First Interstate BancSystem - 10-Q quarterly report FY

 

 

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The Registrant had 7,884,897 shares of common stock outstanding on March 31, 2008.

 

 

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES

Quarterly Report on Form 10-Q

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(In thousands, except share data)
(Unaudited)

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
Consolidated Statements of Income
(In thousands, except per share data)
(Unaudited)

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
Consolidated Statements of Changes In Stockholders’ Equity
(In thousands, except share and per share data)
(Unaudited)

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (continued)
(In thousands)
(Unaudited)

     The following discussion should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2007, including the audited financial statements contained therein, filed with the Securities and Exchange Commission.

     When we refer to “we,” “our,” and “us” in this report, we mean First Interstate BancSystem, Inc. and our consolidated subsidiaries, unless the context indicates that we refer only to the parent company, First Interstate BancSystem, Inc. When we refer to “Banks” in this report, we mean First Interstate Bank, First Western Bank and The First Western Bank Sturgis, our bank subsidiaries.

     This report contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Rule 175 promulgated thereunder, and Section 21E of the Securities Exchange Act of 1934, as amended, and Rule 3b-6 promulgated thereunder, that involve inherent risks and uncertainties. Any statements about our plans, objectives, expectations, strategies, beliefs, or future performance or events constitute forward-looking statements. Such statements are identified as those that include words or phrases such as “believes,” “expects,” “anticipates,” “plans,” “trend,” “objective,” “continue” or similar expressions or future or conditional verbs such as “will,” “would,” “should,” “could,” “might,” “may” or similar expressions. Forward-looking statements involve known and unknown risks, uncertainties, assumptions, estimates and other important factors that could cause actual results to differ materially from any results, performance or events expressed or implied by such forward-looking statements. All forward-looking statements are qualified in their entirety by reference to the factors discussed in this report and the following risk factors discussed more fully in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2007: (i) credit risk; (ii) concentrations of real estate loans; (iii) commercial loan risk; (iv) economic conditions in Montana, Wyoming and South Dakota; (v) adequacy of the allowance for loan losses; (vi) changes in interest rates; (vii) inability to meet liquidity requirements; (viii) inability of our subsidiaries to pay dividends; (ix) failure to meet debt covenants; (x) competition; (xi) environmental remediation and other costs; (xii) breach in information system security; (xiii) failure of technology; (xiv) failure to effectively implement technology-driven products and services; (xv) ineffective internal operational controls; (xvi) difficulties in integrating operations of First Western; (xvii) dependence on our management team; (xviii) the ability to attract and retain qualified employees; (xix) disruption of vital infrastructure and other business interruptions; (xx) Visa indemnification obligations; (xxi) litigation pertaining to fiduciary responsibilities; (xxii) changes in or noncompliance with governmental regulations; (xxiii) capital required to support our bank subsidiaries; and, (xxiv) investment risks affecting holders of common stock.

     Because the foregoing factors could cause actual results or outcomes to differ materially from those expressed or implied in any forward-looking statements, undue reliance should not be placed on any forward-looking statements. Further, any forward-looking statement speaks only as of the date on which it is made, and we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of future events or developments.

     Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States and follow general practices within the industries in which we operate. Application of these principles requires management to make estimates, assumptions and judgments that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ significantly from those estimates.

     Our accounting policies are fundamental to understanding Management’s Discussion and Analysis of Financial Condition and Results of Operations. The most significant accounting policies we follow are presented in Note 1 of the Notes to Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2007.

     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.

