FEDERAL DEPOSIT INSURANCE CORPORATION Washington D.C FORM 10-K. IDAHO INDEPENDENT BANK (Exact name of registrant as specified in its charter)

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1 [X] FEDERAL DEPOSIT INSURANCE CORPORATION Washington D.C FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the year ended December 31, 2008 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 OR IDAHO INDEPENDENT BANK (Exact name of registrant as specified in its charter) Idaho (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 1260 W. Riverstone Drive Coeur d'alene, Idaho (Address of principal executive offices) (Zip Code) (Registrant's telephone number, including area code) Securities Registered Pursuant to Section 12(b) of the Act: None Securities Registered Pursuant to Section 12(g) of the Act: Common Stock, $5.00 Par Value Name of Each Exchange on Which Registered: None Indicate by check mark if the registrant is a well-known seasoned issuer, as defined by Rule 405 of the Securities Act. YES [ ] NO [X] Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. YES [ ] NO [X] 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 twelve months and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [ ] Indicate by check mark if disclosure of delinquent filers pursuant to item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendments to this Form 10-K. [ ] Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of Large Accelerated Filer, Accelerated Filer and Smaller Reporting Company in Rule 12b-2 of the Exchange Act. Large accelerated filer [ ] Accelerated filer [X] Non-accelerated filer [ ] Smaller reporting company [ ] Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). YES [ ] NO [X] a The aggregate market value of the voting stock held by non-affiliates of the registrant as of June 30, 2008, based upon the closing sale price reported by the OTC Bulletin Board on such date, was $87,494,000. The number of shares outstanding of the registrant s common stock, par value $5.00 per share, as of January 31, 2009 was 6,194,380. DOCUMENTS INCORPORATED BY REFERENCE Portions of the definitive Proxy Statement for registrant's Annual Meeting of Shareholders to be held on May 15, 2009, are incorporated by reference into Part III of this Form 10-K.

2 (This Annual Report on Form 10-K has not been reviewed or approved by the Federal Deposit Insurance Corporation)

3 IDAHO INDEPENDENT BANK 2008 ANNUAL REPORT ON FORM 10-K TABLE OF CONTENTS PART I. Page # Item 1 - Business... 4 Item 1A - Risk Factors Item 1B - Unresolved Staff Comments Item 2 - Properties Item 3 - Legal Proceedings Item 4 - Submission of Matters to a Vote of Security Holders PART II. Item 5 - Market for Registrant s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities Item 6 - Selected Financial Data Item 7 - Management s Discussion and Analysis of Financial Condition and Results of Operations Item 7A - Quantitative and Qualitative Disclosures About Market Risk Item 8 - Financial Statements and Supplementary Data Item 9 - Changes in and Disagreements with Accountants on Accounting and Financial Disclosure Item 9A- Controls and Procedures Item 9B - Other Information PART III. Item 10 Directors, Executive Officers, and Corporate Governance Item 11 - Executive Compensation Item 12 - Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters Item 13 - Certain Relationships, Related Transactions, and Director Independence Item 14 - Principal Accounting Fees and Services PART IV. Item 15 - Exhibits and Financial Statement Schedules... 52

4 Disclosure Regarding Forward-Looking Statements Statements contained herein concerning future performance, developments or events, expectations for earnings, growth and market forecasts, and any other guidance for future periods constitute forward-looking statements within the meaning of the Private Securities Reform Act of 1995, and as such, are subject to a number of risks and uncertainties that might cause actual results to differ materially from expectations or our stated objectives. Factors that could cause actual results to differ materially include but are not limited to: changes in regional or general economic conditions; changes in interest rates, deposit flows, demand for loans, real estate values, competition, or loan delinquency rates; changes in accounting principles, practices, policies, or guidelines; changes in legislation or regulations; changes in the regulatory environment; changes in monetary policy of the Federal Reserve Bank; changes in fiscal policy of the Federal government and the state of Idaho; changes in other economic, competitive, governmental, regulatory, and technological factors affecting operations, pricing, products, and services; material unforeseen changes in the liquidity, results of operations, or financial condition of the Bank s customers; and other risks detailed from time to time in the Bank s filings with the Federal Deposit Insurance Corporation. Accordingly, these factors should be considered in evaluating forward-looking statements, and undue reliance should not be placed on such statements. The Bank undertakes no responsibility to update or revise any forward-looking statements. Item 1. Business Introduction PART I Idaho Independent Bank (the Bank ) is an Idaho state-chartered, full-service commercial bank that focuses on small to medium-sized businesses, professionals, and retail customers. The Bank commenced its banking business in October 1993 and at December 31, 2008, operated twelve branches. The Bank s principal executive office and the Coeur d'alene Branch is located at 1260 West Riverstone Drive, Coeur d Alene, Idaho 83814, and its telephone number is (208) The Bank's other branch offices are located at: 8882 North Government Way, Hayden, Idaho 83835; 317 North 9th Street, Boise, Idaho 83702; 8351 West Overland Road, Boise, Idaho, 83709; 401 West Front Street, Boise, Idaho, 83702; 113 East Idaho Street, Meridian, Idaho 83642; th Avenue South, Nampa, Idaho 83651; 310 American Legion Boulevard, Mountain Home, Idaho, 83647; 620 South Kimball Avenue, Caldwell, Idaho 83605; 491 North Main Street, Suite 101, Ketchum, Idaho 83340; 90 South Star Road, Star, Idaho, 83669; and 560 East State Street, Eagle, Idaho At December 31, 2008, 2007, and 2006, the Bank had net income after taxes of $1.1 million, $11.1 million, and $11.0 million; total assets of $588.4 million, $625.7 million, and $615.1 million; total loans, not including loans held for sale, and net of deferred fees and the allowance for loan losses, of $459.1 million, $515.1 million, and $518.0 million; and total deposits and customer repurchase agreements of $457.6 million, $503.2 million, and $516.3 million, respectively. For the year ending December 31, 2008, the Bank s assets decreased $37.3 million, or 6.0%, net loans decreased $56.0 million, or 10.9%, and total deposits and repurchase agreements decreased $45.6 million, or 9.1%, in each case compared to December 31, The decrease in assets and earnings for the year ended December 31, 2008, was primarily due to the ongoing effects of a continued deterioration of the real estate markets and slowdown in economic activity within the communities the Bank serves. Available Information 4

