FIRST INTERSTATE BANCSYSTEM INC - FORM 10-Q - May 6, 2016

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EX-31.1 - CERTIFICATON BY CHIEF EXECUTIVE OFFICER PURSUANT TO SECTION 302 - FIRST INTERSTATE BANCSYSTEM INCfibk-20160331xex311.htm
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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 March 31, 2016
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:
 
March 31, 2016 – Class A common stock
 
21,007,483

 
 
March 31, 2016 – Class B common stock
 
23,700,002

 
 



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 - March 31, 2016 and December 31, 2015
3

 
 
 
 
Consolidated Statements of Income - Three Months Ended March 31, 2016 and 2015
4

 
 
 
 
Consolidated Statements of Comprehensive Income - Three Months Ended March 31, 2016 and 2015
5

 
 
 
 
Consolidated Statements of Changes in Stockholders’ Equity - Three Months Ended March 31, 2016 and 2015
6

 
 
 
 
Consolidated Statements of Cash Flows - Three Months Ended March 31, 2016 and 2015
7

 
 
 
 
9

 
 
 
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
36

 
 
 
Item 3.
49

 
 
 
Item 4.
49

 
 
Part II.
 
 
 
 
Item 1.
49

 
 
 
Item 1A .
49

 
 
 
Item  2.
50

 
 
 
Item 3.
50

 
 
 
Item 4.
Mine Safety Disclosures
50

 
 
 
Item 5.
50

 
 
 
Item 6.
50

 
 
52








2

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

 
March 31,
2016
 
December 31,
2015
Assets
 
 
 
Cash and due from banks
$
113,755

 
$
132,595

Interest bearing deposits in banks
541,577

 
647,299

Federal funds sold
196

 
563

Total cash and cash equivalents
655,528

 
780,457

Investment securities:
 
 
 
Available-for-sale
1,563,350

 
1,456,840

Held-to-maturity (estimated fair values of $593,904 and $607,550 at March 31, 2016 and December 31, 2015, respectively)
581,390

 
600,665

Total investment securities
2,144,740

 
2,057,505

Loans held for investment
5,191,469

 
5,193,321

Mortgage loans held for sale
52,989

 
52,875

Total loans
5,244,458

 
5,246,196

Less allowance for loan losses
79,924

 
76,817

Net loans
5,164,534

 
5,169,379

Goodwill
204,481

 
204,523

Premises and equipment, net of accumulated depreciation
188,714

 
190,812

Company-owned life insurance
188,396

 
187,253

Accrued interest receivable
26,907

 
27,729

Mortgage servicing rights, net of accumulated amortization and impairment reserve
15,574

 
15,621

Core deposit intangibles, net of accumulated amortization
9,762

 
10,589

Other real estate owned (“OREO”)
9,257

 
6,254

Other assets
82,787

 
78,074

Total assets
$
8,690,680

 
$
8,728,196

Liabilities and Stockholders’ Equity
 
 
 
Deposits:
 
 
 
Non-interest bearing
$
1,860,472

 
$
1,823,716

Interest bearing
5,246,991

 
5,265,221

Total deposits
7,107,463

 
7,088,937

Securities sold under repurchase agreements
465,523

 
510,635

Accounts payable and accrued expenses
48,102

 
53,042

Accrued interest payable
5,184

 
4,960

Deferred tax liability
11,977

 
9,765

Long-term debt
27,907

 
27,885

Other borrowed funds
33

 
2

Subordinated debentures held by subsidiary trusts
82,477

 
82,477

Total liabilities
7,748,666

 
7,777,703

Stockholders’ equity:
 
 
 
Nonvoting noncumulative preferred stock without par value; authorized 100,000 shares; no shares issued and outstanding as of March 31, 2016 or December 31, 2015
—

 
—

Common stock
288,782

 
311,720

Retained earnings
648,631

 
638,367

Accumulated other comprehensive income, net
4,601

 
406

Total stockholders’ equity
942,014

 
950,493

Total liabilities and stockholders’ equity
$
8,690,680

 
$
8,728,196

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 March 31,
 
2016
 
2015
Interest income:
 
 
 
Interest and fees on loans
$
62,816

 
$
59,371

Interest and dividends on investment securities:
 
 
 
Taxable
8,038

 
7,971

Exempt from federal taxes
879

 
1,059

Interest on deposits in banks
645

 
389

Interest on federal funds sold
2

 
2

Total interest income
72,380

 
68,792

Interest expense:
 
 
 
Interest on deposits
3,228

 
3,309

Interest on securities sold under repurchase agreements
90

 
54

Interest on long-term debt
449

 
515

Interest on subordinated debentures held by subsidiary trusts
663

 
589

Total interest expense
4,430

 
4,467

Net interest income
67,950

 
64,325

Provision for loan losses
4,000

 
1,095

Net interest income after provision for loan losses
63,950

 
63,230

Non-interest income:
 
 
 
Payment services revenues
7,991

 
7,372

Mortgage banking revenues
6,141

 
5,906

Wealth management revenues
4,575

 
4,937

Service charges on deposit accounts
4,463

 
3,944

Other service charges, commissions and fees
2,608

 
2,495

Investment securities gains (losses), net
(21
)
 
6

Other income
1,486

 
3,122

Total non-interest income
27,243

 
27,782

Non-interest expense:
 
 
 
Salaries and wages
24,682

 
25,349

Employee benefits
8,802

 
7,780

Occupancy, net
4,664

 
4,492

Furniture and equipment
2,256

 
3,793

Outsourced technology services
4,832

 
2,463

OREO expense, net of income
(39
)
 
(61
)
Professional fees
1,308

 
1,301

FDIC insurance premiums
1,258

 
1,142

Mortgage servicing rights amortization
634

 
619

Mortgage servicing rights impairment (recovery)
15

 
(15
)
Core deposit intangibles amortization
827

 
855

Other expenses
11,623

 
11,804

Acquisition expenses
—

 
70

Total non-interest expense
60,862

 
59,592

Income before income tax expense
30,331

 
31,420

Income tax expense
10,207

 
10,440

Net income
$
20,124

 
$
20,980

 
 
 
 
Basic earnings per common share
$
0.45

 
$
0.46

Diluted earnings per common share
$
0.45

 
$
0.46

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 March 31,
 
2016
2015
Net income
$
20,124

$
20,980

Other comprehensive income, before tax:
 
 
Investment securities available-for sale:
 
 
Change in net unrealized gains during period
8,613

10,608

Reclassification adjustment for net (gains) losses included in income
21

(6
)
Change in unamortized loss on available-for-sale securities transferred into held-to-maturity
465

451

Unrealized loss on derivatives
(2,197
)
—

Defined benefit post-retirement benefits plans:
 
 
Change in net actuarial loss
15

15

Other comprehensive income, before tax
6,917

11,068

Deferred tax expense related to other comprehensive income
(2,722
)
(4,355
)
Other comprehensive income, net of tax
4,195

6,713

Comprehensive income, net of tax
$
24,319

$
27,693

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, 2015
$
311,720

 
$
638,367

 
$
406

 
$
950,493

Net income
—

 
20,124

 
—

 
20,124

Other comprehensive income, net of tax expense
—

 
—

 
4,195

 
4,195

Common stock transactions:
 
 
 
 
 
 
 
 967,965 common shares purchased and retired
(25,309
)
 
—

 
—

 
(25,309
)
182,544 non-vested common shares issued
—

 
—

 
—

 
—

12,347 non-vested common shares forfeited
—

 
—

 
—

 
—

77,028 stock options exercised, net of 34,816 shares tendered in payment of option price and income tax withholding amounts
996

 
—

 
—

 
996

Tax benefit of stock-based compensation
420

 
—

 
—

 
420

Stock-based compensation expense
955

 
—

 
—

 
955

Common cash dividend declared ($0.22 per share)
—

 
(9,860
)
 
—

 
(9,860
)
Balance at March 31, 2016
$
288,782

 
$
648,631

 
$
4,601

 
$
942,014

 
 
 
 
 
 
 
 
Balance at December 31, 2014
$
323,596

 
$
587,862

 
$
(2,534
)
 
$
908,924

Net income
—

 
20,980

 
—

 
20,980

Other comprehensive income, net of tax expense
—

 
—

 
6,713

 
6,713

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

 
—

 
(15,264
)
156,956 common shares issued
—

 
—

 
—

 
—

838 non-vested common shares forfeited
—

 
—

 
—

 
—

73,344 stock options exercised, net of 22,042 shares tendered in payment of option price and income tax withholding amounts
900

 
—

 
—

 
900

Tax benefit of stock-based compensation
480

 
—

 
—

 
480

Stock-based compensation expense
832

 
—

 
—

 
832

Common cash dividend declared ($0.20 per share)
—

 
(9,115
)
 
—

 
(9,115
)
Balance at March 31, 2015
$
310,544

 
$
599,727

 
$
4,179

 
$
914,450

See accompanying notes to unaudited consolidated financial statements.

6

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

 
Three Months Ended March 31,
 
2016
 
2015
Cash flows from operating activities:
 
 
 
Net income
$
20,124

 
$
20,980

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Provision for loan losses
4,000

 
1,095

Net (gain) loss on disposal of premises and equipment
142

 
(204
)
Depreciation and amortization
4,679

 
4,544

Net premium amortization on investment securities
3,238

 
3,684

Net (gain) loss on investment securities transactions
21

 
(6
)
Realized and unrealized net gains on mortgage banking activities
(4,588
)
 
(4,321
)
Net gain on sale of OREO
(102
)
 
(750
)
Write-downs of OREO and other assets pending disposal
17

 
106

Mortgage servicing rights impairment (charge) reversal
15

 
(15
)
Deferred income tax (benefit) expense
(517
)
 
4,914

Net increase in cash surrender value of company-owned life insurance
(1,143
)
 
(920
)
Stock-based compensation expense
955

 
832

Tax benefits from stock-based compensation expense
420

 
480

Excess tax benefits from stock-based compensation expense
(307
)
 
(292
)
Originations of mortgage loans held for sale
(195,444
)
 
(239,527
)
Proceeds from sales of mortgage loans held for sale
199,316

 
228,259

Changes in operating assets and liabilities:
 
 
 
Decrease (increase) in interest receivable
822

 
(179
)
Increase in other assets
(4,567
)
 
(3,630
)
Increase (decrease) in accrued interest payable
224

 
(720
)
Decrease in accounts payable and accrued expenses
(7,128
)
 
(15,682
)
Net cash provided by (used in) operating activities
20,177

 
(1,352
)
Cash flows from investing activities:
 
 
 
Purchases of investment securities:
 
 
 
Held-to-maturity
(4,870
)
 
(11,733
)
Available-for-sale
(254,098
)
 
(153,953
)
Proceeds from maturities, pay-downs and sales of investment securities:
 
 
 
Held-to-maturity
23,925

 
22,826

Available-for-sale
153,703

 
95,996

Extensions of credit to customers, net of repayments
(5,677
)
 
(20,050
)
Recoveries of loans charged-off
3,409

 
1,901

Proceeds from sales of OREO
309

 
2,321

Capital expenditures, net of sales
(1,408
)
 
(382
)
Net cash used in investing activities
$
(84,707
)
 
$
(63,074
)

7

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

 
Three Months Ended March 31,
 
2016
 
2015
Cash flows from financing activities:
 
 
 
Net increase (decrease) in deposits
$
18,526

 
$
(38,053
)
Net decrease in securities sold under repurchase agreements
(45,112
)
 
(40,177
)
Net increase (decrease) in other borrowed funds
31

 
(5
)
Repayments of long-term debt
(15
)
 
(15
)
Advances on long-term debt
37

 
4,996

Proceeds from issuance of common stock
996

 
900

Excess tax benefits from stock-based compensation expense
307

 
292

Purchase and retirement of common stock
(25,309
)
 
(15,264
)
Dividends paid to common stockholders
(9,860
)
 
(9,115
)
Net cash used in financing activities
(60,399
)
 
(96,441
)
Net decrease in cash and cash equivalents
(124,929
)
 
(160,867
)
Cash and cash equivalents at beginning of period
780,457

 
798,670

Cash and cash equivalents at end of period
$
655,528

 
$
637,803

 
 
 
 
Supplemental disclosures of cash flow information:
 
 
 
Cash paid during the period for income taxes
$
4,206

 
$
5,100

Cash paid during the period for interest expense
15,390

 
5,187

 
 
 
 
Supplemental disclosures of noncash investing and financing activities:
 
 
 
Transfer of loans to other real estate owned
3,227

 
3,257

Capitalization of internally originated mortgage servicing rights
602

 
659

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 March 31, 2016 and December 31, 2015, and the results of operations and cash flows for each of the three month periods ended March 31, 2016 and 2015 in conformity with U.S. generally accepted accounting principles. The balance sheet information at December 31, 2015 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 March 31, 2016 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, 2015. Operating results for the three months ended March 31, 2016 are not necessarily indicative of the results that may be expected for the year ending December 31, 2016.