     The allowance for loan losses represents management’s estimate of probable credit losses inherent in the loan portfolio. Determining the amount of the allowance for loan losses is considered a critical accounting estimate because it requires significant judgment and the use of subjective measurements, including management’s assessment of the internal risk classifications of loans, changes in the nature of the loan portfolio, industry concentrations and the impact of current local, regional and national economic factors on the quality of the loan portfolio. Changes in these estimates and assumptions are reasonably possible and may have a material impact on our consolidated financial statements, results of operations or liquidity. The allowance for loan losses is maintained at an amount we believe is sufficient to provide for estimated losses inherent in our loan portfolio at each balance sheet date. Management continuously monitors qualitative and quantitative trends in the loan portfolio, including changes in the levels of past due, internally classified and non-performing loans. As a result, our historical experience has provided for an adequate allowance for loan losses. Note 1 of the Notes to Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended December 31, 2007 describes the methodology used to determine the allowance for loan losses. A discussion of the factors driving changes in the amount of the allowance for loan losses is included herein under the heading “Asset Quality.”

     We recognize as assets the rights to service mortgage loans for others, whether acquired or internally originated. Mortgage servicing rights are initially recorded at fair value and are amortized over the period of estimated servicing income. Mortgage servicing rights are carried on the consolidated balance sheet at the lower of amortized cost or fair value. We utilize the expertise of a third-party consultant to estimate the fair value of our mortgage servicing rights quarterly. In evaluating the mortgage servicing rights, the consultant uses discounted cash flow modeling techniques, which require estimates regarding the amount and timing of expected future cash flows, including assumptions about loan repayment rates, costs to service, as well as interest rate assumptions that contemplate the risk involved. Management believes the valuation techniques and assumptions used by the consultant are reasonable.

     Determining the fair value of mortgage servicing rights is considered a critical accounting estimate because of the assets’ sensitivity to changes in estimates and assumptions used, particularly loan prepayment speeds and discount rates. Changes in these estimates and assumptions are reasonably possible and may have a material impact on our consolidated financial statements, results of operations or liquidity. Notes 1 and 7 of the Notes to Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2007 describe the methodology we use to determine fair value of mortgage servicing rights.

     The excess purchase price over the fair value of net assets from acquisitions, or goodwill, is evaluated for impairment at the reporting unit level at least annually, or on an interim basis if an event or circumstance indicates that it is likely an impairment has occurred. In testing for impairment, the fair value of each reporting unit is estimated based on an analysis of market-based trading and transaction multiples of selected banks in the western and central regions of the United States; and, if required, the estimated fair value is allocated to the assets and liabilities of each reporting unit. Determining the fair value of goodwill is considered a critical accounting estimate because of its sensitivity to market-based trading and transaction multiples. In addition, any allocation of the fair value of goodwill to assets and liabilities requires significant management judgment and the use of subjective measurements. Variability in the market and changes in assumptions or subjective measurements used to allocate fair value are reasonably possible and may have a material impact on our consolidated financial statements, results of operations or liquidity. Note 1 of the Notes to Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2007 describes our accounting policy with regard to goodwill.

     Net income available to common shareholders was $17.3 million, or $2.14 per diluted common share, for the quarter ended March 31, 2008. This is an increase of $811 thousand, or 4.9%, as compared to $16.5 million, or $1.97 per diluted common share, for the same period in 2007. Our financial performance for first quarter 2008 includes our acquisition of The First Western Bank Sturgis, Sturgis, South Dakota, First Western Bank, Wall, South Dakota, and First Western Data, Inc. on January 10, 2008. The acquired entities operate eighteen banking offices in twelve western South Dakota communities. As of the date of acquisition, the acquired entities had combined total assets of $918 million, combined total loans of $725 million and combined total deposits of $812 million. Our financial condition and results of operations for the three months ended March 31, 2008 include the results of the acquired entities since the date of acquisition.

     Our success is highly dependent on economic conditions and market interest rates. Because we operate in Montana, Wyoming and South Dakota, the local economic conditions in each of these areas are particularly important. Our local economies have not been as severely impacted by the national economic and real estate downturn, subprime mortgage crisis and credit market turmoil as many areas of the United States.

