the date of acquisition. Subsequent to the acquisition date, an allowance for loan loss is recorded for the emergence of new probable and estimable losses on loans acquired without evidence of credit impairment. Loans acquired with evidence of credit impairment are regularly monitored and to the extent that the performance has deteriorated from management's expectations at the date of acquisition, an allowance for loan losses is established. As of June 30, 2015, management determined that an allowance for loan losses related to acquired loans of $501 thousand was required under generally accepted accounting principles.
            
Loans, or portions thereof, are charged-off against the allowance for loan losses when management believes that the collectability of the principal is unlikely, or, with respect to consumer installment loans, according to an established delinquency schedule. Generally, loans are charged-off when (1) there has been no material principal reduction within the previous 90 days and there is no pending sale of collateral or other assets, (2) there is no significant or pending event which will result in principal reduction within the upcoming 90 days, (3) it is clear that we will not be able to collect all or a portion of the loan, (4) payments on the loan are sporadic, will result in an excessive amortization or are not consistent with the collateral held and (5) foreclosure or repossession actions are pending. Loan charge-offs do not directly correspond with the receipt of independent appraisals or the use of observable market data if the collateral value is determined to be sufficient to repay the principal balance of the loan.
    
If the impaired loan is adequately collateralized, a specific valuation allowance is not recorded. As such, significant changes in impaired and non-performing loans do not necessarily correspond proportionally with changes in the specific valuation component of the allowance for loan losses. Additionally, management expects the timing of charge-offs will vary between quarters and will not necessarily correspond proportionally to changes in the allowance for loan losses or changes in non-performing or impaired loans due to timing differences among the initial identification of an impaired loan, recording of a specific valuation allowance for the impaired loan and any resulting charge-off of uncollectible principal.
    

47

The following table sets forth information regarding our allowance for loan losses as of and for the periods indicated.
Allowance for Loan Losses
 
 
 
 
 
 
 
 
 
(Dollars in thousands)
Three Months Ended
 
June 30,
 
March 31,
 
December 31,
 
September 30,
 
June 30,
 
2015
 
2015
 
2014
 
2014
 
2014
Balance at beginning of period
$
75,336

 
$
74,200

 
$
74,231

 
$
78,266

 
$
81,371

Provision charged to operating expense
1,340

 
1,095

 
118

 
261

 
(2,001
)
Charge offs:
 
 
 
 
 
 
 
 
 
Real estate
 
 
 
 
 
 
 
 
 
Commercial
47

 
109

 
485

 
41

 
699

Construction
—

 
30

 
108

 
20

 
48

Residential
510

 
45

 
30

 
84

 
409

Agricultural
53

 
2

 
1

 
2

 
2

Consumer
837

 
1,301

 
1,658

 
1,437

 
934

Commercial
61

 
374

 
22

 
4,678

 
534

Agricultural
—

 
—

 
—

 
—

 
—

Other
—

 
—

 
—

 
12

 
—

Total charge-offs
1,508

 
1,861

 
2,304

 
6,274

 
2,626

Recoveries:
 
 
 
 
 
 
 
 
 
Real estate
 
 
 
 
 
 
 
 
 
Commercial
293

 
512

 
446

 
181

 
167

Construction
49

 
316

 
736

 
728

 
458

Residential
80

 
154

 
124

 
88

 
26

Agricultural
3

 
10

 
—

 
2

 
—

Consumer
520

 
640

 
686

 
495

 
558

Commercial
438

 
270

 
162

 
484

 
313

Agricultural
1

 
—

 
1

 
—

 
—

Total recoveries
1,384

 
1,902

 
2,155

 
1,978

 
1,522

Net charge-offs
124

 
(41
)
 
149

 
4,296

 
1,104

Balance at end of period
$
76,552

 
$
75,336

 
$
74,200

 
$
74,231

 
$
78,266

 
 
 
 
 
 
 
 
 
 
Period end loans
$
5,103,946

 
$
4,927,306

 
$
4,897,443

 
$
4,854,382

 
$
4,506,362

Average loans
4,991,416

 
4,895,146

 
4,870,509

 
4,751,928

 
4,436,786

Net loans charged-off to average loans, annualized
0.01
%
 
—
 %
 
0.01
%
 
0.36
%
 
0.10
%
Allowance to period end loans
1.50
%
 
1.53
 %
 
1.52
%
 
1.53
%
 
1.74
%
    
Our allowance for loan losses as a percentage of period end loans declined slightly to 1.50% as of June 30, 2015, as compared to 1.52% as of December 31, 2014, primarily due to loan growth. The decrease in our allowance for loan losses as a percentage of period end loans to 1.53% as of September 30, 2014, from 1.74% as of June 30, 2014,was due to the acquisition of Mountain West loans, which were initially recorded at fair value with no carryover of the related allowance for loan losses.

