Exiting 12 Branches And Managing Credit Risks Will Shape Stability

Key Takeaways

• Strategic shifts including branch exits and loan portfolio reduction suggest short-term revenue contraction, with potential recovery delayed until later years.
  
• Increased criticized loans, especially in commercial real estate, signal margin pressure and heightened risk of credit loss provisions, affecting earnings.
  
• De-emphasizing large-scale M&A and focusing on organic growth could improve net margins and earnings, supported by strong capital levels and proactive credit risk management.

Catalysts

Operates as the bank holding company for First Interstate Bank that provides a range of banking products and services in the United States.

• First Interstate BancSystem's decision to exit its 12 branches in Arizona and Kansas and its intentional shrinking of its loan portfolio indicate a strategic shift towards organic growth, which may initially contract revenue and challenge earnings before any potential recovery by 2026.
  
• Criticized loans increased significantly, particularly in commercial real estate and multifamily sectors, suggesting further potential pressure on net margins and a heightened risk of provisions for credit losses, which can negatively impact earnings.
  
• Loan production and customer demand, especially in commercial real estate, fell below expectations, combined with anticipated further reductions in loan balances, indicating possible headwinds to revenue growth and core earnings strength.
  
• The announced severance costs and the exit of indirect lending underline a focus on cost management; however, this does not mask the expected increase in 2025's noninterest expenses by 2-4%, potentially squeezing net margins further and lowering profitability.
  
• Interest-bearing deposit costs declined but any future Fed rate decisions could affect net interest income adversely, compressing net interest margins and impeding earnings momentum if rate cuts materialize sooner or more deeply than anticipated.

First Interstate BancSystem Future Earnings and Revenue Growth

Assumptions

How have these above catalysts been quantified?

• This narrative explores a more pessimistic perspective on First Interstate BancSystem compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming First Interstate BancSystem's revenue will remain fairly flat over the next 3 years.
• The bearish analysts assume that profit margins will increase from 30.0% today to 33.0% in 3 years time.
• The bearish analysts expect earnings to reach $351.4 million (and earnings per share of $3.21) by about June 2029, up from $312.1 million today. However, there is some disagreement amongst the analysts with the more bullish ones expecting earnings as high as $1.6 billion.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 9.0x on those 2029 earnings, down from 11.3x today. This future PE is lower than the current PE for the US Banks industry at 11.9x.
• The bearish analysts expect the number of shares outstanding to decline by 7.0% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.11%, as per the Simply Wall St company report.

Risks

• First Interstate BancSystem's strategy to de-emphasize large-scale M&A and focus on organic growth and full relationship banking could lead to improved net margins and earnings as the company invests in markets with strong growth potential.
  
• The company's strong capital levels and flexible balance sheet could allow capital deployment to areas of strength, potentially increasing future earnings and sustaining shareholder returns.
  
• The proactive approach to managing credit risks, with strong collateral and guarantor support, suggests that potential losses may be mitigated, thus maintaining healthier net margins.
  
• Anticipated improvement in net interest income, supported by asset repricing, could provide a positive outlook for revenue and earnings growth in the medium term.
  
• Cost reduction efforts, alongside strategic branch optimization and the reinvestment in growing markets, could lead to enhanced operational efficiency and improved profit margins.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bearish price target for First Interstate BancSystem is $33.0, which represents up to two standard deviations below the consensus price target of $37.0. This valuation is based on what can be assumed as the expectations of First Interstate BancSystem's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $41.0, and the most bearish reporting a price target of just $33.0.
• In order for you to agree with the more bearish analyst cohort, you'd need to believe that by 2029, revenues will be $1.1 billion, earnings will come to $351.4 million, and it would be trading on a PE ratio of 9.0x, assuming you use a discount rate of 7.1%.
• Given the current share price of $36.43, the analyst price target of $33.0 is 10.4% lower. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.