     Net interest income, on a fully taxable equivalent, or FTE, basis, increased $9.0 million, or 18.3%, to $58.2 million for the three months ended March 31, 2008 as compared to $49.2 million for the same period in 2007, primarily due to increases in average earning assets combined with an increase in the spread between rates earned on interest earning assets and rate paid on interest bearing liabilities.

     Despite growth in average interest earning assets and an increase in the interest rate spread, our net FTE interest margin decreased 17 basis points to 4.29% for the three months ended March 31, 2008, from 4.46% during the same period in the prior year. This decrease in FTE net interest margin is due, in part, to the deployment of available funding into non-earning assets including premises and equipment, goodwill and core deposit intangible assets recorded as part of the First Western acquisition. In addition, free funding sources comprised a smaller percentage of our total funding base during first quarter 2008, which further eroded our FTE net interest margin.

     Exclusive of the results of the acquired First Western entities, noninterest income increased 13.1% and noninterest expense increased 10.8% during first quarter 2008, as compared to the same period in 2007. Significant components of these increases include:

     Net Interest Income. Net interest income, our largest source of operating income, is derived from interest, dividends and fees received on interest earning assets, less interest expense incurred on interest bearing liabilities. The most significant impact on our net interest income between periods is derived from the interaction of changes in the volume of and rates earned or paid on interest earning assets and interest bearing liabilities (spread). The volume of loans, investment securities and other interest earning assets, compared to the volume of interest bearing deposits and indebtedness, combined with the spread, produces changes in the net interest income between periods. Noninterest bearing sources of funds, such as demand deposits and stockholders’ equity, also support earning assets. The impact of free funding sources is captured in the net interest margin, which is calculated as net interest income divided by average earning assets. Given the interest free nature of free funding sources, the net interest margin is generally higher than the spread.

     The following table presents, for the periods indicated, condensed average balance sheet information, together with interest income and yields earned on average interest earning assets and interest expense and rates paid on average interest bearing liabilities.

     Net interest income, on a fully taxable equivalent, or FTE, basis, increased $9.0 million, or 18.3%, to $58.2 million for the three months ended March 31, 2008 as compared to $49.2 million for the same period in 2007, primarily due to increases in average earning assets combined with an increase in the spread between rates earned on interest earning assets and rate paid on interest bearing liabilities. Growth in average earning assets and average interest bearing liabilities is primarily due to the First Western acquisition.

     Despite growth in average interest earning assets and an increase in the interest rate spread, our net FTE interest margin decreased 17 basis points to 4.29% for the three months ended March 31, 2008, from 4.46% during the same period in the prior year. This decrease in FTE net interest margin is due, in part, to the deployment of available funding into non-earning assets including premises and equipment, goodwill and core deposit intangible assets recorded as part of the First Western acquisition. In addition, free funding sources comprised a smaller percentage of our total funding base during first quarter 2008, which further eroded our FTE net interest margin.

     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.

     The provision for loan losses creates an allowance for loan losses known and inherent in the loan portfolio at each balance sheet date. We perform a quarterly assessment of the risks inherent in our loan portfolio, as well as a detailed review of each significant asset with identified weaknesses. Based on this analysis, we record a provision for loan losses in order to maintain the allowance for loan losses at appropriate levels. Fluctuations in the provision for loan losses result from management’s assessment of the adequacy of the allowance for loan losses. Ultimate loan losses may vary from current estimates. For additional information concerning the provision for loan losses, see “Critical Accounting Estimates and Significant Accounting Policies” above.

     The provision for loan losses increased $488 thousand, or 26.0%, to $2.4 million for the three months ended March 31, 2008, as compared to $1.9 million for the same period in 2007. Approximately $150 thousand of the increase is attributable to the First Western entities acquired. The remaining increase is primarily due to increases in the levels of internally risk rated loans.

     Noninterest Income. Our principal sources of noninterest income include other service charges, commissions and fees; technology services revenues; service charges on deposit accounts; revenues from financial services; and, income from the origination and sale of loans. Noninterest income increased $4.5 million, or 20.7%, to $26.4 million for the three months ended March 31, 2008, as compared to $21.8 million for the same period in 2007. Significant components of the increase are discussed below.

