First Interstate BancSystem - 10-Q quarterly report FY

 

(Exact name of registrant as specified in its charter)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer                                     Accelerated filer                                      Non-accelerated filer x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

The Registrant had 8,183,412 shares of common stock outstanding on March 31, 2007.

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 Stockholders’ Equity and Comprehensive Income
(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
Notes to Unaudited Consolidated Financial Statements
(In thousands, except share and per share data)

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(In thousands, except share and per share data)

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(In thousands, except share and per share data)

     The following discussion should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2006, 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 the “Bank” in this report, we mean First Interstate Bank, our only bank subsidiary.

     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, 2006: (i) credit risk; (ii) business concentration and economic conditions in Montana and Wyoming; (iii) declines in real estate values; (iv) changes in interest rates; (v) inability to meet liquidity requirements; (vi) competition; (vii) failure of technology; (viii) breach in information system security; (ix) ineffective internal operational controls; (x) difficulties in execution of business strategy; (xi) disruption of vital infrastructure and other business interruptions; (xii) litigation pertaining to fiduciary responsibilities; (xiii) changes in or noncompliance with governmental regulations; (xiv) restrictions on dividends and stock redemptions; (xv) capital required to support our bank subsidiary; and (xvi) 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, 2006.

     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, 2006 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, 2006 describe the methodology we use to determine fair value of mortgage servicing rights.

     Net income of $16.5 million, or $1.97 per diluted share, increased $362 thousand, or 2.2%, for the quarter ended March 31, 2007, as compared to $16.1 million, or $1.95 per diluted share, for the same period in 2006. Net interest income on a fully taxable-equivalent basis of $49.2 million during the first quarter 2007, increased $2.6 million from $46.5 million for the same period in 2006, due to organic growth in earning assets, primarily loans. Average earning assets grew 8.7% and comprised a larger percentage of total assets during the three months ended March 31, 2007, as compared to the same period in 2006. In addition, interest-free funding sources, including noninterest-bearing deposits, other liabilities and common equity, contributed an additional $87.9 million of our funding base during first quarter 2007, compared to the same period in 2006. Net income during first quarter 2007 was also positively impacted by a $1.1 million gain on the sale of mortgage servicing rights. These increases in net income were significantly offset by higher salaries, wages and benefits expenses and impairment of mortgage servicing rights.

     Although we experienced significant growth in earning assets, our net interest margin on a fully taxable equivalent basis decreased 13 basis points to 4.46% for the three months ended March 31, 2007 from 4.59% during the same period in the prior year. This decline is primarily the result of a continuing inverted yield-rate environment in which short-term interest rates are higher than long-term interest rates. In addition, competitive pressure induced us to increase interest rates paid on deposit accounts and repurchase agreements during the last half of 2006, further constraining our net interest margin.

     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 $2.6 million, or 5.6%, to $49.2 million for the three months ended March 31, 2007 as compared to $46.5 million for the same period in 2006 primarily due to organic growth in earning assets, primarily loans. Average earning assets grew 8.7% and comprised a larger percentage of total assets during the three months ended March 31, 2007, as compared to the same period in 2006. Despite growth in earning assets, our net interest margin on a fully taxable equivalent basis decreased 13 basis points to 4.46% for the three months ended March 31, 2007 from 4.59% during the same period in the prior year. This decline is primarily the result of a continuing inverted yield-rate environment in which short-term interest rates are higher than long-term interest rates. In addition, competitive pressure induced us to increase interest rates paid on deposit accounts and repurchase agreements during the last half of 2006, further constraining our 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.

     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 $2.4 million, or 12.5%, to $21.7 million for the three months ended March 31, 2007, as compared to $19.3 million for the same period in 2006. 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 $465 thousand, or 9.2%, to $5.5 million for the three months ended March 31, 2007, as compared to $5.0 million for the same period in 2006. This increase is primarily due to additional fee income from higher volumes of credit and debit card transactions and increases in mortgage servicing revenues resulting from increases in the principal balances of loans serviced.

     Technology services revenues increased $720 thousand, or 19.8%, to $4.3 million for the three months ended March 31, 2007, as compared to $3.6 million for the same period in 2006 primarily due to increases in the number of customers using core data processing services and the volume of core data and debit card transactions processed.

     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 $297 thousand, or 16.0%, to $2.2 million for the three months ended March 31, 2007, as compared to $1.9 million for the same period in 2006.

     Other income primarily includes increases in the cash surrender value of company-owned life insurance, check printing income, agency stock dividends and gains of sales of assets other than investment securities. Other income increased $640 thousand, or 32.3%, to $2.6 million during the three months ended March 31, 2007, as compared to $2.0 million for the same period in 2006, primarily due to a $1.1 million gain on the sale of mortgage servicing rights recorded during first quarter 2007.

     Noninterest Expense. Noninterest expense increased $4.4 million, or 11.5%, to $42.8 million for the three months ended March 31, 2007, as compared to $38.4 million for the same period in 2006. Significant components of the increase are discussed below.

