Item 1A. Risk Factors
Like other financial institutions and bank holding companies, the success of our business is subject to a number of risks and uncertainties, many of which are outside our control. The material risks and uncertainties of which we are currently aware are set forth below under headings that are provided for convenience and intended to organize the risks and uncertainties into related categories to improve readability for investors; no inference should be drawn, however, that the placement of a risk factor under a particular category means it is not applicable to another category of risks or that it may be more or less material than another risk factor. Regardless, if any of the events or circumstances described below actually occur, our business, financial condition, results of operations, and prospects could be harmed. These risks are not the only ones we may face. Other risks of which we are not aware, including those which relate to the banking and financial services industry in general and us in particular, or those which we do not currently believe are material, may harm our future business, financial condition, results of operations, and prospects. You should consider carefully the following important factors in evaluating us and our business before you make an investment decision about our securities.
Regulatory and Compliance Risks
New governmental regulations and/or changes in existing governmental regulations could have a material, adverse effect on the Company.
The Company is extensively regulated under federal and state banking laws and regulations that are intended primarily for the protection of depositors, the DIF, and the banking system as a whole. Both the scope of the laws and regulations and the intensity of the supervision to which our business is subject have increased in recent years in response, we believe, to the financial crisis as well as other factors, such as technological and market changes. Regulatory enforcement and fines have also increased across the banking and financial services sector. Many of these changes have occurred as a result of the Dodd-Frank Act and its implementing regulations. The Company expects its business will remain subject to extensive regulation and supervision.
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Regulations, along with the currently existing tax, accounting, securities, insurance, employment, monetary, and other laws and regulations, rules, standards, policies, and interpretations control the methods by which we conduct business, implement strategic initiatives and tax compliance, and govern financial reporting and disclosures. In addition, the Company is subject to changes in federal and state laws as well as changes in banking and credit regulations and governmental economic and monetary policies. Congress may enact legislation from time-to-time that affects the regulation of the financial services industry, and state legislatures may enact legislation from time-to-time affecting the regulation of financial institutions chartered by or operating in those states. Federal and state regulatory agencies also periodically propose and adopt changes to their regulations or change the manner in which existing regulations are applied.
The results of the 2020 elections have produced, and likely will continue to produce, certain changes in the leadership and senior staffs of the federal banking agencies, the CFPB, CFTC, SEC, and the Treasury Department as well as the state level where gubernatorial and legislative elections have resulted in changes may lead to change in state regulatory agencies. With few exceptions, the heads of agencies and departments will change at the federal level in 2021, pending Senate confirmation, and may also change at the state level. These changes could impact the rulemaking, supervision, examination and enforcement priorities, and policies of the agencies. We continue to assess the potential impact this may have on financial and economic markets and on our business. The nature, timing, and economic and political effects of potential future changes to the current legal and regulatory framework affecting financial institutions remain highly uncertain. It is unclear what additional laws, regulations, and policies may change and whether future changes or uncertainty surrounding future changes will adversely affect our operating environment and therefore our results of operations and financial condition.
Tax legislative initiatives or assessments could adversely affect our results of operations and financial condition.
We are subject to income and other taxes in the United States and in the various jurisdictions in which we operate. The laws and regulations related to tax matters are extremely complex and subject to varying interpretations. Although management believes our positions are reasonable, we are subject to audit by the Internal Revenue Service in the United States and by tax authorities in all the jurisdictions in which we conduct business operations. While we believe we comply with all applicable tax laws, rules, and regulations in the relevant jurisdictions, the tax authorities may determine that we owe additional taxes or apply existing laws and regulations more broadly, which could result in a significant increase in liabilities for taxes and interest in excess of accrued liabilities.
New tax legislative initiatives, including increases in the corporate tax rate, may be enacted, impacting our effective tax rate at the federal and state level and potentially adversely affecting our tax positions or tax liabilities. In addition, unilateral or multi-jurisdictional actions by various tax authorities, including an increase in tax audit activity, could have an adverse impact on our tax liabilities.
We may be subject to more stringent capital requirements in the future, the impact of which could have a material risk on our operations.
Federal and state banking regulators also possess broad powers to take supervisory actions as they deem appropriate. These supervisory actions may result in higher capital requirements, higher deposit insurance premiums, and limitations on the Company’s activities that could have a material adverse effect on its business and profitability. For example, in July 2013, the FDIC and the federal banking agencies approved a new rule that substantially amended the regulatory risk-based capital rules applicable to us by adopting “Basel III” regulatory capital reforms and other changes required by the Dodd-Frank Act.
That rule included minimum risk-based capital and leverage ratios, which became effective for us on January 1, 2015, and refined the definition of what constitutes “capital” for calculating these ratios. The rule required unrealized gains and losses on certain “available-for-sale” securities holdings to be included for calculating regulatory capital requirements unless a one-time opt-out is exercised. In addition, the final rule established a “capital conservation buffer” that, once fully phased in and combined with established minimum common equity, risk-based assets capital, and total capital ratios, will exceed the prompt corrective action “well-capitalized” thresholds. (According to the FDIC Improvement Act of 1991, a depository institution is “well-capitalized” if it has a total risk-based capital ratio of 10% or greater; a Tier 1 risk-based capital ratio of 8.0% or greater; a Tier 1 leverage ratio of 5.0% or greater; a common equity Tier 1 capital ratio of 6.5% or greater; and is not subject to a regulatory order, agreement, or directive to meet and maintain a specific capital level for any capital measure.)
In January 2019, the phase-in of the new capital conservation buffer requirement was completed. An institution will be subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount. These limitations will establish a maximum percentage of eligible retained income that can be utilized for such actions.
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Our total assets exceed $10 billion, which subjects us to heightened regulatory requirements that could negatively impact our results of operations.
As of December 31, 2020, we had consolidated total assets of $17.6 billion. This means the Company is subject to various additional requirements on bank holding companies with $10 billion or more total assets, as imposed by the Dodd-Frank Act and its implementing regulations, including compliance with portions of the Federal Reserve’s enhanced prudential oversight requirements, limitations on the amount of interchange fees we may charge for debit and credit card transactions, and a more frequent and enhanced regulatory examination regime. In addition, for compliance in certain areas such as consumer financial protection laws and regulations, the Bank, with $10 billion or more in total assets, is primarily examined by the CFPB, with the Federal Reserve maintaining supervision over some consumer-related regulations. The Bank previously was examined by the Federal Reserve for compliance with consumer protection laws. The CFPB is a relatively new federal agency with evolving regulations and practices, causing some uncertainty as to how the CFPB’s examination and regulatory authority might impact our business.
Violations of applicable consumer protection laws can result in significant potential liability from litigation brought by clients, including actual damages, restitution, and attorney's fees. Federal bank regulators, state attorneys general, and state and local consumer protection agencies may also seek to enforce consumer protection requirements and obtain these and other remedies, including regulatory sanctions, client rescission rights, and civil money penalties in the jurisdictions in which we operate. Failure to comply with consumer protection requirements may also result in delays or restrictions on mergers and acquisitions and expansionary activities we may wish to pursue, and could otherwise materially and adversely affect our business, financial condition, and results of operations.
Changes in accounting standards could materially negatively impact our financial statements.
From time-to-time, the Financial Accounting Standards Board (“FASB”) and the SEC change the financial accounting and reporting standards that govern the preparation of our financial statements. These changes can materially impact how we record and report our financial condition and results of operations. For example, the FASB issued amendments to its guidance on the credit impairment of financial instruments. The amendments were effective for fiscal year 2020, which introduced a new impairment model based on current expected credit losses (“CECL”) rather than incurred losses. As a result of the amendments, we increased our allowance for credit losses, which had a significant impact on our results of operations.
Any failure to comply with laws and regulations, including the Community Reinvestment Act (CRA) and fair lending laws, could lead to material penalties.
We must comply with the CRA, the Equal Credit Opportunity Act, the Fair Housing Act, and other fair lending laws and regulations that impose non-discriminatory lending and other requirements on financial institutions. A failure to comply with these laws could result in a wide variety of sanctions, including the required payment of damages and civil money penalties, injunctive relief, imposition of restrictions on mergers and acquisitions activity, and restrictions on expansion. In addition to actions by the U.S. Department of Justice and other federal agencies, including the Federal Reserve and CFPB, who are responsible for enforcing these laws, our compliance with fair lending laws could be challenged in private class action litigation. The costs of defending any such challenge and any adverse outcome arising from such a challenge could damage our reputation or could have a material adverse effect on our business, financial condition, or results of operations.
We are subject to the USA PATRIOT Act, OFAC guidelines and requirements, the BSA, and related FinCEN and FFIEC Guidelines and regulations and any failure to comply with them could result in material implications that could harm our business.
We are routinely examined by our regulators for compliance with the USA PATRIOT Act, OFAC guidelines and requirements, the BSA, and related FinCEN and FFIEC Guidelines. Failure to maintain and implement adequate programs and fully comply with all of the relevant laws or regulations could have serious legal, financial, and reputational consequences for us, including causing applicable bank regulatory authorities not to approve merger or acquisition transactions when regulatory approval is required, or to prohibit such transactions even if approval is not required. Regulatory authorities have imposed cease and desist orders and significant civil money penalties against institutions found to be violating these regulations. If any of the foregoing were to come to pass, our business, financial condition, or results of operations could be materially and adversely affected.
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Credit Risks
We are subject to lending risks and risks associated with loan sector concentrations to which other companies may not be exposed, which could adversely affect the Company.
We take on credit risk by virtue of making loans and extending loan commitments and letters of credit. Our credit standards, procedures, and policies may not prevent us from incurring substantial credit losses, particularly in light of market developments.
Our loans held for investment portfolio are concentrated in commercial real estate and commercial business loans. As of December 31, 2020, we had $5.9 billion of commercial loans, including $3.7 billion of commercial real estate loans, representing approximately 60.2% of our loans held for investment portfolio. These loans may involve greater risks than other types of lending. Because payments on such loans are often dependent on the successful operation or development of the property or business involved, repayment of such loans is more sensitive than other types of loans to adverse conditions in the real estate market or the general economy. Commercial loans typically are made based on borrowers’ ability to make repayment from the cash flow of the commercial venture. If the cash flow from business operations is reduced, the borrower’s ability to repay the loan may be impaired. Due to the larger average size of each commercial loan as compared with other loans, as well as the collateral that is generally less readily-marketable, losses incurred on commercial loans could have a material adverse impact on our business, financial condition, and results of operations.
In addition, as of December 31, 2020, we had $2.9 billion of agricultural, agricultural real estate, construction real estate, and residential real estate loans, representing approximately 29.6% of our total loans held for investment portfolio. Many of our borrowers operate in industries that are directly or indirectly impacted by changes in commodity prices, such as agriculture, livestock, and energy businesses, as well as businesses indirectly impacted by commodities prices, such as businesses that transport commodities or manufacture equipment used in production of commodities. Changes in commodity products prices depend on local, regional, and global events or conditions that affect supply and demand for the relevant commodity. Deterioration in economic conditions or in the real estate market could result in increased delinquencies and foreclosures and could have an adverse effect on the collateral value for many of these loans and on the repayment ability of many of our borrowers. Deterioration in economic conditions or in the real estate market could also reduce the number of loans we make to businesses in the construction and real estate industry, which could negatively impact our interest income and results of operations. Similarly, the occurrence of a natural or manmade disaster in our market areas could impair the value of the collateral we hold for real estate secured loans. Any one or a combination of the factors identified above could negatively impact our business, financial condition, results of operations, and prospects.
A decline in economic conditions could reduce demand for our products and services and negatively impact the credit quality of loans, which could have an adverse effect on our results of operations.
Our clients are located predominantly in Idaho, Montana, Oregon, South Dakota, Washington, and Wyoming. Unlike larger banks that are more geographically diversified, our profitability largely depends on the general economic conditions in these areas. Deterioration in economic conditions could result in the following consequences, any of which could have a material, adverse effect on our business, financial condition, liquidity, and results of operations:
•demand for our products and services may decline;
•loan delinquencies, problem assets, and foreclosures may increase;
•collateral for loans, especially real estate, may decline in value;
•future borrowing power of our clients may be reduced;
•the value of our securities portfolio may decline; and
•the net worth and liquidity of loan guarantors may decline, impairing their ability to honor commitments to us.
Additionally, a significant decline in general economic conditions caused by inflation, recession, acts of terrorism, an outbreak of hostilities, or other international or domestic calamities, including wars or international conflicts with respect to which the United States may or may not be directly involved in the Middle East or elsewhere in the world, unemployment, or other economic and geopolitical factors beyond our control, could further impact these local economic conditions and negatively affect our business and results of operations.
Deflationary pressures, while possibly lowering our operating costs, could also have a significant negative effect on our borrowers, especially our business borrowers, and the values of underlying collateral securing loans, which could negatively affect our business, financial condition, and results of operations.