5 Idaho Independent Bank's Internet address is Electronic copies of the Bank's registration statement on Form 10, annual report on Form 10-K, quarterly reports on Form 10-Q, and reports on Form 8-K, if any, are available free of charge by visiting the Investor Relations page of These reports are posted as soon as practicable after they are filed with the Federal Deposit Insurance Corporation ( FDIC ). Information contained on the Bank's website is not part of this report. Industry Overview Beginning in the latter half of 2007, disruptions in the sub-prime real estate market and in the securitization markets for such loans created uncertainty in the financial markets and contributed to a general economic downturn and disruption in most financial markets, that has continued through 2008 and is expected to continue into Along with many other lending institutions, the Bank has experienced significant increases in delinquent and nonperforming loans, including construction, development and land loans, commercial loans, and consumer loans. At the same time, competition for deposits and high quality loans has increased significantly. In addition, the values of real estate collateral supporting many construction, development, and land loans, commercial loans, and home mortgages have declined and may continue to decline. In general, bank and holding company stock prices have been negatively affected, as has the ability of banks and holding companies to raise capital or borrow in the debt markets when compared to recent years. As a result, there is a potential for new federal or state laws and regulations related to lending and funding practices and liquidity standards, and bank regulatory agencies are expected to be very aggressive in responding to concerns and trends identified in examinations, including the expected issuance of formal enforcement orders. The commercial banking industry continues to experience a high level of competition and rapid change. Financial service providers such as mutual fund companies, brokerage firms, insurance companies, mortgage companies, credit unions, and leasing companies are offering alternatives for customer funds and alternative lending sources for their borrowing needs. In recent years, increased competition has also developed from specialized finance and non-finance companies that offer money market and mutual funds, wholesale finance, credit card, and other consumer finance services, including online banking. Strong competition for deposit and loan products affects the rates of those products as well as the terms on which they are offered to customers. Consolidation of the banking industry has placed additional pressure on surviving banks to streamline their operations, reduce expenses, and increase revenues to remain competitive. Commercial banks are reducing costs through implementation of various technologies, consolidation, and alternative ways of delivering bank products. Although new community banks continue to be organized, the total number of commercial banks in the United States has decreased, and this trend is expected to continue. While all banks are experiencing the effects of the changing environment, the manner in which banks choose to compete creates a marked difference between the super-regional and national brand name banks as compared to the community banks that provide most of the same products as the larger banks, but with more of a commitment to personal service to the customers and communities they serve. Business Strategy The Bank s business strategy is to continue to operate a full-service, profitable community bank by emphasizing high quality customer service and by focusing on the financial needs of small to medium-sized businesses, professionals, and retail customers. Over the medium and longer term, the Bank will consider a growth strategy, the key components of which include: Providing a high level of personalized customer service; Increasing market share in profitable segments of existing markets; Opening new branches and/or loan production offices in selected markets within the state of Idaho; Participating with other banks on large loans; and Encouraging the use of electronic banking services and payment processing services offered by the Bank. 5

6 Since opening for business in 1993, the Bank has focused on providing commercial banking services to small and medium-sized businesses, professionals, and retail customers in the state of Idaho. Management believes that the Bank can continue to gain market share and grow by promoting and cross-selling its products and services in the markets it currently serves as well as expanding into new markets as opportunities present themselves. The Bank emphasizes the development of long-term relationships with its customers and strives to develop and offer new products that meet its customers needs. The Bank is dedicated to the communities it serves and is actively involved in these communities. Management believes this community involvement gives it a competitive advantage in attracting and retaining targeted customers. Consolidation within the banking industry in recent years has resulted in centralized loan approvals in the larger financial institutions that compete with the Bank. This has caused some inconvenience and reduced service levels for many small businesses and individual customers of these institutions and has created opportunities for smaller, locally-focused institutions, such as the Bank, which can approve loans within its branch offices. The Bank maintains loan officers in each of its branches, thereby enabling it to respond to loan requests in a timely manner. Management considers a variety of criteria in evaluating potential expansion opportunities, including market conditions, demographics, and short- and long-term growth prospects for the location, management, and other resources needed to integrate the branch or loan production office into its existing operations, the degree to which the branch or loan production office would enhance the geographic diversity of the Bank or would enhance the Bank s presence in an existing market, and the estimated cost of opening and operating the branch or loan production office. Lending Activities The Bank s loan portfolio primarily consists of commercial loans, residential and commercial real estate loans, residential and commercial construction loans, consumer loans, and credit card accounts. At December 31, 2008, the Bank had gross loans outstanding, not including loans held for sale, of $472.0 million, which equals approximately 103.1% of the Bank s total deposits and repurchase agreements, and 80.2% of its total assets as of that date. At December 31, 2008, most of the loans held by the Bank were to borrowers and/or secured by collateral located within the Bank s principal market areas. The following table sets forth the composition of the Bank s loan portfolio at December 31, 2008, 2007, 2006, 2005, and At December 31, Amount % Amount % Amount % Amount % Amount % (Dollars in thousands) Commercial $ 94, $ 103, $ 90, $ 78, $ 62, Agricultural 1, , , , Real estate 302, , , , , Real estate construction 31, , , , , Consumer 39, , , , , Other 2, Total loans 472, , , , , Less: Deferred loan fees Allowance for loan losses 12,630 10,075 9,882 7,854 5,613 Loans receivable, net $ 459,081 $ 515,135 $ 517,967 $ 412,149 $ 285,088 Commercial loans primarily consist of loans to businesses for various purposes, including, but not limited to revolving lines of credit and equipment loans. These loans generally have relatively short maturities, adjustable rates or fixed rates, and are either unsecured or secured by inventory, accounts receivable, equipment, other personal property, real estate, or a combination thereof. 6