     Salaries, wages and employee benefits expense increased $2.7 million, or 12.7%, to $24.1 million for the three months ended March 31, 2007, as compared to $21.3 million for the same period in 2006, primarily due to inflationary wage increases, increased staffing levels, higher stock-based compensation expense and increases in group medical insurance costs.

     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 $225 thousand, or 23.9%, to $1.2 million for the three months ended March 31, 2007, as compared to $943 thousand for the same period in 2006.

     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 of $793 thousand during the three months ended March 31, 2007, as compared to the reversal of previously recorded impairment of $170 thousand during the same period in 2006.

     Other expenses primarily include advertising and public relations costs; office supply, postage, freight, telephone and travel expenses; donations expense; board of director fees; and, other losses. Other expenses increased $369 thousand, or 5.0%, to $7.8 million for the three months ended March 31, 2007, as compared to $7.4 million for the same period in 2006, primarily due to inflationary expense increases and higher non-recurring fraud and other losses in the current year.

     Income Tax Expense. Our effective federal income tax rate was 30.7% for the three months ended March 31, 2007, and 30.8% for the three months ended March 31, 2006. State income tax applies primarily to pretax earnings generated within Montana, Colorado, Idaho and Oregon. Our effective state tax rate was 3.8% for the three months ended March 31, 2007, and 4.1% for the three months ended March 31, 2006.

     Our primary operating segment is Community Banking. The Community Banking segment represented over 90% of our combined revenues and income during the three months ended March 31, 2007 and 2006, and our consolidated assets as of March 31, 2007 and December 31, 2006.

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

     Net income from the Community Banking operating segment increased $653 thousand, or 4.0%, to $17.0 million for the three months ended March 31, 2007, as compared to $16.4 million for the same period in 2006. Significant components of this increase are discussed in “Results of Operations” included herein.

     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 $54 million, or 1.6%, to $3,364 million as of March 31, 2007 from $3,310 million as of December 31, 2006, with the most significant growth occurring in commercial and commercial real estate loans. Management attributes our loan growth to generally favorable economic conditions and 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 decreased $140 million, or 12.5%, to $984 million as of March 31, 2007 from $1,125 million as of December 31, 2006. This decrease occurred principally in short-term available-for-sale investment securities used as collateral for securities sold under repurchase agreements. For further information, see “Deposits” and “Repurchase Agreements” below.

     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, 2007, we had investment securities with fair values of $517 million that had been in a continuous loss position more than twelve months. Gross unrealized losses on these securities totaled $9 million as of March 31, 2007, and were primarily attributable to changes in interest rates. No impairment losses were recorded during the three months ended March 31, 2007 or 2006.

     Mortgage Servicing Rights. We recognize the rights to service mortgage loans for others whether acquired or internally originated. Net mortgage servicing rights decreased $2 million, or 10.1%, to $20 million as of March 31, 2007 from $23 million as of December 31, 2006, primarily due to the sale of mortgage servicing rights to a third party in February 2007.

     Deferred Tax Asset. Deferred tax asset of $7 million as of March 31, 2007 decreased $1 million, or 13.5%, from $8 million as of December 31, 2006, primarily due to fluctuations in net unrealized losses on available-for-sale investment securities.

     Deposits. Total deposits increased $155 million, or 4.2%, to $3,863 million as of March 31, 2007 from $3,709 million as of December 31, 2006, primarily due to the introduction of a new money market cash sweep deposit product during first quarter 2007. The money market cash sweep deposit product is available to commercial customers as an alternative to traditional repurchase agreements. The money market cash sweep product allows customers’ to invest on a daily basis excess demand deposit funds into a higher yielding money market savings account held by the Bank. Customer balances invested in the money market cash sweep product are insured by the Federal Deposit Insurance Corporation up to statutory limits.

     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 $164 million, or 22.5%, to $568 million as of March 31, 2007 from $732 million as of December 31, 2006, primarily due to the introduction of the money market cash sweep product described above.

     Other Borrowed Funds. Other borrowed funds decreased $5 million, or 96.1% to $220 thousand as of March 31, 2007 from $6 million as of December 31, 2006. 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.

     Long Term Debt. Long term debt decreased $10 million, or 48.0%, to $11 million as of March 31, 2007 from $22 million as of December 31, 2006 due the scheduled March 2007 maturity of a $10 million, 3.03% fixed rate Federal Home Loan Bank note.

     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 $8 million, or 44.3%, to $26 million as of March 31, 2007, as compared to $18 million as of December 31, 2006. Approximately $4 million of the increase is related to the adequately secured loans of two commercial borrowers past due 90 days or more and in the process of renewal or refinance. The remaining increase is primarily due to the loans of two additional commercial borrowers currently past due 90 days or more and in the process of being placed on nonaccrual status.

     Provision/Allowance for Loan Losses. 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. 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. 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 $122 thousand, or 7.0%, to $1.9 million for the three months ended March 31, 2007, as compared to $1.8 million for the same period in the prior year. The allowance for loan losses was $49 million, or 1.45% of total loans, as of March 31, 2007, as compared to $47 million, or 1.43% of total loans, at December 31, 2006.

     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.