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If we experience loan credit losses in excess of estimated amounts, our earnings could be adversely affected.
The risk of credit losses on loans varies with, among other things, general economic conditions, the composition of our loan portfolio, the creditworthiness of the borrower over the term of the loan, and, in the case of a collateralized loan, the value and marketability of the collateral for the loan. We maintain an allowance for credit losses based upon, among other things, historical experience, delinquency trends, economic conditions, and regular reviews of loan portfolio quality. Based upon such factors, management makes various assumptions and judgments about the ultimate collectability of our loan portfolio and provides an allowance for credit losses. These assumptions and judgments are complex and difficult to determine given the significant uncertainty surrounding future conditions in the general economy and banking industry. If management’s assumptions and judgments prove to be incorrect and the allowance for credit losses is inadequate, or if banking authorities or regulations require us to increase the allowance for credit losses, our net income may be adversely affected. As a result, an increase in credit losses could have a material adverse effect on our earnings, financial condition, results of operations, and prospects.
The soundness of other financial institutions could adversely affect the Company.
Financial services companies are interrelated as a result of trading, clearing, counterparty, or other relationships. We have exposure to many different industries and counterparties. For example, we execute transactions with counterparties in the financial services industry, including brokers and dealers, commercial banks, investment banks, and other institutional clients. As a result, defaults by, or even rumors or questions about, one or more financial services companies or the financial services industry generally have led to market-wide liquidity problems and could lead to losses or defaults by us or by other institutions. Many of these transactions expose us to increased credit risk in the event of default of a counterparty or client.
We may be adversely affected by declining oil and gas prices, and declining demand for coal could negatively impact the demand and credit quality of loans.
Oil and gas drilling and production in and adjacent to our footprint have been important contributors to our region’s economic growth. As of December 31, 2020, our direct exposure to the oil and gas industry was approximately $75.9 million in loan commitments, including approximately $57.3 million advanced to oil and gas service companies. As of December 31, 2020, we also had commitments to lend an additional $18.6 million to oil and gas borrowers. These borrowers may be significantly affected by volatility in oil and gas prices and declines in the level of drilling and production activity. A prolonged period of low oil and gas prices or other events that result in a decline in drilling activity could have a negative impact on the economies of our market areas and on our clients. As of December 31, 2020, 19.7% of our outstanding oil and gas loans were criticized.
Additionally, adverse developments in the demand for coal due to tightening environmental regulations, the suspension of new coal leasing on federal lands, slower growth in electricity demand, and fuel competition from low natural gas prices may impact the economies of the Powder River Basin in Montana and Wyoming. Adverse developments in the energy sector could have spillover effects on the broader economies of our market areas, including commercial and residential real estate values and the general level of economic activity. The State of Wyoming derives a significant portion of its operating budget from energy extraction and related industries. As such, reductions in oil, gas, and coal-related revenues may have additional negative economic implications for the State of Wyoming. There is no assurance that our business, financial condition, results of operations, and cash flows will not be adversely impacted by increases in non-performing oil and gas loans, or by the direct and indirect effects of current and future conditions in the energy industry.
Liquidity Risks
We are subject to liquidity risks which could impair our cash flows and adversely affect the Company.
Liquidity is the ability to meet current and future cash flow needs on a timely basis at a reasonable cost. Our liquidity is used to make loans and repay deposit liabilities as they become due or are demanded by clients. Potential alternative sources of liquidity include federal funds purchased and securities sold under repurchase agreements. We maintain a portfolio of investment securities and hold overnight funds that may be used as a secondary source of liquidity to the extent the securities are not pledged for collateral. Other potential sources of liquidity include the sale of loans, the utilization of available government and regulatory assistance programs, the ability to acquire brokered deposits, the issuance of additional collateralized borrowings such as Federal Home Loan Bank advances, the issuance of debt or equity securities, and borrowings through the Federal Reserve’s discount window. Without sufficient liquidity from these potential sources, we may not be able to meet the cash flow requirements of our depositors and borrowers.
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Additionally, our access to funding sources in amounts adequate to finance our activities or on terms that are acceptable to us could be impaired by factors specific to us, the financial services industry, or the economy in general. Factors that could reduce our access to liquidity sources include a downturn in our local or national economies, difficult or illiquid credit markets, or adverse regulatory actions against us. A failure to maintain adequate liquidity could have a material, adverse effect on our regulatory standing, business, financial condition, and results of operations.
Loss of deposits or a change in deposit mix could increase the Company’s funding costs and negatively affect the Company’s operations.
Deposits are a low cost and stable source of funding. We depend on checking and savings, negotiable order of withdrawal, and money market deposit account balances and other forms of client deposits as our primary source of funding. The availability of internet banking products has increased the mobility of client deposits. We compete with banks and other financial institutions for deposits. Funding costs may increase because the Company may lose deposits and replace them with more expensive sources of funding. Clients may shift their deposits into higher-cost products or the Company may need to raise its interest rates to remain competitive in the marketplace. Higher funding costs reduce the Company’s net interest income and net income.
Market Risks
Changes in interest rates may have an adverse effect on demand for our products and services and on our profitability.
Our earnings and cash flows are largely dependent on net interest income, which is the difference between interest income earned on interest-earning assets, such as loans and investment securities, and interest expense paid on interest-bearing liabilities, such as deposits and borrowed funds. The level of net interest income is primarily a function of the average balance of interest-earning assets, the average balance of interest-bearing liabilities, and the spread between the yield on such assets and the cost of such liabilities. The narrowing of interest rate spreads could adversely affect our earnings and financial condition. We cannot control or predict with certainty changes in interest rates. Regional and local economic conditions, competitive pressures, and the policies of regulatory authorities, including monetary policies of the Federal Open Market Committee, affect interest income and interest expense.
Changes in monetary policy, including changes in interest rates, could influence not only the interest we receive on loans and securities and the amount of interest we pay on deposits and borrowings, but could also adversely affect (1) our ability to originate loans and obtain deposits, (2) the fair value of our financial assets and liabilities, including mortgage servicing rights, (3) our ability to realize gains on the sale of assets, and (4) the average duration of our mortgage-backed securities and collateralized mortgage obligations portfolios. For example, rising interest rates could adversely affect our mortgage banking business because higher interest rates could cause clients to apply for fewer mortgages. Similarly, rising interest rates would increase the required periodic payment for variable rate loans and may result in an increase in non-performing loans. Additionally, rising interest rates may increase the cost of our deposits, which are a primary source of funding. Any substantial, unexpected, or prolonged change in market interest rates could have a material, adverse effect on our cash flows, financial condition, and results of operations.
Changes in interest rates can also affect the slope of the yield curve. A decline in the current yield curve or a flatter or inverted yield curve could cause our net interest income and net interest margin to contract, which could have a material adverse effect on our net income and cash flows, as well as the value of our assets. An inverted yield curve may also adversely affect the yield on investment securities by increasing the prepayment risk of any securities purchased at a premium. A flattening or inversion of the yield curve or a negative interest rate environment in the United States could create downward pressure on our net interest margin.
Changes in interest rates could also have a negative impact on our results of operations by reducing the ability of borrowers to repay their current loan obligations or by reducing our margins and profitability. As of December 31, 2020, 44.4% of our loans were advanced to our clients on a variable or adjustable-rate basis. As a result, an increase in interest rates could result in increased loan defaults, foreclosures, and charge-offs and could necessitate further increases to the allowance for credit losses, any of which could have a material adverse effect on our business, financial condition, or results of operations. In addition, a decrease in interest rates could negatively impact our margins and profitability.
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Changes to United States trade policies and other factors beyond the Company’s control, including the imposition of tariffs and retaliatory tariffs, may adversely impact our business, financial condition, and results of operations.
Changes to United States trade policies, legislation, treaties, and tariffs, including trade policies and tariffs affecting other countries, including China, countries comprising the European Union or Middle East, Canada, and Mexico, and retaliatory tariffs by such countries, could materially harm our business. Tariffs and retaliatory tariffs have been imposed, and additional tariffs and retaliatory tariffs have been discussed. Such tariffs, retaliatory tariffs, or other trade restrictions on products and materials our clients import or export, including, among others, agricultural and oil and gas products, could cause the prices of our clients’ products to increase, which could reduce demand for such products, or reduce our clients’ margins, which would adversely impact their revenues, financial results, and ability to service debt. This in turn could adversely affect our financial condition and results of operations. In addition, to the extent changes in the political environment have a negative impact on us or on the markets in which we operate, our business, results of operations, and financial condition could be materially and adversely impacted.
On October 1, 2018, the United States, Mexico, and Canada agreement (“USMCA”), or new trade deal, replaced the North American Free Trade Agreement. The USMCA entered into force on July 1, 2020. The full impact of the USMCA on us, our clients, and on the economic conditions in our states is currently unknown and, thus, could adversely impact our business, financial condition, and results of operations.
The Company may experience significant competition from new or existing competitors, which may reduce its client base or cause it to lower prices for its products and services in order to maintain market share.
There is intense competition among banks in the Company’s market area. In addition, the Company competes with other providers of financial services, such as savings and loan associations, credit unions, consumer finance companies, securities firms, insurance companies, commercial finance and leasing companies, factoring companies, the mutual funds industry, financial technology (“fin-tech”) companies, full-service brokerage firms, and discount brokerage firms, some of which are subject to less extensive regulations than us with respect to the products and services they provide. Our success depends, in part, on our ability to adapt our products and services to evolving industry standards and client expectations. There is increasing pressure to provide products and services at lower prices. Lower prices can reduce our net interest margin and revenues from our fee-based products and services.
In addition, the adoption of new technologies by competitors, including internet banking services, mobile applications, and advanced ATM functionality, could require us to make substantial expenditures to modify or adapt our existing products and services. Also, these and other capital investments in our business may not produce expected growth in earnings anticipated at the time of the expenditure. The Company may not be successful in introducing new products and services, achieving market acceptance of its products and services, anticipating or reacting to consumers’ changing technological preferences, or developing and maintaining loyal clients. In addition, we could lose market share to the shadow banking system or other non-traditional banking organizations.
Some of our larger competitors may have greater capital and resources than the Company, higher lending limits, and products and services not offered by us. Any potential adverse reactions to our financial condition or status in the marketplace, as compared to its competitors, could limit our ability to attract and retain clients and to compete for new business opportunities. The inability to attract and retain clients or to effectively compete for new business may have a material and adverse effect on our financial condition and results of operations.
The Company also experiences competition from non-bank companies inside and outside of its market area and, in some cases, from companies other than those traditionally considered financial sector participants. In particular, technology companies have begun to focus on the financial sector and offer software and products primarily over the internet, with an increasing focus on mobile device delivery. These companies generally are not subject to regulatory requirements comparable to those to which financial institutions are subject, and may accordingly realize certain cost savings and offer products and services at more favorable rates and with greater convenience to the client. For example, a number of companies offer bill pay and funds transfer services that allow clients to avoid using a bank. Technology companies are generally positioned and structured to quickly adapt to technological advances and directly focus resources on implementing those advances. This competition could result in the loss of fee income and client deposits and related income. In addition, changes in consumer spending and saving habits could adversely affect our operations, and the Company may be unable to develop competitive and timely new products and services in response. As the pace of technology and change advance, continuous innovation is expected to exert long-term pressure on the financial services industry.
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Many of our loans held for investment and our obligations for borrowed money are priced based on variable interest rates tied to the London Inter-Bank Offered Rate, or LIBOR, which may no longer be available, or may become unreliable, as a result of the United Kingdom’s Financial Conduct Authority ceasing to require the submission of LIBOR quotes as of December 31, 2021.
LIBOR has been used extensively in the United States as a reference rate for various financial contracts, including adjustable-rate loans, asset-backed securities, and interest rate swaps. The United Kingdom’s Financial Conduct Authority, which regulates LIBOR, announced that it intends to stop persuading or compelling banks to submit LIBOR rates after 2021, which means the continuation of LIBOR cannot be guaranteed after 2021. In November 2020, however, the administrator of LIBOR announced it will consult on its intention to extend until June 30, 2023, the publication of the U.S. dollar LIBOR offered rates other than the one week and two month U.S. dollar LIBOR offered rates. Regardless, the Federal Reserve, FDIC and the Office of the Comptroller of the Currency, because of concerns associated with consumer protection, litigation and reputational risks that could in turn create safety and soundness risks, have encouraged banks to cease entering into new contracts that use U.S. dollar LIBOR as a reference rate as soon as practical and in any event by the end of the year. The potential cessation of or practical inability to use LIBOR quotes or the future unavailability or unreliability of LIBOR creates substantial risks to the banking industry, including us. Unless alternative rates can be negotiated and become accepted, our variable-rate loans, funding, and derivative obligations that specify the use of a LIBOR index would no longer be able to adjust as anticipated. This could adversely affect our asset and liability management and could lead to more asset and liability mismatches and interest rate risk unless appropriate LIBOR alternatives are developed. It could also disrupt the capital and credit markets as a result of confusion or uncertainty.