7 Real estate loans include various types of loans for which the Bank holds real property as collateral, including land acquisition and land development loans totaling $122.6 million and $43.8 million, respectively, as of December 31, At December 31, 2008, real estate loans also included approximately $27.7 million of closed-end, adjustable and fixedrate loans secured by first priority liens on one- to four-family residential properties that are not being held for sale in the secondary market. Real estate loans held in the Bank's portfolio typically have maturities from one to ten years with amortization schedules ranging up to 30 years. The Bank also sells real estate loans into the secondary market to various investors and other financial institutions through its residential real estate department. The Bank sells both variable- and fixed-rate, and single-family as well as other residential real estate loans. In 2008, the Bank sold $80.7 million in real estate loans as compared to $90.5 million in 2007, and $92.8 million in These loans are typically sold on a servicing-released basis, meaning the Bank does not retain real estate servicing responsibilities or the income associated therewith. The Bank may be required to repurchase sold loans in some circumstances, including when certain loans become more than 60 days delinquent in the year of origination. At December 31, 2008, residential real estate loans held for sale were $4.6 million and are not included in the table above. The amount of loans held for sale can vary significantly from period to period reflecting loan demand by borrowers, secondary market conditions for the sale and securitization of such loans, and the current interest rate environment. Real estate construction loans are typically made to individuals and/or contractors to construct single-family residences and commercial buildings. These loans generally have maturities of one to twenty-four months. Consumer loans are primarily unsecured, automobile, bankcard, or home equity lines of credit, and closed-end home equity loans. Consumer loans generally have maturities of ten years or less, with fixed or variable interest rates. Personal lines of credit and home equity lines generally carry maturities from one to ten years and have variable interest rates. Credit card loans generally require monthly payments and bear interest at rates that vary from time-to-time. The interest rates charged on loans vary with the degree of risk, the amount of compensating balances, the dollar amount of the loan, competitive pressures, market rates, the availability of deposits and other funding, and government regulations. Approximately 87% of the loans in the Bank s portfolio have interest rates that float with a reference rate. Many of the variable rate loans made by the Bank have rate floors below which they do not reprice. Due to significant decreases in the prime rate during 2008, the majority of the Bank s variable rate loans at December 31, 2008, reflect rates at their respective floors, and consequently, may not reprice when interest rates start moving up again. The Bank follows loan policies that have been approved by the Bank s Board of Directors and are overseen by Management. The policies address such things as lending levels, review and grading criteria, guidelines for loan administration, loan loss reserves, and related issues. Loan requests are approved by the Board of Directors through designated officers and/or committees in accordance with the guidelines and underwriting policies of the Bank. Credit authority throughout the Bank generally varies according to the type of loan and the individual loan officer s experience. Under applicable federal and state law, the Bank s total amount of loans that may be made to one borrower is limited. The Bank's internal limits may be less than or equal to the total amount of the prevailing legal limits. 7

8 Asset Quality Nonperforming Assets. The following table sets forth information concerning the Bank s nonperforming assets as of December 31, 2008, 2007, 2006, 2005, and (1) Year Ended December 31, (Dollars in thousands) Loans accounted for on a nonaccrual basis $ 7,378 $ 943 $ 2,784 $ - $ - Loans past due 90 days or more but still accruing Other real estate owned 7, Total nonperforming assets $ 14,627 $ 943 $ 2,784 $ - $ 342 Allowance for loan losses $ 12,630 $ 10,075 $ 9,882 $ 7,854 $ 5,613 Nonperforming assets as a percent of total assets 2.49% 0.15% 0.45% 0.00% 0.09% Nonaccrual loans as a percent of total loans 1.56% 0.18% 0.53% 0.00% 0.00% Allowance for loan losses as a percent of nonperforming assets 86% 1,068% 355% N/A 1,640% (1) Impaired loan information is outlined in Note 3 of Notes to the Bank s 2008 Consolidated Financial Statements ( Financial Statements ). Loans are generally placed on a nonaccrual status when they are past due over 90 days, unless they are adequately collateralized and in the process of collection. No interest is accounted for as income on nonaccrual loans unless received in cash or until such time as the borrower demonstrates an ability to resume payments of principal and interest. Generally, interest previously accrued but not collected is reversed and charged against income at the time a loan is placed on nonaccrual status. Interest income recognized on nonaccrual loans in 2008, 2007, and 2006 totaled $514,000, $230,000, and $0, respectively. Interest accrued but reversed and not recognized in 2008, 2007, and 2006 totaled $75,000, $85,000 and $58,000, respectively. A restructured loan is a loan whose terms have been modified or amended to provide a below market interest rate or the deferral of interest or principal due to the borrower s weakened financial condition. Interest on restructured loans is accrued at the restructured rate when it is anticipated that no loss of original principal will occur. There were no restructured loans during the years ended December 31, 2008, 2007, and Other real estate owned includes property acquired by the Bank in foreclosure proceedings or by acceptance of a deed in lieu of foreclosure. Foreclosure proceedings may be initiated when it is determined that the prospect of payment by the borrower is remote and that the only means of collecting the loan is foreclosure on the collateral. Such property is carried at the lower of cost or estimated net realizable value at the time it is acquired by the Bank. Expenses and/or valuation allowances arising from the acquisition may be charged against earnings and/or the allowance for loan losses. Potential Problem Loans. Potential problem loans are loans that do not yet meet the criteria for placement on nonaccrual status, but the Bank has information that there are potential credit problems with the borrowers that causes Management to have concerns about the ability of the borrowers to substantially comply with existing loan repayment terms. This may result in the future inclusion of such loans in the non-accrual loan category. As of December 31, 2008, the aggregate amount of potential problem loans was approximately $9.5 million, which includes certain loans that were rated Substandard under the Bank s risk grading process as well as other loans that possessed inherent weaknesses other than their delinquent status but were not impaired or on non-accrual status. 8

9 Allowance for Loan Losses. The allowance for loan losses represents Management s recognition of the risks of extending credit and its estimate of the quality and collectibility of the loan portfolio of the Bank. The allowance is maintained at a level considered adequate by Management to provide for probable loan losses and is based on Management s assessment of various factors affecting the loan portfolio, including problem loans, economic conditions, concentrations, loss experience, an overall evaluation of the quality of the underlying collateral, and estimated holding and disposal costs. The allowance is increased by provisions charged to expense and is reduced by loans charged off, net of any recoveries. Management maintained the allowance for loan losses at December 31, 2008, and 2007, at 2.68% and 1.92%, respectively, of total loans, net of loans held for sale. To maintain this level in the allowance, $12.0 million was charged to expense for the provision for loan losses in 2008, compared to $605,000 charged to expense for the provision in The amount added to the provision in 2008 was primarily to offset $9.5 million of net charge-offs during the year. Total loans, net of deferred fees and not including loans held for sale, decreased $53.5 million in 2008, compared to a decrease of $2.6 million in In general, the Bank experienced a negative rate of growth during the year ended December 31, Management believes this is largely due to operating strategies related to Bank policy and a continued slowdown in economic activity in the Bank s primary markets. The decline in real estate market values in many parts of the country and the significant losses experienced by many financial institutions has resulted in increased regulatory scrutiny of the loan portfolios of financial institutions, including the Bank. The Bank s land acquisition, land development, and real estate construction loans continue to be the most negatively affected by the decline in real estate values and the slowdown in economic activity, both nationally and in the Bank s primary markets. There remains a heightened level of uncertainty regarding the duration and depth of the economic and real estate slowdown, and thus, the decline in real estate and other collateral values. Although Management believes the Bank s allowance for loan losses is adequate to cover anticipated losses, there can be no assurance that Management will not need to increase the allowance for loan losses in the future, or that regulators, when reviewing the Bank s loan portfolio, will not request that the Bank increase the allowance. In addition, there can be no assurance that the Bank s actual loan losses will not exceed its allowance for loan losses. Any of these events could materially and adversely affect the Bank s earnings. 9

