FIBK - Regional Bank First Interstate BancSystem Is Poorly Positioned For An Upcoming Recession

2023-05-01 17:30:45 ET

Summary

• First Interstate again reported lower than estimated 1Q results of $0.54 per share.
• Deposits decreased by $966.6 million in 1Q and continued to decrease in April according to management.
• They sold $853 million worth of securities in their AFS portfolio at a loss of $23.4 million.
• The Scott family has been selling stock.
• Their dividend payout is a very high 87%.

While investors are focusing on the negatives that are impacting the entire banking industry, they also need to take a closer look at problems facing specific banks. First Interstate BancSystem ( FIBK ), a regional bank headquartered in Montana, has a number of negatives that could have a significant impact on their stock price if the economy enters a recession. Their friendly customer service may not be enough to offset their current poor business model. I rate FIBK stock a sell.

There are number of negatives impacting First Interstate that collectively make FIBK a "sell":

1. Overpaid for troubled Great Western Bank in 2022
2. Have large unrealized losses in their securities portfolio
3. Significant exposure to falling agricultural and energy commodity prices
4. Controlling Scott family has been selling their stock
5. High dividend could be at risk of being cut

Great Western Bank Acquisition Issues

First Interstate is a regional bank headquartered in Billings, Montana that grew dramatically in early 2022 after it acquired Great Western Bank. That acquisition, in my opinion, was very irrational and seems to indicate that current management is part of the current problems.

Great Western Bank was hit very hard by the pandemic. As can be seen by the chart below Great Western's stock price greatly underperformed the market and other regional banks. The ending price performance in the chart below was soon after the announcement in September 2021 that First Interstate would buy them for 0.8425 FIBK shares or about $36.65 per share. GWA shareholders received 43% of the newly combined banks after the deal closed. The effective purchase price was about a 25% premium to GWB last stock price prior to the announcement. I think that they grossly overpaid for a multiple of reasons, including that GWB's tangible book value was only $21.71 per share.

Great Western Bank Performance Prior to Being Acquired By FIBK

Great Western's operations partially stabilized by the time of the September acquisition announcement after their balance sheet had imploded over the prior 18 months because of the pandemic. For example, total shareholder equity was $1.847 billion for the fiscal year ending September 30, 2019 but plunged to $1.106 billion as of September 30, 2021. They had a loan portfolio that was exposed to many industries that were severely hurt by the pandemic, such as hotels/resorts that were 7.7% of their loan portfolio. Total Great Western loans dropped to $8.785 billion as of September 30, 2021 from $9.800 billion as of September 30, 2020.

I think this acquisition was more than First Interstate could "chew". To acquire a troubled bank, you need capital and quality management to turn the acquired bank around and integrate it into an efficient operation. First Interstate really did not have a lot of excess capital when they announced the deal, and they made it worse by using cash to repurchase $199 million of FIBK shares in 2022 and raising their dividend. I also question the quality of their management based on some of their recent statements and what I consider irresponsible actions.

By almost doubling the size the bank risks losing its status as being perceived as a friendly local/community bank. In Wyoming, for example, 15% of the total bank deposits are currently from Wyoming, but only 4% of the loans are from Wyoming. Based on my discussions with people in the state they are beginning to think First Interstate is becoming just another Wells Fargo ( WFC ) or some other large unresponsive "corporate controlled" bank.

Unrealized Securities Losses

Like a number of other banks, First Interstate has very large unrealized losses in their securities portfolio. As of December 31, 2022 they had a $627.4 million unrealized loss on available-for-sale AFS securities ($7.5735 billion cost -$6.9461 value) and a $401.5 million unrealized loss on held-to-maturity HTM securities ($3.4537 billion cost-$3.0522 value). These total to be $1.0289 billion or $9.85 per FIBK share.

Because they held long dated paper, their unrealized losses are much higher than if they only held short-term securities. I just do not understand why they increased their portfolio's duration from 2.4 years as December 31, 2019 to 3.3 as of December 31, 2020, then to 3.6 as of December 31, 2021. The duration at the end of 2022 was 3.7 years. You should not, in my opinion, increase duration when interest rates are expected to rise.

During 1Q they sold AFS securities worth $853 million and recorded a loss of $23.4 million on their income statement. Management stated during their recent conference call that they sold them because they were going to reduce their borrowings that cost more than the income received on those securities. I take a somewhat different approach. I think a major reason why they sold was because they had a $966.6 million decline in total deposits in 1Q and they needed the cash from the sales to replace the decline in deposits. Management also stated there was an additional decline in deposits in April, but they asserted that was because customers were using the money to pay their taxes. I wonder if the decline in deposits will continue as there is still uncertainty in the banking industry, which could mean there will be additional AFS securities sales and losses on those sales reported on the income statement.

HTM securities are recorded at their cost basis on the balance sheet and unrealized losses/gains are just mentioned in footnotes. AFS securities are reported at their current market value on the balance sheet and total shareholder equity is adjusted for any unrealized losses/gains via accumulated other comprehensive income -AOCI. Actual losses/gains from the sale or maturity of securities are reported on the income statement. First Interstate does use HTM accounting, but not all banks use that method. (It almost seems like it is just a tool to "hide' unrealized losses on securities, in my opinion.)

When they file their 10-Q in a few weeks we will be able to see the 1Q details regarding AFS and HTM securities.

Exposure to Falling Commodity Prices

While total agricultural loans totaled $1.42 billion or 7.8% of their loan portfolio as of March 31, there is also significant indirect exposure to agriculture. For example, a loan to a restaurant in a farming town could be impacted by lower agricultural prices because if farmers are in financial difficulties, they are much less likely to go out to eat at a restaurant. Much of this exposure came from the acquisition of Great Western Bank that had about 17.5% of their loans in agriculture sector.

I was not able to get any specific numbers for their exposure to the oil/gas industry, but they have branches in cities, such as Casper, where the local economy is very dependent on the energy industry.

Grain prices have dropped sharply over the last year, but cattle prices have actually increased about 10% over the last year. For example, the July 2023 hard red winter wheat future is trading at $7.76, which is down from over $12.00 in May 2022. Energy prices have dropped, especially natural gas, which was over $9 last fall and has fallen to $2.35. Often the decline in commodity prices takes a while before the impact is reflected in a loan repayment status.

Scott Family Has Been Selling Stock

While the Scott family may no longer "control" First Interstate BancSystem according to the strict legal definition after the Great Western Bank transaction, effectively they still control the bank by owning a collective 14.9% of the stock and having three board seats. Collectively they currently own 15,553,922 shares, which is down from 16,049,363 as of March 25, 2022. Family members have been selling including 288,000 shares @ $35.63 per share by Julie Scott in late February.

Dividend Payout Risk

First Interstate currently has a very high dividend payout rate of 87% based on their quarterly dividend of $0.47 and 1Q EPS of $0.54. The high dividend yield of 7.3% based on the latest FIBK stock price helps to keep the stock from falling even lower. I think there is a realistic risk that the quarterly dividend could be cut to preserve capital if (or when) earnings are hurt by loan write-offs caused by a recession and by the negative impact on their regional banking market from lower commodity prices.

The dividend payout issue was even asked by an analyst during their recent conference call. The response by CEO Kevin Riley confused me. He stated: "I mean, right now, the payout ratio is probably going to go around 65%". This would imply an EPS of $2.89, but with 1Q EPS of $0.54 they would have to average about $0.78 per quarter for the next three quarters. I think their earnings will be below this because of my forecast for a recession and continued challenges to keep deposits.

The reality is that they have boxed themselves into this problem after raising the quarterly dividend last year from $0.41. Now if they cut their dividend they risk that this would be a "yellow flag" and customers may withdraw/reduce deposits. The $0.41 dividend would have been easier to maintain than $0.47.

Riley also stated: "we see nothing that would concern us in cutting the dividend due to the fact that capital will continue to grow throughout the year at that dividend payout rate". Really? I have been involved in investments for many decades and I am always troubled when I hear these types of assertions by senior management. Regional banks are failing, the world economy could be headed into a recession, many commodity prices have already fallen, and FIBK currently has a very high payout rate, but you "see nothing that would concern us"?

First Quarter Results

First Interstate again reported results that were below estimates last week. The 1Q $0.54 EPS was negatively impacted by a $23.4 million loss on the sale of some AFS securities and $20.4 million for non-performing loans. I will post comments on these 1Q results in the comment section below after they file their 10-Q because details contained in 10-Q filings are often significant and are not reported in the basic news releases.

Quarterly Income Results

Why I Sold FIBK Short

In late February I sold short a number of bank stocks, including FIBK, immediately after they filed their 10-K reports that showed very significant unrealized losses on their securities because of higher interest rates. I considered these unrealized losses would eventually become a major issue as far back as last May when I wrote on Citigroup ( C ). After these bank stocks dropped in March, I covered the short sales, except banks that I considered to have major problems specific to that bank. This group of bank shorts are effective paired trades to some higher-quality regional bank stocks I purchased in March.

I will most likely will start repurchasing my FIBK short trades when the stock trades below $20 as it gets closer to the $18.57 tangible book value. I don't think FIBK should be trading at a premium to tangible book value considering their clouded near-term outlook. I will use descending ladder trades to repurchase all the shorted shares.

Conclusion

I think that First Interstate BancSystem would not be in trouble if it did not buy Great Western Bank in 2022. Now they have increased exposure to commodity prices and are much less likely to be perceived as a local/community bank with a loyal local customer base.

The FIBK sales by the Scott family members was a red flag that should have been an indicator to sell FIBK stock. With the economy potentially headed into a recession, I expect a significant increase in non-performing loans, which will have a negative impact on earnings in 2023 and 2024. I also think the dividend is at risk to be reduced. I rate FIBK a sell.

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