The Federal Reserve has sponsored the Alternative Reference Rates Committee, or ARRC, which serves as a forum to coordinate and track planning as market participants currently using LIBOR consider (a) transitioning to alternative reference rates where it is deemed appropriate and (b) addressing risks in legacy contracts language given the possibility that LIBOR might cease publication. On April 3, 2018, the Federal Reserve began publishing three new reference rates, including the Secured Overnight Financing Rate, or SOFR. ARRC has recommended SOFR as the alternative to LIBOR and published fallback interest rate consultations for public comment as well as a Paced Transition Plan to SOFR use. The Financial Stability Board has taken an interest in LIBOR and possible replacement indices as a matter of risk management. The International Organization of Securities Commissions, or IOSCO, has been active in this area and is expected to call on market participants to have backup options if a reference rate, such as LIBOR, ceases publication. The International Swap Dealers Association has published guidance on interest rate benchmarks and alternatives in July and August 2018. It cannot be predicted whether SOFR or another index or indices will become a market standard that replaces LIBOR, and if so, the effects on our clients, our future results of operations, or financial condition.
The market transition away from LIBOR to an alternative reference rate is complex. If LIBOR rates are no longer available and we are required to implement replacement reference rates for the calculation of interest rates under our loan agreements with borrowers, we may incur significant expense in effecting the transition and may be subject to disputes or litigation with our borrowers over the appropriateness or comparability of the replacement reference rates to LIBOR. The replacement reference rates could also result in a reduction of our interest income. We may also receive inquiries and other actions from regulators in respect to the Company’ preparation and readiness for the replacement of LIBOR with alternative reference rates.
Operational Risks
Our Company faces cyber-security risks, including “denial-of-service attacks,”“hacking,” and “identity theft” that could result in the disclosure of confidential information, adversely affect our business or reputation, and create significant legal and financial exposure.
Our computer systems and network infrastructure are subject to security risks and could be susceptible to cyber-attacks, such as denial-of-service attacks, hacking, malware, terrorist activities, or identity theft. Financial services institutions and companies engaged in data processing have reported breaches in the security of their websites or other systems, some of which have involved sophisticated and targeted attacks intended to obtain unauthorized access to confidential information, destroy data, disable or degrade service, or sabotage systems, often through the introduction of computer viruses, malware, ransomware, cyber-attacks, and other means. Denial-of-service attacks have been launched against a number of large financial services institutions, primarily resulting in inconvenience. Future ransomware and cyber-attacks could be more disruptive and damaging. Hacking and identity theft risks, in particular, could cause serious reputational harm to the Company and the Bank.
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The hardware and software we purchase from suppliers to facilitate financial services and perform company operations are also at risk of having embedded malware, viruses, and other methods intended to develop unauthorized access to confidential information. These types of attacks, known as “supply-chain attacks”, have become more prevalent and are creating additional risks through the solutions and tools upon which we rely. While we have a third-party risk management program to oversee our vendors and procurement, our ability to successfully mitigate these risks that occur in the hardware and software of these vendors is limited. To the extent we experience supply-chain attacks, our business and reputation could be materially adversely affected.
In addition, we provide our clients with the ability to bank remotely, including online, through their mobile device, and over the telephone. The secure transmission of confidential information over the internet and other remote channels is a critical element of remote banking. Our network could be vulnerable to unauthorized access, computer viruses, malware, phishing schemes, and other internal and external security breaches. We may be required to spend significant capital and other resources to protect against threats, or to alleviate problems caused by security breaches or malicious software. To the extent that our activities or the activities of our clients involve the storage and transmission of confidential information, security breaches, and viruses could expose us to claims, regulatory scrutiny, litigation, and other possible liabilities.
Despite efforts to ensure the integrity of our systems, cyber threats are rapidly evolving and we may not be able to anticipate or prevent all such attacks, nor may we be able to implement guaranteed preventive measures against such security breaches. The techniques used by cyber criminals change frequently, may not be recognized until launched or later, and can originate from a wide variety of sources, including outside groups such as external service providers. These risks may increase in the future as we continue to increase our mobile payment and other internet-based product offerings and expand our internal usage of web-based products and applications. Further, targeted social engineering attacks may be sophisticated and difficult to prevent and our employees, clients, or other users of our systems may be fraudulently induced to disclose sensitive information, allowing cyber criminals to gain access to our systems or data of our clients.
A successful penetration or circumvention of system security could cause us serious negative consequences, including significant disruption of operations, misappropriation of confidential information, or damage to our computers or systems or to those of our clients and counterparties. A successful security breach could result in violations of applicable privacy and other laws, financial loss to us or to our clients, loss of confidence in our security measures, significant litigation exposure, and harm to our reputation, all of which could have a material adverse effect on our business, financial condition, results of operations, and prospects.
Privacy, information security, and data protection laws, rules, and regulations could affect or limit how we collect and use personal information, increase our costs, and adversely affect our business opportunities.
We are subject to various privacy, information security, and data protection laws, including: (i) certain limitations on our ability to share non-public personal information about our clients with non-affiliated third parties; (ii) requirements for certain disclosures to clients about our information collection, sharing, and security practices and that afford clients the right to “opt out” of any information sharing by us with non-affiliated third parties (with certain exceptions); and (iii) requirements that we develop, implement, and maintain a written information security program containing appropriate safeguards based on our size and complexity, the nature and scope of our activities, and the sensitivity of client information we process, as well as plans for responding to data security breaches. Compliance with current or future privacy, data protection, and information security laws (including those regarding security breach notification) affecting client or employee data could result in higher compliance and technology costs and could restrict our ability to provide certain products and services, which could have a material adverse effect on our business, financial conditions, or results of operations. Our failure to comply with privacy, data protection, and information security laws could result in potentially significant regulatory or governmental investigations or actions, litigation, fines, sanctions, and damage to our reputation, which could have a material adverse effect on our business, financial condition, or results of operations.
Our goodwill may become impaired, which may adversely impact our results of operations and financial condition.
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 it is likely an impairment has occurred. In testing for impairment, the Company performs 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, the fair value of net assets is estimated based on analyses of our market value, discounted cash flows, and peer values. Consequently, the determination of the fair value of goodwill is sensitive to market-based economics and other key assumptions. Variability in market conditions or in key assumptions could result in impairment of goodwill, which is recorded as a non-cash adjustment to income. An impairment of goodwill could have a material adverse effect on our business, financial condition, and results of operations. As of December 31, 2020, we had goodwill of $621.6 million, or 31.7% of our total stockholders’ equity.
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We may invest in Collateralized Loan Obligations (CLO) securities or CLO warehouse financing structures, which may expose us to losses in connection with such investments.
We may invest in certain CLO subordinated notes or preference shares or other CLO securities. The subordinated notes or preference shares of a CLO are usually entitled to all of the income generated by the CLO after the CLO pays all of the interest due on the notes and its expenses. However, there will be little or no income available to the CLO subordinated notes or preference shares if there are defaults on the underlying collateral in excess of certain amounts or if the recoveries on such defaulted collateral are less than certain amounts. Similarly, any investment we make in debt securities of a CLO that are junior to other debt securities of the entity will be payable only in the event that the underlying collateral generates sufficient income to make the interest payments on the securities of the CLO that are senior to any such junior debt instruments. Consequently, the value of any investment we make in the subordinated notes, preference shares, or other debt securities of CLOs could decrease substantially depending on the performance of the underlying collateral in such CLO. In addition, the subordinated notes, preference shares and other debt securities of CLOs are generally illiquid, and because they represent a leveraged investment in the CLO’s assets, their value will generally fluctuate more than the values of the underlying collateral.
In addition we may invest in the subordinated notes or preference shares of CLO warehouse financing structures. Such investments will be entitled to all income generated by the underlying investments acquired during the warehouse period after the financing cost from warehouse credit facility is paid, but will bear the first loss incurred on such investments if they decrease in value and the CLO or other investment product is unable to be issued and the warehouse portfolio is liquidated. In such event, the subordinate note or preference share investors in such CLO warehouse would be exposed to losses up to the total amount of such investment if the CLO or other investment product does not close and the underlying investment pool is liquidated for a loss. Such a scenario may become more likely in times of economic distress or when the loans comprising the collateral pool of such warehouse, although still performing, may have declined in market value. Although we generally expect CLO warehouse arrangements to last approximately six to nine months before a CLO is issued, the CLO issuer may not be able to complete the issuance within the expected time frame or at all. A decline in market value may negatively impact the value of our CLOs and therefore negatively impact our financial condition and results of operations.
The Company relies on other companies to provide certain key components of its business infrastructure.
We are reliant upon certain external vendors to provide products and services necessary to maintain our day-to-day operations and we outsource many of our major systems, such as certain data processing, loan servicing, and deposit processing systems. While the Company has selected these external vendors and systems carefully and continues to manage and oversee these vendors, it does not control their operations. Failure of certain external vendors or systems to perform or provide services in accordance with contractual arrangements could be disruptive to our operations and limit our ability to provide certain products and services demanded by our clients. Because our information technology and telecommunications systems interface with and depend on third-party systems, we could experience disruptions if demand for such services exceeds capacity or such third-party systems fail or experience interruptions. If significant, sustained, or repeated, a system failure or disruption could compromise our ability to operate effectively, damage our reputation, result in a loss of client business, and/or subject us to additional regulatory scrutiny and possible financial liability. Any of the failures or disruptions mentioned above could negatively impact our financial condition, results of operations, cash flows, and prospects. Replacing these third-party vendors could also entail significant delay and expense.
Our reputation is very important to our ability to maintain, attract and retain client relationships and if our reputation were impaired it, could have an adverse effect on the Company.
Our clients expect us to deliver personalized financial services with the highest standards of performance, professionalism, compliance, and ethics. Damage to our reputation could undermine retention of our current clients and our ability to attract potential clients while also impairing the confidence of our counterparties and vendors, the result of which affects our ability to effect transactions. Maintaining our reputation depends, in part, on our ability to identify and address issues that may arise such as potential conflicts of interest, anti-money laundering, fair lending issues, client personal information and privacy issues, cyber-security, employee, client and other third-party fraud, record-keeping, regulatory investigations, and any litigation that may arise from the failure or perceived failure of us to comply with legal and regulatory requirements. To maintain our reputation, we also must prevent third parties from infringing on the “First Interstate Bank” brand and associated trademarks and our other intellectual property. Our reputation or prospects could be significantly damaged by adverse publicity or negative information regarding our Company, whether or not true, that may be posted on social media, reported in the news, or posted in other parts of the internet. Defending of our reputation, trademarks, and other intellectual property, including through litigation, could result in costs that could have a material adverse effect on our business, financial condition, or results of operations.
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We are dependent upon the services of our management team and directors and if the services of any of them were to become unavailable, it could have an adverse effect on the Company.
Our future success and profitability is substantially dependent upon the management skills of our executive officers and directors, many of whom have held officer and director positions with us for many years. We currently have employment agreements or non-competition agreements with five of our key executives: Kevin P. Riley, our president and chief executive officer; Marcy D. Mutch, our chief financial officer; Jodi Delahunt Hubbell, our chief operating officer; and Philip G. Gaglia, our chief risk officer. We do not have employment agreements with the other executives. The unanticipated loss or unavailability of key employees could harm our ability to operate our business or execute our business strategy. We may not be successful in retaining key employees or finding and integrating suitable successors in the event of key employee loss or unavailability.
We may not be able to attract and retain qualified employees to operate our business effectively, which could have an adverse effect on our business.
As a result of low unemployment rates in our historical geographic footprint and the Northwest region of the United States, there is substantial competition for qualified personnel in our markets. It may be difficult for us to attract and retain qualified employees at all management and staffing levels. Failure to attract and retain employees and maintain adequate staffing of qualified personnel could adversely impact our operations and our ability to execute our business strategy. Furthermore, relatively low unemployment rates may lead to significant increases in salaries, wages, and employee benefits expenses as we compete for qualified and skilled employees, which could negatively impact our results of operations and prospects.
Costs associated with repossessed properties, including environmental remediation, may adversely impact our results of operations, cash flows, and financial condition.
A significant portion of our loan portfolio is secured by real property. During the ordinary course of business, we may foreclose on and take title to properties serving as collateral for certain loans. There are significant costs associated with our ownership of these properties including, but not limited to, personnel costs, taxes and insurance, completion and repair costs, and valuation adjustments. Additionally, we may experience unfavorable pricing in connection with our disposition of foreclosed properties. These costs, along with unfavorable pricing upon disposition, may adversely affect our cash flows, financial condition, and results of operations.
If hazardous or toxic substances are found on these properties, we may be liable for remediation costs, as well as for personal injury and property damage. Environmental laws may require us to incur substantial expenses and may materially reduce the affected property’s value or limit our ability to use or sell the affected property. In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase our exposure to environmental liability. The remediation costs and any other financial liabilities associated with an environmental hazard could have a material, adverse effect on our cash flows, financial condition, and results of operations.
If our systems of internal operating controls were to become ineffective, our financial information could be negatively impacted.
We establish and maintain systems of internal operational controls that provide us with critical information used to manage our business. These systems are subject to various inherent limitations, including cost, 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, controls may become inadequate because of changes in conditions or processes and the risk that the degree of compliance with policies or procedures may deteriorate over time. Because of these limitations, any system of internal operating controls 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. From time-to-time, control deficiencies and losses from operational malfunctions or fraud have occurred and may occur in the future. Any future deficiencies, weaknesses, or losses related to internal operating control systems could have an adverse effect on our business, financial condition, results of operations, and prospects.
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We may not effectively implement new technology-driven products and services or be successful in marketing these products and services to our clients, which could negatively impact our business.
The financial services industry is continually undergoing rapid technological change with frequent introductions of new technology-driven products and services. The effective use of technology enables financial institutions to better serve clients and perform more efficiently. Our future success depends, in part, upon our ability to use technology to provide products and services that will satisfy clients’ demands for convenience, as well as create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements. We may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our clients. Failure to successfully keep pace with technological change affecting the financial services industry could have a material, adverse impact on our business and, in turn, on our financial condition, results of operations, and prospects.
Strategic Risks
If we are not able to execute on our intended expansion plans, our business, reputation, and results of operations could be materially, adversely affected.
Our current plans for organic growth and growth through merger and acquisition opportunities in our core and other markets may be adversely affected by a number of factors, including competition from other banking and financial institutions, many of which have resources significantly greater than ours, and a decline in the number of attractive financial institution acquisition targets headquartered in our geographic markets. This competition, especially as the number of acquisition targets decreases, could, for example, increase acquisition purchase prices in our targeted areas for growth, which could reduce our potential returns on successfully completed acquisitions or otherwise make such acquisitions too expensive to be attractive to consummate.
Furthermore, as a regulated financial institution, our ability to pursue or complete attractive acquisitions or de novo or other expansion opportunities could be negatively impacted by regulatory approval issues, including delays in obtaining required approvals or an inability to obtain required regulatory approvals on terms deemed reasonable to us or at all. In considering whether to approve or deny our expansion proposals, government regulators consider our capital, liquidity, profitability, regulatory compliance, including with respect to consumer protection laws and CRA obligations, and levels of goodwill and intangibles. They also must consider, from time-to-time, regulatory initiatives designed to limit systemic risk that may have the effect of limiting our desired expansion. If our regulators are not satisfied with one or more of the foregoing financial metrics, or regulatory initiatives turn out to be unexpected impediments to growth, our expansion opportunities could be delayed or diminished, all to the detriment of our financial results.
Difficulties in combining the operations of acquired entities or assets with our own operations or assessing the effectiveness of businesses in which we make strategic investments or with which we enter into strategic contractual relationships may prevent us from achieving the expected benefits from these acquisitions, investments, or relationships.
Acquisitions of other companies or of financial assets and related deposits and other liabilities present risks and uncertainties to us based in part on the nature of the business or assets and liabilities acquired. For example, if an acquisition includes loan portfolios, the extent of credit losses following completion of the acquisition could adversely affect our combined results of operations. Similarly, if an acquisition includes deposits, the extent of deposit attrition after closing could adversely affect our combined results of operations. Acquisitions of banking companies typically include both loans and deposits, and the extent of any post-closing credit losses and deposit attrition could be affected by a number of factors, including the state of the economy following the acquisition and the geographic area or markets in which the target operates. If the markets were to react negatively to the announcement of the acquisition, or if the economy were to suffer or enter into a recession following an acquisition, we may not timely, or at all, achieve the expected benefits of an acquisition and our business and the value of our Class A common stock could be harmed.
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Acquisitions of other companies or of financial assets and related deposits and other liabilities also present risks and uncertainties to us in addition to those presented by the nature of the business acquired. These risks include unanticipated costs incurred in connection with the integration of the acquired business. For example, the total cost and time required to complete the integration successfully could be greater than estimated and result in higher acquisition costs than expected or a loss of market opportunity due to any such delay. Furthermore, the results of litigation or governmental investigations that may have been pending at the time of an acquisition, or may be filed or commenced thereafter, as a result of an acquisition or otherwise, may be materially underestimated and harm our operating results more than originally anticipated. On the other hand, some or all of the anticipated benefits of a particular acquisition, such as cost savings from synergies or strategic gains from being able to offer product sets to a broader potential client base, may not be realized. It can take longer or require greater resources than originally expected to achieve any of such benefits. It also may prove impossible to achieve them at all or in their entirety as a result of unexpected factors or events. As a result, any acquisition could ultimately prove dilutive to our equity and shareholders’ earnings per share, thereby adversely affecting our financial condition and results of operations.
Acquisitions may also result in business disruptions that could cause clients to remove their accounts from us and move their business to competing financial institutions. It is possible that the integration process related to acquisitions could also result in the disruption of our ongoing businesses or inconsistencies in standards, controls, procedures, and policies that could adversely affect our ability to maintain relationships with clients and employees. The loss of key employees in connection with an acquisition could also adversely affect our ability to successfully conduct our business. Acquisition and integration efforts could divert management attention and resources, which could have an adverse effect on our financial condition and results of operations. Additionally, the operation of the acquired branches may adversely affect our existing profitability, and we may not be able to achieve results in the future similar to those achieved by the existing banking business or manage growth resulting from the acquisition effectively, any of which could harm our business and reputation.
In addition to post-acquisition integration related risks, inherent uncertainties exist when assessing or integrating the operations of another business into which we may make an investment or with which we may enter into a commercial relationship. We may not be able to fully achieve the strategic objectives and planned operating efficiencies relevant to an investment or strategic relationship. In addition, the markets and industries in which we and the potential investment targets operate are highly competitive. Investment targets and commercial contract counterparties may lose clients or customers or otherwise perform poorly or unprofitably, or in the case of a strategic relationship, cause us to lose clients or perform poorly or unprofitably. Future investment activities and efforts to monitor or reap the benefits of a new strategic relationship may require us to devote substantial time and resources and may cause these investments and relationships to be unprofitable or cause us to be unable to pursue other business opportunities, any of which could harm our business.
Common Stock Risks
We qualify as a “controlled company” under the NASDAQ Marketplace Rules and may rely on exemptions from certain corporate governance requirements.
Due to the combined voting power of the members of the Scott family, we qualify as a “controlled company” under the NASDAQ Marketplace Rules. As a “controlled company,” we are exempt from certain NASDAQ corporate governance requirements, including the requirements that:
•a majority of the board of directors consist of independent directors;
•the compensation of officers be determined, or recommended to the board of directors for determination, by a majority of the independent directors or a compensation committee comprised solely of independent directors; and
•director nominees be selected, or recommended for the board of directors’ selection, by a majority of the independent directors or a nominating committee comprised solely of independent directors with a written charter or board resolution addressing the nomination process.
Our compensation and governance and nominating committees may not consist entirely of independent directors. As long as we choose to rely on these exemptions from NASDAQ Marketplace Rules, stockholders and other interested parties should be aware, therefore, that decisions concerning executive compensation and director nominations may not be determined solely by the Board’s independent directors and may be adverse to their particular interests.
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Volatility in the price and volume of our Class A common stock may be unfavorable.
The market price of our Class A common stock is volatile and could be subject to wide fluctuations in price in response to various factors, some of which are beyond our control. These factors include:
•prevailing market conditions;
•our historical performance and capital structure;
•estimates of our business potential and earnings prospects;
•an overall assessment of our management;
•conversion by our Class B shareholders of their shares into Class A common stock to liquidate their holdings;
•our performance relative to our peers;
•market demand for our shares;
•perceptions of the banking industry in general;
•political influences on investor sentiment; and
•consumer confidence.
At times, the stock markets, including the NASDAQ Stock Market on which our Class A common stock is listed, may experience significant price and volume fluctuations. As a result, the market price of our Class A common stock is likely to be similarly volatile and investors in our Class A common stock may experience a decrease in the value of their shares, including decreases unrelated to our operating performance or prospects. Further, because our Class B common stock is convertible on a share-for-share basis into Class A common stock and the share price of our Class B common stock is based upon the share price of our Class A common stock, our Class B common stock price is similarly impacted by the factors affecting our Class A common stock.
In addition, following periods of volatility in the overall market and the market price of a company’s securities, securities class action litigation has often been instituted against companies. This litigation, if instituted against us, could result in substantial costs and a diversion of our management’s attention and resources.
“Anti-takeover” provisions and the regulations to which we are subject may also make it more difficult for a third party to acquire control of us, even if the change in control could be deemed beneficial to stockholders.
We are a financial and bank holding company incorporated in the State of Montana. Anti-takeover provisions in Montana law and our articles of incorporation and bylaws, as well as regulatory approvals that would be required under federal law, could make it more difficult for a third party to acquire control of us and may prevent stockholders from receiving a premium for their shares of our Class A common stock. These provisions could adversely affect the market price of our Class A common stock and could reduce the amount stockholders might receive if we are sold.
Our articles of incorporation provide that our Board may issue up to 100,000 shares of preferred stock, in one or more series, without stockholder approval and with such terms, conditions, rights, privileges, and preferences as the Board may deem appropriate. In addition, our articles of incorporation provide for staggered terms for our Board and limitations on persons authorized to call a special meeting of stockholders. In addition, certain provisions of Montana law may have the effect of inhibiting a third party from making a proposal to acquire us or of impeding a change of control under circumstances that otherwise could provide the holders of our common stock with the opportunity to realize a premium over the then-prevailing market price of such Class A common stock.
Further, the acquisition of specified amounts of our common stock (in some cases, the acquisition or control of more than 5% of our voting stock) may require certain regulatory approvals, including the approval of the Federal Reserve and one or more of our state banking regulatory agencies. The filing of applications with these agencies and the accompanying review process can take several months. Additionally, as discussed above, the holders of the Class B common stock will have voting control of the Company. This and the other factors described above may hinder or even prevent a change in control of us, even if a change in control would be beneficial to our stockholders.
Our dividend policy, or our ability to pay dividends, may change.
We are a legal entity separate and distinct from our subsidiary Bank. Since we are a holding company with no significant assets other than the capital stock of our subsidiaries, we depend upon dividends from our Bank for a substantial part of our revenue. Accordingly, our ability to pay dividends, cover operating expenses, and acquire other institutions depends primarily upon the receipt of dividends or other capital distributions from the Bank. The ability of our Bank to pay dividends to us is subject to, among other things, its earnings, financial condition, and need for funds, as well as federal and state governmental policies and regulations applicable to us and the Bank, which limit the amount that may be paid as dividends without prior approval.
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Although we have historically paid dividends to our stockholders, we have no obligation to continue doing so and may change our dividend policy at any time without notice to our stockholders. Holders of our common stock are only entitled to receive such cash dividends as our board of directors may declare out of funds legally available for such payments. The amount of any dividend declaration is subject to our evaluation of our strategic plans, growth initiatives, capital availability, projected liquidity needs, and other factors.
An investment in our common stock is not an insured deposit.
Our Class A and Class B common stock is not a bank savings account or deposit and, therefore, is not insured against loss by the FDIC, any other deposit insurance fund, or any other public or private entity. As a result, holders of our common stock could lose some or all of their investment.
Holders of the Class B common stock have voting control of the Company and are able to determine virtually all matters submitted to stockholders, including potential change in control transactions, and our dual class common stock structure may put downward pressure on the price per share of our Class A common stock.
Members of the Scott family control a majority of the voting power of our outstanding common stock. Due to their holdings of common stock, members of the Scott family are able to determine the outcome of virtually all matters submitted to stockholders for approval, including the election of directors, amendment of our articles of incorporation (except when a class vote is required by law or pursuant to our articles of incorporation), any merger or consolidation requiring common stockholder approval, and the sale of all or substantially all of our assets. Accordingly, such holders have the ability to prevent change in control transactions as long as they maintain voting control of the Company.
In addition, because these holders have the ability to elect all of our directors, they are able to control our policies and operations, including the appointment of management, the payments of dividends on our common stock, and entering into extraordinary transactions; their interests may not in all cases be aligned with the interests of all stockholders. For example, members of the Scott family have adopted a charter with the intended purpose of reaching a voluntarily consensus on issues considered by the family to be important, and their interests may diverge from the interests of other stockholders. The Scott family members have also entered into a stockholder agreement giving family members a right of first refusal to purchase shares of Class B common stock that are intended to be sold or transferred, subject to certain exceptions, by other family members. This agreement may have the effect of continuing ownership of the Class B common stock and control within the Scott family. This concentrated control limits stockholders’ ability to influence corporate matters. As a result, the market price of our Class A common stock could be adversely affected.