10 The following table sets forth information regarding changes in the Bank s allowance for loan losses for the years ended December 31, 2008, 2007, 2006, 2005, and Year Ended December 31, (Dollars in thousands) Balance of allowance for loan losses at beginning of period $ 10,075 $ 9,882 $ 7,854 $ 5,613 $ 4,543 Total charge-offs (10,233) (423) (30) (108) (209) Total recoveries Net (charge-offs) recoveries (9,460) (412) Provision for loan losses 12, ,079 2, Transfer to off-balance sheet loss reserve - - (60) - - Balance of allowance for loan losses at at end of period $ 12,630 $ 10,075 $ 9,882 $ 7,854 $ 5,613 Loans outstanding, net of deferred fees $ 471,711 $ 525,210 $ 527,850 $ 420,003 $ 290,718 Allowance for loan losses as a percentage of loans outstanding at end of period 2.68% 1.92% 1.87% 1.87% 1.93% Net charge-offs as a percentage of average loans outstanding during the period 1.82% 0.08% 0.00% -0.02% -0.13% Total charge-offs and recoveries, segregated by components of the Bank's loan portfolio, for the years ended December 31, 2008, 2007, 2006, 2005, and 2004 are as follows. Year Ended December 31, (in thousands) Charge-offs: Commercial $ (267) $ (99) $ - $ (69) $ (26) Agricultural Real estate (7,610) - - (5) (171) Real estate construction (2,275) (305) Consumer (81) (19) (30) (34) (12) Other Total charge-offs $ (10,233) $ (423) $ (30) $ (108) $ (209) Recoveries: Commercial $ 45 $ 3 $ 15 $ 11 $ 5 Agricultural Real estate Real estate construction Consumer Other Total recoveries $ 773 $ 11 $ 39 $ 187 $ 554 Management of the Bank periodically reviews the status of loans that are contractually past due and the fair value of the collateral securing such loans and establishes reserves through the provision for loan losses where ultimate collection of 10

11 such loans may be questionable. The provision for loan losses also reflects a general allocation of unanticipated losses based in part on the size of the Bank s loan portfolio, Management s assessment of economic conditions within the Bank s service area, and concentrations within the portfolio. Provisions for loan losses have been made in order to maintain the reserve for loan losses comparable with the Bank s internal and external analysis of the loan portfolio. Management believes that the allowance for loan losses is adequate and represents the best estimate of the probable credit losses inherent in the loan portfolio, although there can be no assurances in this regard. Investment Activities Certificates of Deposit Held with Other Financial Institutions. The Bank acquired certificates of deposit from various other financial institutions during 2008, 2007, and At December 31, 2008, 2007, and 2006, the total amount of the certificates of deposit owned by the Bank was $55.3 million, $34.7 million, and $18.7 million, respectively. As of December 31, 2008, all certificates of deposit with any one bank were $250,000 or less, and therefore, were insured against loss by the FDIC. These certificates all mature in less than 29 months from December 31, 2008, and bear interest rates ranging from 3.19% to 5.50% per annum. Investments. The following table sets forth the carrying value, by type, of the securities in the Bank s portfolio at December 31, 2008, 2007, and At December 31, (in thousands) U.S. Treasury and agency securities $ 413 $ 15,723 $ 17,510 Municipal bonds 188 1, Trading securities 2,030 2,754 2,128 Other securities, including FHLB of Seattle stock 1,993 1,448 1,442 Total securities $ 4,624 $ 21,027 $ 21,502 As of December 31, 2008, the amortized cost of the Bank s investment portfolio exceeded its market value by $3,000. This compared to the market value exceeding the amortized cost by $20,000 at December 31, The change in the market value of the Bank's investments compared to amortized cost from December 31, 2007, to December 31, 2008, was largely due to the Bank s practice of maintaining short maturities on high quality investments. Management believes that the Bank has adequate liquidity for operations without selling its securities, and as such, it is unlikely any unrealized market losses in the investment portfolio will have to be recognized. The Bank has other sources, including borrowing lines that provide additional liquidity. No portion of the Bank s investment portfolio is invested in derivative securities (defined as securities whose value derives from the value of underlying securities or a market index of underlying securities values) or mortgage backed securities as of December 31,

12 The following table sets forth the book values, maturities, and approximate average aggregate yields of securities in the Bank s investment portfolio, by type, at December 31, Percentage Type and Maturity of Securities Amount Yield (in thousands) U.S. Treasury and agencies: Due in 1 year or less $ % Due in 1 to 5 years Due in 5 to 10 years Due in over 10 years Total Municipal bonds: Due in 1 year or less Due in 1 to 5 years Due in 5 to 10 years Due in over 10 years Total Other securities 4,023 N/A Total securities $ 4,624 (1) (2) (1) Yields for securities of state and political subdivisions are calculated on a tax-equivalent basis using combined federal and state income tax rates of approximately 39.0%. (2) Yields for securities are based on amortized cost. At December 31, 2008, 2007, and 2006, the book values and market values of securities held in the Bank s investment portfolio were as follows: At December 31, Book Fair Book Fair Book Fair Value Value Value Value Value Value (in thousands) U.S. Treasury and agency securities $ 408 $ 413 $ 15,699 $ 15,723 $ 17,529 $ 17,510 Municipal bonds ,096 1, Trading securities 2,030 2,030 2,754 2,754 2,128 2,128 Other investments including FHLB of Seattle stock 2,003 1,993 1,458 1,448 1,458 1,442 $ 4,627 $ 4,624 $ 21,007 $ 21,027 $ 21,542 $ 21,502 Deposits The Bank s primary source of funds is customer deposits. The Bank strives to maintain a high percentage of noninterestbearing deposits, because they are low-cost funds and can assist the Bank in achieving higher interest margins. At December 31, 2008, 2007, and 2006, the Bank s ratio of noninterest-bearing deposits to total deposits was 25.6%, 26.2%, and 32.1%, respectively. The decline in noninterest-bearing deposits reflects the slowdown in economic activity in the Bank s primary markets, resulting in lower deposit balances being maintained by the Bank s customers. 12