     Other service charges, commissions and fees primarily include debit and credit card interchange income, mortgage servicing fees and ATM service charge revenues. Other service charges, commissions and fees increased $1.2 million, or 21.8%, to $6.9 million for the three months ended March 31, 2008, as compared to $5.6 million for the same period in 2007. Approximately $377 thousand of this increase is attributable to the acquired First Western entities. The remaining increase is primarily due to higher insurance commissions and additional fee income resulting from higher volumes of credit and debit card transactions.

     Service charges on deposit accounts increased $534 thousand, or 12.3%, to $4.9 million for the three months ended March 31, 2008, as compared to $4.3 million for the same period in 2007. All of this increase is attributable to the acquired First Western entities.

     Income from the origination and sale of loans includes 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 the level of income generated from the origination and sale of loans. 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. Income from the origination and sale of loans increased $1.2 million, or 56.6%, to $3.4 million for the three months ended March 31, 2008, as compared to $2.2 million for the same period in 2007 primarily due to decreases in mortgage interest rates.

     Wealth management revenues are comprised principally of fees earned for management of trust assets and investment services revenues. Wealth management revenues increased $493 thousand, or 18.0%, to $3.2 million for the three months ended March 31, 2008, as compared to $2.7 million for the same period in 2007. Approximately $165 thousand of this increase is attributable to the acquired First Western entities. The remaining increase is primarily due to higher asset management fees, the result of growth in assets under management.

     Other income primarily includes company-owned life insurance revenues, check printing income, agency stock dividends and gains on sales of assets other than investment securities. Other income increased $990 thousand, or 37.7%, to $3.6 million for the three months ended March 31, 2008, as compared to $2.6 million for the same period in 2007. Approximately $389 thousand of the increase is attributable to the acquired First Western entities. The remaining increase is primarily due to a one-time gain of $1.6 million resulting from the mandatory redemption of our class B shares of Visa, Inc. recorded during first quarter 2008. The net gain was split between our community banking and technology services operating segments. In addition, during first quarter 2008 we recorded a non-recurring gain of $1.1 million resulting from the release of funds escrowed in conjunction with the December 2006 sale of our interest in iPay Technologies, LLC. The increase in other income during first quarter 2008, as compared to the same period in the prior year, was partially offset by a one-time gain of $1.1 million on the sale of mortgage servicing rights recorded during first quarter 2007.

     Noninterest Expense. Noninterest expense increased $10.2 million, or 23.9%, to $53.2 million for the three months ended March 31, 2008, as compared to $42.9 million for the same period in 2007. Significant components of the increase are discussed below.

     Salaries, wages and employee benefits expense increased $4.3 million, or 17.8%, to $28.3 million for the three months ended March 31, 2008, as compared to $24.1 million for the same period in 2007. Approximately $2.7 million of this increase is directly attributable to the acquired First Western entities. The remaining increase is primarily due to inflationary wage increases.

     Furniture and equipment expense increased $556 thousand, or 13.7%, to $4.6 million for the three months ended March 31, 2008, as compared to $4.1 million for the same period in 2007. Approximately $283 thousand of this increase is attributable the acquired First Western entities. The remaining increase is primarily due to higher depreciation expense resulting from the addition or replacement of equipment in the ordinary course of business.

     Occupancy expense increased $831 thousand, or 24.2%, to $4.3 million for the three months ended March 31, 2008, as compared to $3.4 million for the same period in 2007. Approximately $413 thousand of this increase is attributable to the acquired First Western entities. The remaining increase is primarily due to increases in repairs, maintenance and utilities expenses and higher depreciation expense resulting from building improvements and the adjustment of the useful live of one building and its related leasehold improvements.