     Capital Resources. Stockholders’ equity is influenced primarily by earnings, dividends and, to a lesser extent, sales and redemptions of common stock and changes in the unrealized holding gains or losses, net of taxes, on available-for-sale investment securities. Stockholders’ equity increased $11 million, or 2.7%, to $422 million as of March 31, 2007 from $410 million as of December 31, 2006, primarily due to retention of earnings. We paid aggregate cash dividends to stockholders of $8.4 million during the three months ended March 31, 2007, including a special dividend of $0.41 per share paid in January 2007. As of March 31, 2007 and December 31, 2006, we exceeded the “well-capitalized” requirements established by the federal banking agencies.

     Liquidity. Liquidity is our ability to meet current and future cash flow needs on a timely basis and at a reasonable cost. We manage our liquidity position to meet the daily cash flow needs of customers, while maintaining an appropriate balance between assets and liabilities to meet the return on investment objectives of our shareholders. Our liquidity position is supported by management of liquid assets and liabilities. Liquid assets include cash, interest bearing deposits in banks, federal funds sold, available-for-sale investment securities and maturing or prepaying balances in our held-to-maturity investment and loan portfolios. Liquid liabilities include core deposits, federal funds purchased, securities sold under repurchase agreements and borrowings. We do not engage in derivatives or hedging activities to support our liquidity position.

     Our short-term and long-term liquidity requirements are primarily to fund on-going operations, including payment of interest on deposits and debt, extensions of credit, capital expenditures and shareholder dividends. These liquidity requirements are met primarily through cash flow from operations, redeployment of prepaying and maturing balances in our loan and investment portfolios, debt obligations and increases in customer deposits.

     Other sources of liquidity are available should they be needed. These sources include the drawing of additional funds on our unsecured revolving term loan, the sale of loans, the ability to acquire additional national market, non-core deposits, the issuance of additional collateralized borrowings such as FHLB advances, the issuance of debt securities and the issuance of preferred or common securities. The Bank also can borrow through the Federal Reserve’s discount window.

     As a holding company, we are a corporation separate and apart from our subsidiary Bank and, therefore, we provide for our own liquidity. A significant amount of our revenues are obtained from management fees and dividends declared and paid by the Bank and other non-bank subsidiaries. There are statutory and regulatory limitations that affect the ability of the Bank to pay dividends to us. Our debt instruments also include dividend limitations. Management believes that such limitations will not have an impact on our ability to meet our ongoing short-term cash obligations.

     The goal of asset liability management is the prudent control of market risk, liquidity and capital. Asset liability management is governed by policies, goals and objectives adopted and reviewed by the Bank’s board of directors. The board delegates its responsibility for development of asset liability management strategies to achieve these goals and objectives to the Asset Liability Committee, or ALCO, which is comprised of members of senior management.

     We target a mix of interest earning assets and interest bearing liabilities such that no more than 5% of the net interest margin will be at risk over a one-year period should short-term interest rates shift gradually up or down 2%. As of March 31, 2007, our income simulation model predicted net interest income would decrease $1.2 million, or 0.6%, assuming a gradual 2% increase in short-term market interest rates and gradual 1.0% increase in long-term interest rates. This scenario predicts our funding sources will reprice faster than our interest earning assets, thereby reducing interest rate spread and net interest margin. Conversely, assuming a gradual 2% decrease in short-term market interest rates and gradual 1.0% decrease in long-term interest rates, our income simulation model predicted net interest income would decrease $1.9 million, or 1.0%. This scenario predicts that interest rates on non-maturing demand and savings deposits will not decrease in direct proportion to a simulated downward shift in interest rates, thereby reducing interest rate spread and net interest margin.

     The preceding interest rate sensitivity analysis does not represent a forecast and should not be relied upon as being indicative of expected operating results.

     As of March 31, 2007, there have been no material changes in the quantitative and qualitative information about market risk provided pursuant to Item 305 of Regulation S-K as presented in our Annual Report on Form 10-K for the year ended December 31, 2006.

     Our management is responsible for establishing and maintaining effective disclosure controls and procedures, as defined under Rules 13a-15(e) and 15d-15(e) of the Exchange Act. As of March 31, 2007, an evaluation was performed, under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial

Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures as of March 31,

     2007, were effective in ensuring that information required to be disclosed in this Quarterly Report on Form 10-Q was recorded, processed, summarized, and reported within the time period required by the SEC’s rules and forms.

     There were no changes in our internal controls over financial reporting for the quarter ended March 31, 2007, that have materially affected, or are reasonably likely to materially affect, such controls.

     The effectiveness of our disclosure controls and procedures and our internal control over financial reporting is subject to various inherent limitations, including cost limitations, judgments used in decision-making, assumptions about the likelihood of future events, the soundness of our systems, the possibility of human error, and the risk of fraud. Moreover, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions and the risk that the degree of compliance with policies or procedures may deteriorate over time. Because of these limitations, any system of disclosure controls and procedures or internal control over financial reporting may not be successful in preventing all errors or fraud or in making all material information known in a timely manner to the appropriate levels of management.

     There have been no material changes in legal proceedings as described in our Annual Report on Form 10-K for the year ended December 31, 2006.

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

FIRST INTERSTATE BANCSYSTEM, INC.