(2)
Acquisitions

Flathead Bank. On April 6, 2016, the Company's bank subsidiary, First Interstate Bank, entered into a stock purchase agreement to acquire all of the outstanding stock of Flathead Bank of Bigfork ("Flathead Bank"), a Montana-based bank wholly owned by Flathead Holding Company. With total assets of $231,574 as of December 31, 2015, Flathead Bank operates seven branches in western and northwestern Montana. Upon closing of the transaction, which is expected to occur during the third quarter of 2016 subject to regulatory approval, all Flathead Bank branches will become branches of First Interstate Bank. Pursuant to the Purchase Agreement, First Interstate Bank will pay cash consideration of approximately $34,237 for the stock, subject to certain financial performance and other adjustments, the amount of which will be determined prior to the closing date of the transaction.

Absarokee Bancorporation, Inc. On July 24, 2015, the Company acquired all of the outstanding stock of Absarokee Bancorporation, Inc. ("Absarokee"), a Montana-based bank holding company that operated one subsidiary bank, United Bank. The Company merged United Bank with and into First Interstate Bank immediately subsequent to the acquisition. During March 2016, the Company completed its review of Absarokee's tax items and finalized the fair value of the acquired deferred tax asset. Finalization of provisional estimates resulted in a $42 decrease in goodwill.

(3)
Investment Securities

The amortized cost and approximate fair values of investment securities are summarized as follows:
March 31, 2016
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Estimated
Fair
Value
Available-for-Sale:
 
 
 
 
U.S. Treasury notes
$
3,911

$
24

$
—

$
3,935

Obligations of U.S. government agencies
530,037

1,719

(324
)
531,432

U.S. agency residential mortgage-backed securities & collateralized mortgage obligations
1,010,675

14,550

(862
)
1,024,363

Private mortgage-backed securities
144

1

(2
)
143

Other investments
3,450

27

—

3,477

Total
$
1,548,217

$
16,321

$
(1,188
)
$
1,563,350


9

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


March 31, 2016
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Estimated
Fair
Value
Held-to-Maturity:
 
 
 
 
State, county and municipal securities
$
167,975

$
5,553

$
(14
)
$
173,514

Corporate securities
51,918

292

(61
)
52,149

U.S agency residential mortgage-backed securities &
    collateralized mortgage obligations
341,434

11,640

(5,145
)
347,929

Obligations of U.S. government agencies
19,737

248

—

19,985

Other investments
326

1

—

327

Total
$
581,390

$
17,734

$
(5,220
)
$
593,904

December 31, 2015
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Estimated
Fair
Value
Available-for-Sale:
 
 
 
 
U.S. Treasury notes
$
3,912

$
3

$
(4
)
$
3,911

Obligations of U.S. government agencies
521,079

712

(1,610
)
520,181

U.S. agency residential mortgage-backed securities & collateralized mortgage obligations
921,699

9,448

(2,101
)
929,046

Private mortgage-backed securities
156

1

(1
)
156

Other investments
3,550

5

(9
)
3,546

Total
$
1,450,396

$
10,169

$
(3,725
)
$
1,456,840

December 31, 2015
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Estimated
Fair
Value
Held-to-Maturity:
 
 
 
 
State, county and municipal securities
$
173,785

$
5,103

$
(227
)
$
178,661

Corporate securities
50,046

64

(220
)
49,890

U.S. agency residential mortgage-backed securities & collateralized mortgage obligations
356,742

7,686

(5,420
)
359,008

Obligations of U.S. government agencies
19,738

—

(102
)
19,636

Other investments
354

1

—

355

Total
$
600,665

$
12,854

$
(5,969
)
$
607,550

    
Gross realized gains and losses from the disposition of investment securities are summarized in the following table:
 
Three Months Ended March 31,
 
2016
 
2015
Gross realized gains
$
57

 
$
6

Gross realized losses
(78
)
 
—

    

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 March 31, 2016 and December 31, 2015.
 
Less than 12 Months
 
12 Months or More
 
Total
March 31, 2016
Fair
Value
Gross
Unrealized
Losses
 
Fair
Value
Gross
Unrealized
Losses
 
Fair
Value
Gross
Unrealized
Losses
Available-for-Sale:
 
 
 
 
 
 
 
 
Obligations of U.S. government agencies
$
118,698

$
(226
)
 
$
35,355

$
(98
)
 
$
154,053

$
(324
)
U.S. agency residential mortgage-backed securities & collateralized mortgage obligations
146,840

(586
)
 
25,708

(276
)
 
172,548

(862
)
Private mortgage-backed securities
—

—

 
57

(2
)
 
57

(2
)
Other investments
—

—

 
—

—

 
—

—

Total
$
265,538

$
(812
)
 
$
61,120

$
(376
)
 
$
326,658

$
(1,188
)
 
Less than 12 Months
 
12 Months or More
 
Total
March 31, 2016
Fair
Value
Gross
Unrealized
Losses
 
Fair
Value
Gross
Unrealized
Losses
 
Fair
Value
Gross
Unrealized
Losses
Held-to-Maturity:
 
 
 
 
 
 
 
 
State, county and municipal securities
$
3,379

$
(7
)
 
$
3,606

$
(7
)
 
$
6,985

$
(14
)
U.S. agency residential mortgage-backed securities & collateralized mortgage obligations
13,801

(4,364
)
 
24,049

(781
)
 
37,850

(5,145
)
Corporate securities
10,049

(61
)
 
—

—

 
10,049

(61
)
Total
$
27,229

$
(4,432
)
 
$
27,655

$
(788
)
 
$
54,884

$
(5,220
)

 
Less than 12 Months
 
12 Months or More
 
Total
December 31, 2015
Fair
Value
Gross
Unrealized
Losses
 
Fair
Value
Gross
Unrealized
Losses
 
Fair
Value
Gross
Unrealized
Losses
Available-for-Sale:
 
 
 
 
 
 
 
 
U.S. Treasury notes
$
2,092

$
(4
)
 
$
—

$
—

 
$
2,092

$
(4
)
Obligations of U.S. government agencies
209,631

(1,077
)
 
54,619

(533
)
 
264,250

(1,610
)
U.S. agency residential mortgage-backed securities & collateralized mortgage obligations
343,875

(1,577
)
 
28,010

(524
)
 
371,885

(2,101
)
Private mortgage-backed securities
—

—

 
61

(1
)
 
61

(1
)
Other investments
1,225

(9
)
 
—

—

 
1,225

(9
)
Total
$
556,823

$
(2,667
)

$
82,690

$
(1,058
)

$
639,513

$
(3,725
)


11

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


 
Less than 12 Months
 
12 Months or More
 
Total
December 31, 2015
Fair
Value
Gross
Unrealized
Losses
 
Fair
Value
Gross
Unrealized
Losses
 
Fair
Value
Gross
Unrealized
Losses
Held-to-Maturity:
 
 
 
 
 
 
 
 
State, county and municipal securities
$
10,182

$
(39
)
 
$
9,476

$
(188
)
 
$
19,658

$
(227
)
U.S. agency residential mortgage-backed securities & collateralized mortgage obligations
67,295

(4,288
)
 
69,539

(1,132
)
 
136,834

(5,420
)
Obligations of U.S. government agencies
19,738

(102
)
 
—

—

 
19,738

(102
)
Corporate securities
31,135

(220
)
 
—

—

 
31,135

(220
)
Total
$
128,350

$
(4,649
)
 
$
79,015

$
(1,320
)
 
$
207,365

$
(5,969
)
        
The investment portfolio is evaluated quarterly for other-than-temporary declines in the market value of each individual investment security. The Company had 109 and 198 individual investment securities that were in an unrealized loss position as of March 31, 2016 and December 31, 2015, respectively. As of March 31, 2016, the Company had the intent and ability to hold these investment securities for a period of time sufficient to allow for an anticipated recovery. Furthermore, the Company does not have the intent to sell any of the available-for-sale securities in the above table and it is more likely than not that the Company will not have to sell any securities before a recovery in cost. No impairment losses were recorded during three months ended March 31, 2016 and 2015.

Maturities of investment securities at March 31, 2016 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
March 31, 2016
Amortized
Cost
Estimated
Fair Value
 
Amortized
Cost
Estimated
Fair Value
Within one year
$
317,502

$
320,927

 
$
87,930

$
90,154

After one year but within five years
1,089,290

1,099,333

 
328,090

333,231

After five years but within ten years
70,534

71,242

 
125,412

128,977

After ten years
70,891

71,848

 
39,958

41,542

Total
$
1,548,217

$
1,563,350

 
$
581,390

$
593,904

    
As of March 31, 2016, the Company had investment securities callable within one year with amortized costs and estimated fair values of $277,491 and $277,837, respectively, including callable structured notes with amortized costs and estimated fair values of $10,000 and $10,000, respectively. These investment securities are primarily 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:
 
March 31,
2016
 
December 31,
2015
Real estate loans:
 
 
 
Commercial
$
1,764,492

 
$
1,793,258

Construction:
 
 
 
Land acquisition & development
219,450

 
224,066

Residential
113,317

 
111,763

Commercial
102,382

 
94,890

Total construction loans
435,149

 
430,719

Residential
1,021,443

 
1,032,851

Agricultural
153,054

 
156,234

Total real estate loans
3,374,138

 
3,413,062

Consumer:
 
 
 
Indirect consumer
651,057

 
622,529

Other consumer
150,774

 
153,717

Credit card
63,624

 
68,107

Total consumer loans
865,455

 
844,353

Commercial
825,043

 
792,416

Agricultural
126,290

 
142,151

Other, including overdrafts
543

 
1,339

Loans held for investment
5,191,469

 
5,193,321

Mortgage loans held for sale
52,989

 
52,875

Total loans
$
5,244,458

 
$
5,246,196

    
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 March 31, 2016 and 2015:    
As of March 31,
2016
 
2015
 
 
 
 
Outstanding balance
$
33,175

 
$
32,445

 
 
 
 
Carrying value
 
 
 
Loans on accrual status
21,064

 
23,909

Loans on non-accrual status
—

 
—

Total carrying value
$
21,064

 
$
23,909

    

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 months ended March 31, 2016 and 2015:
 
Three Months Ended March 31,
 
2016
2015
 
 
 
Beginning balance
$
6,713

$
5,781

Accretion income
(614
)
(548
)
Reductions due to exit events
(147
)
(396
)
Reclassifications from nonaccretable differences
726

2,143

Ending balance
$
6,678

$
6,980

    
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 March 31, 2016
Past Due
Past Due
Past Due
Past Due
Loans
Loans
Loans
Real estate
 
 
 
 
 
 
 
Commercial
$
2,302

$
2,975

$
5

$
5,282

$
1,736,374

$
22,836

$
1,764,492

Construction:
 
 
 
 
 
 

 

Land acquisition & development
951

351

857

2,159

210,994

6,297

219,450

Residential
96

—

—

96

112,166

1,055

113,317

Commercial
184

—

—

184

101,915

283

102,382

Total construction loans
1,231

351

857

2,439

425,075

7,635

435,149

Residential
4,804

985

1,750

7,539

1,010,803

3,101

1,021,443

Agricultural
27

—

—

27

147,423

5,604

153,054

Total real estate loans
8,364

4,311

2,612

15,287

3,319,675

39,176

3,374,138

Consumer:
 
 
 
 
 
 
 

Indirect consumer
4,448

1,075

188

5,711

644,517

829

651,057

Other consumer
613

226

38

877

149,419

478

150,774

Credit card
412

346

529

1,287

62,325

12

63,624

Total consumer loans
5,473

1,647

755

7,875

856,261

1,319

865,455

Commercial
2,144

763

232

3,139

799,325

22,579

825,043

Agricultural
1,972

322

451

2,745

122,782

763

126,290

Other, including overdrafts
—

5

312

317

226

—

543

Loans held for investment
17,953

7,048

4,362

29,363

5,098,269

63,837

5,191,469

Mortgage loans originated for sale
—

—

—

—

52,989

—

52,989

Total loans
$
17,953

$
7,048

$
4,362

$
29,363

$
5,151,258

$
63,837

$
5,244,458


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, 2015
Past Due
Past Due
Past Due
Past Due
Loans
Loans
Loans
Real estate
 
 
 
 
 
 
 
Commercial
$
6,051

$
724

$
418

$
7,193

$
1,762,294

$
23,771

$
1,793,258

Construction:
 
 
 
 
 
 

 

Land acquisition & development
3,190

163

1,325

4,678

212,757

6,631

224,066

Residential
1,288

—

—

1,288

110,182

293

111,763

Commercial
3,232

—

—

3,232

90,703

955

94,890

Total construction loans
7,710

163

1,325

9,198

413,642

7,879

430,719

Residential
5,991

1,196

2,063

9,250

1,018,359

5,242

1,032,851

Agricultural
176

17

—

193

150,686

5,355

156,234

Total real estate loans
19,928

2,100

3,806

25,834

3,344,981

42,247

3,413,062

Consumer:
 
 
 
 
 
 
 

Indirect consumer
6,675

1,089

210

7,974

614,029

526

622,529

Other consumer
1,312

331

34

1,677

151,381

659

153,717

Credit card
533

317

477

1,327

66,768

12

68,107

Total consumer loans
8,520

1,737

721

10,978

832,178

1,197

844,353

Commercial
8,493

1,060

699

10,252

759,851

22,313

792,416

Agricultural
879

152

62

1,093

140,430

628

142,151

Other, including overdrafts
—

—

314

314

1,025

—

1,339

Loans held for investment
37,820

5,049

5,602

48,471

5,078,465

66,385

5,193,321

Mortgage loans originated for sale
—

—

—

—

52,875

—

52,875

Total loans
$
37,820

$
5,049

$
5,602

$
48,471

$
5,131,340

$
66,385

$
5,246,196


Acquired loans that met the criteria for nonaccrual of interest prior to acquisition were considered performing upon acquisition. If interest on non-accrual loans had been accrued, such income would have been approximately $790 and $832 for the three months ended March 31, 2016 and 2015.
        