Although we have established our allowance for loan losses in accordance with accounting principles generally accepted in the United States and we believe that our allowance for loan losses is adequate to provide for known and inherent losses in the portfolio at all times, future provisions will be subject to on-going evaluations of the risks in the loan portfolio. If the economy declines or asset quality deteriorates, material additional provisions could be required.
                    
Investment Securities. We manage our investment portfolio to obtain the highest yield possible, while meeting our risk tolerance and liquidity guidelines and satisfying the pledging requirements for deposits of state and political subdivisions and securities sold under repurchase agreements. Investment securities decreased $148 million, or 6.5%, to $2,139 million, or 25.5% of total assets, as of June 30, 2015, from $2,287 million, or 26.6% of total assets, as of December 31, 2014. During the first six months of 2015, proceeds from maturities, calls and pay-downs of investment securities were used to fund loan growth.
    
We evaluate our investment portfolio quarterly for other-than-temporary declines in the market value of individual investment securities. This evaluation includes monitoring credit ratings; market, industry and corporate news; volatility in market prices; and, determining whether the market value of a security has been below its cost for an extended period of time. As of June 30, 2015, we had investment securities with fair values aggregating $387 million that had been in a continuous loss position more than twelve months. Gross unrealized losses on these securities of $5 million as of June 30, 2015, were attributable to changes in interest rates. No impairment losses were recorded during the three and six months ended June 30, 2015 and 2014.


48

Cash and Cash Equivalents. Cash and cash equivalents decreased $292 million, or 36.6%, to $506 million as of June 30, 2015, from $799 million as of December 31, 2014. During the first six months of 2015, loan growth was funded through available funds resulting in decreases in cash and cash equivalents from December 31, 2014 to June 30, 2015. Remaining decreases in cash and cash equivalents occurred during the normal course of business and are not reflective of changes in business plan or strategy.    
Goodwill. Goodwill decreased $1 million to $204 million as of June 30, 2015, from $205 million as of December 31, 2014. During first quarter 2015, we completed our review of Mountain West tax items and finalized the fair valuation of acquired deferred tax assets, which resulted in a decrease in recorded goodwill.
Company-Owned Life Insurance. Company-owned life insurance increased $24 million, or 15.5%, to $178 million as of June 30, 2015, from $154 million as of December 31, 2014. During second quarter 2015, we purchased an additional $23 million of life insurance covering selected officers of FIB.
Deferred Tax Asset/Liability. As of June 30, 2015, we had a net deferred tax liability of $3 million, as compared to a net deferred tax asset of $5 million as of December 31, 2014. The shift in deferred taxes from a net asset to a net liability was primarily due to decreases in deferred tax assets related to unrealized losses on available-for sale investment securities and the removal of deferred tax assets upon the disposal of real property acquired as part of the Mountain West acquisition. The shift in the deferred taxes from a net asset to a net liability was also impacted by increases in deferred tax liabilities related to tax deductible goodwill from previous acquisitions.

Deposits. Our deposits consist of non-interest bearing and interest bearing demand, savings, individual retirement and time deposit accounts. Total deposits decreased $202 million, or 2.9%, to $6,804 million as of June 30, 2015, from $7,006 million as of December 31, 2014. Historically, we have experienced a decrease in total deposits during the first six months of each year. Our mix of deposits continued to shift away from higher-costing time deposits to lower-costing savings and non-interest bearing demand deposits. The following table summarizes our deposits as of the dates indicated:
Deposits
 
 
 
 
 
 
 
(Dollars in thousands)
June 30,
2015
 
Percent
of Total
 
December 31,
2014
 
Percent
of Total
Non-interest bearing demand
$
1,757,641

 
25.8
%
 
$
1,791,364

 
25.5
%
Interest bearing:
 
 
 
 
 
 
 
Demand
2,028,648

 
29.8

 
2,133,273

 
30.5

Savings
1,868,877

 
27.5

 
1,843,355

 
26.3

Time, $100 and over
490,088

 
7.2

 
520,125

 
7.4

Time, other (1)
659,147

 
9.7

 
718,095

 
10.2

Total interest bearing
5,046,760

 
74.2

 
5,214,848

 
74.5

Total deposits
$
6,804,401

 
100.0
%
 
$
7,006,212

 
100.0
%
    
(1)
Included in Time, other are Certificate of Deposit Account Registry Service, or CDAR, deposits of $35 million as of June 30, 2015 and $40 million as of December 31, 2014.