In addition, we cannot predict whether our dual class common stock structure, combined with the concentrated control by the Scott family, will result in a lower or more volatile market price of our Class A common stock or in adverse publicity or other adverse consequences. For example, some developers of popular indexes have announced restrictions on including companies with multiple-class voting structures in certain of their indexes. S&P Dow Jones announced that it will no longer admit companies with multiple-class voting structures to certain of its indexes. Because of our dual class common stock structure, we may be excluded from these indexes and we cannot assure you that other stock indexes will not take similar actions. Given the sustained flow of investment funds into passive strategies that seek to track certain indexes, exclusion from stock indexes would likely preclude investment by many of these funds and could make our Class A common stock less attractive to other investors. As a result, the market price of our Class A common stock could be adversely affected.
Future equity issuances could result in dilution, which could cause our common stock price to decline.
We may issue additional Class A common stock in the future pursuant to current or future employee equity compensation plans or in connection with future acquisitions or financings. Should we choose to raise capital by selling shares of Class A common stock for any reason, the issuance would have a dilutive effect on the holders of our Class A and Class B common stock and could have a material negative effect on the market price of our Class A common stock. In addition, our Class B common stock is convertible into Class A common stock at any time at the sole discretion of the holders of Class B shares or automatically if, on the record date for any meeting of stockholders, the number of outstanding Class B shares constitutes less than 20% of the aggregate number of common stock then outstanding.
The common stock is equity and is subordinate to our existing and future indebtedness.
Shares of our Class A and Class B common stock are equity interests and do not constitute indebtedness. As such, shares of our Class A and Class B common stock rank junior to all our indebtedness, including any subordinated term loans, subordinated debentures held by trusts that have issued trust-preferred securities, and other non-equity claims on us with respect to assets available to satisfy claims on us. In the future, we may make additional offerings of debt or equity securities or we may issue additional debt or equity securities as consideration for future mergers and acquisitions.
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General Risk Factors
The COVID-19 pandemic has caused a significant global disruption which has adversely affected, and is expected to continue to adversely affect, our business and results of operations, and the future impacts of the COVID-19 pandemic and the U.S. Government response to the pandemic on the global economy could adversely affect our business, results of operations, liquidity, and financial condition.
The disease caused by the novel coronavirus (also known as, and referred to herein, as “COVID-19”), which was identified as a pandemic by the World Health Organization, created a global public-health crisis that resulted in challenging economic conditions for households and businesses around the world. Since the onset of the COVID-19 pandemic, Federal, state, and local governments have responded to the COVID-19 pandemic in a variety of ways including, without limitation, by declaring states of emergency, restricting people from gathering in groups or interacting within a certain physical distance (i.e., social distancing), ordering businesses to close or limit operations and ordering people to stay at home (i.e., shelter in place), and imposing travel restrictions (including quarantine requirements). Although many of the restrictions have eased across the country, the pandemic has yet to show sustained signs of decline in the U.S. Some areas may re-impose closures and other restrictions due to increased rates of COVID-19 cases. The economic impact of the COVID-19 pandemic has affected a broad range of industries, including banking, travel, hospitality, and entertainment. There is increasing concern about the longer lasting impact on local businesses, as well as the travel and entertainment industries, resulting from the COVID-19 pandemic.
The Federal Reserve returned to a zero-interest rate policy in March 2020 and the U.S. government enacted several fiscal stimulus measures to counteract the economic disruption caused by the COVID-19 pandemic and provide economic assistance to businesses and households. The dramatic lowering of market interest rates in a short period of time had an adverse effect on the Company’s asset yields. The extent of these impacts will depend on future developments, including, among others, governmental, regulatory and private sector actions and responses, new information that may emerge concerning the COVID-19 pandemic, new strains of the virus that causes COVID-19, and actions taken to contain or prevent further spread, each of which are highly uncertain and cannot be predicted.
Our business is dependent upon the ability and willingness of our clients to conduct banking and other financial transactions, including the payment of loan obligations. COVID-19 has and continues to disrupt the business, activities, and operations of our clients, which may cause a decline in demand for our products and services and which may, in turn, result in a significant decrease in our business, negatively impacting our liquidity position and financial results. Our financial results could also be impacted by an inability of our clients to meet their loan commitments because of their losses associated with the effects of COVID-19 on their businesses, resulting in increased risk of delinquencies, defaults, foreclosures, declining collateral values, and other losses to our Bank. Moreover, current and future governmental action may temporarily require the Company to conduct business differently with respect to foreclosures, repossessions, payments, deferrals, and other client-related transactions.
Furthermore, commercial real estate markets have been particularly impacted by the economic disruption resulting from the COVID-19 pandemic. Accordingly, the federal banking regulatory agencies have expressed concerns about weaknesses in the current commercial real estate market. Failures in our risk management policies, procedures, and controls could adversely affect our ability to manage this portfolio going forward and could result in an increased rate of delinquencies in, and increased losses from, this portfolio, which, accordingly, could have a material adverse effect on our business, financial condition, and results of operations.
In addition, our workforce has been, is, and may continue to be impacted by COVID-19. The precautions we are taking to protect the safety and well-being of our employees and clients, including temporary branch and office closures, may be inadequate, and we cannot predict the level of disruption that will occur to our employees’ ability to provide support and service to our clients. The spread could also negatively impact availability of key personnel and employee productivity, as well as the business and operations of third-party service providers who perform critical services for us, which could adversely impact our ability to deliver products and services to our clients.
There is pervasive uncertainty surrounding the future economic conditions that will emerge in the months and years following the start of the COVID-19 pandemic. As a result, management is confronted with a significant and unfamiliar degree of uncertainty in estimating the impact of the pandemic on credit quality, revenues, and asset values. Asset quality may deteriorate and the amount of our allowance for credit losses may not be sufficient for future credit losses we may experience. This could require us to increase our reserves and recognize more expense in future periods. The changes in market rates of interest and the impact on our ability to price our products may reduce our net interest income in the future or negatively impact the demand for our products. There is also risk that operational costs could continue to increase as we maintain existing facilities in accordance with health guidelines, which could impact negatively the results of our operations and financial condition.
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The extent to which the COVID-19 pandemic impacts our business, results of operations, and financial condition, as well as our regulatory capital and liquidity ratios, will depend on future developments that are highly uncertain and cannot be predicted, including the scope and duration of the COVID-19 pandemic, the impact of potential new strains of the virus, and actions taken by governmental authorities and other third parties in response to the pandemic.
Our business is subject to the risks of certain global conditions, earthquakes, tsunamis, floods, fires, and other natural catastrophic events.
A major catastrophe, such as a pandemic, disease outbreak, or other natural disaster including extreme weather or other events, such as an earthquake, tsunami, flood, fire, winter storms, or other type of natural disaster, could adversely affect our financial condition or result in a prolonged interruption of our business. We have operations and clients in the Northwest, a geographical region that has been or may be affected by disease, earthquake, volcano, tsunami, and flooding activity, which could be adversely impacted by these natural disasters or other severe weather in the region. Unpredictable natural and other disasters could have an adverse effect on the Company in that such events could materially disrupt our operations or the ability or willingness of our clients to access the financial services offered by the Company. These events could reduce our earnings and cause volatility in its financial results for any fiscal quarter or year and have a material, adverse effect on our financial condition and/or results of operations and prospects.
Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
Our principal executive offices and one of our banking offices are anchor tenants in an 18-story commercial building located in Billings, Montana. The building is owned by a joint venture limited liability company in which FIB owns a 50.0% interest. We lease approximately 100,193 square feet of office space in the building. We also own a 65,226 square foot building that houses our operations center in Billings, Montana. We provide banking services at 150 locations in Idaho, Montana, Oregon, South Dakota, Washington, and Wyoming, of which 39 properties are leased from independent third parties and 111 properties are owned by us. We believe each of our facilities is suitable and adequate to meet our current operational needs.
Item 3. Legal Proceedings
In the normal course of business, we may be named or threatened to be named as a defendant in various lawsuits. We record accruals for outstanding legal matters when it is believed to be probable that a loss will be incurred and the amount can be reasonably estimated. Management, following consultation with legal counsel, does not expect the ultimate disposition of any or a combination of any such ongoing or anticipated matters to have a material, adverse effect on our business, financial condition, or operating results.
Item 4. Mine Safety Disclosures
Not applicable.
PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
The Class A common stock is listed on the NASDAQ Stock Market under the symbol “FIBK.” As December 31, 2020, we had 1,470 record shareholders, including the Wealth Management division of FIB as trustee for 529,919 shares of Class A common stock held on behalf of 641 individual participants in the Savings and Profit Sharing Plan for Employees of First Interstate BancSystem, Inc., or the Savings Plan. The Class B common stock is not and will not be listed on the NASDAQ Stock Market or any other exchange. Therefore, no trading market is expected to develop in the Class B common stock.
Dividends
It is our policy to pay a quarterly dividend to all common shareholders. The Board recently approved a quarterly cash dividend amount of $0.41 per share of common stock. We currently intend to continue paying quarterly dividends; however, the Board may change or eliminate the payment of future dividends.
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Dividend Restrictions
For a description of restrictions on the payment of dividends, see Part I, Item 1, “Business — Government Regulation and Supervision — Dividends and Restrictions on Transfers of Funds,” and Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Capital Resources and Liquidity Management” included herein.
Sales of Unregistered Securities
There were no sales of equity securities by us during the years ended December 31, 2020, 2019, or 2018 that were not registered under the Securities Act of 1933.
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
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 December 31, 2020.
Total Number of Shares Maximum Number of Shares
(1) Stock repurchases were redemptions of vested restricted shares tendered in lieu of cash for payment of income tax withholding amounts by participants of the Company’s 2015 Equity Compensation Plan and purchases related to our stock repurchase program.
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Performance Graph
The performance graph below compares the cumulative total shareholder return on our Class A common stock with the cumulative total return on equity securities of companies included in the NASDAQ Composite Index and the SNL U.S. Bank NASDAQ index, measured on the last trading day of each year shown. The SNL U.S. Bank NASDAQ index is a comparative peer index comprised of financial companies, including banks, savings institutions, and related holding companies that perform banking-related functions, listed on the NASDAQ Stock Market. The NASDAQ Composite Index is a comparative broad market index comprised of all domestic and international common stocks listed on the NASDAQ Stock Market. This graph assumes a $100 investment in our Class A common stock on December 31, 2015, and reinvestment of dividends on the date of payment without commissions. The plot points on the graph were provided by SNL Financial LC, Charlottesville, VA. The performance graph represents past performance, which may not be indicative of the future performance of our Class A common stock.
Item 6. Selected Consolidated Financial Data
The information previously required by Item 6 of this Form 10-K has been intentionally omitted, as permitted by the SEC in connection with its adoption of its final rules regarding the amendments to modernize, simplify, and enhance identified financial disclosure requirements of registrants, which became effective beginning February 11, 2021.
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis should be read in conjunction with the consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K. We make statements in this section that are forward-looking statements within the meaning of the federal securities laws. All of such forward-looking statements are expressly qualified by reference to the cautionary statements provided under the caption “Cautionary Note Regarding Forward-Looking Statements” included on page 1 in Part I of this report. Furthermore, a number of known and unknown factors may cause our actual results, performance or achievements to differ materially from those expressed or implied by the following discussion. Therefore, you are encouraged to read in its entirety the information provided under the caption “Risk Factors” included under Item 1A in Part I of this report for a discussion of risk factors that may negatively impact our expected results, performance, or achievements discussed below.
Executive Overview
We are a financial and bank holding company headquartered in Billings, Montana. As of December 31, 2020, we had consolidated assets of $17.6 billion, deposits of $14.2 billion, loans held for investment of $9.8 billion, and total stockholders’ equity of $2.0 billion.
We operate 150 banking offices, including detached drive-up facilities, in communities across Idaho, Montana, Oregon, South Dakota, Washington, and Wyoming. Through our bank subsidiary, FIB, we deliver a comprehensive range of banking products and services—including online and mobile banking—to individuals, businesses, municipalities, and others throughout our market areas. Our clients participate in a wide variety of industries, including agriculture, construction, education, energy, governmental services, healthcare, mining, professional services, retail, tourism, and wholesale trade.
Our Business
Our principal business activity is lending to, accepting deposits from, and conducting financial transactions with and for 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 credit 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 must meet minimum underwriting standards established in our credit policies, bankers 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 clients, generally without utilizing brokered deposits and with minimal reliance on wholesale funding sources. For additional information about our underwriting standards and loan approval process, see “Business—Lending Activities,” included in Part I, Item 1 of this report.
Recent Trends and Developments
Current Expected Credit Losses
On January 1, 2020, the Company adopted Accounting Standards Codification (“ASC”) 326, Measurement of Credit Losses on Financial Instruments (“ASC 326”), and replaced the historically used incurred loss methodology with an expected loss methodology that is referred to as the Current Expected Credit Loss (CECL) methodology. The measurement of expected credit losses under the CECL methodology is applicable to financial assets measured at amortized cost, including loans held for investment and held-to-maturity debt securities. It also applies to off-balance sheet credit exposures not accounted for as insurance (for example, loan commitments, standby letters of credit, financial guarantees, and other similar instruments) and net investments in leases recognized by a lessor in accordance with Topic 842 on leases. In addition, ASC 326 made changes to the accounting for available-for-sale debt securities. One such change is to require credit losses to be presented as an allowance rather than as a write-down on available-for-sale debt securities that management does not intend to sell or believes that it is more likely than not they will be required to sell.
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The following table summarizes the estimated allowance for credit losses related to financial assets and off-balance sheet credit exposures and the corresponding impacts on the deferred tax liability and retained earnings upon adoption of ASC 326 on January 1, 2020:
Pre-ASC 326 Adoption Post-ASC 326 Adoption Impact of ASC 326 Adoption
Assets:
Allowance for credit losses on HTM securities $ — $ — $ —
Allowance for credit losses on loans held for investment 73.0 103.0 30.0
Liabilities:
Off-balance sheet credit exposures — 2.3 2.3
Equity:
For additional information regarding the CECL adoption, see “Notes to Consolidated Financial Statements—Summary of Significant Accounting Policies” and “Notes to Consolidated Financial Statements—Recent Authoritative Accounting Guidance” included in Part IV, Item 15 of this report.
COVID-19
Since its emergence in Wuhan, China in December 2019, COVID-19 has spread throughout the world, significantly impacting the entire world’s economies. In many cases, COVID-19 causes severe illness and in a significant minority of cases can result in death. The global impact of the pandemic has been rapidly evolving and many countries, including the United States, reacted by instituting a wide variety of control measures including states of emergency, mandatory quarantines, required business and school closures, implementing state-wide “shelter in place” orders, and restricting travel. The United States government has taken a number of actions to mitigate the impact of the COVID-19 pandemic on the U.S. economy.
The Coronavirus Aid, Relief, and Economic Security Act, or CARES Act, signed into law in March 2020, provided one-time payments to individuals, additional health-care funding, loans, and grants to certain businesses, temporary amendments to the Internal Revenue Code, and strengthened unemployment insurance. In addition, the Federal Reserve cut the federal funds rate, lowered the interest rate on emergency lending at the discount window, and lengthened the term of overnight loans up to 90 days. The CARES Act was later extended by the Coronavirus Response and Relief Supplemental Appropriations Act, 2021, or RELIEF Act, which was signed into law on December 27, 2020. A number of key provisions of the RELIEF Act include additional loans and grants for small businesses, one-time payments to individuals, extensions to the increased unemployment insurance, additional health-care funding, and aid for rental assistance programs, amongst other short-term relief programs. The RELIEF Act also included funding for the vaccine rollout, transportation, education, and agricultural aid.
The CARES Act (extended by the RELIEF Act) created a new guaranteed, unsecured loan program under the Small Business Administration called the Paycheck Protection Program, or the PPP, in which the Company participates. Designed to incentivize certain businesses to keep their workers on the payroll during the pandemic period, PPP loans are fully forgivable so long as the funds are used as prescribed by the program, are for a two-year or five-year term, earn interest at a rate of 1%, require no collateral or personal guarantees, and have deferred loan payments. The Company actively participated in assisting our clients with applications for resources through the program and approved approximately 11,700 applications for approximately $1.2 billion. The program ended on August 8, 2020 under the CARES Act and the RELIEF Act re-opened the program in January 2021 with $284 billion of additional funding available. The Company is actively participating in the extended program and assisting our customers with applications and as of February 19, 2021 has approved more than 3,150 applications, for approximately $296.3 million.
The CARES Act permits financial institutions to suspend requirements under GAAP for loan modifications to borrowers affected by COVID-19 and is intended to provide guidance as to conditions that would constitute a short-term modification that would not meet the definition of a troubled debt restructuring. This includes the following: (i) the loan modification is made after March 1, 2020 through December 31, 2021, as extended under the RELIEF Act, (ii) the applicable loan was not more than 30 days past due as of December 31, 2019, and (iii) the modification is due to COVID-19. The Company is applying this guidance to qualifying loan modifications and, as of December 31, 2020, we had approximately 295 loans on deferrals totaling approximately $23.7 million, or 0.24% of loans held for investment. Additionally, as of December 31, 2020, the Company currently has forbearance requests granted on approximately 29 residential mortgage loans totaling $9.0 million.
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On December 11, 2020, the U.S. Food and Drug Administration (the “FDA”) issued the first emergency use authorization for the Pfizer-BioNTech COVID-19 vaccine for the prevention of COVID-19 for individuals 16 years of age and older. On December 18, 2020, the FDA issued a second emergency use authorization for the Moderna COVID-19 vaccine. On February 4, 2021, Johnson & Johnson submitted an application for emergency use authorization for their single-shot vaccine with other companies expected to follow. Distribution of the vaccines has commenced, initially with front-line health-care workers receiving vaccinations to be followed by individuals deemed at high-risk of contracting COVID-19 or for severe illness from COVID-19. During the initial phases of the vaccine distribution, vaccine shortages and delays have been caused by high demand outstripping supply and challenging distribution logistics. With vaccine production ramping up and improvements to distribution logistics, experts estimate that the vaccines will be available to the general public by late spring/early summer of 2021.
On February 3, 2021, the US House of Representatives approved an additional COVID-19 relief package but it has not yet been signed into law.
The COVID-19 pandemic triggered a period of material global economic slowdown and recent trends suggest that, while the ongoing recovery is progressing, with the pace impacted by changing rates of positive diagnoses and additional measures by U.S. and local governments to manage developments. Management continues to actively work to minimize the current and future impact of this unprecedented situation, making adjustments to operations where appropriate or necessary to try and minimize the impact of COVID-19. As of January 31, 2021, a significant number of Company employees continue to work remotely and the Company has not yet established a timetable for the full work force to return to our facilities. This has not, however, caused a significant disruption to the Company operations. The extent to which COVID-19 impacts the Company’s financial results remains fluid and will continue to depend on a number of things, including the extent of the spread of the virus, the rate of infection, possible resurgence of the virus, the emergence of new strains of variants of the virus, the severity of illness and the degree of lethality, the relative effect on various portions of the population, the measures taken to combat the virus and their effectiveness, including the development and availability of vaccines and therapeutics and the prevalence of adoption barriers or resistance to them, the impact of control measures such as states of emergency, mandatory quarantines, and required business and school closures, the effect on international trade of any measures taken to combat the virus, including the reinstitution of travel restrictions, any action taken (such as the lowering of interest rates) by government entities to combat the negative macroeconomic effects of these measures, and other factors.
Management continues to monitor the impact of COVID-19 on the Company’s financial results. The COVID-19 pandemic has affected modestly our operations and has had varying degrees of disruptions and restrictions to our borrowers and to our borrowers’ supply chains, closures of some facilities, and decreases in demand for certain products and services. The United States has signaled that the scope, duration, and severity of the pandemic is not yet fully known. As a result, there continues to be uncertainty as to the long-term effect on the economy and the Company.
Acquisitions
During the past few years, we have increased our community banking footprint across the Rocky Mountain and Pacific Northwest regions, in large part due to our acquisition activity. We continue to evaluate bank acquisitions and other strategic opportunities on an on-going basis. For additional information regarding our recent acquisitions, see “Risk Factors” included in Part I, Item 1A and “Notes to Consolidated Financial Statements — Acquisitions” included in Part IV, Item 15 of 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.
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Results of Operations
Principal tools we use in managing and evaluating our results of operations include tracking performance as measured by certain metrics including return on average equity, return on average assets, efficiency ratio, non-interest expense as a percent of total average assets, earnings per share, total shareholder return, net interest income, non-interest income, non-interest expense, and net income. Net interest income is affected by a number of factors such as the level of interest rates, changes in interest rates, and changes in the volume and composition of interest earning assets and interest-bearing liabilities. Changes in interest rate spread, which is the difference between interest earned on assets and interest paid on liabilities, has the most significant impact on net interest income. Other factors like volume of loans, investment securities, and other interest earning assets, compared to the volume of interest-bearing deposits and indebtedness, also cause changes in our net interest income between periods. Non-interest bearing sources of funds, such as demand deposits and stockholders’ equity, help support earning assets.
The impact of funding, including non-interest-bearing deposit 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 by assessing the yields on our loans and other earning assets, the costs of our deposits and other funding sources, and the levels of our net interest spread and net interest margin.
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 client 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 similar bank holding companies on factors that include return on average assets, return on average equity, total shareholder return, and growth in earnings.
Financial Condition
We manage and evaluate our financial condition by focusing on liquidity, the diversification and quality of our loans, the adequacy of our allowance for credit 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 held for investment 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 loans held for investment and OREO, and loan charge-offs as a percentage of average loans. We maintain our allowance for credit losses based on an estimate of expected credit losses in the loans held for investment portfolio over the life of the loan, including the incorporation of a one-year forecast period at each balance sheet date, and we evaluate the level of our allowance for credit 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 client 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.
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Critical Accounting Estimates and Significant Accounting Policies
Our consolidated financial statements are prepared in accordance with generally accepted accounting principles (“GAAP”) in the United States and follow general practices within the banking industry. 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 “Notes to Consolidated Financial Statements—Summary of Significant Accounting Policies” included in Part IV, Item 15 of this report.
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.
Allowance for Credit Losses
The allowance for credit losses is a valuation account that creates an allowance for credit losses expected over the life of loans at each balance sheet date which is deducted from the loans’ amortized cost basis to present the net amount expected to be collected on the loans. Increases in the allowance are recorded through net income as a provision for credit loss expense. Decreases in the allowance are recorded through net income as a reversal of provision for credit loss expense. Loans are charged-off against the allowance when management believes the uncollectibility of a loan balance is confirmed. Expected recoveries recorded in the valuation account do not exceed the aggregate of loan amounts previously charged-off and loans expected to be charged-off. The allowance for credit losses represents management’s estimate of expected credit losses in the loans held for investment portfolio over the life of the loan, including the incorporation of a one-year forecast period for economic conditions.
We perform a quarterly assessment of the risks inherent in our loan portfolio, as well as a detailed review of each significant loan we have assessed to have weaknesses that does not share common risk characteristics with other loans. Based on this analysis, we record a provision for credit losses in order to maintain the allowance for credit losses at appropriate levels. In determining the allowance for credit losses, management estimates the allowance balance using relevant available information, from internal and external sources, relating to past events, current conditions, and reasonable and supportable forecasts. Historical credit loss experience provides the basis for the estimation of expected credit losses. Adjustments to historical loss information are made for differences in current loan-specific risk characteristics such as differences in underwriting standards, portfolio mix, delinquency level, or term as well as for changes in environmental and economic conditions, such as changes in unemployment rates, property values, or other relevant factors. The allowance for credit losses is measured on a collective (pool) basis when similar risk characteristics exist.
For loans acquired in a business combination with no significant evidence of credit deterioration since origination, the Company estimates an allowance for credit losses of the loans determined using the same methodology as other loans held for investment.
The allowance for credit losses is maintained at an amount we believe to be sufficient to provide for estimated losses expected over the life of the loans at each balance sheet date resulting from management’s assessment of the quantitative and qualitative factors utilized to determine the allowance for credit 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. Changes in the estimates and assumptions are possible and may have a material impact on our allowance, and as a result, on our consolidated financial statements or results of operations.
As of January 1, 2020, the Company’s accounting policies changed significantly to comply with the adoption of ASC 326. Consistent with the transition guidance within ASC 326, prior years were not restated. Prior to January 1, 2020, general allowances and nonspecific allowances were based on incurred credit losses as described in our 2019 Form 10-K. See “Notes to Consolidated Financial Statements—Summary of Significant Accounting Policies” for a description of the methodology used to determine the allowance for credit losses and our policy pertaining to acquired loans. See “Notes to Consolidated Financial Statements—Loans” for a discussion on the factors driving changes in the amount of the allowance for credit losses. See also Part I, Item 1A, “Risk Factors—Credit Risks.”
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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 it is likely impairment has occurred. Goodwill impairment is determined by comparing the fair value of a reporting unit to its carrying amount. 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 quantitative impairment test is performed. In performing a quantitative test for impairment, the fair value of net assets is estimated based on analyses of the Company’s market value, discounted cash flows, and peer values. The determination of goodwill impairment is sensitive to market-based economics and other key assumptions used in determining or allocating fair value. Variability in the market and changes in assumptions or subjective measurements used to estimate fair value are reasonably possible and may have a material impact on our consolidated financial statements or results of operations.
Our annual goodwill impairment test is performed each year as of July 1st. The Company performed its 2020 annual goodwill impairment qualitative assessment and determined the Company’s goodwill was not considered impaired. We monitor our performance and evaluate our goodwill for impairment annually or more frequently as needed.
For additional information regarding goodwill, see “Notes to Consolidated Financial Statements—Summary of Significant Accounting Policies,” included in Part IV, Item 15 of this report and “Risk Factors—Operational Risks,” included in Part I, Item 1A of this report.
Fair Values of Loans Acquired in Business Combinations
Loans acquired in business combinations are initially recorded at fair value as adjusted for credit risk and an allowance for credit losses at the date of acquisition. For loans with no significant evidence of credit deterioration since origination, the difference between the fair value and the unpaid principal balance of the loan at the acquisition date is amortized into interest income using the effective interest method over the remaining period to contractual maturity.
Loans acquired with evidence of deterioration in credit quality since origination, or PCD loans, are accounted for in accordance with ASC Topic 326-20 “Financial instruments - 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. An allowance for credit losses is recognized by estimating the expected credit losses of the purchased asset and recording an adjustment to the acquisition date fair value to establish the initial amortized cost basis of the asset. Differences between the established fair value, or amortized cost basis, and the unpaid principal balance of the asset is considered to be a non-credit discount/premium and is accreted/amortized into interest income using the interest method in accordance with ASC 310-10. Subsequent changes to the allowance for credit losses are recorded through provision for credit loss expense using the same methodology as other loans held for investment.
For additional information regarding acquired loans, see “Notes to Consolidated Financial Statements—Summary of Significant Accounting Policies,” “Notes to Consolidated Financial Statements—Acquisitions,” and “Notes to Consolidated Financial Statements—Loans Held for Investment,” included in Part IV, Item 15 of this report.
Results of Operations
The following discussion and analysis is intended to provide detail about the results of operations by comparing the years ended December 31, 2020 to December 31, 2019 and the years ended December 31, 2019 to December 31, 2018.
Performance Ratios
Return on average common stockholders’ equity 8.12 9.53 10.50
(1)Our efficiency ratio definition conforms with the FDIC definition for all periods presented as non-interest expense less amortization of intangible assets divided by net interest income plus non-interest income.
(2)Common stock dividend payout ratio represents dividends per common share divided by basic earnings per common share.
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Net Interest Income
Net interest income, the largest source of our operating income, is derived from interest, dividends, and fees received on interest earning assets, less interest expense incurred on interest bearing liabilities. Interest earning assets primarily include loans and investment securities. Interest bearing liabilities include deposits and various forms of indebtedness. Net interest income is affected by the level of interest rates, changes in interest rates, and changes in the composition of interest earning assets and interest-bearing liabilities.
Changes in interest rate spread, which is the difference between interest earned on assets and interest paid on liabilities, has the most significant impact on net interest income. Other factors like volume of loans, investment securities, and other interest earning assets compared to the volume of interest-bearing deposits and indebtedness also cause changes in our net interest income between periods. Non-interest-bearing sources of funds, such as demand deposits and stockholders’ equity, help to support earning assets.
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The following table presents, for the periods indicated, condensed average balance sheet information using daily average balances, 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
Year Ended December 31,
Interest earning assets:
Federal funds sold 0.1 — — 0.8 — — 11.1 — —
Interest-bearing liabilities:
Other borrowed funds — — — — — — 1.7 0.2 11.76
Less FTE adjustments (2) (2.0) (2.0) (2.2)
(1)Average loan balances include mortgage loans held for sale and non-accrual loans. Interest income on loans includes amortization of deferred loan fees net of deferred loan costs of $32.5 million, $3.9 million, and $3.4 million during 2020, 2019, and 2018, respectively.
(2)Interest income and average rates for tax exempt loans and securities are presented on a fully taxable equivalent, or FTE, basis utilizing the 21% federal income tax rate.
(3)Net FTE interest margin during the period equals (i) the difference between interest income on interest earning assets and the interest expense on interest bearing liabilities, divided by (ii) average interest earning assets for the period.
(4)Calculated by dividing total interest on interest-bearing liabilities by the sum of total interest-bearing liabilities plus non-interest-bearing deposits.
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Net FTE interest income increased $2.0 million to $499.0 million during 2020, as compared to $497.0 million in 2019. The increase is primarily attributable to lower cost of funds on interest-bearing deposit balances, which was partially offset by interest on higher long-term debt balances, as a result of the subordinated debt offering in May 2020, and lower levels of interest earned on earning assets as a result of lower interest rates. Also contributing to net FTE interest income during 2020, as compared to 2019, was interest accretion related to the fair value of acquired loans of $13.1 million during 2020 as compared to $18.4 million in 2019, of which $5.2 million was the result of early loan payoffs during 2020, as compared to $8.0 million in 2019. Net FTE interest income was also impacted by recoveries of previously charged-off interest of $0.4 million in 2020, as compared to $3.1 million in 2019. The Company’s net interest margin ratio decreased 52 basis points to 3.47% during 2020, as compared to 3.99% in 2019. Exclusive of interest accretion related to acquired loans and the impact of recoveries of charged-off interest, our 2020 net interest margin ratio decreased 44 basis points over our similarly calculated net interest margin ratio in 2019.
Net FTE interest income increased $62.3 million to $497.0 million during 2019, as compared to $434.7 million in 2018, primarily due to higher outstanding loan balances as a result of the full year impact of the Inland Northwest Bank (“INB”) acquisition, the Idaho Independent Bank (“IIBK”) and Community 1st Bank (“CMYF”) acquisitions, and organic loan growth, combined with increases in yields earned on interest earning assets, which were partially offset by a higher cost of funds. Also contributing to the increase in net FTE interest income during 2019, as compared to 2018, was interest accretion related to the fair value of acquired loans of $18.4 million during 2019 as compared to $13.7 million in 2018, of which $8.0 million was the result of early loan payoffs during 2019 as compared to $5.9 million in 2018. Net FTE interest income was also positively impacted by recoveries of previously charged-off interest of $3.1 million in 2019, as compared to $4.0 million in 2018. The Company’s net interest margin ratio increased 11 basis points to 3.99% during 2019, as compared to 3.88% in 2018. Exclusive of interest accretion related to acquired loans and the impact of recoveries of charged-off interest, our 2019 net interest margin ratio increased 10 basis points over our similarly calculated net interest margin ratio in 2018.
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 millions) Volume Rate Net Volume Rate Net Volume Rate Net
Interest earning assets:
Interest bearing liabilities:
Other borrowed funds — — — (0.2) — (0.2) (1.4) 0.1 (1.3)
(1)Interest income and average rates for tax exempt loans and securities are presented on a FTE basis.
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Provision for Credit Losses
Effective January 1, 2020, the Company adopted ASC 326, Measurement of Credit Losses on Financial Instruments, which replaced the historically used incurred loss methodology with an expected loss methodology and is referred to as the current expected credit loss (CECL) accounting standard. Upon adoption, the Company recorded an increase in the allowance for credit losses on loans of $30.0 million and an increase in the allowance for credit losses on off-balance sheet credit exposures of $2.3 million that was offset in shareholders’ equity and deferred taxes. Fluctuations in the provision for credit losses reflect management’s estimate of possible credit losses based upon the composition of our loan portfolio, evaluation of the borrowers’ ability to repay, collateral value underlying loans, loan loss trends, and estimated effects of current and forecasted economic conditions on our loans held for investment portfolio. During 2020, we recorded a provision for credit losses of $56.9 million, as compared to $13.9 million in 2019, with the difference largely attributable to the adoption of CECL and which reflects an increase in expected losses over the life of the loans held for investment portfolios associated with significant changes in the Company’s internal economic forecast as a result of COVID-19, including uncertainty regarding the benefits of government stimulus programs. The provision for credit losses is reflective of net charge-offs of $14.2 million, or 0.14% of average loans outstanding, for 2020, compared to $13.9 million, or 0.16% of average loans outstanding in 2019.
For information regarding our non-performing loans, see “Non-Performing Assets” included herein. For information regarding our allowance for credit losses, see “Financial Condition—Allowance for Credit 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. The following table presents the composition of our non-interest income as of the dates indicated:
Non-interest Income Year Ended December 31, % Change
Other service charges, commissions, and fees* 12.1 7.0 5.8 72.9 20.7
Non-interest income increased $14.1 million, or 9.9%, to $156.7 million in 2020, as compared to $142.6 million in 2019, and increased $3.8 million, or 2.7%, to $142.6 million in 2019 as compared to $138.8 million in 2018. Significant components of these fluctuations are discussed below.
Mortgage banking revenues include origination and processing fees on residential real estate loans held for sale and gains on residential real estate loans sold to third parties. Fluctuations in market interest rates have a significant impact on mortgage banking revenues. Higher interest rates can reduce the demand for home loans and loans to refinance existing mortgages. Conversely, lower interest rates generally stimulate refinancing and home loan origination. Mortgage banking revenues increased $14.1 million, or 42.5%, to $47.3 million in 2020, as compared to $33.2 million in 2019. The increase was primarily driven by increased mortgage loan production due to higher levels of refinance activity as a result of the favorable interest rate environment. The increase was partially offset by mortgage servicing impairments related to projected increases in mortgage prepayment rates due to the favorable interest rate environment of $9.9 million in 2020 and $0.4 million in 2019. Loans originated for home purchases accounted for approximately 42.7% of 2020 loan production, as compared to approximately 68.2% in 2019.
Mortgage banking revenues increased $3.5 million, or 11.8%, to $33.2 million in 2019, as compared to $29.7 million in 2018. The increase is primarily attributable to increased demand in the refinance market as a result of lower interest rates. Loans originated for home purchases accounted for approximately 68.2% of 2019 loan production, as compared to approximately 79.3% in 2018.
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Service charge fees are primarily driven by service and overdraft charges on deposit accounts. These service charges decreased $3.5 million, or 16.6%, to $17.6 million in 2020, as compared to $21.1 million in 2019 and decreased $0.7 million, or 3.2%, in 2019, as compared to $21.8 million in 2018. The decrease in 2020 is primarily due to changes in client behavior in addition to the Company waiving continuous overdraft fees and regular overdraft fees for clients receiving U.S. government stimulus checks during the second quarter of 2020.
Other service charges, commissions, and fees primarily include fees earned on certain derivative interest rate contracts, insurance commissions, and safe deposit boxes. Other service charges, commissions, and fees increased $5.1 million, or 72.9%, to $12.1 million in 2020, as compared $7.0 million in 2019 and increased $1.2 million, or 20.7%, in 2019, as compared to $5.8 million in 2018. These increases were primarily due to additional fees earned on derivative interest rate swap contracts offered to clients.
Non-interest Expense
The following table presents the composition of our non-interest expense as of the dates indicated:
Non-interest Expense Year Ended December 31, % Change
OREO expense, net of income (0.5) (2.2) 0.3 (77.3) NM
Non-interest expense decreased $1.1 million, or 0.3%, to $387.5 million in 2020, as compared to $388.6 million in 2019, and increased $32.2 million, or 9.0%, to $388.6 million in 2019, as compared to $356.4 million in 2018. Significant components of these increases are discussed in more detail below.
Salaries and wages expense increased $18.4 million, or 11.8%, to $173.7 million in 2020, as compared to $155.3 million in 2019. The increase was primarily due to normal merit wage increases, higher mortgage loan originator commissions, higher levels of incentive accruals, and increased personnel costs associated with the full-year impact of the IIBK and CMYF acquisitions in April 2019.
Salaries and wages expense increased $8.9 million, or 6.1%, to $155.3 million in 2019, as compared to $146.4 million in 2018. The increase was primarily due to normal merit increases and increased personnel costs associated with the IIBK and CMYF acquisitions in April 2019 and the full-year impact of the INB acquisition in August 2018.
Employee benefits expense decreased $2.1 million, or 4.1%, to $49.4 million in 2020, as compared to $51.5 million in 2019. The decrease in employee benefits expense was primarily due to decreased health care costs, partially offset by the full-year impact of the IIBK and CMYF acquisitions in April 2019.
Employee benefits expense increased $3.6 million, or 7.5%, to $51.5 million in 2019, as compared to $47.9 million in 2018. The increase in employee benefits expense in 2019, as compared to 2018, was primarily due to additional benefit costs resulting from the IIBK and CMYF acquisitions in April 2019 and the full-year impact of the INB acquisition in August 2018.
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Outsourced technology services expense increased $0.5 million, or 1.5%, to $32.8 million in 2020, as compared to $32.3 million in 2019, and increased $3.6 million, or 12.5%, in 2019, as compared to $28.7 million in 2018. The 2019 increase was primarily due to expenses resulting from the IIBK and CMYF acquisitions in April 2019 and the full-year impact of the INB acquisition in August 2018.
Occupancy, net expense increased $0.2 million, or 0.7%, to $28.5 million in 2020, as compared to $28.3 million in 2019 and increased $2.9 million, or 11.4%, in 2019, as compared to $25.4 million in 2018. The 2019 increase was primarily due to expenses resulting from the IIBK and CMYF acquisitions in April 2019.
Core deposit intangibles represent the intangible value of depositor relationships resulting from deposit liabilities assumed, as a result of acquisitions, and are amortized based on the estimated useful lives of the related deposits. Core deposit intangibles amortization expense decreased $0.3 million, or 2.7%, to $10.9 million in 2020, as compared to $11.2 million in 2019, and increased $3.3 million or 41.8%, to $11.2 million in 2019, as compared to $7.9 million in 2018, due to additional amortization of core deposit intangibles recorded in conjunction with recent acquisitions. We acquired core deposit intangibles of $16.6 million in conjunction with our acquisitions of IIBK and CMYF in April 2019 and $15.7 million in conjunction with our acquisition of INB in August 2018. For additional information regarding acquired core deposit intangibles, see “Notes to Consolidated Financial Statements—Acquisitions,” included in Part IV, Item 15 of this report.
Other expenses primarily include advertising and public relations costs; office supply, postage, freight, telephone, and travel expenses; donations expense; debit and credit card expenses; board of director fees; legal expenses; and, other losses. Other expenses decreased $3.2 million, or 5.0%, to $60.4 million in 2020, as compared to $63.6 million in 2019. The decrease in other expenses were primarily the result of lower travel expenses as a result of COVID-19 travel restrictions.
Other expenses increased $5.0 million, or 8.5%, to $63.6 million in 2019, as compared to $58.6 million in 2018. The increase in other expenses were due to the additional operating expenses resulting from the IIBK and CMYF acquisitions in April 2019 and the INB acquisition in August 2018.
We recorded no acquisition related expenses during 2020, compared to $20.3 million and $12.4 million during 2019 and 2018, respectively. Acquisition related expenses primarily include legal and professional fees; technology, conversion, and contract termination costs; employee retention payments; and travel expenses. For additional information regarding our acquisitions, see “Recent Trends and Developments” included herein and “Notes to Consolidated Financial Statements—Acquisitions,” included in Part IV, Item 15 of this report.
Income Tax Expense
Our effective federal tax rate was 17.5% for the year ended December 31, 2020, 18.8% for the year ended December 31, 2019, and 17.1% for the year ended December 31, 2018. Fluctuations in effective federal income tax rates are primarily due to the timing of federal tax credits resulting from our participation in the New Markets Tax Credits Program, a program through the U.S. Department of Treasury aimed at attracting private capital into low-income communities. For additional information about our participation in the New Markets Tax Credits Program, see “Notes to Consolidated Financial Statements—Summary of Significant Accounting Policies,” included in Part IV, Item 15 of this report.
State income tax applies primarily to pretax earnings generated within Idaho, Montana, Oregon, and South Dakota. Our effective state tax rate was 5.4% for the year ended December 31, 2020, 4.2% for the year ended December 31, 2019, and 5.2% for the year ended December 31, 2018.
Net Income
Net income decreased $19.8 million, or 10.9%, to $161.2 million, or $2.53 per diluted share, in 2020, compared to $181.0 million, or $2.83 per diluted share, in 2019 and increased $20.8 million, or 13.0%, to $181.0 million, or $2.83 per diluted share, in 2019, as compared to $160.2 million, or $2.75 per diluted share, in 2018. There were no acquisition related expenses in 2020. The after-tax impact of acquisition related expenses on earnings per share was $0.24 and $0.17 in 2019 and 2018, respectively.
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Summary of Quarterly Results
The following tables present the Company’s summarized quarterly financial information for the fiscal years ended December 31, 2020 and 2019.
Quarterly Results (Unaudited)(Dollars in millions except per share data)
FirstQuarter SecondQuarter ThirdQuarter FourthQuarter
Special dividends per common share 0.60 — — —
Provision for loan losses 3.7 3.8 2.6 3.8
Financial Condition
Total assets increased $3,004.5 million, or 20.5%, to $17,648.7 million as of December 31, 2020, from $14,644.2 million as of December 31, 2019, primarily as a result of higher deposits and the impact of PPP loans, which resulted in an increase in cash and cash equivalents of $1,200.0 million, an increase to our investment securities portfolio of $1,008.0 million, and an increase in loans held for investment of $876.8 million.
Total assets increased $1,344.0 million, or 10.1%, to $14,644.2 million as of December 31, 2019, from $13,300.2 million as of December 31, 2018, with $862.3 million of the increase attributable to the IIBK and CMYF acquisitions. The remaining increase was primarily due to the deployment of funds generated through organic deposit growth into interest earning assets.
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Loans Held for Sale
Loans held for sale consist of residential mortgage loans pending sale to investors in the secondary market. Loans held for sale decreased $26.9 million, or 26.7%, to $74.0 million as of December 31, 2020, compared to $100.9 million as of December 31, 2019. The decrease was primarily due to the decision to hold additional mortgage loans originated as loans held for investment on our balance sheet.
Loans held for sale increased $67.6 million, or 203.0%, to $100.9 million as of December 31, 2019, compared to $33.3 million as of December 31, 2018. The increase was primarily due to an increase in originations of mortgage loans held for sale as a result of higher levels of refinance activity driven by lower interest rates.
Loans Held for Investment, Net of Deferred Fees and Costs
The following table presents the composition of our loan portfolio as of the dates indicated:
Loans Outstanding
(Dollars in millions)
As of December 31,
Real estate:
Deferred loan and fees and costs (21.0) (5.5) (4.4) (2.5) (2.8)
Loans held for investment, net of deferred fees and costs, increased $876.8 million, or 9.8%, to $9,807.5 million as of December 31, 2020, from $8,930.7 million as of December 31, 2019. Approximately $739.8 million of the increase was attributable to PPP loans. Significant contributing portfolios are discussed in greater detail below.
Loans held for investment, net of deferred fees and costs, increased $460.3 million, or 5.4%, to $8,930.7 million as of December 31, 2019, as compared to $8,470.4 million as of December 31, 2018. Approximately $416.6 million of this increase was attributable to the acquisitions of IIBK and CMYF in April 2019. Exclusive of the IIBK and CMYF acquisitions, loans held for investment grew organically $43.6 million, or 0.5%, with the growth occurring in commercial real estate, construction, agricultural real estate, agricultural, and loans held for sale. These increases were partially offset by declines in residential real estate, consumer, and commercial loans.
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Real Estate Loans. We provide interim construction and permanent financing for both single-family and multi-unit properties, medium-term loans for commercial, agricultural and industrial property and/or buildings and equity lines of credit secured by real estate.
Commercial real estate loans. 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 45.5% and 44.7% of our commercial real estate loans were owner occupied as of December 31, 2020 and 2019, respectively. Commercial real estate loans increased $255.4 million, or 7.3%, to $3,743.2 million as of December 31, 2020, from $3,487.8 million as of December 31, 2019. Growth primarily occurred in Idaho, Oregon, and Washington.
Commercial real estate loans increased $240.3 million, or 7.4%, to $3,487.8 million as of December 31, 2019, from $3,247.5 million as of December 31, 2018. Exclusive of $151.5 million of IIBK and CMYF acquired loans, commercial real estate loans increased organically $88.8 million, or 2.7%. Organic growth primarily occurred in Idaho and Oregon.
Construction loans. Construction loans are primarily to commercial builders for residential lot development and the construction of single-family residences and commercial real estate properties. Construction loans are generally underwritten pursuant to pre-approved permanent financing. As of December 31, 2020, our construction loan portfolio was divided among the following categories: approximately $250.9 million, or 24.1%, residential construction; approximately $523.5 million, or 50.4%, commercial construction; and approximately $265.0 million, or 25.5%, land acquisition and development. This compares to approximately $244.1 million, or 25.0%, residential construction; approximately $431.5 million, or 44.1%, commercial construction; and approximately $302.1 million, or 31.0%, land acquisition and development as of December 31, 2019.
Construction loans increased $61.7 million, or 6.3%, to $1,039.4 million as of December 31, 2020, from $977.7 million as of December 31, 2019. Construction loans increased due to increases in commercial and residential construction loans, which were partially offset by a decrease in land acquisition and development loans. Construction loans increased $139.0 million, or 16.6%, to $977.7 million as of December 31, 2019, from $838.7 million as of December 31, 2018. Exclusive of $100.5 million of IIBK and CMYF acquired loans, construction loans increased organically $38.5 million, or 4.6%, due to increases in commercial construction loans, which were partially offset by decreases in land acquisition and development and residential construction loans.
Residential real estate loans. Retained residential real estate loans are typically secured by first liens on the financed property and generally mature in less than 15 years. Included in residential real estate loans were home equity loans and lines of credit of $384.0 million and $423.5 million as of December 31, 2020 and December 31, 2019, respectively. Residential real estate loans increased $150.2 million, or 12.1%, to $1,396.3 million as of December 31, 2020, from $1,246.1 million as of December 31, 2019 as a result of our decision to hold a portion of our mortgage loans originated on our balance sheet.
Residential real estate loans decreased $38.2 million, or 3.0%, to $1,246.1 million as of December 31, 2019, from $1,284.3 million as of December 31, 2018. Exclusive of $76.0 million of IIBK and CMYF acquired loans, residential real estate loans decreased $114.2 million, or 8.9%.
During 2020 and 2019, we sold most of our residential real estate loan production to secondary investors.
Consumer Loans. Our consumer loans include direct personal loans; credit card loans and lines of credit; and indirect loans created when we purchase consumer loan contracts advanced for the purchase of automobiles, boats, and other consumer goods from the consumer product dealer network within the market areas we serve. Personal loans and indirect dealer loans are generally secured by automobiles, recreational vehicles, boats, and other types of personal property and are made on an installment basis. Credit cards are offered to clients in our market areas. Lines of credit are generally floating rate loans that are unsecured or secured by personal property. Approximately 78.5% and 75.1% of our consumer loans as of December 31, 2020 and 2019, respectively, were indirect consumer loans.
Consumer loans decreased $19.3 million, or 1.8%, to $1,025.9 million as of December 31, 2020, from $1,045.2 million as of December 31, 2019. Within the consumer loan portfolio direct consumer loans decreased $28.4 million, or 15.9%, and credit card loans decreased $11.4 million, or 14.0%, partially offset by an increase in indirect consumer loans of $20.5 million, or 2.6%. Consumer loans decreased $25.0 million, or 2.3%, to $1,045.2 million as of December 31, 2019, from $1,070.2 million as of December 31, 2018. Exclusive of $14.6 million of IIBK and CMYF acquired loans, consumer loans decreased organically $39.6 million, or 3.7%, across all consumer loan categories.
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Commercial Loans. We provide a mix of variable and fixed rate commercial loans. The loans are typically made to small and medium-sized manufacturing, wholesale, retail, and service businesses for working capital needs and business expansions. Commercial loans generally include lines of credit, business credit cards, and loans with maturities of five years or less and outstanding balances tend to be cyclical in nature. The loans are generally made with business operations as the primary source of repayment and are typically collateralized by inventory, accounts receivable, equipment, and/or personal guarantees.
Commercial loans increased $480.2 million, or 28.7%, to $2,153.9 million as of December 31, 2020, from $1,673.7 million as of December 31, 2019. Exclusive of $739.8 million of PPP loans, commercial loans decreased $259.5 million, primarily due to paydowns within the portfolio. Commercial loans increased $113.4 million, or 7.3%, to $1,673.7 million as of December 31, 2019, from $1,560.3 million as of December 31, 2018. Exclusive of $61.4 million of IIBK and CMYF acquired loans, commercial loans increased $52.0 million.
Agricultural Loans. Our 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. Agricultural loans are ordinarily secured by assets such as livestock or equipment and are repaid from the operations of the farm or ranch. Agricultural loans generally have maturities of five years or less, with operating lines for one production season. Agricultural loans decreased $31.5 million, or 11.3%, to $247.6 million as of December 31, 2020, from $279.1 million as of December 31, 2019. The decrease occurred primarily in Montana. Agricultural loans increased $24.3 million, or 9.5%, to $279.1 million as of December 31, 2019, from $254.8 million as of December 31, 2018. Exclusive of $12.6 million of IIBK and CMYF acquired loans, agricultural loans increased organically $11.7 million, or 4.6%. The increase is primarily attributable to Oregon.
The following table presents the maturity distribution of our loan portfolio and the sensitivity of the loans to changes in interest rates as of December 31, 2020:
Maturities and Interest Rate Sensitivities(Dollars in millions)
Non-accrual loans — — — 39.5 39.5
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Non-Performing Assets
Non-performing assets include non-accrual loans, loans contractually past due by 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:
Non-Performing Assets and Troubled Debt Restructurings
(Dollars in millions)
Non-performing loans:
(1)Accruing loans modified in troubled debt restructurings are not considered non-performing loans. While still considered impaired under applicable accounting guidance, these loans are performing as agreed under their modified terms and management expects performance to continue.
(2)Including accruing troubled debt restructurings described in footnote 1, the ratio of non-performing assets to loans held for investment and OREO would be 0.55%, 0.70%, 0.92%, 1.26% and 2.01% as of December 31, 2020, 2019, 2018, 2017, and 2016, respectively.