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 originated and acquired 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 March 31, 2016
Unpaid
Total
Principal
Balance
Recorded
Investment
With No
Allowance
Recorded
Investment
With
Allowance
Total
Recorded
Investment
Related
Allowance
Real estate:
 
 
 
 
 
Commercial
$
55,222

$
25,759

$
18,117

$
43,876

$
4,526

Construction:
 
 
 
 
 
Land acquisition & development
15,252

7,742

322

8,064

150

Residential
988

282

—

282

—

Commercial
1,370

446

731

1,177

739

Total construction loans
17,610

8,470

1,053

9,523

889

Residential
5,664

3,019

1,152

4,171

160

Agricultural
6,685

5,816

201

6,017

7

Total real estate loans
85,181

43,064

20,523

63,587

5,582

Commercial
28,782

8,113

16,150

24,263

8,176

Agricultural
908

250

544

794

189

Total
$
114,871

$
51,427

$
37,217

$
88,644

$
13,947


As of December 31, 2015
Unpaid
Total
Principal
Balance
Recorded
Investment
With No
Allowance
Recorded
Investment
With
Allowance
Total
Recorded
Investment
Related
Allowance
Real estate:
 
 
 
 
 
Commercial
$
58,179

$
27,882

$
17,614

$
45,496

$
3,401

Construction:
 
 
 
 
 
Land acquisition & development
15,503

7,245

778

8,023

282

Residential
992

293

—

293

—

Commercial
1,264

340

739

1,079

739

Total construction loans
17,759

7,878

1,517

9,395

1,021

Residential
7,073

3,547

2,317

5,864

367

Agricultural
6,434

5,563

198

5,761

5

Total real estate loans
89,445

44,870

21,646

66,516

4,794

Commercial
29,593

10,744

13,727

24,471

6,487

Agricultural
1,349

622

356

978

294

Total
$
120,387

$
56,236

$
35,729

$
91,965

$
11,575



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 March 31,
 
2016
 
2015
 
 Average Recorded Investment
 
 Income Recognized
 
 Average Recorded Investment
 
 Income Recognized
 
 
 
 
 
 
Real estate:
 
 
 
 
 
 
 
Commercial
$
33,483

 
$
36

 
$
42,077

 
$
150

Construction:
 
 
 
 
 
 
 
Land acquisition & development
7,508

 
7

 
8,930

 
10

Residential
288

 
—

 
308

 
—

Commercial
1,067

 
—

 
3,055

 
2

Total construction loans
8,863

 
7

 
12,293

 
12

Residential
4,206

 
1

 
3,127

 
1

Agricultural
5,748

 
1

 
8,655

 
22

Total real estate loans
52,300

 
45

 
66,152

 
185

Commercial
23,379

 
15

 
17,533

 
8

Agricultural
856

 
—

 
914

 
5

Total
$
76,535

 
$
60

 
$
84,599

 
$
198

 
 
 
 
 
 
 
 
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 $929 and $1,035 for the three months ended March 31, 2016 and 2015.
    
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.

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 $34,344 as of March 31, 2016, of which $22,274 were included in non-accrual loans and $12,070 were on accrual status. The Company had loans renegotiated in troubled debt restructurings of $40,330 as of December 31, 2015, of which $24,911 were included in non-accrual loans and $15,419 were on accrual status.

17

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 on the Company's troubled debt restructurings that occurred during the three months ended March 31, 2016.
 
 
Number of Notes
 
Type of Concession
Principal Balance at Restructure Date
Three Months Ended March 31, 2016
 
 
Interest only period
Extension of terms or maturity
Commercial Real Estate
 
3
 
$
576

$
204

$
780

Total loans restructured during period
 
3
 
$
576

$
204

$
780

 
 
 
 
 
 
 
 
 
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 months ended March 31, 2016 or 2015.
    
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 three months ended March 31, 2016. 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 March 31, 2016
 
Number of Notes
 
Balance
Commercial Real Estate
1
 
$
203

Total
1
 
$
203


At March 31, 2016, 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:
    
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.


18

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


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 March 31, 2016
Other Assets
Especially
Mentioned
Substandard
Doubtful
Total
Criticized
Loans
Real estate:
 
 
 
 
Commercial
$
77,147

$
82,536

$
14,311

$
173,994

Construction:
 
 
 
 
Land acquisition & development
11,854

11,226

1,515

24,595

Residential
2,003

389

—

2,392

Commercial
4,056

429

748

5,233

Total construction loans
17,913

12,044

2,263

32,220

Residential
5,681

10,107

477

16,265

Agricultural
7,519

18,920

—

26,439

Total real estate loans
108,260

123,607

17,051

248,918

Consumer:
 
 
 
 
Indirect consumer
704

1,446

144

2,294

Other consumer
1,024

914

211

2,149

Total consumer loans
1,728

2,360

355

4,443

Commercial
31,392

34,039

16,629

82,060

Agricultural
3,613

7,820

543

11,976

Total
$
144,993

$
167,826

$
34,578

$
347,397

As of December 31, 2015
Other Assets
Especially
Mentioned
Substandard
Doubtful
Total
Criticized
Loans
Real estate:
 
 
 
 
Commercial
$
61,787

$
84,556

$
10,609

$
156,952

Construction:
 
 
 
 
Land acquisition & development
16,593

12,482

591

29,666

Residential
1,640

1,886

—

3,526

Commercial
166

323

756

1,245

Total construction loans
18,399

14,691

1,347

34,437

Residential
4,453

9,661

2,540

16,654

Agricultural
6,114

16,529

—

22,643

Total real estate loans
90,753

125,437

14,496

230,686

Consumer:
 
 
 
 
Indirect consumer
644

1,131

154

1,929

Other consumer
651

1,130

198

1,979

Total consumer loans
1,295

2,261

352

3,908

Commercial
32,975

27,982

15,085

76,042

Agricultural
2,247

7,105

417

9,769

Total
$
127,270

$
162,785

$
30,350

$
320,405

    
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.



19

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 March 31, 2016
Real Estate
Consumer
Commercial
Agriculture
Other
Total
Allowance for loan losses:
 
 
 
 
 
 
Beginning balance
$
52,296

$
5,144

$
18,775

$
602

$
—

$
76,817

Provision charged to operating expense
(16,081
)
1,229

17,690

1,162

—

4,000

Less loans charged-off
(1,922
)
(1,892
)
(488
)
—

—

(4,302
)
Add back recoveries of loans previously
   charged-off
2,359

775

275

—

—

3,409

Ending balance
$
36,652

$
5,256

$
36,252

$
1,764

$
—

$
79,924

 
 
 
 
 
 
 
As of March 31, 2016
Real Estate
Consumer
Commercial
Agriculture
Other
Total
Allowance for loan losses:
 
 
 
 
 
 
Loans individually evaluated for impairment
$
5,582

$
—

$
8,176

$
189

$
—

$
13,947

Loans collectively evaluated for impairment
31,070

5,256

28,076

1,575

—

65,977

Allowance for loan losses
$
36,652

$
5,256

$
36,252

$
1,764

$
—

$
79,924

 
 
 
 
 
 
 
Individually evaluated for impairment
$
63,587

$
—

$
24,263

$
794

$
—

$
88,644

Collectively evaluated for impairment
3,310,551

865,455

800,780

125,496

543

5,102,825

Total loans
$
3,374,138

$
865,455

$
825,043

$
126,290

$
543

$
5,191,469

Three Months Ended March 31, 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
(1,031
)
1,125

993

8

—

1,095

Less loans charged-off
(186
)
(1,301
)
(374
)
—

—

(1,861
)
Add back recoveries of loans previously
   charged-off
992

640

270

—

—

1,902

Ending balance
$
53,659

$
5,499

$
15,196

$
982

$
—

$
75,336

As of December 31, 2015
Real Estate

Consumer

Commercial

Agriculture

Other
Total
Allowance for loan losses:
 
 
 
 
 
 
Loans individually evaluated for impairment
$
4,794

$
—

$
6,487

$
294

$
—

$
11,575

Loans collectively evaluated for impairment
47,502

5,144

12,288

308

—

65,242

Allowance for loan losses
$
52,296

$
5,144

$
18,775

$
602

$
—

$
76,817

 
 
 
 
 
 
 
Total loans:
 

 

 

 

 

 

Individually evaluated for impairment
$
66,516

$
—

$
24,471

$
978

$
—

$
91,965

Collectively evaluated for impairment
3,346,546

844,353

767,945

141,173

1,339

5,101,356

Total loans
$
3,413,062

$
844,353

$
792,416

$
142,151

$
1,339

$
5,193,321

    

20

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


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 March 31, 2016 and December 31, 2015, the Company's allowance for loan losses included $393 and $287, respectively, related to loans acquired credit impaired.

(6)
Other Real Estate Owned
    
Information with respect to the Company's other real estate owned follows:
 
Three Months Ended March 31,
 
2016
 
2015
Beginning balance
$
6,254

 
$
13,554

Additions
3,227

 
3,257

Valuation adjustments
(17
)
 
(106
)
Dispositions
(207
)
 
(1,571
)
Ending balance
$
9,257

 
$
15,134


Foreclosed residential real estate properties of $4,087 and $1,686 were included in other real estate owned as of March 31, 2016 and December 31, 2015, respectively. The Company did not have any consumer mortgage loans collateralized by residential real estate property that were in the process of foreclosure as of March 31, 2016 or December 31, 2015.

(7)
Derivatives and Hedging Activities

Interest Rate Swap Contracts Designated as Hedges. For asset and liability management purposes, the Company has entered into interest rate swap contracts to hedge against changes in forecasted cash flows due to interest rate exposures. The swap agreements are derivative instruments and convert a portion of the Company’s forecasted variable rate debt to a fixed rate (i.e., cash flow hedge) over the payment term of the interest rate swap. The effective portion of the gain or loss on cash flow hedging instruments is initially reported as a component of other comprehensive income and subsequently reclassified into earnings in the same period during which the transaction affects earnings. The ineffective portion of the gain or loss on derivative instruments, if any, is recognized in earnings. The Company does not enter into interest rate swap agreements for trading or speculative purposes.


21

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


On September 22, 2015, the Company entered into an interest rate swap contract with a notional amount of $100,000 that was designated as a cash flow hedge. Under the terms of the interest rate swap contract, the Company pays a fixed interest rate of 1.94% and the counterparty pays to the Company a variable interest rate equal to the three-month LIBOR. No cash is exchanged until the effective date, which begins on September 15, 2017 and ends on September 15, 2020. The Company designated the interest payments related to Federal Home Loan Bank borrowings as the cash flow hedge. The hedge was fully effective during the current period. As such, no amount of ineffectiveness was included in the Company's income statement for the three months ended March 31, 2016. The Company expects the hedge to remain highly effective during the remaining term of the interest rate swap.

Non-Hedging Interest Rate Swap Contracts. The Company enters into certain interest rate swap contracts that are not designated as hedging instruments. These derivative contracts relate to transactions in which the Company enters into an interest rate swap with a customer while at the same time entering into an offsetting interest rate swap with a third party financial institution. Because the Company acts as an intermediary for the customer, changes in the fair value of the underlying derivative contracts for the most part offset each other and do not significantly impact the Company's results of operations.

Interest Rate Lock Commitments and Forward Loan Sales Contracts. In the normal course of business, the Company enters into interest rate lock commitments to finance residential mortgage loans that are not designated as accounting hedges. These commitments, which contain fixed expiration dates, offer the borrower an interest rate guarantee provided the loan meets underwriting guidelines and closes within the timeframe established by the Company. Interest rate risk arises on these commitments and subsequently closed loans if interest rates change between the time of the interest rate lock and the delivery of the loan to the investor. Loan commitments related to residential mortgage loans intended to be sold are considered derivatives and are marked to market through earnings. In addition to the effects of the change in market interest rate, the fair value measurement of the derivative also contemplates the expected cash flows to be received from the counterparty to the future sale of the loan.

The Company sells residential mortgage loans on either a best efforts or mandatory delivery basis. The Company mitigates the effect of the interest rate risk inherent in providing interest rate lock commitments by entering into a forward loan sales contract. During the interest rate lock commitment period, these forward loan sales contracts are marked to market through earnings and are not designated as accounting hedges. Exclusive of the fair value component associated with the projected cash flows from the loan delivery to the investor, the changes in fair value related to movements in market rates of the interest rate lock commitments and the forward loan sales contracts generally move in opposite directions, and the net impact of changes in these valuations on net income during the loan commitment period is generally inconsequential. When the loan is funded to the borrower, the interest rate lock commitment derivative expires and the Company records a loan held for sale. The forward loan sales contract acts as a hedge against the variability in cash to be received from the loan sale.

The changes in measurement of the estimated fair values of the interest rate lock commitments and forward loan sales contracts are included in mortgage banking revenues in the accompanying consolidated statements of income.


22

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


The notional amounts and estimated fair values of the Company's derivatives are presented in the following table. Fair value estimates are obtained from third parties and are based on pricing models.
 
March 31, 2016
 
December 31, 2015
 
Notional Amount
Estimated
Fair Value
 
Notional Amount
Estimated
Fair Value
Derivative Assets (included in other assets on balance sheet):
Derivatives designated as hedges:
 
 
 
 
 
Interest rate swap contracts
$
—

$
—

 
$
100,000

$
165

 
 
 
 
 
 
Non-hedging interest rate derivatives:
 
 
 
 
 
Interest rate swap contracts
9,281

1,102

 
9,369

788

Interest rate lock commitments
112,705

1,036

 
—

—

Total derivative assets
$
121,986

$
2,138

 
$
109,369

$
953

 
 
 
 
 
 
Derivative Liabilities (included in accounts payable and accrued expenses on balance sheet):
Derivatives designated as hedges:
 
 
 
 
 
Interest rate swap contracts
$
100,000

$
2,032

 
$
—

$
—

 
 
 
 
 
 
Non-hedging interest rate derivatives:
 
 
 
 
 
Interest rate swap contracts
9,281

1,173

 
9,369

829

Forward loan sales contracts
77,329

414

 
—

—

Total derivative liabilities
$
186,610

$
3,619

 
$
9,369

$
829


The following table presents the pre-tax gains or losses related to derivative contracts that were recorded in accumulated other comprehensive income and other non-interest income in the Company's statements of income for the periods indicated:
 
Three months ended
 
March 31, 2016
March 31, 2015
Derivatives designated as hedges:
 
 
Amount of loss recognized in other comprehensive income (effective portion)
$
(2,197
)
$
—

Non-hedging interest rate derivatives:
 
 
Amount of loss recognized in other non-interest income
(29
)
(7
)
Amount of gains recognized in mortgage banking revenues
695

—


(8)
Capital Stock
    
The Company had 21,007,483 shares of Class A common stock and 23,700,002 shares of Class B common stock outstanding as of March 31, 2016. The Company had 21,698,594 shares of Class A common stock and 23,729,631 shares of Class B common stock outstanding as of December 31, 2015.
    
During the three months ended March 31, 2016, the Company repurchased and retired 948,242 shares of its Class A common stock in open market transactions at an aggregate purchase price of $24,792. During the three months ended March 31, 2015, the Company repurchased and retired 565,875 shares of its Class A common stock in a privately negotiated transaction at an aggregate purchase price of $14,674. 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 51,758 shares of its Class A common stock. All other stock repurchases during the three months ended March 31, 2016 and 2015 were redemptions of vested restricted shares tendered in lieu of cash for payment of income tax withholding amounts by participants of the Company's equity compensation plans.

23

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



(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.

The following table sets forth the computation of basic and diluted earnings per share for the three month periods ended March 31, 2016 and 2015.
 
Three Months Ended March 31,
 
2016
2015
Net income
$
20,124

$
20,980

Weighted average common shares outstanding for basic earnings per share computation
44,719,218

45,378,230

Dilutive effects of stock-based compensation
394,834

461,961

Weighted average common shares outstanding for diluted earnings per common share computation
45,114,052

45,840,191

 
 
 
Basic earnings per common share
$
0.45

$
0.46

Diluted earnings per common share
$
0.45

$
0.46

        
The Company had 226,821 and 166,770 shares of unvested restricted stock as of March 31, 2016 and 2015, respectively, that were not included in the computation of diluted earnings per common share because performance conditions for vesting had not been met. In addition, the Company had 40,865 and 5,000 shares of unvested time restricted stock and stock options outstanding as of March 31, 2016 and as of March 31, 2015, respectively, that were not included in the computation of diluted earnings per common shares because their effect would be anti-dilutive.

(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, ("Basel III"). 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. Under Basel III, 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 required under Basel III began to phase in starting January 1, 2016 and will be fully implemented on January 1, 2019.


24

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


As of March 31, 2016 and December 31, 2015, 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 March 31, 2016 and December 31, 2015 are presented in the following tables: 
 
Actual
 
Adequately Capitalized
 Basel III
Phase-In Schedule
 
Adequately Capitalized
Basel III
Fully Phased-In
 
Well Capitalized (1)
 
Amount
 Ratio
 
Amount
 Ratio
 
Amount
 Ratio
 
Amount
 Ratio
March 31, 2016
 
 
 
 
 
 
 
 
 
 
 
Total risk-based capital:
 
 
 
 
 
 
 
 
 
 
 
Consolidated
$
930,048

15.0
%
 
$
533,419

8.6
%
 
$
649,379

10.5
%
 
$
618,456

10.0
%
FIB
876,265

14.2

 
531,493

8.6

 
647,035

10.5

 
616,224

10.0

Tier 1 risk-based capital:
 
 
 
 
 
 
 
 
 
 
 
Consolidated
848,709

13.7

 
409,727

6.6

 
525,688

8.5

 
494,765

8.0

FIB
799,201

13.0

 
408,248

6.6

 
523,790

8.5

 
492,979

8.0

Common equity tier 1 risk-based capital:
 
 
 
 
 
 
 
 
 
 
 
Consolidated
768,709

12.4

 
316,959

5.1

 
432,919

7.0

 
401,997

6.5

FIB
799,201

13.0

 
315,815

5.1

 
431,357

7.0

 
400,546

6.5

Leverage capital ratio:
 
 
 
 
 
 
 
 
 
 
 
Consolidated
848,709

10.1

 
337,137

4.0

 
337,137

4.0

 
421,421

5.0

FIB
799,201

9.5

 
336,258

4.0

 
336,258

4.0

 
420,322

5.0


 
Actual
 
Adequately Capitalized
 Basel III
Phase-In Schedule
 
Adequately Capitalized
Basel III
Fully Phased-In
 
Well Capitalized (1)
 
Amount
 Ratio
 
Amount
 Ratio
 
Amount
 Ratio
 
Amount
 Ratio
December 31, 2015
 
 
 
 
 
 
 
 
 
 
 
Total risk-based capital:
 
 
 
 
 
 
 
 
 
 
 
Consolidated
$
946,156

15.4
%
 
$
492,692

8.0
%
 
$
646,658

10.5
%
 
$
615,865

10.0
%
FIB
882,504

14.4

 
490,866

8.0

 
644,262

10.5

 
613,582

10.0

Tier 1 risk-based capital:
 
 
 
 
 
 
 
 
 
 
 
Consolidated
861,339

14.0

 
369,519

6.0

 
523,485

8.5

 
$
492,692

8.0

FIB
805,805

13.1

 
368,149

6.0

 
521,545

8.5

 
490,866

8.0

Common equity tier 1 risk-based capital:
 
 
 
 
 
 
 
 
 
 
 
Consolidated
781,339

12.7

 
277,139

4.5

 
431,105

7.0

 
$
400,312

6.5

FIB
805,805

13.1

 
276,112

4.5

 
429,508

7.0

 
398,829

6.5

Leverage capital ratio:
 
 
 
 
 
 
 
 
 
 
 
Consolidated
861,339

10.1

 
340,480

4.0

 
340,480

4.0

 
$
425,600

5.0

FIB
805,805

9.5

 
339,316

4.0

 
339,316

4.0

 
424,145

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.

25

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



(11)
Commitments and Contingencies

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.

As of March 31, 2016, the Company had a commitment under a forward starting interest rate swap contract with a notional amount of $100,000. For additional information about the forward starting interest rate swap contract, see Note 7 — Derivatives and Hedging Activity.

Residential mortgage loans sold to investors in the secondary market are sold with varying recourse provisions. Essentially all of the loan sales agreements require the repurchase of a mortgage loan by the seller in situations such as breach of representation, warranty or covenant; untimely document delivery; false or misleading statements; failure to obtain certain certificates or insurance; unmarketability; etc. Certain loan sales agreements contain repurchase requirements based on payment-related defects that are defined in terms of the number of days or months since the purchase, the sequence number of the payment, and/or the number of days of payment delinquency. Based on the specific terms stated in the agreements, the Company had $3,465 of sold residential mortgage loans with recourse provisions still in effect as of March 31, 2016.
    
(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 March 31, 2016, commitments to extend credit to existing and new borrowers approximated $1,582,107, which included $562,367 on unused credit card lines and $400,922 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 March 31, 2016, the Company had outstanding standby letters of credit of $52,402. 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)
Other Comprehensive Income/Loss
    
The gross amounts of each component of other comprehensive income and the related tax effects are as follows:
 
Pre-tax
 
Tax Expense (Benefit)
 
Net of Tax
Three Months Ended March 31,
2016
 
2015
 
2016
 
2015
 
2016
 
2015
Investment securities available-for sale:
 
 
 
 
 
 
 
 
 
 
 
Change in net unrealized gains during period
$
8,613

 
$
10,608

 
$
3,360

 
$
4,174

 
$
5,253

 
$
6,434

Reclassification adjustment for net (gains) losses included in net income
21

 
(6
)
 
8

 
(2
)
 
13

 
(4
)
Change in unamortized loss on available-
 for-sale securities transferred into held-to-
 maturity
465

 
451

 
183

 
177

 
282

 
274

Unrealized loss on derivatives
(2,197
)
 
—

 
(835
)
 
—

 
(1,362
)
 
—

Defined benefits post-retirement benefit plan:
 
 
 
 
 
 
 
 
 
 
 
Change in net actuarial loss
15

 
15

 
6

 
6

 
9

 
9

Total other comprehensive income (loss)
$
6,917

 
$
11,068

 
$
2,722

 
$
4,355

 
$
4,195

 
$
6,713


26

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


The components of accumulated other comprehensive income, net of related tax effects, are as follows:
 
March 31,
2016
 
December 31,
2015
Net unrealized gain on investment securities available-for-sale
$
6,232

 
$
684

Net unrealized gain (loss) on derivatives
(1,262
)
 
100

Net actuarial loss on defined benefit post-retirement benefit plans
(369
)
 
(378
)
Net accumulated other comprehensive income
$
4,601

 
$
406

    
(14)
Fair Value Measurements
                
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. There is a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The three levels of inputs that may be used to measure fair value are as follows:
    
•Level 1 - Quoted prices in active markets for identical assets or liabilities
    
•Level 2 - Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities
    
•Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of of assets or liabilities
    
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, and therefore as classified within Level 2 of the valuation hierarchy. There were no transfers between fair value hierarchy levels during the three months ended March 31, 2016 and 2015.
    
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 Company obtains fair value measurements for investment securities from an independent pricing service. 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. 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. If needed, a broker may be utilized to determine the reported fair value of investment securities .
    
Loans Held for Sale. Fair value measurements for loans held for sale are obtained from an independent pricing service. The fair value measurements consider observable data that may include binding contracts or quotes or bids from third party investors.
    
Interest Rate Swap Contracts. Fair values for derivative interest rate swap contracts are based upon the estimated amounts to settle the contracts considering current interest rates and are calculated using discounted cash flows that are observable or that can be corroborated by observable market data. The inputs used to determine fair value include the 3 month LIBOR forward curve to estimate variable rate cash inflows and the fed funds effective swap rate to estimate the discount rate. The estimated variable rate cash inflows are compared to the fixed rate outflows and such difference is discounted to a present value to estimate the fair value of the interest rate swaps. The change in the value of derivative assets attributable to basis risk, or the risk that offsetting investments in a hedging strategy will not experience price changes in entirely opposite directions from each other, was not significant in the reported periods. The Company also obtains and compares the reasonableness of the pricing from an independent third party.


27

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


Interest Rate Lock Commitments. Fair value measurements for interest rate lock commitments are obtained from an independent pricing service. The fair value measurements consider observable data that may include prices available from secondary market investors taking into consideration various characteristics of the loan, including the loan amount, interest rate, value of the servicing and loan to value ratio, among other things, adjusted to reflect changes in interest rates, the estimated pull-through rate and estimated direct costs necessary to complete the commitment into a closed loan.

Forward Loan Sales Contracts. The fair value measurements for forward loan sales contracts are obtained from an independent pricing service. The fair value measurements consider observable data that includes sales of similar loans and mortgage-backed securities that are traded publicly in active exchange markets.

Deferred Compensation Plan Assets and Liabilities. The fair values of deferred compensation plan assets 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. These investments are in the same funds and purchased in the same amounts as the participants’ selected investments, which represent the underlying liabilities to plan participants. Deferred compensation plan liabilities are recorded at amounts due to participants, based on the fair value of participants’ selected investments.

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 March 31, 2016
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:
 
 
 
 
 
 
U.S. Treasury Notes
$
3,935

$
—
$
3,935

$
—
Obligations of U.S. government agencies
531,432

 
—
531,432

 
—
U.S. agencies mortgage-backed securities & collateralized mortgage obligations
1,024,363

 
—
1,024,363

 
—
Private mortgage-backed securities
143

 
—
143

 
—
Other investments
3,477

 
—
3,477

 
—
Loans held for sale
52,989

 
—
52,989

 
—
Derivative assets:


 
 
 
 
 
Interest rate swap contracts
1,102

 
—
1,102

 
—
Interest rate lock commitments
1,036

 
—
1,036

 
—
Derivative liabilities:


 
 
 
 
 
Interest rate swap contracts
3,205

 
—
3,205

 
—
Forward loan sale contracts
414

 
—
414

 
—
Deferred compensation plan assets
9,566

 
—
9,566

 
—
Deferred compensation plan liabilities
9,566

 
—
9,566

 
—

28

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


 
 
Fair Value Measurements at Reporting Date Using
As of December 31, 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:
 
 
 
 
 
 
U.S. Treasury notes
$
3,911

$
—
$
3,911

$
—
Obligations of U.S. government agencies
520,181

 
—
520,181

 
—
U.S. agencies mortgage-backed securities & collateralized mortgage obligations
929,046

 
—
929,046

 
—
Private mortgage-backed securities
156

 
—
156

 
—
Other investments
3,546

 
—
3,546

 
—
Derivative assets:
 
 
 
 
 
 
Interest rate swap contracts
953

 
—
953

 
—
Derivative liabilities
 
 
 
 
 
 
Interest rate swap contracts
829

 
—
829

 
—
Deferred compensation plan assets
10,149

 
—
10,149

 
—
Deferred compensation plan liabilities
10,149

 
—
10,149

 
—
    
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. 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 March 31, 2016
Balance
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
Significant Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Impaired loans
$
19,363

$
—
$
—
$
19,363

Other real estate owned
3,464

 
—
 
—
3,464

Long-lived assets to be disposed of by sale
1,506

 
—
 
—
1,506

 
 
 
 
 
 
 
 
 
 
Fair Value Measurements at Reporting Date Using
As of December 31, 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
$
20,875

$
—
$
—
$
20,875

Other real estate owned
1,789

 
—
 
—
1,789

Long-lived assets to be disposed of by sale
1,506

 
—
 
—
1,506

    
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 March 31, 2016, certain impaired loans with a carrying value of $42,700 were reduced by specific valuation allowance allocations of $13,946 and partial loan charge-offs of $9,391 resulting in a reported fair value of $19,363. As of December 31, 2015, certain impaired loans with a carrying value of $42,679 were reduced by specific valuation allowance allocations of $11,575 and partial loan charge-offs of $10,229 resulting in a reported fair value of $20,875.
        

29

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


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 $17 during the three months ended March 31, 2016 included $11 directly related to receipt of updated appraisals and $6 based on management estimates of the current fair value of properties. Write downs of $106 during the three months ended March 31, 2015 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 March 31, 2016 and December 31, 2015, the Company had long-lived assets to be disposed of by sale with carrying values aggregating $2,363 that were reduced by write-downs of $857 resulting in an aggregate fair value of $1,506.         

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:
 
Fair Value As of
 
 
 
 
 
 
 
March 31, 2016
December 31, 2015
Valuation
Technique
Unobservable
Inputs
Range
(Weighted Average)
Impaired loans
$
19,363

$
20,875

Appraisal
Appraisal adjustment
0%
-
53%
(38%)
Other real estate owned
3,464

1,789

Appraisal
Appraisal adjustment
2%
-
96%
(19%)
Long-lived assets to be disposed of by sale
1,506

1,506

Appraisal
Appraisal adjustment
0%
-
9%
(6%)
 
 
 
 
 
 
 
 
 
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 fair values of derivative liabilities are obtained from an independent pricing service, which considers observable data that may include the three-month LIBOR forward curve, the federal funds effective swap rate and cash flows, among other things. 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 March 31, 2016
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
$
655,528

$
655,528

$
655,528

$
—

$
—

Investment securities available-for-sale
1,563,350

1,563,350

—

1,563,350

—

Investment securities held-to-maturity
581,390

593,904

—

593,904

—

Accrued interest receivable
26,907

26,907

—

26,907

—

Mortgage servicing rights, net
15,574

26,359

—

26,359

—

Net loans
5,164,534

5,105,350

—

5,085,987

19,363

Derivative assets
2,138

2,138

—

2,138

—

Deferred compensation plan assets
9,566

9,566

—

9,566

—

Total financial assets
$
8,018,987

$
7,983,102

$
655,528

$
7,308,211

$
19,363

 
 
 
 
 
 
Financial liabilities:
 
 
 
 
 
Total deposits, excluding time deposits
$
6,004,127

$
6,004,127

$
6,004,127

$
—

$
—

Time deposits
1,103,336

1,100,852

—

1,100,852

—

Securities sold under repurchase agreements
465,523

465,523

—

465,523

—

Other borrowed funds
33

33

—

33

—

Accrued interest payable
5,184

5,184

—

5,184

—

Long-term debt
27,907

27,662

—

27,662

—

Subordinated debentures held by subsidiary
   trusts
82,477

72,252

—

72,252

—

Derivative liabilities
3,619

3,619

—

3,619

—

Deferred compensation plan liabilities
9,566

9,566

—

9,566

—

Total financial liabilities
$
7,701,772

$
7,688,818

$
6,004,127

$
1,684,691

$
—


31

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


 
 
 
Fair Value Measurements at Reporting Date Using
As of December 31, 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
$
780,457

$
780,457

$
780,457

$
—

$
—

Investment securities available-for-sale
1,456,840

1,456,840

—

1,456,840

—

Investment securities held-to-maturity
600,665

607,550

—

607,550

—

Accrued interest receivable
27,729

27,729

—

27,729

—

Mortgage servicing rights, net
15,621

31,011

—

31,011

—

Net loans
5,169,379

5,128,705

—

5,107,830

20,875

Derivative assets
953

953

—

953

—

Deferred compensation plan assets
10,149

10,149

—

10,149

—

Total financial assets
$
8,061,793

$
8,043,394

$
780,457

$
7,242,062

$
20,875

 
 
 
 
 
 
Financial liabilities:
 
 
 
 
 
Total deposits, excluding time deposits
$
5,957,345

$
5,975,345

$
5,975,345

$
—

$
—

Time deposits
1,131,592

1,137,289

—

1,137,289

—

Securities sold under repurchase agreements
510,635

510,635

—

510,635

—

Other borrowed funds
2

2

—

2

—

Accrued interest payable
4,960

4,960

—

4,960

—

Long-term debt
27,885

27,622

—

27,622

—

Subordinated debentures held by subsidiary
   trusts
82,477

74,969

—

74,969

—

Derivative liabilities
829

829

—

829

—

Deferred compensation plan liabilities
10,149

10,149

—

10,149

—

Total financial liabilities
$
7,725,874

$
7,741,800

$
5,975,345

$
1,766,455

$
—


(15)
Recent Authoritative Accounting Guidance            
    
ASU 2014-09 "Revenue from Contracts with Customers." The amendments in Accounting Standards Update ("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. ASU 2015-14, “Revenue from Contracts with Customers (Topic 606) – Deferral of the Effective Date" was released in August of 2015 deferring the effective date of 2014-09 for all entities by one year until January 1, 2018. The Company is evaluating the new guidance to determine the impact it will have on its consolidated financial statements, results of operations or liquidity.
    

32

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


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 Company adopted the amendments in ASU 2014-12 effective January 1, 2016. The adoption 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 Company adopted the amendments in ASU 2014-16 effective January 1, 2016. The adoption did 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 Company adopted the amendments in ASU 2015-02 effective January 1, 2016. The adoption did 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 guidance in ASU 2015-03 did not address presentation or subsequent measurement of debt issues costs related to line-of-credit arrangements. ASU 2015-15, “Interest – Imputation of Interest (Subtopic 835-30) – Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements, Amendments to SEC Paragraphs Pursuant to Staff Announcement at June 18, 2015 EITF Meeting," addresses this gap. ASU 2015-15 adds that the SEC staff would not object to an entity deferring and presenting debt issuance costs as an asset and subsequently amortizing the deferred debt issuance costs ratably over the term of the line-of-credit arrangement, regardless of whether there are any outstanding borrowings on the line-of-credit arrangement. The Company adopted the amendments in ASU 2015-03 and ASU 2015-15 effective January 1, 2016. The adoption did 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 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 Company adopted the amendments in ASU 2015-05 effective January 1, 2016. The adoption did 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 Company adopted the amendments in ASU 2015-10 effective January 1, 2016. The adoption did not have a material impact on the Company’s consolidated financial statements, results of operations or liquidity.

ASU 2015-16 "Business Combinations-Simplifying the Accounting for Measurement-Period Adjustments." The amendments in ASU 2015-16 eliminate the requirement to retrospectively account for adjustments made to provisional amounts recognized as part of a business combination. Under the amendments in ASU 2015-16, an acquirer must recognize adjustments to the provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The amendments in ASU 2015-16 require that the acquirer record, in the same period’s financial statements, the effect on earnings of changes in depreciation, amortization or other income effects, if any, as a result of the change to the provisional amounts, calculated as if the accounting had been completed at the acquisition date. The Company adopted the amendments in ASU 2015-16 effective January 1, 2016. The adoption did not have a material impact on the Company’s consolidated financial statements, results of operations or liquidity.

ASU 2016-01 "Financial Instruments-Overall: Recognition and Measurement of Financial Assets and Financial Liabilities." The amendments in ASU 2016-1, among other things, (i) require equity investments, with certain exceptions, to be measured at fair value with changes in fair value recognized in net income, (ii) simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment, (iii) eliminates the requirement for public business entities to disclose the methods and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet, (iv) requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes, (v) requires an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments, (vi) requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the balance sheet or the accompanying notes to the financial statements and (viii) clarifies that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale investment securities. The amendments in ASU 2016-1 will be effective for the Company on January 1, 2018, and are not expected to have a significant impact on the Company’s consolidated financial statements, results of operations or liquidity.

ASU 2016-02 "Leases (Topic 842)." On February 25, 2016, the Financial Accounting Standards Board issued new lease accounting guidance in ASU No. 2016-02. Under the new guidance, lessees will be required to recognize a lease liability and a right of use asset for all leases (with the exception of short-term leases) at the commencement date of the lease and disclose key information about leasing arrangements.  Accounting by lessors is largely unchanged.  ASU 2016-02 will be effective for the Company on January 1, 2019 and will be applied using a modified retrospective approach.  The Company is evaluating the new guidance to determine the impact ASU 2016-02 will have on its consolidated financial statements, results of operations or liquidity.

ASU 2016-05 "Derivatives and Hedging (Topic 815): Effect of Derivative Contract Novations on Existing Hedge Accounting Relationships." The amendments in ASU 2016-05 clarify that a change in the counterparty to a derivative instrument that has been designated as the hedging instrument under ASC Topic 815 does not, in and of itself, require dedesignation of that hedging relationship provided that all other hedge accounting criteria continue to be met. The amendments in ASU 2016-05 will be effective for the Company on January 1, 2017, and are not expected to have a significant impact on the Company’s consolidated financial statements, results of operations or liquidity.
 
ASU 2016-07 "Investments - Equity Method and Joint Ventures (Topic 323): Simplifying the Transition to the Equity Method of Accounting." The amendments in ASU 2016-07 eliminate the requirement that when an investment qualified for use of the equity method as a result of an increase in the level of ownership interest or degree of influence, an investor must adjust the investments, results of operations and retained earnings retroactively on a step-by-step basis as if the equity method had been in effect during all previous periods hat the investment had been held. The amendments

34

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


in ASU 2016-07 also simplify the transition to the equity method of accounting by eliminating retroactive adjustment of the investment when an investment qualifies for use of the equity method, among other things. The amendments in ASU 2016-07 will be effective for the Company on January 1, 2017, and are not expected to have a significant impact on on the Company’s consolidated financial statements, results of operations or liquidity.

ASU 2016-08 "Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net)." The amendments in ASU 2016-08 were issued to clarify certain principal versus agent considerations within the implementation guidance of ASC Topic 606, “Revenue from Contracts with Customers.” The effective date and transition of ASU 2016-08 is the same as the effective date and transition of ASU 2014-09, Revenue from Contracts with Customers (Topic 606), as discussed above. The Company is continuing to evaluate the new guidance to determine the impact it will have on its consolidated financial statements, results of operations or liquidity.

ASU 2016-09 "Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting." Under the amendments in ASU 2016-09, all excess tax benefits and tax deficiencies related to share-based payment awards should be recognized as income tax expense or benefit in the income statement during the period in which they occur. Previously, such amounts were recorded in the pool of excess tax benefits included in additional paid-in capital, if such pool was available. Because excess tax benefits are no longer recognized in additional paid-in capital, the assumed proceeds from applying the treasury stock method when computing earnings per share should exclude the amount of excess tax benefits that would have previously been recognized in additional paid-in capital. Additionally, excess tax benefits should be classified along with other income tax cash flows as an operating activity rather than a financing activity, as was previously the case. The amendments in ASU 2016-09 also provide that an entity can make an entity-wide accounting policy election to either estimate the number of awards that are expected to vest (current GAAP) or account for forfeitures when they occur. The amendments in ASU 2016-09 change the threshold to qualify for equity classification to permit withholding up to the maximum statutory tax rates (rather than the minimum as was previously the case) in the applicable jurisdictions. The amendments in ASU 2016-09 will be effective for the Company on January 1, 2017, and are not expected to have a significant impact on impact on the Company’s consolidated financial statements, results of operations or liquidity.

ASU No. 2016-10 "Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing." The amendments in ASU 2016-10 were issued to clarify ASC Topic 606, “Revenue from Contracts with Customers” related to (i) identifying performance obligations; and (ii) the licensing implementation guidance. The effective date and transition of ASU 2016-10 is the same as the effective date and transition of ASU 2014-09, “Revenue from Contracts with Customers (Topic 606),” as discussed above. The Company is continuing to evaluate the new guidance to determine the impact it will have on its consolidated financial statements, results of operations or liquidity.

(16)
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 April 18, 2016, the Company declared a quarterly dividend to common shareholders of $0.22 per share, to be paid on May 13, 2016 to shareholders of record as of May 2, 2016.     

No other events requiring recognition or disclosure were identified.

35

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, 2015, 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: declining business and economic conditions, credit losses, adverse economic conditions affecting Montana, Wyoming and South Dakota, declining oil and gas prices, lending risk, adequacy of the allowance for loan losses, impairment of goodwill, failure to integrate or profitably operate acquired organizations, additional regulatory requirements if our assets exceed $10 billion, 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 litigation, inability to meet liquidity requirements, environmental remediation and other costs, ineffective internal operational controls, competition, reliance on external vendors, implementation of new lines of business or new product or service offerings, soundness of other financial institutions, failure to effectively implement technology-driven products and services, inability of our bank subsidiary to pay dividends, risks associated with introducing new lines of business, products or services, litigation pertaining to fiduciary responsibilities, change in dividend policy, uninsured nature of any investment in Class A common stock, volatility of Class A common stock, decline in market price of Class A common stock, voting control of Class B stockholders, anti-takeover provisions, dilution as a result of future equity issuances, 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, 2015, filed March 1, 2016. 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, 2015.
    
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 March 31, 2016, we had consolidated assets of $8,691 million, deposits of $7,107 million, loans of $5,244 million and total stockholders’ equity of $942 million. We currently operate 79 banking offices, including detached drive-up facilities, in 45 communities located in Montana, Wyoming and 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.

36

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 April 6, 2016, the Company's bank subsidiary, First Interstate Bank, entered into a stock purchase agreement to acquire all of the outstanding stock of Flathead Bank of Bigfork ("Flathead Bank"), a Montana-based bank wholly owned by Flathead Holding Company. With total assets of $231.6 million as of December 31, 2015, Flathead Bank operates seven branches in western and northwestern Montana. Upon closing of the transaction, which is expected to occur during the third quarter of 2016 subject to regulatory approval, all Flathead Bank branches will become branches of First Interstate Bank. Pursuant to the Purchase Agreement, First Interstate Bank will pay cash consideration of approximately $34.2 million for the stock, subject to certain financial performance and other adjustments, the amount of which will be determined prior to the closing date of the transaction.

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, or Basel III. Under Basel II, certain deductions and adjustments to regulatory capital began phasing 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 March 31, 2016 and December 31, 2015, we had capital levels that, in all cases, exceeded the well-capitalized guidelines. For additional information regarding our capital levels, see "Capital Resources and Liquidity Management" included herein and “Note 11 – 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 and evaluate the levels and trends of the line items included in our balance sheet and statements of income, as well as various financial ratios that are commonly used in our industry. We analyze these ratios and financial trends against both our own historical levels and the financial condition and performance of comparable banking institutions in our region and nationally.
    
Results of Operations
        
Principal factors used in managing and evaluating our results of operations include return on average equity, net interest income, non-interest income, non-interest expense and net income. Net interest income is affected by the level of interest rates, changes in interest rates and changes in the volume and composition of interest earning assets and interest bearing liabilities. The most significant impact on our net interest income between periods is derived from the interaction of changes in the rates earned or paid on interest earning assets and interest bearing liabilities, which we refer to as interest rate spread. The volume of loans, investment securities and other interest earning assets, compared to the volume of interest bearing deposits and indebtedness, combined with the interest rate spread, produces changes in our net interest income between periods. Non-interest bearing sources of funds, such as demand deposits and stockholders’ equity, also support earning assets.

The impact of free funding sources is captured in the net interest margin, which is calculated as net interest income divided by average earning assets. We evaluate our net interest income on factors that include the yields on our loans and other earning assets, the costs of our deposits and other funding sources, the levels of our net interest spread and net interest margin.

37

        
We seek to increase our non-interest income over time and we evaluate our non-interest income relative to the trends of the individual types of non-interest income in view of prevailing market conditions.
    
We manage our non-interest expenses in consideration of growth opportunities and our community banking model that emphasizes customer service and responsiveness. We evaluate our non-interest expense on factors that include our non-interest expense relative to our average assets, our efficiency ratio and the trends of the individual categories of non-interest expense.
    
Finally, we seek to increase our net income and provide favorable shareholder returns over time, and we evaluate our net income relative to the performance of other bank holding companies on factors that include return on average assets, return on average equity, total shareholder return and growth in earnings.
    
Financial Condition
    
Principal areas of focus in managing and evaluating our financial condition include liquidity, the diversification and quality of our loans, the adequacy of our allowance for loan losses, the diversification and terms of our deposits and other funding sources, the re-pricing characteristics and maturities of our assets and liabilities, including potential interest rate exposure and the adequacy of our capital levels. We seek to maintain sufficient levels of cash and investment securities to meet potential payment and funding obligations, and we evaluate our liquidity on factors that include the levels of cash and highly liquid assets relative to our liabilities, the quality and maturities of our investment securities, the ratio of loans to deposits and any reliance on brokered certificates of deposit or other wholesale funding sources.
    
We seek to maintain a diverse and high quality loan portfolio and evaluate our asset quality on factors that include the allocation of our loans among loan types, credit exposure to any single borrower or industry type, non-performing assets as a percentage of total loans and OREO, and loan charge-offs as a percentage of average loans. We seek to maintain our allowance for loan losses at a level adequate to absorb probable losses inherent in our loan portfolio at each balance sheet date, and we evaluate the level of our allowance for loan losses relative to our overall loan portfolio and the level of non-performing loans and potential charge-offs.
        
We seek to fund our assets primarily using core customer deposits spread among various deposit categories, and we evaluate our deposit and funding mix on factors that include the allocation of our deposits among deposit types, the level of our non-interest bearing deposits, the ratio of our core deposits (i.e. excluding time deposits above $100,000) to our total deposits and our reliance on brokered deposits or other wholesale funding sources, such as borrowings from other banks or agencies. We seek to manage the mix, maturities and re-pricing characteristics of our assets and liabilities to maintain relative stability of our net interest rate margin in a changing interest rate environment, and we evaluate our asset-liability management using models to evaluate the changes to our net interest income under different interest rate scenarios.
    
Finally, we seek to maintain adequate capital levels to absorb unforeseen operating losses and to help support the growth of our balance sheet. We evaluate our capital adequacy using the regulatory and financial capital ratios including leverage capital ratio, tier 1 risk-based capital ratio, total risk-based capital ratio, tangible common equity to tangible assets and tier 1 common capital to total risk-weighted assets.
    
Critical Accounting Estimates and Significant Accounting Policies
        
Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States and follow general practices within the industries in which we operate. Application of these principles requires management to make estimates, assumptions and judgments that affect the amounts reported in the consolidated financial statements and accompanying notes. 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, 2015.
    
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.
    

38

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, 2015 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, 2015 describes our accounting policy with regard to goodwill.
        
Our annual goodwill impairment test is performed each year as of July 1st. 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, 2015 describes our accounting policy with regard to acquired loans.
    

39

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. The most significant impact on our net interest income between periods is derived from the interaction of changes in the volume of and rates earned or paid on interest earning assets and interest bearing liabilities. The volume of loans, investment securities and other interest earning assets, compared to the volume of interest bearing deposits and indebtedness, combined with the interest rate spread, produces changes in the net interest income between periods.
    
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 March 31,
 
2016
 
2015
 
Average
Balance
Interest
Average
Rate
 
Average
Balance
Interest
Average
Rate
Interest earning assets:
 
 
 
 
 
 
 
Loans (1) (2)
$
5,222,905

$
63,371

4.88
%
 
$
4,895,146

$
59,816

4.96
%
Investment securities (2)
2,107,977

9,424

1.80

 
2,294,433

9,641

1.70

Interest bearing deposits in banks
506,839

645

0.51

 
546,583

389

0.29

Federal funds sold
1,292

2

0.62

 
1,174

2

0.69

Total interest earnings assets
7,839,013

73,442

3.77

 
7,737,336

69,848

3.66

Non-earning assets
754,962

 
 
 
752,077

 
 
Total assets
$
8,593,975

 
 
 
$
8,489,413

 
 
Interest bearing liabilities:
 
 
 
 
 
 
 
Demand deposits
$
2,147,532

$
558

0.10
%
 
$
2,089,203

$
506

0.10
%
Savings deposits
1,985,233

650

0.13

 
1,882,816

628

0.14

Time deposits
1,118,049

2,020

0.73

 
1,220,590

2,175

0.72

Repurchase agreements
477,207

90

0.08

 
479,525

54

0.05

Other borrowed funds
8

—

—

 
4

—

—

Long-term debt
29,129

449

6.20

 
38,113

515

5.48

Subordinated debentures held by subsidiary trusts
82,477

663

3.23

 
82,477

589

2.90

Total interest bearing liabilities
5,839,635

4,430

0.31

 
5,792,728

4,467

0.31

Non-interest bearing deposits
1,755,515

 
 
 
1,723,001

 
 
Other non-interest bearing liabilities
57,145

 
 
 
66,391

 
 
Stockholders’ equity
941,680

 
 
 
907,293

 
 
Total liabilities and stockholders’ equity
$
8,593,975

 

 
 
$
8,489,413

 

 
Net FTE interest income
 
69,012

 
 
 
65,381

 
Less FTE adjustments (2)
 
(1,062
)
 
 
 
(1,056
)
 
Net interest income from consolidated statements of income
 
$
67,950

 

 
 
$
64,325

 

Interest rate spread
 
 
3.46
%
 
 
 
3.35
%
Net FTE interest margin (3)
 
 
3.54
%
 
 
 
3.43
%
Cost of funds, including non-interest bearing demand deposits (4)
 
 
0.23
%
 
 
 
0.24
%
    
(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 an 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

Our net interest income on a fully taxable equivalent, or FTE, basis increased $3.6 million, or 5.6%, to $69.0 million during the three months ended March 31, 2016, as compared to $65.4 million for the same period in 2015. First quarter 2016 included one additional accrual day, as compared to first quarter 2015 as a result of leap year. This additional accrual day added approximately $750 thousand to net FTE interest income during the first quarter of 2016. Excluding the impact of the additional accrual day during first quarter 2016, net FTE interest income increased approximately $2.9 million, as compared to first quarter 2015, primarily due to increases in average loans outstanding, higher yields earned on investment securities and interest bearing deposits in banks and a shift in the mix of interest earning assets away from lower yielding assets into higher yielding loans, which made up approximately 67% of average interest-earning assets during the first quarter of 2016 compared to 63% during the first quarter of 2015.

Also positively impacting our net interest income during the three months ended March 31, 2016, as compared to the same period 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 March 31, 2016, of which $549 thousand was the result of early loan payoffs. This compares to interest accretion of $1.1 million during the three months ended March 31, 2015, of which $351 thousand was the result of early loan payoffs. In addition, we recorded recoveries of previously charged-off interest of $265 thousand during first quarter 2016, compared to $591 thousand during first quarter 2015.
    
Our net interest margin ratio increased 11 basis points to 3.54% during first quarter 2016, as compared to 3.43% during first quarter 2015. Exclusive of the accelerated interest accretion related to early payoffs of acquired loans and the impact of recoveries of charged-off interest, our net interest margin ratio increased 15 basis points to 3.53% during first quarter 2016, compared to 3.38% during first quarter 2015. The increase in net interest margin ratio was primarily due to to an 11 basis point increase in the yield on average interest earnings assets to 3.77% during first quarter 2016, as compared to 3.66% during first quarter 2015. The increase in the average yield on interest earning assets was primarily due to higher yields earned on interest-bearing deposits in bank and investment securities.

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 March 31, 2016
compared with
Three Months Ended March 31, 2015
 
Volume
 
Rate
 
Net
Interest earning assets:
 
 
 
 
 
Loans (1)
$
4,005

 
$
(450
)
 
$
3,555

Investment securities (1)
(783
)
 
566

 
(217
)
Interest bearing deposits in banks
(28
)
 
284

 
256

Federal funds sold
—

 
—

 
—

Total change
3,194

 
400

 
3,594

Interest bearing liabilities:
 
 
 
 
 
Demand deposits
14

 
38

 
52

Savings deposits
34

 
(12
)
 
22

Time deposits
(183
)
 
28

 
(155
)
Repurchase agreements
—

 
36

 
36

Other borrowed funds
—

 
—

 
—

Long-term debt
(121
)
 
55

 
(66
)
Subordinated debentures held by subsidiary trusts
—

 
74

 
74

Total change
(256
)
 
219

 
(37
)
Increase in FTE net interest income
$
3,450

 
$
181

 
$
3,631

                
(1)Interest income for tax exempt loans and securities are presented on an FTE basis.
        

41

Provision for Loan Losses. Fluctuations in the provision for loan losses reflect management's estimate of possible loan losses based upon evaluation of the borrowers' ability to repay, collateral value underlying loans, loan loss trends and estimated effects of current economic conditions on our loan portfolio. During the three months ended March 31, 2016, we recorded a provision for loan losses of $4.0 million, as compared to $1.1 million during the same period in 2015. Our first quarter 2016 provision was elevated due to increases in specific reserves on impaired energy loans, the application of historical loss factors to downgraded credits and an increase in the general economic loss factor applied to loans in our Wyoming markets as a result of stress in the energy sector. For additional information regarding our provision for loan losses, see “Allowance for Loan Losses” included herein.
                        
Non-interest Income. Our principal sources of non-interest income primarily include fee-based revenues such as payment services, mortgage banking and wealth management revenues, service charges on deposit accounts and other service charges, commissions and fees. Non-interest income decreased $539 thousand or 1.9%, to $27.2 million for the three months ended March 31, 2016, as compared to $27.8 million for the same period in 2015. Significant components of this decrease are discussed below.
                
Payment services revenues consist of interchange fees that merchants pay for processing electronic payment transactions and ATM service fees. Payment services revenues increased $619 thousand, or 8.4%, to $8.0 million during the three months ended March 31, 2016, as compared to $7.4 million for the same period in 2015, due to additional interchange income resulting from higher payment card transaction volumes.
    
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. Volatility in the equity and bond markets impacts the market value of trust assets and the related trust asset management fees. As of March 31, 2016, we had assets under management of $4.6 billion, as compared to $4.5 billion as of December 31, 2015. Wealth management revenues decreased $362 thousand, or 7.3%, to $4.6 million during the three months ended March 31, 2016, as compared to $4.9 million during the same period in 2015, primarily due to decreases in the market values of assets under trust management.
    
Other income includes company-owned life insurance revenues, net gains or losses on securities held under deferred compensation plans, check printing income, agency stock dividends and gains on sales of miscellaneous assets. Other income decreased $1.6 million, or 52.4%, to $1.5 million during the three months ended March 31, 2016, as compared to $3.1 million during the same period in 2015. During first quarter 2015, other income included the reversal of a $1.0 million expense accrual due to final settlement of secondary investor claims assumed as part of acquisitions in 2014. The remaining decrease is primarily due to lower earnings on assets held under deferred compensation plans during first quarter 2016, as compared to the same period in 2015.
    
Non-interest Expense. Non-interest expense increased $1.3 million, or 2.1%, to $60.9 million for the three months ended March 31, 2016, as compared to $59.6 million for the same period in 2015. Significant components of the increase are discussed below.
        
Salaries and wages expense decreased $667 thousand, or 2.6%, to $24.7 million during the three months ended March 31, 2016, as compared to $25.3 million during the same period in 2015, primarily due to lower incentive bonus expense, which was partially offset by one-time separation and special bonus expense of $1.2 million recorded during first quarter 2016 and inflationary increases in salary expense.
    
Employee benefits expense increased $1.0 million, or 13.1%, to $8.8 million for the three months ended March 31, 2016, as compared to $7.8 million during the same period in 2015, primarily due to increases in payroll taxes, group health insurance and profit sharing expenses. These increases were partially offset by lower earnings on assets held under deferred compensation plans.
    
Furniture and equipment expense decreased $1.5 million or 40.5%, to $2.3 million for the three months ended March 31, 2016, as compared to $3.8 million during the same period in 2015. Effective January 1, 2016, we began capturing certain software costs separately from equipment costs, resulting in a decrease in furniture and equipment expense of approximately $2.1 million and a corresponding increase in outsourced technology expenses during first quarter 2016, as compared to fourth quarter 2015.
    
Outsourced technology services expense increased $2.4 million or 96.2%, to $4.8 million for the three months ended March 31, 2016, as compared to $2.5 million during the same period in 2015, primarily due to the classification of approximately $2.1 million of software costs as outsourced technology services expense in the current year versus classification as furniture and equipment expense in the prior year.

42


Income Tax Expense. Our effective federal income tax rate was 29.8% for the three months ended March 31, 2016 and 29.0% for the three months ended March 31, 2015. State income tax applies primarily to pretax earnings generated within Montana and South Dakota. Our effective state tax rate was 3.8% for the three months ended March 31, 2016 and 4.2% for the three months ended March 31, 2015. Fluctuations in our effective income tax rates were primarily due to the timing of tax credits.    
 
Financial Condition
        
Total assets decreased $37 million, or less than 1.0%, to $8,691 million as of March 31, 2016, from $8,728 million as of December  31, 2015. Significant fluctuations in balance sheet accounts are discussed below.
        
Loans. Total loans remained stable at $5,244 million and $5,246 million as of March 31, 2016 and December 31, 2015, respectively. Loan categories with the most notable fluctuations are discussed below.

Commercial loans are typically made to small and medium-sized manufacturing, wholesale, retail and service businesses for working capital needs and business expansions. The loans are generally made with business operations as the primary source of repayment, but also include loans collateralized by inventory, accounts receivable, equipment and/or personal guarantees. Commercial loans increased $33 million, or 4.1%, to $825 million as of March 31, 2016, from $792 million as of December 31, 2015, primarily due to continuing business expansion in the Company's market areas.

Commercial real estate loans include loans for property and improvements used commercially by the borrower or for lease to others for the production of goods or services. Approximately 50% of our commercial real estate loans were owner occupied as of March 31, 2016 and December 31, 2015. Commercial real estate loans decreased $29 million, or 1.6%, to $1,764 million as of March 31, 2016, from $1,793 million as of December 31, 2015, primarily due to the repayment of one large loan and an increase in loan participations sold.

Indirect loans include consumer loan contracts advanced for the purchase of automobiles, recreational vehicles, boats and other consumer goods that we acquire from the consumer product dealer network within the market areas we serve. Indirect consumer loans increased $29 million, or 4.6%, to $651 million as of March 31, 2016, from $623 million as of December 31, 2015, primarily due to the continued expansion of our indirect lending program within our existing market areas and increases in the average loan amounts advanced.

Agricultural loans generally consist of short and medium-term loans and lines of credit that are primarily used for crops, livestock, equipment and general operations that are ordinarily secured by assets such as livestock or equipment and are repaid from the operations of the farm or ranch. Agricultural loans decreased $16 million, or 11.2%, to $126 million as of March 31, 2016, from $142 million as of December 31, 2015. Management attributes this decrease to seasonal reductions in credit lines that typically occur during the first quarter of each year.

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)
March 31,
2016
 
December 31,
2015
 
September 30,
2015
 
June 30,
2015
 
March 31,
2015
Non-performing loans:
 
 
 
 
 
 
 
 
 
Non-accrual loans
$
63,837

 
$
66,385

 
$
66,359

 
$
70,848

 
$
73,941

Accruing loans past due 90 days or more
4,362

 
5,602

 
3,357

 
2,153

 
5,175

 
 
 
 
 
 
 
 
 
 
Total non-performing loans
68,199

 
71,987

 
69,716

 
73,001

 
79,116

OREO
9,257

 
6,254

 
8,031

 
11,773

 
15,134

 
 
 
 
 
 
 
 
 
 
Total non-performing assets
$
77,456

 
$
78,241

 
$
77,747

 
$
84,774

 
$
94,250

 
 
 
 
 
 
 
 
 
 
Troubled debt restructurings not included above
$
12,070

 
$
15,419

 
$
16,702

 
$
15,127

 
$
16,070

 
 
 
 
 
 
 
 
 
 
Non-performing loans to total loans
1.30
%
 
1.37
%
 
1.35
%
 
1.43
%
 
1.61
%
Non-performing assets to total loans and OREO
1.47
%
 
1.49
%
 
1.50
%
 
1.66
%
 
1.91
%
Non-performing assets to total assets
0.89
%
 
0.90
%
 
0.90
%
 
1.01
%
 
1.11
%
    

43

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 update valuations on collateral underlying oil and gas credits based on recent market-based oil price forecasts. We also 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 collateral valuation 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)
March 31,
2016
 
Percent
of Total
 
December 31,
2015
 
Percent
of Total
Real estate:
 
 
 
 
 
 
 
Commercial
$
22,841

 
33.5
%
 
$
24,189

 
33.6
%
Construction:
 
 
.
 