Securities Sold Under Repurchase Agreements. In addition to deposits, repurchase agreements with commercial depositors, which include municipalities, provide an additional source of funds. Under repurchase agreements, deposit balances are invested in short-term U.S. government agency securities overnight and are then repurchased the following day. All outstanding repurchase agreements are due in one day. Repurchase agreement balances decreased $33 million, or 6.6%, to $469 million as of June 30, 2015, from $502 million as of December 31, 2014, due to fluctuations in the liquidity of our customers.

Long-Term Debt. Long-term debt increased $5 million, or 13.1%, to $43 million as of June 30, 2015, from $38 million as of December 31, 2014. On January 29, 2015, the Company borrowed $5 million on a 2.28% note payable maturing July 29, 2022, with interest payable monthly and principal due at maturity. The note is collateralized by the Company's equity interest in Universal Sub CDE, LLC, a community development entity owned 99.9% by the Company.

Capital Resources and Liquidity Management
    
Stockholders’ equity is influenced primarily by earnings, dividends, changes in the unrealized holding gains or losses, net of taxes, on available-for-sale investment securities and sales and redemptions of common stock. Stockholders’ equity increased $16 million, or 1.8%, to $925 million as of June 30, 2015, from $909 million as of December 31, 2014, primarily due to the retention of earnings, which was partially offset by the redemption and retirement of Class A common shares.

49

        
During the three months ended March 31, 2015, we repurchased and retired 565,875 shares of our Class A common stock in open market transactions at an aggregate purchase price of $15 million. The repurchases were made pursuant to a stock repurchase program approved by our Board of Directors. No repurchases of shares of our Class A common stock were made during the three months ended June 30, 2015. For additional information regarding the repurchase, see “Note 8 – Capital Stock” in the accompanying “Notes to Unaudited Consolidated Financial Statements” included in this report.

On July 2, 2013, the Board of Governors of the Federal Reserve Bank issued a final rule implementing a revised regulatory capital framework for U.S. banks in accordance with the Basel III international accord and satisfying related mandates under the Dodd-Frank Wall Street Reform and Consumer Protection Act . The revised regulatory capital framework ("Basel III ") includes a more stringent definition of capital and introduces a new common equity tier 1, or CET1, capital requirement; sets forth a comprehensive methodology for calculating risk-weighted assets, introduces a conservation buffer and sets out minimum capital ratios and overall capital adequacy standards. As a banking organization subject to the standardized approach, Basel III became effective for us on January 1, 2015. Certain deductions and adjustments to regulatory capital began to phase in starting January 1, 2015 and will be fully implemented on January 1, 2018. The capital conservation buffer phases in beginning January 1, 2016 and will be fully implemented on January 1, 2019.

As of June 30, 2015 and December 31, 2014, we had capital levels that, in all cases, exceeded the well-capitalized guidelines. For additional information regarding our capital levels, see “Note 10 – Regulatory Capital” in the accompanying “Notes to Unaudited Consolidated Financial Statements” included in this report.

Liquidity. Liquidity measures our ability to meet current and future cash flow needs on a timely basis and at a reasonable cost. We manage our liquidity position to meet the daily cash flow needs of customers, while maintaining an appropriate balance between assets and liabilities to meet the return on investment objectives of our shareholders. Our liquidity position is supported by management of liquid assets and liabilities and access to alternative sources of funds. Liquid assets include cash, interest bearing deposits in banks, federal funds sold, available-for-sale investment securities and maturing or prepaying balances in our held-to-maturity investment and loan portfolios. Liquid liabilities include core deposits, federal funds purchased, securities sold under repurchase agreements and borrowings. Other sources of liquidity include the sale of loans, the ability to acquire additional national market funds through non-core deposits, the issuance of additional collateralized borrowings such as FHLB advances, the issuance of debt securities, additional borrowings through the Federal Reserve’s discount window and the issuance of preferred or common securities.
Our short-term and long-term liquidity requirements are primarily to fund on-going operations, including payment of interest on deposits and debt, extensions of credit to borrowers, capital expenditures and shareholder dividends. These liquidity requirements are met primarily through cash flow from operations, redeployment of prepaying and maturing balances in our loan and investment portfolios, debt financing and increases in customer deposits. For additional information regarding our operating, investing and financing cash flows, see the unaudited “Consolidated Statements of Cash Flows,” included in Part I, Item 1.
As a holding company, we are a corporation separate and apart from the Bank and, therefore, we provide for our own liquidity. Our main sources of funding include management fees and dividends declared and paid by the Bank and access to capital markets. There are statutory, regulatory and debt covenant limitations that affect the ability of our subsidiary bank to pay dividends to us. Management believes that such limitations will not impact our ability to meet our ongoing short-term cash obligations.
Management continuously monitors our liquidity position and adjustments are made to the balance between sources and uses of funds as deemed appropriate. Our management is not aware of any events that are reasonably likely to have a material adverse effect on our liquidity, capital resources or operations. In addition, our management is not aware of any regulatory recommendations regarding liquidity, which if implemented, would have a material adverse effect on us.
Recent Accounting Pronouncements
    
See “Note 16 – Recent Authoritative Accounting Guidance” in the accompanying “Notes to Unaudited Consolidated Financial Statements” included in this report for details of recently issued accounting pronouncements and their expected impact on our financial statements.    

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Item 3.
    
QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
    
As of June 30, 2015, 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 our Annual Report on Form 10-K for the year ended December 31, 2014.

Item 4.
    
CONTROLS AND PROCEDURES
    
Disclosure Controls and Procedures
    
Our management is responsible for establishing and maintaining effective disclosure controls and procedures, as defined under Rules 13a-15(e) and 15d-15(e) of the Exchange Act. As of June 30, 2015, an evaluation was performed, under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures as of June 30, 2015, were effective in ensuring that information required to be disclosed in our reports filed or submitted under the Exchange Act is recorded, processed, summarized, and reported within the time periods required by the SEC’s rules and forms, and is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
    
Changes in Internal Control Over Financial Reporting
    
There were no changes in our internal control over financial reporting for the quarter ended June 30, 2015, that have materially affected, or are reasonably likely to materially affect, such control.
    
Limitations on Controls and Procedures
    
The effectiveness of our disclosure controls and procedures and our internal control over financial reporting is subject to various inherent limitations, including cost limitations, judgments used in decision making, assumptions about the likelihood of future events, the soundness of our systems, the possibility of human error, and the risk of fraud. Moreover, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions and the risk that the degree of compliance with policies or procedures may deteriorate over time. Because of these limitations, any system of disclosure controls and procedures or internal control over financial reporting may not be successful in preventing all errors or fraud or in making all material information known in a timely manner to the appropriate levels of management.    

PART II.
    
OTHER INFORMATION

Item 1.
Legal Proceedings
There have been no material changes in legal proceedings as described in our Annual Report on Form 10-K for the year ended December 31, 2014.

Item 1A.
Risk Factors
There have been no material changes in risk factors described in our Annual Report on Form 10-K for the year ended December 31, 2014.

Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
(a) There were no unregistered sales of equity securities during the three months ended June 30, 2015.
(b) Not applicable.

51

(c) There were no purchases made by or on behalf of us or any "affiliated purchasers" (as defined in Rule 10b-18(a)(3) under the Exchange Act), of our common stock during the three months ended June 30, 2015. 

 
 
 
 
 
Total Number of
 
Maximum Number
 
 
 
 
 
 
Shares Purchased
 
of Shares That
 
 
Total Number
 
Average
 
as Part of Publicly
 
May Yet Be
 
 
of Shares
 
Price Paid
 
Announced Plans
 
Purchased Under the
Period
 
Purchased
 
Per Share
 
or Programs
 
Plans or Programs
April 2015
 
—

 
$
—

 
—

 
434,125

May 2015
 
—

 
—

 
—

 
434,125

June 2015
 
—

 
—

 
—

 
434,125

Total
 
—

 
$
—

 
—

 
434,125


Item 3.
Defaults upon Senior Securities
None.

Item 4.
Mine Safety Disclosures
Not applicable.

Item 5.
Other Information
Not applicable or required.