13 The Bank offers a variety of interest-bearing accounts designed to attract both short-term and long-term deposits. These accounts include negotiable order of withdrawal ( NOW ) accounts, money market investment accounts, savings accounts, certificates of deposit, and other time deposits. Interest-bearing accounts earn interest at rates established by Management based on competitive market factors and Management s desire to increase or decrease certain types or maturities of deposits consistent with its Funds Management Policy. The Bank traditionally has not sought brokered deposits but does utilize other sources of wholesale funding. The following table sets forth the average balances for each major category of deposit and the weighted-average interest rate paid for deposits during the months of December 2008, 2007, and Month of December Weighted Average Weighted Average (Dollars in thousands) Weighted Average Average Interest Average Interest Average Interest Balance Rate % Balance Rate % Balance Rate % (Dollars in thousands) Interest-bearing transaction accounts $ 72, $ 67, $ 82, Certificates of deposit 93, , , Savings and money market accounts 151, , , Noninterest-bearing demand accounts 102, , , Total $ 419,877 $ 490,330 $ 484,170 The following table shows the amounts and remaining maturities of certificates of deposit (CDs) that had balances of $100,000 or more at December 31, 2008, 2007, and At December 31, (in thousands) One year or less $ 41,176 $ 47,720 $ 54,995 Over one year 14,247 13,297 12,435 Total $ 55,423 $ 61,017 $ 67,430 Competition The Bank faces strong competition, both in attracting deposits and in originating loans from other commercial banks, savings and loan associations, mutual savings banks, credit unions, and non-bank financial services providers such as brokerage and mortgage companies. All of these types of competitors exist in the Bank s service area, and many of them have greater financial resources than the Bank. The Bank aggressively competes in its market area with these other institutions and financial intermediaries in all phases of its operations. Employees As of December 31, 2008, the Bank had 196 full-time equivalent employees. None of the Bank s employees are covered by a collective bargaining agreement. Management believes relations with the Bank s employees are good. 13

14 Supervision and Regulation General. The Bank is extensively regulated under federal and Idaho law by the FDIC and the Idaho Department of Finance. The laws and regulations administered by these regulatory authorities are primarily intended to protect the FDIC insurance fund, depositors, and other customers of the Bank and its subsidiaries. Any change in applicable laws, regulations, or regulatory policies may have a material adverse effect on the business, operations, and prospects of the Bank. The following is not a complete discussion but is intended to be a summary of some of the most significant provisions of law applicable to the Bank. Recent Legislative and Regulatory Initiatives to Address Financial and Economic Crises. The U.S. Congress, U.S. Department of the Treasury (the Treasury Department ), Federal Reserve Bank, and the federal banking regulators, including the FDIC, have taken broad action since early September 2008 to address volatility in the U.S. banking system. In October 2008, the Emergency Economic Stabilization Act of 2008 ( EESA ) was enacted. The EESA authorizes the Treasury Department to purchase from financial institutions and their holding companies up to $700 billion in real estate loans, real estate-related securities and certain other financial instruments, including debt and equity securities issued by financial institutions and their holding companies in a Troubled Asset Relief Program ( TARP ). The purpose of TARP is to restore confidence and stability to the U.S. banking system and to encourage financial institutions to increase their lending to customers and to each other. The Treasury Department initially allocated $250 billion toward the TARP Capital Purchase Program ( CPP ). Under the CPP, the Treasury Department purchases debt or equity securities from participating institutions. The TARP also allows for direct purchases or guarantees of troubled assets of financial institutions. Participants in the CPP are subject to executive compensation limits, restrictions on dividends payments and share stock repurchases, earnings dilution related to the issuance of warrants, and are encouraged to expand their lending and real estate loan modifications. Further, the Treasury Department retains unilateral authority to amend the any term of the CPP to comply with any future changes in applicable federal statues. The Bank did not apply for government assistance through the CPP under the Treasury Department TARP. Management believes the Bank s capital level and balance sheet provides it with adequate flexibility in today's environment to execute the Bank s business plan without TARP capital. Under EESA, FDIC deposit insurance also increased on most accounts from $100,000 to $250,000. This increase is intended to be in effect until the end of 2009 and is covered by increased deposit insurance premiums paid by the banking industry. After it was determined that the banking industry faced systemic risk, on October 14, 2008, the FDIC established a Temporary Liquidity Guarantee Program ( TLGP ). The TLGP includes the Transaction Account Guarantee Program ( TAGP ), which provides unlimited deposit insurance coverage through December 31, 2009, for noninterest-bearing transaction accounts (typically business checking accounts), certain interest-bearing transaction accounts earning less than 0.5%, and certain funds swept into noninterest-bearing savings accounts. Institutions participating in the TAGP pay a fee equal to 10 basis points (annualized) on the balance of each covered account in excess of $250,000 while the extra deposit insurance coverage is in place. The TLGP also includes the Debt Guarantee Program ( DGP ), under which the FDIC guarantees certain senior unsecured debt of FDIC insured institutions and their holding companies. The unsecured debt must be issued on or after October 14, 2008, and no later than June 30, The guarantee is effective through the earlier of the maturity date or June 30, The DGP coverage limit is generally 125% of the eligible entity s eligible debt outstanding on September 30, 2008, and scheduled to mature on or before June 30, 2009, or for certain insured institutions, 2% of their liabilities as of September 30, Depending on the term of the debt maturity, the nonrefundable DGP fee ranges from 50 to 100 basis points (annualized) for covered debt outstanding until the earlier of maturity or June 30, The TAGP and DGP are in effect for all eligible entities, unless the entity opted out on or before December 5, Management has elected to participate in the TLGP and DGP. As of December 31, 2008, the Bank had no outstanding unsecured debt guaranteed by the DGP. Branching. The state of Idaho permits open branching. No limitations (other than regulatory capital requirements) are placed on the number of branches a bank may establish, although no branch may be opened without application to, and approval by, the appropriate regulatory authorities, including the FDIC and the Idaho Department of Finance. 14