 
 
 
Land acquisition and development
7,154

 
10.6
%
 
7,956

 
11.1
%
Commercial
1,055

 
1.5
%
 
955

 
1.3
%
Residential
283

 
0.4
%
 
293

 
0.4
%
Total construction
8,492

 
12.5
%
 
9,204

 
12.8
%
Residential
4,851

 
7.1
%
 
7,305

 
10.1
%
Agricultural
5,604

 
8.2
%
 
5,355

 
7.4
%
Total real estate
41,788

 
61.3
%
 
46,053

 
63.9
%
Consumer
2,074

 
3.0
%
 
1,918

 
2.7
%
Commercial
22,811

 
33.4
%
 
23,012

 
32.0
%
Agricultural
1,214

 
1.8
%
 
690

 
1.0
%
Other
312

 
0.5
%
 
314

 
0.4
%
Total non-performing loans
$
68,199

 
100.0
%
 
$
71,987

 
100.0
%
        
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 $790 thousand and $832 thousand would have been accrued for the three months ended March 31, 2016 and 2015, respectively. Non-accrual loans, the largest component of non-performing assets, decreased $2 million, to $64 million as of March 31, 2016, from $66 million as of December 31, 2015, primarily due to the movement of lower quality loans out of the portfolio through foreclosure.
            
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.        
        

44

OREO increased $3 million, or 48.0%, to $9 million as of March 31, 2016, from $6 million as of December 31, 2015, primarily due to foreclosures on one residential real estate property and one land development property during first quarter 2016. As of March 31, 2016, the composition of OREO properties was 44% residential real estate, 31% land and land development, 21% commercial, 3% agricultural real estate and 1% commercial construction.
                    
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.

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.

During fourth quarter 2015, we added a general economic qualitative loss factor to our allowance for loan loss calculation to estimate the potential impact of economic stresses in the energy sector on loans to borrowers in our Wyoming markets, which are heavily impacted by energy prices. As of March 31, 2016, our direct exposure to the energy sector was approximately $69 million in outstanding loans, including approximately $50 million related to drilling and extraction activity and approximately $19 million advanced to service companies. We also had commitments to lend an additional $27 million to energy borrowers. Reserves allocated to energy loans as a percentage of total energy loans totaled 11.7% as of March 31, 2016, compared to 7.8% as of December 31, 2015. The increase in reserves allocated to energy loans was primarily due to specific valuation allowances related to the loans of two energy borrowers and an increase in the general economic loss factor applied to loans in our Wyoming markets.
    
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 March 31, 2016, management determined that an allowance for loan losses related to acquired loans of $455 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

45

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.
    
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
 
March 31
 
December 31
 
September 30,
 
June 30,
 
March 31,
 
2016
 
2015
 
2015
 
2015
 
2015
Balance at beginning of period
$
76,817

 
$
74,256

 
$
76,552

 
$
75,336

 
$
74,200

Provision charged to operating expense
4,000

 
3,289

 
1,098

 
1,340

 
1,095

Charge offs:
 
 
 
 
 
 
 
 
 
Real estate
 
 
 
 
 
 
 
 
 
Commercial
694

 
50

 
120

 
47

 
109

Construction
625

 
305

 
2,028

 
—

 
30

Residential
601

 
91

 
71

 
510

 
45

Agricultural
2

 
614

 
—

 
53

 
2

Consumer
1,892

 
2,008

 
1,537

 
837

 
1,301

Commercial
488

 
432

 
791

 
61

 
374

Agricultural
—

 
221

 
—

 
—

 
—

Total charge-offs
4,302

 
3,721

 
4,547

 
1,508

 
1,861

Recoveries:
 
 
 
 
 
 
 
 
 
Real estate
 
 
 
 
 
 
 
 
 
Commercial
309

 
639

 
387

 
293

 
512

Construction
1,441

 
538

 
—

 
49

 
316

Residential
51

 
153

 
—

 
80

 
154

Agricultural
558

 
—

 
—

 
3

 
10

Consumer
775

 
736

 
653

 
520

 
640

Commercial
275

 
927

 
113

 
438

 
270

Agricultural
—

 
—

 
—

 
1

 
—

Total recoveries
3,409

 
2,993

 
1,153

 
1,384

 
1,902

Net charge-offs
893

 
728

 
3,394

 
124

 
(41
)
Balance at end of period
$
79,924

 
$
76,817

 
$
74,256

 
$
76,552

 
$
75,336

 
 
 
 
 
 
 
 
 
 
Period end loans
$
5,244,458

 
$
5,246,196

 
$
5,244,458

 
$
5,103,946

 
$
4,927,306

Average loans
5,222,905

 
5,194,970

 
5,222,905

 
4,991,416

 
4,895,146

Net loans charged-off to average loans, annualized
0.07
%
 
0.06
%
 
0.26
%
 
0.01
%
 
—
 %
Allowance to period end loans
1.52
%
 
1.46
%
 
1.43
%
 
1.50
%
 
1.53
 %
    
Our allowance for loan losses as a percentage of period end loans increased to 1.52% as of March 31, 2016, as compared to 1.46% as of December 31, 2015.

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.
                    

46

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 increased $87 million, or 4.2%, to $2,145 million, or 24.7% of total assets, as of March 31, 2016, from $2,058 million, or 23.6% of total assets, as of December 31, 2015. As of March 31, 2016, the estimated duration of our investment portfolio was 2.4 years, as compared to 2.8 years as of December 31, 2015.
    
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 March 31, 2016, we had investment securities with fair values aggregating $89 million that had been in a continuous loss position more than twelve months. Gross unrealized losses on these securities of $1.2 million as of March 31, 2016 were attributable to changes in interest rates. No impairment losses were recorded during the three months ended March 31, 2016 and 2015.

Cash and Cash Equivalents. Cash and cash equivalents decreased $124 million, or 16.0%, to $656 million as of March 31, 2016, from $780 million as of December 31, 2015. During the first three months of 2016, stock repurchases were funded through available funds resulting in decreases in cash and cash equivalents from December 31, 2015 to March 31, 2016. Remaining decreases in cash and cash equivalents occurred in the normal course of business and are not reflective of changes in business plan or strategy.    
Goodwill. Goodwill decreased $42 thousand to $204 million as of March 31, 2016, from $205 million as of December 31, 2015. During first quarter 2016, we finalized the fair valuation of deferred tax assets acquired in the Absarokee Bancorporation, Inc. acquisition resulting in a $42 thousand decrease in recorded goodwill.
Deposits. Our deposits consist of non-interest bearing and interest bearing demand, savings, individual retirement and time deposit accounts. Total deposits increased $19 million, or less than 1.0%, to $7,107 million as of March 31, 2016, from $7,089 million as of December 31, 2015. The following table summarizes our deposits as of the dates indicated:
Deposits
 
 
 
 
 
 
 
(Dollars in thousands)
March 31,
2016
 
Percent
of Total
 
December 31,
2015
 
Percent
of Total
Non-interest bearing demand
$
1,860,472

 
26.2
%
 
$
1,823,716

 
25.5
%
Interest bearing:
 
 
 
 
 
 
 
Demand
2,142,326

 
30.1

 
2,133,273

 
30.5

Savings
2,001,329

 
28.2

 
1,843,355

 
26.3

Time, $100 and over
478,527

 
6.7

 
520,125

 
7.4

Time, other (1)
624,809

 
8.8

 
718,095

 
10.2

Total interest bearing
5,246,991

 
73.8

 
5,214,848

 
74.5

Total deposits
$
7,107,463

 
100.0
%
 
$
7,038,564

 
100.0
%
    
(1)
Included in Time, other are Certificate of Deposit Account Registry Service, or CDAR, deposits of $32 million as of March 31, 2016 and $38 million as of December 31, 2015.

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 $45 million, or 8.8%, to $466 million as of March 31, 2016, from $511 million as of December 31, 2015. Fluctuations in repurchase agreement balances correspond with fluctuations in the liquidity of our customers.

Deferred Tax Liability. Our net deferred tax liability increased $2 million, or 22.7%, to $12 million as of March 31, 2016, from $10 million as of December 31, 2015, primarily due to increases in deferred tax liabilities related to unrealized gains on available-for sale investment securities.

Accounts Payable and Accrued Expenses. Accounts payable and accrued expenses decreased $5 million, or 9.3%, to $48 million as of March 31, 2016, from $53 million as of December 31, 2015. This decrease is due to fluctuations in the timing and amounts of corporate income tax payments.


47

Capital Resources and Liquidity Management
    
Stockholders’ equity is influenced primarily by earnings, dividends, sales and redemptions of common stock and changes in the unrealized holding gains or losses, net of taxes, on available-for-sale investment securities. Stockholders’ equity decreased $9 million, or less than 1.0%, to $942 million as of March 31, 2016, from $950 million as of December 31, 2015. During the three months ended March 31, 2016, increases in stockholders' equity due to the retention of earnings, increases in unrealized holding gains, net of taxes, on available-for-sale investment securities and proceeds from the issuance of stock options were more than offset by the repurchase and retirement of Class A common shares. During first quarter 2016, we repurchased and retired 948,242 shares of our Class A common stock in open market transactions at an aggregate purchase price of $24.8 million. The repurchases were made pursuant to a stock purchase plan approved by our Board of Directors. 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 April 18, 2016, we declared a quarterly dividend to common stockholders of $0.22 per share payable on May 13, 2016 to to shareholders of record as of May 2, 2016. This dividend equates to a 3.3% annual yield based on the $27.09 average closing price of the Company's common stock during first quarter 2016.
        
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, or Basel III. Under Basel II, certain deductions and adjustments to regulatory capital began phasing 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 March 31, 2016 and December 31, 2015, we had capital levels that, in all cases, exceeded the well-capitalized guidelines. For additional information regarding our capital levels, see "Note 11 – Regulatory Capital” in the accompanying “Notes to Unaudited Consolidated Financial Statements” included in this report.

As of March 31, 2016 and December 31, 2015, we had capital levels that, in all cases, exceeded the well-capitalized guidelines. For additional information regarding our capital levels, see “Note 11 – 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.

48

Recent Accounting Pronouncements
    
See “Note 15 – 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.    

Item 3.
    
QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
    
As of March 31, 2016, 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, 2015.

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 March 31, 2016, 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 March 31, 2016, 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 March 31, 2016, 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, 2015.
    
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, 2015.
    

49

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 March 31, 2016.
(b) Not applicable.
(c) The following table provides information with respect to purchases made by or on behalf of us or any "affiliated purchasers" (as defined in Rule 10b-18(a)(3) under the Exchange Act), of our common stock during the three months ended March 31, 2016. 

 
 
 
 
 
Total Number of
 
Maximum Number
 
 
 
 
 
 
Shares Purchased
 
of Shares That
 
 
Total Number
 
Average
 
as Part of Publicly
 
May Yet Be
 
 
of Shares
 
Price Paid
 
Announced Plans
 
Purchased Under the
Period
 
Purchased
 
Per Share
 
or Programs
 
Plans or Programs
January 2016
 
352,160

 
$
25.91

 
352,160

 
647,840

February 2016
 
615,805

 
26.28

 
596,082

 
51,758

March 2016
 
—

 
—

 
—

 
51,758

Total
 
967,965

 
$
26.15

 
948,242

 
51,758


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
 
 
 
2.1
 
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, Inc. Deferred Compensation Plan restated effective January 1, 2016
 
 
 
10.4†
 
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)
 
 
 
10.5†
 
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)
 
 
 
10.6†
 
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 )
 
 
 
10.7†
 
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).
 
 
 

50




Exhibit Number
 
Description
 
 
 
10.8†
 
Form of First Interstate BancSystem, Inc. 2015 Equity and Incentive Plan Restricted Stock Agreement (Time) 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, 2015)
 
 
 
10.9†
 
Form of First Interstate BancSystem, Inc. 2015 Equity and Incentive Plan Restricted Stock Agreement (Performance) for Certain Executive and Other 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, 2015)
 
 
 
10.10†
 
Form of First Interstate BancSystem, Inc. 2006 Equity Compensation Plan Restricted Stock Agreement (Performance) for Certain Executive and Other Officers (incorporated herein by reference to Exhibit 10.10 of the Company’s Current Report on Form 8-K filed on February 13, 2013)
 
 
 
10.11†
 
Executive Employment Agreement between First Interstate BancSystem, Inc. and Kevin P. Riley dated September 23, 2015 (incorporated herein by reference to Exhibit 10.12 of the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 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.

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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
 
 
 
FIRST INTERSTATE BANCSYSTEM, INC.
 
 
 
 
 
Date:
May 6, 2016
 
 
/S/  KEVIN P. RILEY        
 
 
 
 
Kevin P. Riley
 
 
 
 
President and Chief Executive Officer
 
 
 
 
 
Date:
May 6, 2016
 
 
/S/  MARCY D. MUTCH
 
 
 
 
Marcy D. Mutch
 
 
 
 
Executive Vice President and Chief Financial Officer

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