     Mortgage servicing rights are evaluated quarterly for impairment by discounting the expected future cash flows, taking into consideration the estimated level of prepayments based on current industry expectations and the predominant risk characteristics of the underlying loans. Impairment adjustments are recorded through a valuation allowance. The valuation allowance is adjusted for changes in impairment through a charge to current period earnings. We recorded impairment charges of $3.6 million during first quarter 2008, as compared to $793 thousand during first quarter 2007.

     Mortgage servicing rights are amortized in proportion to and over the period of estimated net servicing income. Changes in estimated servicing period and growth in the serviced loan portfolio cause amortization expense to vary between periods. Mortgage servicing rights amortization increased $197 thousand, or 16.9%, to $1.4 million for the three months ended March 31, 2008, as compared to $1.2 million for the same period in 2007.

     Other expenses primarily include advertising and public relations costs; office supply, postage, freight, telephone and travel expenses; donations expense; director fees; and, other losses. Other expenses increased $620 thousand, or 7.9%, to $8.5 million for the three months ended March 31, 2008, as compared to $7.9 million for the same period in 2007. Other expenses attributable to the acquired First Western entities were approximately $1.2 million during the three months ended March 31, 2008. This increase in other expenses was partially offset by the reversal of $625 thousand of previously recorded contingency accruals related to our agreement to indemnify Visa USA for certain litigation losses. For additional information regarding our indemnification agreement with Visa USA, see “Risk Factors — Operational Risks” included in our Annual Report on Form 10-K for the year ended December 31, 2007.

     Income Tax Expense. Our effective federal income tax rate was 30.2% for the three months ended March 31, 2008, and 30.7% for the three months ended March 31, 2007. State income tax applies primarily to pretax earnings generated within Montana, Colorado, Idaho, Oregon and South Dakota. Our effective state tax rate was 4.4% for the three months ended March 31, 2008, and 3.8% for the three months ended March 31, 2007. Changes in effective federal and state income tax rates are primarily fluctuations in tax exempt interest income as a percentage of total income.

     The following table summarizes net income (loss) for each of our operating segments.

     Our principal operating segment is community banking, which encompasses commercial and consumer banking services offered to individuals, businesses, municipalities and other entities. The community banking operating segment includes results of the acquired First Western entities since the date of acquisition. The community banking segment represented over 90% of our combined revenues and income for the three months ended March 31, 2008 and 2007, and of our consolidated assets as of March 31, 2008 and December 31, 2007. Components of the changes in community banking net income for the three months ended March 31, 2008 as compared to the same period in 2007 are discussed above.

     The technology services operating segment encompasses services provided through i_Tech to affiliated and non-affiliated customers including core application data processing; ATM and debit card processing; item proof, capture and imaging; wide area network services; and, system support. Technology services net income increased $276 thousand, or 31.7%, to $1.1 million for the three months ended March 31, 2008, as compared to $870 thousand for the same period in the prior year. This increase is primarily due to a one-time gain of $894 thousand resulting from the mandatory redemption of our class B shares of Visa, Inc. recorded during first quarter 2008. This one-time gain was partially offset by increases in salaries, wages and benefits expenses. Overall, staffing levels at the technology services operating segment decreased during first quarter 2008, as compared to first quarter 2007; however, some lower level positions were replaced with higher level positions.

     Other includes the net funding cost and other expenses of the parent holding company, the operational results of consolidated nonbank subsidiaries (except i_Tech) and intercompany eliminations. Other net losses increased $1.3 million, or 90.3%, to $2.7 million for the three months ended March 31, 2008, as compared to the same period in 2007, due to higher interest expense resulting from additional debt obtained to fund the First Western acquisition. Interest expense increased $2.5 million for the three months ended March 31, 2008, as compared to the same period in 2007. Increases in interest expense were partially offset by decreases in share-based compensation expense and appreciation on deferred officer bonus amounts.