15 Community Reinvestment Act. The Federal Community Reinvestment Act ( CRA ) was enacted in 1974 in response to the practice of some banks to redline or systematically deny credit to areas within their markets that were believed to pose significantly greater credit risks. Since 1974, the CRA has become increasingly important to financial institutions. The CRA, in essence, allows regulators to turn down an applicant seeking to make an acquisition or establish a branch unless it has performed satisfactorily under the CRA. Satisfactory performance means adequately meeting the credit needs of the communities the applicant serves. The applicable regulators regularly conduct CRA examinations of the Bank. Transactions with Affiliates. The Bank is subject to certain Federal Reserve Board restrictions related to transactions with related parties. Section 23A of the Federal Reserve Act limits the amount of loans to, investments in, and other transactions with affiliates of the Bank, requires certain levels of collateral for such loans, and limits the amount of advances to third parties that are collateralized by the securities or obligations of the Bank. The aggregate amount of an institution s loans to officers, Directors, and principal shareholders (or their affiliates) is limited to the amount of its unimpaired capital and surplus, unless the FDIC determines that a lesser amount is appropriate. A violation of these restrictions may result in the assessment of civil money penalties on a bank or person participating in the conduct of the affairs of such bank or the imposition of an order to cease and desist. Dividend Restrictions. Payment of dividends, including stock dividends, is subject to regulatory limitations. Under federal banking law, the payment of dividends by the Bank is subject to capital adequacy and other requirements established by the FDIC. See -Capital Adequacy. Under Idaho banking law, no dividend may be declared or paid until the Bank has reached certain surplus levels to be added to the paid-in capital of the Bank and then only in an amount up to the net profits then available. The Bank has maintained sufficient surplus and additional paid-in capital to allow for the payment of dividends. Examinations. The FDIC periodically examines and evaluates state-chartered, Federal Reserve nonmember banks like the Bank. Based upon such an evaluation, the FDIC may, among other things, revalue the assets of an insured institution and require that it establish specific reserves to compensate for the difference between the value determined by the FDIC and the book value of such assets. The costs of conducting the examinations are assessed to the Bank through FDIC insurance assessments. The Idaho Department of Finance also has regulatory authority over the Bank. The Idaho Department of Finance may or may not conduct joint examinations with the FDIC, but examines the Bank at least every 18 months. Capital Adequacy. Federal regulations establish minimum requirements for the capital adequacy of depository institutions. The regulators may establish higher minimum requirements if, for example, a bank has previously required special attention or has a high susceptibility to interest rate, credit, or other risks. Banks with capital ratios below the required minimum are subject to certain administrative actions, including prompt corrective action, the termination of deposit insurance upon notice and hearing, or a temporary suspension of insurance without a hearing. The federal risk-based capital guidelines for banks establish ratios of Tier 1 or core capital to total risk-weighted assets, total capital to total risk-weighted assets, and Tier 1 capital to total assets (the leverage ratio). The following table shows the Tier 1 Capital, Total Capital, and capital ratios of the Bank at December 31, December 31, 2008 (Dollars in thousands) Tier 1 capital $ 67,383 Total capital (Tier 1 plus Tier 2) $ 74,195 Tier 1 capital to risk-weighted assets 12.50% Total capital to risk-weighted assets 13.76% Tier 1 capital to average assets 11.22% 15

16 Five capital levels have been defined pursuant to the Federal Deposit Insurance Corporation Improvement Act of 1991 ( FDICIA ): well capitalized, adequately capitalized, undercapitalized, severely undercapitalized, and critically undercapitalized. An institution is critically undercapitalized if it has a tangible equity to total asset ratio that is equal to or less than 2%. An institution is well capitalized if it has a total risk-based capital ratio of 10% or greater, a Tier 1 riskbased capital ratio of 6% or greater, a leverage ratio of 5% or greater, and the institution is not subject to an order, written agreement, capital directive, or prompt corrective action directive to meet and maintain a specific capital level for any of the capital measures. At December 31, 2008, the Bank remained well capitalized under this regulation. FDICIA requires that federal banking regulators take prompt corrective action with respect to capital-deficient institutions. In addition to requiring the submission of a capital restoration plan, FDICIA contains broad restrictions on certain activities of undercapitalized institutions involving asset growth, acquisitions, branching, and expansion into new lines of business. With certain exceptions, an insured depository institution is prohibited from making capital distributions, including dividends, and is prohibited from paying management fees to control persons, if the institution would be undercapitalized after any such distribution or payment. As an institution s capital decreases, the powers of the regulators become greater. A significantly undercapitalized institution is subject to mandated capital raising activities, restrictions on interest rates paid, limitations on transactions with affiliates, removal of management, and/or other restrictions. The regulators have very limited discretion in dealing with a critically undercapitalized institution and are virtually required to appoint a receiver or conservator if the capital deficiency is not corrected promptly. Internal Operating Requirements. FDICIA requires the regulators to promote the safety and soundness of individual institutions by specifically addressing, among other things: internal controls and internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, the ratio of classified assets to capital, minimum earnings, and compensation and benefit payments for Management. These regulations add further to the cost of compliance and impose comprehensive record keeping requirements. Real Estate Lending Evaluations. The regulators have adopted uniform standards for evaluating loans secured by real estate or made to finance improvements to real estate. Banks are required to establish and maintain written internal real estate lending policies consistent with safe and sound banking practices that are appropriate to the size of the institution and the nature and scope of its operations. The regulations establish loan-to-value ratio limitations on real estate loans, which are equal to or higher than the loan-to-value policy limitations established by the Bank. Deposit Insurance Premiums. The Bank s deposits are insured by and within the limits of the FDIC, and the Bank is therefore subject to FDIC deposit insurance assessments. The FDIC uses a risk-based deposit premium assessment system under which each depository institution is placed in an assessment category based on certain capital and supervisory measures. The assessment rates under the system currently vary depending upon the assessment category into which the depository institution is placed. Beginning in 2007, assessment rates have been increased substantially and are expected to increase again in It is possible that the deposit insurance assessments will be further increased in the future or that special assessments could occur. Significant increases in the assessment rate or a special additional assessment could have an adverse impact on the Bank s operating results. The Fair and Accurate Credit Transactions Act. On December 4, 2003, the Fair and Accurate Credit Transactions Act of 2003 ( FACTA ) was signed into law. FACTA includes many provisions concerning national credit reporting standards and permits consumers, including the customers of the Bank, to opt out of information sharing among affiliated companies for marketing purposes. FACTA also requires financial institutions to provide consumers certain information regarding the consumer's credit score. Additionally, financial institutions must notify their customers if they report negative information about them to credit bureaus or if the credit terms offered to a customer are materially less favorable than the most favorable terms offered to a substantial portion of their customers because of information in the customer's credit report. FACTA also contains provisions intended to help detect identity theft. The Sarbanes-Oxley Act. In July 2002, the Sarbanes-Oxley Act of 2002 (the SOA ) was enacted in response to public concerns regarding corporate accountability. The stated goals of the SOA are to increase corporate responsibility, to 16

17 provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies, and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws. The SOA represents a comprehensive revision of laws affecting corporate governance, accounting obligations, and corporate reporting. The SOA generally applies to all companies that file or are required to file periodic reports under the Securities Exchange Act of 1934, as amended ( Exchange Act ). The SOA includes disclosure requirements and corporate governance rules, required the Securities and Exchange Commission ( SEC ) and securities exchanges to adopt extensive additional disclosure, corporate governance, and other related rules, and mandated further studies of certain issues by the SEC and the Comptroller General. In particular, the SOA established: new requirements for audit committees, additional responsibilities regarding financial statements of reporting companies, new standards for auditors and regulation of audits, increased disclosure and reporting obligations for a reporting company and its directors and executive officers, and new civil and criminal penalties for violation of the securities laws. The SEC was directed to enact rules to implement various provisions with respect to, among other matters, disclosure in periodic filings pursuant to the Exchange Act. Compliance with the SOA and the rules promulgated thereunder has significantly added to the Bank s cost structure and imposes significant recordkeeping, audit, accounting, and other requirements. Expenses and opportunity costs related to SOA compliance could continue to increase in the future and could have additional adverse impacts on the Bank s operating results. The U.S.A. Patriot Act. The Bank Secrecy Act of 1970 ( BSA ) requires banks to maintain internal systems to prevent banks from being utilized to facilitate the flow of illegal or illicit money. In December 2001, the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the Patriot Act ) became effective. The Patriot Act is designed to combat money laundering and terrorist financing while protecting the United States financial system. The Patriot Act imposes enhanced policy, record keeping, and due diligence requirements on domestic financial institutions. The Patriot Act also amended the Bank Secrecy Act to facilitate access to customer account information by government officials while providing banks with a safe-harbor from liability for releasing such information to applicable government authorities. These statutes and related regulations have required the Bank to implement additional operating systems and controls, to expand record-keeping and customer identification policies, and to develop additional reporting systems to ensure compliance and to assist the federal government in detecting money laundering schemes and terrorist financing activities. Bank regulatory authorities have been placing an emphasis upon banks' compliance with BSA and the Patriot Act as a part of the effort to thwart terrorism and other criminal activity in this country. Failure to comply could result in legal consequences and/or penalties to the Bank. The Gramm-Leach-Bliley Act. In November 1999, the Gramm-Leach-Bliley Act (the GLBA ) was enacted. The GLBA is also known as the Financial Services Modernization Act due to its sweeping overhaul of the financial services industry. Enactment of the GLBA allows banks, securities firms, and insurance companies to affiliate. Now financial institutions can act as financial supermarkets offering customers one stop shopping for bank accounts, insurance, investment banking, and securities transactions. The GLBA, among other things, provides customers with greater financial privacy by requiring financial institutions to safeguard their nonpublic personal information. Financial institutions must advise customers about their policies related to the sharing of nonpublic information with non-affiliated third parties, and allow customers to opt-out of such sharing (subject to a number of exceptions related mainly to processing customer-initiated transactions and compliance with current law). Home Mortgage Disclosure Act. The Home Mortgage Disclosure Act ( HMDA ) grew out of public concern over credit shortages in certain urban neighborhoods and provides public information that is intended to help to show whether financial institutions are serving the housing credit needs of the neighborhoods and communities in which they are located. The HMDA also includes a fair lending aspect that requires the collection and disclosure of data about applicant and borrower characteristics as a way of identifying possible discriminatory lending patterns and enforcing antidiscrimination statutes. Beginning with data reported for 2004, the amount of information that financial institutions collect and disclose concerning applicants and borrowers has expanded, and is expected to increase the attention that HMDA data receives from state and federal banking supervisory authorities, community-oriented organizations, and the 17

18 general public. Real Estate Settlement Procedures Act. The Real Estate Settlement Procedures Act ( RESPA ) requires lenders to provide borrowers with disclosures regarding the nature and cost of real estate settlements. RESPA also prohibits certain abusive practices, such as kickbacks and fee-splitting without providing settlement services. Penalties under the above laws may include fines, reimbursements, and other penalties. Due to heightened regulatory concern related to compliance with these laws generally, the Bank may incur additional compliance costs or be required to expend additional funds for investments in its local community. Home Ownership Equity and Protection Act of The Home Ownership Equity and Protection Act of 1994 ( HOEPA ) and regulations adopted by the Federal Reserve to implement it require additional disclosures and extend additional protection to borrowers in certain closed-end consumer credit transactions, such as for home repairs or renovation, that are secured by a mortgage on the borrower s primary residence. HOEPA disclosures and protections are applicable to such transactions with any of the following features: interest rates for first lien real estate loans more than 8 percentage points above the yield on U.S. Treasury securities having a comparable maturity, interest rates for subordinate lien real estate loans more than 10 percentage points above the yield on U.S. Treasury securities having a comparable maturity, or total points and fees paid in connection with the credit transaction exceed the greater of either 8% of the loan amount or a specified dollar amount that is inflation-adjusted each year. HOEPA prohibits or restricts numerous credit practices including loan flipping by the same lender or loan servicer within a year of the loan being refinanced. Lenders are presumed to have violated the law unless they document that the borrower has the ability to repay. Lenders that violate the rules face substantial penalties. Federal Reserve System. The Bank is subject to various regulations promulgated by the Federal Reserve ( Fed ) including, among others, Regulation B (Equal Credit Opportunity), Regulation D (Reserves), Regulation E (Electronic Fund Transfers), Regulation Z (Truth in Lending), Regulation CC (Availability of Funds), and Regulation DD (Truth in Savings). Regulation D requires noninterest-bearing reserve maintenance in the form of either vault cash or funds on deposit at the Federal Reserve Bank or another designated depository institution in an amount calculated by formula. The balances maintained to meet the reserve requirements imposed by the Fed may be used to satisfy liquidity requirements. Change of Control. Under applicable statutes and regulations, a person or entity may not acquire control of a bank without the prior approval of the FDIC and the Idaho Department of Finance. Control is conclusively deemed to be acquired when, among other things, a person or entity either alone or acting in concert with others, acquires more than 25% of any class of voting stock of a bank. Under federal statutes and regulations, a rebuttable presumption of control arises if a person or entity acquires, either alone or acting in concert with others, more than ten percent of any class of voting stock of a bank. Other Laws and Regulations. Applicable federal and state laws and regulations governing a bank s operations relate, among others, to capital requirements, required reserves against deposits, investments, loans, legal lending limits, certain interest rates payable, mergers and consolidations, borrowings, issuance of securities, payment of dividends, establishment of branches, and dealings with affiliates. The FDIC has authority to prohibit banks under its supervision from engaging in what it considers to be unsafe and unsound practices. Loans to One Borrower. The Bank is subject to limitations on the aggregate amount of loans that it can make to any one borrower, including related entities. Applicable regulations generally limit loans to one borrower to 20% of the Bank's capital structure. As of December 31, 2008, there were loans to six different borrowers that are related entities, where the aggregate amount of the loans exceeded 20% of the Bank s capital structure. The loans were performing according to their terms at December 31, Taxation. For federal and state income tax purposes, the Bank reports its income and expenses on the accrual basis method of accounting and files its federal and state income tax returns on a calendar year basis. 18

19 Future Legislation Periodically, legislation is enacted that has the effect of increasing the cost of doing business, limiting or expanding permissible activities, or affecting the competitive balance between banks and other financial institutions. Proposals to change the laws and regulations governing the operations and taxation of banks and other financial institutions are frequently made in Congress, in state legislatures, and by various bank regulatory agencies. The likelihood of major changes has increased significantly in recent months and the impact such changes might have on the Bank are not possible to predict. Item 1A. Risk Factors Set forth below and elsewhere in this Annual Report on Form 10-K and in other documents the Bank files with the FDIC are (in no particular order) risks and uncertainties that could cause actual results to differ materially from the results contemplated by the forward-looking statements contained in this Annual Report on Form 10-K. As a bank, our earnings are largely dependent upon general business, economic, and political conditions. Earnings are impacted by general business and economic conditions in the United States and abroad. These conditions include short-term and long-term interest rates, inflation, monetary policy, fluctuations in both debt and equity capital markets, changes in regulation, and the strength of the U.S. economy and the local economies in which the Bank operates. Business and economic conditions that negatively impact household incomes or business earnings could decrease the demand for our products and services and increase the number of customers who fail to pay their loans. Current market developments may adversely affect our industry, business, results of operations and access to capital. Dramatic declines in the housing market over the past year, with falling home prices and increasing foreclosures and rising unemployment, have resulted in significant write-downs of asset values by many financial institutions, including government-sponsored entities and major commercial and investment banks. These write-downs, initially of mortgagebacked securities but spreading to other assets, and derivatives, including credit default swaps, in turn have caused many financial institutions to seek additional capital, to merge with larger and stronger institutions and, in some cases, to fail. Reflecting concern about the stability of the financial markets generally and the strength of counterparties, many lenders and institutional investors have ceased to provide or have reduced funding to even the most credit-worthy borrowers or to other financial institutions. The resulting lack of available credit and lack of confidence in the financial markets could materially and adversely affect our financial condition and results of operations and our access to capital. In particular, we may face the following and other risks in connection with these events: Market developments may affect consumer confidence levels and may cause declines in credit card usage and adverse changes in payment patterns on loans, causing increases in delinquencies and default rates. The processes we use to estimate inherent losses may no longer be reliable because they rely on complex judgments, including forecasts of economic conditions, which may no longer be capable of accurate estimation. Our ability to assess the credit worthiness of our customers may be impaired if the models and approaches we use to select, manage, and underwrite our loan customers become less predictive of future charge-offs. The values of real estate collateral supporting many construction, land and lot acquisition, and commercial loans and home mortgages have declined and may continue to decline. Our ability to borrow from other financial institutions or to engage in the sale of loans and/or securitization funding transactions on favorable terms or at all could be adversely affected by further disruptions in the capital markets or other events, including actions by rating agencies and deteriorating investor expectations. 19

20 We may be required to pay significantly higher FDIC premiums because market developments have significantly depleted the insurance fund of the FDIC and reduced the ratio of reserves to insured deposits. Competition in our industry for deposits and high quality loans has increased significantly and could intensify as a result of the increasing consolidation of financial services companies in connection with current market conditions. We expect to face increased amount and intensity of regulation of our industry. Compliance with such regulation may substantially increase our costs, limit our ability to pursue business opportunities, and increase compliance challenges. Current levels of market volatility are unprecedented. The capital and credit markets have been experiencing volatility and disruption for more than 12 months. In recent months, the volatility and disruption has reached unprecedented levels. In some cases, the markets have produced downward pressure on stock prices and credit availability for certain issuers without regard to those issuers underlying financial strength and/or in response to unfounded rumors. If current levels of market disruption and volatility continue or worsen, there can be no assurance that we will not experience an adverse effect, which may be material, on our ability to access capital and on our business, financial condition, and results of operations. The soundness of other financial institutions could adversely affect us. Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial services institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty, or other relationships. We have exposure to many different industries and counterparties, and we routinely execute transactions with counterparties in the financial services industry, including brokers and dealers, commercial banks, mortgage companies and banks, and other institutions, resulting in a significant credit concentration with respect to the financial services industry overall. As a result, defaults by, or even rumors or questions about, one or more financial services institutions, 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. A further downturn in local economies or real estate markets negatively impacts our business. Because we primarily serve individuals and businesses located in Idaho, a significant portion of our total loan portfolio is originated in Idaho or secured by Idaho real estate or other assets. Consequently, our results are impacted by the economic and business conditions in Idaho, particularly in the metropolitan areas of Coeur d Alene and Boise. Continuing deterioration in local economic and business conditions have caused, among other things, further increases in loan delinquencies, decreases in credit quality, decreases in real estate property values, and/or reductions in the level of bank deposits. A continued weakening of the real estate market or employment levels in our primary markets could also cause increases in the number of borrowers who default on their loans and cause a reduction in the value of the collateral securing their loans, which in turn could have an adverse effect on our profitability and asset quality. Any adverse economic or business developments or natural disasters could cause uninsured damage and other loss of value to real estate that secures our loans or could negatively affect the ability of borrowers to make payments of principal and interest on the underlying loans. In the event of any such adverse economic or business development or natural disaster, our results of operations or financial condition could be adversely affected. A significant amount of the Bank's deposits come from customers conducting business related to or strongly influenced by our local real estate markets. At December 31, 2008, the Bank estimated that approximately 11% of its checking and savings deposits were from such customers. A high percentage of these accounts are subject to a high degree of volatility. A further downturn in local real estate markets may result in lower balances being maintained by these customers, and this in turn would have a negative impact on the Bank's earnings and available liquidity. 20