Item 6.    Exhibits
Exhibit Number
 
Description
 
 
 
2.2
 
Agreement and Plan of Merger between First Interstate BancSystem, Inc. and Mountain West Financial Corp dated February 10, 2014 (incorporated herein reference to Exhibit 2.1 of the Company's Pre-Effective Amendment No. 1 to Registration Statement on Form S-4, No. 333-194050, dated April 2, 2014)
 
 
 
3.1
 
Amended and Restated Articles of Incorporation dated March 5, 2010 (incorporated herein by reference to Exhibit 3.1 of the Company’s Current Report on Form 8-K/A filed on March 10, 2010)
 
 
 
3.2
 
Second Amended and Restated Bylaws dated January 27, 2011 (incorporated herein by reference to Exhibit 3.8 of the Company’s Current Report on Form 8-K filed on February 3, 2011)
 
 
 
10.1
 
Credit Agreement Re: Subordinated Term Note dated as of January 10, 2008, between First Interstate BancSystem, Inc. and First Midwest Bank (incorporated herein by reference to Exhibit 10.24 of the Company’s Current Report on Form 8-K filed on January 16, 2008)
 
 
 
10.2
 
Lease Agreement between Billings 401 Joint Venture and First Interstate Bank Montana dated September 20, 1985 and addendum thereto (incorporated herein by reference to Exhibit 10.4 of the Company’s Post-Effective Amendment No. 3 to Registration Statement on Form S-1, No. 033-84540, filed on September 29, 1994)
 
 
 
10.3†
 
First Interstate BancSystem’s Deferred Compensation Plan dated December 1, 2006 (incorporated herein by reference to Exhibit 10.9 of the Company’s Pre-Effective Amendment No. 3 to Registration Statement on Form S-1, No. 333-164380, filed on March 23, 2010)
 
 
 
10.4†
 
First Amendment to the First Interstate BancSystem’s Deferred Compensation Plan dated October 24, 2008 (incorporated herein by reference to Exhibit 10.10 of the Company’s Pre-Effective Amendment No. 3 to Registration Statement on Form S-1, No. 333-164380, filed on March 23, 2010)
 
 
 
10.5†
 
2001 Stock Option Plan, as amended (incorporated herein by reference to Exhibit 4.12 of the Company’s Registration Statement on Form S-8, No. 333-106495, filed on June 25, 2003)
 
 
 
10.6†
 
Second Amendment to 2001 Stock Option Plan (incorporated herein by reference to Exhibit 10.6 of the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2010)
 
 
 


52

Exhibit Number
 
Description
 
 
 
10.7†
 
First Interstate BancSystem, Inc. 2006 Equity Compensation Plan, amended and restated as of November 21, 2013 (incorporated herein by reference to Exhibit 4.4 of the Company's Registration Statement on Form S-8, No. 333-193543, filed January 24, 2014 )
 
 
 
10.8†
 
Form of First Interstate BancSystem, Inc. 2006 Equity Compensation Plan Restricted Stock Agreement (Performance-ROA) for Certain Executive Officers (incorporated herein by reference to Exhibit 10.8 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2013)
 
 
 
10.9†
 
Form of First Interstate BancSystem, Inc. 2006 Equity Compensation Plan Restricted Stock Agreement (Performance-ROE) for Certain Executive Officers (incorporated herein by reference to Exhibit 10.9 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2013)
 
 
 
10.10†
 
Form of First Interstate BancSystem, Inc. 2006 Equity Compensation Plan Restricted Stock Agreement (Performance) for Certain Executive Officers (incorporated herein by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K filed on February 13, 2013)
 
 
 
10.11†
 
First Interstate BancSystem, Inc. 2015 Equity and Incentive Plan (incorporated herein by reference to Appendix A of the Company’s Proxy Statement on Schedule 14A for the 2015 Annual Meeting of Shareholders, filed on April 2, 2015).
 
 
 
10.12
 
Trademark License Agreements between Wells Fargo & Company and First Interstate BancSystem, Inc. (incorporated herein by reference to Exhibit 10.11 of the Registration Statement on Form S-1, filed on April 22, 1997)
 
 
 
31.1*
 
Certification of Quarterly Report on Form 10-Q pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 by Chief Executive Officer
 
 
 
31.2*
 
Certification of Quarterly Report on Form 10-Q pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 by Chief Financial Officer
 
 
 
32*
 
Certification of Quarterly Report on Form 10-Q pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
 
 
 101**
 
Interactive data file
 
 
 
                
†
Management contract or compensatory arrangement.
*
Filed herewith.
**
As provided in Rule 406T of Regulation S-T, this information is furnished and not filed for purposes of Sections 11 and 12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934.

53

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:
August 5, 2015
 
 
/S/    ED GARDING       
 
 
 
 
Ed Garding
 
 
 
 
President and Chief Executive Officer
 
 
 
 
 
Date:
August 5, 2015
 
 
/S/    KEVIN P. RILEY        
 
 
 
 
Kevin P. Riley
 
 
 
 
Executive Vice President and
Chief Financial Officer

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