     Total assets increased $1,068 million, or 20.5%, to $6,284 million as of March 31, 2008, from $5,218 million as of December 31, 2007, primarily due to the First Western acquisition on January 10, 2008. As of the date of acquisition, the acquired entities had combined total assets of $918 million, combined total loans of $725 million , combined premises and equipment of $38 million and combined total deposits of $812 million. In addition, in connection with the acquisition we recorded goodwill and core deposit intangibles of $145 million and $15 million, respectively.

     Loans. Our loan portfolio consists of a mix of real estate, consumer, commercial, agricultural and other loans, including fixed and variable rate loans. Fluctuations in the loan portfolio are directly related to the economies of the communities we serve. The following table presents the composite of our loan portfolio as of the dates indicated:

     Total loans increased $825 million, or 23.2%, to $4,384 million as of March 31, 2008 from $3,559 million as of December 31, 2007. Approximately $731 million of the increase is attributable to the First Western entities acquired. Excluding loans of the acquired entities, total loans increased $94 million, or 2.6%, with the most significant growth occurring in commercial, commercial real estate and residential real estate loans. Management attributes our loan growth to continued demand for housing, growth in our existing market areas and an increase in overall borrowing activity.

     Investment Securities. We manage our investment portfolio to obtain the highest yield possible, while meeting our risk tolerance and liquidity guidelines and satisfying the pledging requirements for deposits of state and political subdivisions and securities sold under repurchase agreements. Investment securities increased $13 million, or 1.2%, to $1,142 million as of March 31, 2008 from $1,129 million as of December 31, 2007. Excluding investment securities of the acquired entities, our investment securities decreased $78 million, or 6.9%.

     We evaluate our investment portfolio quarterly for other-than-temporary declines in the market value of individual investment securities. This evaluation includes monitoring credit ratings; market, industry and corporate news; volatility in market prices; and, determining whether the market value of a security has been below its cost for an extended period of time. As of March 31, 2008, we had investment securities with fair values of $70 million that had been in a continuous loss position more than twelve months. Gross unrealized losses on these securities totaled $997 thousand as of March 31, 2008, and were primarily attributable to changes in interest rates. No impairment losses were recorded during the three months ended March 31, 2008 or 2007.

     Mortgage Servicing Rights. Mortgage servicing rights are initially recorded at fair value based on comparable market quotes and are amortized over the period of estimated net servicing income. Mortgage servicing rights are evaluated quarterly. Impairment adjustments, if any, are recorded through a valuation allowance. Net mortgage servicing rights decreased $3 million, or 13.1%, to $19 million as of March 31, 2008 from $22 million as of December 31, 2007, primarily due to increases in impairment reserves during first quarter 2008.

     Deferred Tax Asset. Deferred tax asset of $1 million as of March 31, 2008 decreased $5 million, or 78.7%, from $7 million as of December 31, 2007, primarily due to fluctuations in net unrealized losses on available-for-sale investment securities.

     Deposits. Our deposits consist of noninterest bearing and interest bearing demand, savings, individual retirement and time deposit accounts. The following table summarizes our deposits as of the dates indicated:

     Total deposits increased $903 million, or 22.6%, to $4,902 million as of March 31, 2008 from $3,999 million as of December 31, 2007. Approximately $796 million of this increase is attributable to the First Western entities acquired. Excluding deposits of the acquired entities, total deposits increased $107 million, or 2.7%, with the majority of the increase occurring in time deposits of $100 thousand or more.

     Repurchase Agreements. In addition to deposits, repurchase agreements with commercial depositors provide an additional source of funds. Under repurchase agreements, deposit balances are invested in short-term U.S. government agency securities overnight and are then repurchased the following day. All outstanding repurchase agreements are due in one day. Repurchase agreements decreased $69 million, or 11.4%, to $536 million as of March 31, 2008 from $605 million as of December 31, 2007, primarily due to fluctuations in the liquidity needs of our customers.

     Other Borrowed Funds. Fluctuations in other borrowed funds are generally due to timing of tax deposits made by customers and the subsequent withdrawal of funds by the federal government. Other borrowed funds increased $3 million, or 37.8% to $12 million as of March 31, 2008 from $9 million as of December 31, 2007. All of the increase is attributable to the First Western entities acquired.

     Long Term Debt. Long term debt increased $92 million to $97 million as of March 31, 2008 from $5 million as of December 31, 2007, due to debt financing for the First Western acquisition. For additional information regarding acquisition financing, see “Notes to Consolidated Financial Statements — Subsequent Events,” included in our Annual Report on Form 10-K for the year ended December 31, 2007. In addition, on February 28, 2008 we entered into a subordinated credit agreement and borrowed $15 million on a variable rate unsecured subordinated term loan maturing February 28, 2018. Interest on the subordinated term loan is payable quarterly and principal is due at maturity. The interest rate on the subordinated term loan was 5.09% as of March 31, 2008.

     Subordinated Debentures Held by Subsidiary Trusts. Subordinated debentures held by subsidiary trusts increased $21 million, or 20.0%, to $124 million as of March 31, 2008, from $103 million as of December 31, 2007. In connection with the First Western acquisition, on January 8, 2008 we issued an aggregate of $20 million of 30-year floating rate mandatorily redeemable capital trust preferred securities to third-party investors and used the proceeds to purchase 30-year junior subordinated deferrable interest debentures issued by our parent company. For additional information regarding the Subordinated Debentures, see “Notes to Consolidated Financial Statements — Subsequent Events,” included in our Annual Report on Form 10-K for the year ended December 31, 2007.

     Accounts Payable and Accrued Expenses. Accounts payable and accrued expenses increased $13 million, or 43.5%, to $43 million as of March 31, 2008, from $30 million as of December 31, 2007. Approximately $6 million of the increase is attributable to the First Western entities acquired. The remaining increase is primarily due to the timing of corporate income tax payments.

     Non-performing Assets. Non-performing assets include loans past due 90 days or more and still accruing interest, nonaccrual loans, loans renegotiated in troubled debt restructurings and other real estate owned, or OREO.

     The following table sets forth information regarding non-performing assets as of the dates indicated:

     Non-performing assets increased $23 million, or 65.1%, to $59 million as of March 31, 2008, as compared to $36 million as of December 31, 2007. Approximately $19 million of the increase is attributable to the acquired First Western entities. Nonaccrual loans increased $19 million, or 61.6%, to $51 million as of March 31, 2008, as compared to $32 million as of December 31, 2007. Approximately $17 million of the increase is attributable to nonaccrual loans of the acquired First Western entities. The remaining increase is primarily due to the loans of one group of related borrowers placed on nonaccrual during first quarter 2008. Accruing loans past due 90 days or more increased $4 million, or 178.0%, to $6 million as of March 31, 2008, as compared to $2 million as of December 31, 2007. Approximately $2 million of the increase is attributable to the acquired First Western entities. The remaining increase is primarily due to one commercial real estate loan in the process of renewal that was past due 90 days and still accruing interest as of March 31, 2008.

     Allowance for Loan Losses. In determining the allowance for loan losses, we estimate losses on specific loans, or groups of loans, where the probable loss can be identified and reasonably determined. The balance of the allowance for loan losses is based on internally assigned risk classifications of loans, historical loan loss rates, changes in the nature of the loan portfolio, overall portfolio quality, industry concentrations, delinquency trends, current economic factors and the estimated impact of current economic conditions on certain historical loan loss rates.

     The following table sets forth information regarding our allowance for loan losses as of and for the periods indicated.

     Although we believe that we have established our allowance for loan losses in accordance with accounting principles generally accepted in the United States and that the allowance for loan losses was adequate to provide for known and inherent losses in the portfolio at all times, future provisions will be subject to on-going evaluations of the risks in the loan portfolio. If the economy declines or asset quality deteriorates, material additional provisions could be required.

     Contractual obligations as of March 31, 2008 are summarized in the following table: