IDAHO INDEPENDENT BANK (Exact name of registrant as specified in its charter)

Transcription

1 FEDERAL DEPOSIT INSURANCE CORPORATION Washington, D.C FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 2010 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to 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) (208) (Registrant s telephone number, including area code) (not applicable) (Former name, former address, and former fiscal year if changed since last report) 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 and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T ( of this chapter) during the preceding 12 months. Yes [ ] No [ ] Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a nonaccelerated 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 [ ] Non-accelerated filer [ ] Smaller reporting company [X ] Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X] Indicate the number of shares outstanding of each of the Registrant s classes of common stock, as of the latest practicable date: Common Stock, $5.00 par value per share, 6,357,112 shares outstanding as of April 30, 2010.

2 IDAHO INDEPENDENT BANK FORM 10-Q TABLE OF CONTENTS PART I - FINANCIAL INFORMATION Item 1 - Financial Statements Consolidated Balance Sheets as of March 31, 2010, and December 31, Consolidated Statements of Operations for the Three Months ended March 31, Consolidated Statements of Changes in Stockholders Equity and Comprehensive Income (Loss)... 3 Consolidated Statements of Cash Flows for the Three Months ended March 31, 2010 and Notes to Consolidated Financial Statements... 6 Item 2 - Management s Discussion and Analysis of Financial Condition and Results of Operations Item 3 - Quantitative and Qualitative Disclosures about Market Risk Item 4T - Controls and Procedures PART II - OTHER INFORMATION Item 1 - Legal Proceedings Item 1A - Risk Factors Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds Item 3 - Defaults upon Senior Securities Item 4 - Reserved Item 5 - Other Information Item 6 - Exhibits SIGNATURES Page

3 PART I FINANCIAL INFORMATION Item 1. Financial Statements IDAHO INDEPENDENT BANK AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS (In thousands, except share data) (Unaudited) March 31, December 31, ASSETS Cash and due from banks $ 31,254 $ 17,895 Federal funds sold Deposits held with other financial institutions 51,807 52,562 Trading securities, at fair value 2,619 2,540 Securities available for sale, at fair value 1,545 1,535 Federal Home Loan Bank stock, at cost 1,503 1,503 Loans held for sale 2,771 2,350 Loans receivable, net of allowance for loan losses of $14,303 and $17,140, respectively 342, ,499 Premises and equipment, net 21,504 21,857 Bank owned life insurance 11,175 11,066 Deferred tax asset 7,719 7,022 Other real estate owned 2,699 2,310 Accrued interest receivable and other assets 7,877 8,807 TOTAL ASSETS $ 485,031 $ 493,239 LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES Deposits: Noninterest-bearing $ 88,235 $ 92,062 Interest-bearing 292, ,936 Securities sold under agreements to repurchase, net 26,536 26,258 Notes payable 9,000 9,000 Accrued interest payable and other liabilities 6,835 6,826 Total liabilities 422, ,082 STOCKHOLDERS' EQUITY Preferred Stock, $0.10 par value; 10,000,000 shares authorized; none issued - - Common stock, $5 par value; 20,000,000 shares authorized; Issued and outstanding, net of treasury stock: 35,626 35,626 March 31, ,357,112 issued and outstanding December 31, ,357,112 issued and outstanding Capital surplus 44,300 44,224 Retained earnings (deficit) (6,550) (6,651) Accumulated other comprehensive income (loss) - (3) Treasury stock, at cost: (11,039) (11,039) March 31, ,153 shares December 31, ,153 shares Total stockholders' equity 62,337 62,157 TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 485,031 $ 493,239 See accompanying notes. 1

4 IDAHO INDEPENDENT BANK AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except share data) (Unaudited) (as restated, Note 8) Interest and dividend income: Loans receivable $ 5,523 $ 7,476 Federal funds sold 8 1 Securities available for sale Deposits with other banks Total interest and dividend income 5,863 8,024 Interest expense: Deposits 840 1,290 Securities sold under agreements to repurchase and other borrowed funds Total interest expense 978 1,506 Net interest income 4,885 6,518 Provision for loan losses 1,315 6,850 Net interest income after provision for loan losses 3,570 (332) Noninterest income: Service charges on deposits Fee income on loans sold Other income Total noninterest income 1,087 1,211 Noninterest expense: Salaries 2,350 2,530 Employee benefits Occupancy Data processing Furniture and equipment Supplies and postage Advertising and business development Insurance and assessments Other real estate owned, net (233) 634 Other operating expenses Total noninterest expense 4,494 5,684 Income (loss) before income taxes 163 (4,805) Income tax expense (benefit) 62 (1,826) NET INCOME (LOSS) $ 101 $ (2,979) Earnings (loss) per common share: Basic $ 0.02 $ (0.48) Diluted $ 0.02 $ (0.48) Weighted average number of shares outstanding: Basic 6,357,112 6,194,380 Diluted 6,357,112 6,194,380 See accompanying notes. Three Months Ended March 31, 2

5 IDAHO INDEPENDENT BANK AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME (LOSS) (In thousands, except share data) (Unaudited) Common Stock Shares Amount Capital Surplus Retained Earnings (Deficit) Treasury Stock Accumulated Other Comprehensive Income (Loss) Balance at December 31, ,194,380 $34,813 $43,613 $ - $ (11,039) $ (1) $67,386 Total Exercise of stock options 162, ,142 Tax benefit of exercised stock options 3 3 Stock-based compensation Comprehensive income: Net loss (6,651) (6,651) Other comprehensive loss: Change in unrealized holding loss on securities available for sale, net of taxes (2) (2) Comprehensive income: (6,653) Balance at December 31, ,357,112 35,626 44,224 (6,651) (11,039) (3) 62,157 Stock-based compensation Comprehensive loss: Net income Other comprehensive income: Change in unrealized holding loss on securities available for sale, net of taxes 3 3 Comprehensive income: 104 Balance at March 31, ,357,112 $35,626 $44,300 $(6,550) $(11,039) $ - $62,337 See accompanying notes. 3

6 IDAHO INDEPENDENT BANK AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) (Unaudited) Three Months Ended March 31, (as restated, Note 8) CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) $ 101 $ (2,979) Adjustments to reconcile net income (loss) to net cash provided (used) by operating activities: Provision for loan losses 1,315 6,850 Valuation allowance on other real estate owned (Gain) loss on sale of repossessed assets (571) 2 Depreciation and amortization Net amortization (accretion) of premium and discounts on investments (4) 4 Provision (benefit) for deferred income taxes - (1,907) Net gain on sale of loans (123) (213) Originations of loans held for sale (11,774) (28,909) Proceeds from sales of loans held for sale 11,476 30,200 Stock-based compensation expense Increase in cash surrender value of life insurance (109) (112) Changes in assets and liabilities: Interest receivable (3) (2) Other assets Interest payable (43) 2 Other liabilities (28) (13) Net cash provided by operating activities 1,198 4,011 CASH FLOWS FROM INVESTING ACTIVITIES: Net increase in federal funds sold (48) (52) Net decrease in deposits held with other financial institutions 755 5,676 Securities available for sale: Purchases (500) - Proceeds from maturities or calls Purchases of premises and equipment (38) (45) Net decrease in loans 18,493 13,826 Proceeds from sale of other real estate owned 1,396 1,133 Net cash provided by investing activities 20,558 20,538 CASH FLOWS FROM FINANCING ACTIVITIES: Net decrease in deposits (8,675) (10,139) Net decrease in other borrowed funds - (8,400) Net increase (decrease) in securities sold under agreements to repurchase 278 (10,875) Net cash used by financing activities (8,397) (29,414) (continues on next page) 4

7 IDAHO INDEPENDENT BANK AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) (Unaudited) Three Months Ended March 31, (as restated, Note 8) CHANGE IN CASH AND DUE FROM BANKS 13,359 (4,865) Cash and due from banks, beginning of period 17,895 14,262 Cash and due from banks, end of period $ 31,254 $ 9,397 SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid during the period for: Interest $ 1,021 $ 1,535 Income taxes - - SUPPLEMENTAL CASH FLOWS DISCLOSURE ON NONCASH INVESTING TRANSACTIONS: Acquisition of real estate in settlement of loans $ 1,474 $ 1,850 Fair value adjustment to securities available for sale, net of deferred income taxes 3 1 See accompanying notes. 5

8 IDAHO INDEPENDENT BANK AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Note 1 - Basis of Presentation The unaudited interim consolidated financial statements presented in this quarterly report include the accounts of Idaho Independent Bank (the Bank or IIB ) and its wholly-owned subsidiary, First Security Corporation. The financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America and prevailing practices within the banking industry for interim financial information, and with the instructions to Form 10-Q and Article 10 of Regulation S-X as promulgated by the Securities and Exchange Commission. All significant intercompany transactions and balances have been eliminated. The unaudited interim results of operations are not necessarily indicative of the results for any future interim period or for an entire year. Accordingly, these interim consolidated financial statements do not include all disclosures associated with annual financial statements, and should be read in conjunction with the Bank s filings with the Federal Deposit Insurance Corporation ( FDIC ), including, but not limited to, the annual financial statements and accompanying notes included in the Bank s Annual Report on Form 10-K for the year ended December 31, 2009 ( 2009 Form 10-K ). In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of certain assets and liabilities as of the date of the Balance Sheet and certain revenues and expenses for the period. Actual results could materially differ, either positively or negatively, from those estimates. The unaudited interim consolidated financial statements reflect all adjustments that are, in the opinion of management, necessary to fairly state the financial condition and results of operations for the periods presented. Material estimates that are particularly susceptible to significant change in the near-term include the determination of the allowance for loan and lease losses ( ALLL ) and off-balance sheet losses, the valuation of real estate acquired in connection with foreclosures or in the satisfaction of loans, the valuation of stock-based compensation expenses, and recognition of deferred income tax assets and liabilities. Management believes the ALLL is adequate and represents its estimate of the probable credit losses inherent in the loan portfolio at March 31, While management uses currently available information to estimate losses on loans, future additions to the ALLL may be necessary based on a number of significant factors, including changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the adequacy of the Bank s ALLL. Such agencies may require the Bank to recognize additions to the allowance based on their judgment of information available to them at the time of their examination. Other real estate owned ( OREO ) acquired through foreclosure or a deed in lieu of foreclosure is reported at the lower of cost or estimated net realizable value. When the property is acquired, any excess of the loan balance over the estimated net realizable value is charged to the reserve for loan losses. The Bank generally obtains independent appraisals of significant OREO properties. Holding costs, subsequent write-downs to net realizable value, if any, or any disposition gains or losses are included in noninterest income and expenses. Significant costs of development and improvement of OREO are capitalized. Financial Accounting Standards Board ( FASB ) Accounting Standards Codification ("ASC") 718, Compensation Stock Compensation, requires companies to recognize in the income statement the grant-date fair value of stock options and other equity-based forms of compensation issued to employees and directors over the requisite service period (generally the vesting period). The fair value of each option grant is estimated by the Bank as of the grant date using the Black-Scholes option-pricing model. This involves assumptions calculated using management s best estimates at the time of the grant, which impacts the fair value of the option calculated under the Black-Scholes methodology and, ultimately, the expense that will be recognized over the life of the option. Actual results could materially differ, either positively or negatively, from those estimates. 6

9 Deferred income tax benefits and liabilities are valued using current federal and state income tax rates. Actual recognition of these deferred tax assets and liabilities will be affected by the tax rates that are applicable when the assets and liabilities become current tax items. Note 2 - Recently Issued Accounting Pronouncements On January 21, 2010, the FASB issued Accounting Standards Update ( ASU or the "Update") , Improving Disclosures About Fair Value Measurements. The Update amends ASC 820, Fair Value Measurements and Disclosures, to add new requirements for disclosures about transfers into and out of Levels 1 and 2 and separate disclosures about purchases, sales, issuances, and settlements relating to Level 3 measurements. It also clarifies existing fair value disclosures about the level of disaggregation and about inputs and valuation techniques used to measure fair values. The guidance in ASU is effective for the first reporting period beginning after December 15, ASU did not have a material impact on the Bank s financial condition or results of operations. On February 24, 2010, the FASB issued ASU , Amendments to Certain Recognition and Disclosure Requirements. The Update amends Accounting Standards Codification 855, Subsequent Events, to address certain implementation issues related to an entity s requirement to perform and disclose subsequent-events procedures. ASU requires SEC filers and other certain entities to evaluate subsequent events through the date the financial statements are issued. The Update exempts SEC filers from disclosing the date through which subsequent events have been evaluated. The guidance in ASU is effective immediately for financial statements that are (1) issued or are available to be issued or (2) revised. ASU did not have a material impact on the Bank s financial condition or results of operations. Note 3 - Securities Available for Sale The following tables summarize the amortized cost, gross unrealized gains and losses, and approximate fair values of securities available for sale at March 31, 2010, and December 31, 2009: Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value March 31, 2010 (in thousands) U.S. Treasury and agency securities $ 1,000 $ - $ - $ 1,000 Municipal bonds Mutual funds (1) 499 $ 1,545 $ 1 $ (1) $ 1,545 Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value December 31, 2009 (in thousands) U.S. Treasury and agency securities $ 996 $ - $ (1) $ 995 Municipal bonds Mutual funds (6) 494 $ 1,541 $ 1 $ (7) $ 1,535 At March 31, 2010, U.S. Treasury and agency securities with a carrying value of $500,000 and a fair value of $501,000 were pledged as collateral at the Federal Reserve Bank for purposes required or permitted by law. 7

10 The investment securities shown below currently have aggregate fair values that are less than their amortized cost and therefore contain unrealized losses as of March 31, 2010, and December 31, The Bank has evaluated these securities and has determined that the decline in value is temporary and is primarily related to the change in market interest rates subsequent to their purchase and not due to concerns regarding the underlying credit of the issuers or the underlying collateral. In addition, management does not intend to sell these securities nor does available evidence suggest it is more likely than not that management will be required to sell these securities. Less Than 12 Months 12 Months or More Total March 31, 2010 Fair Value Unrealized Loss Fair Value Unrealized Loss Fair Value Unrealized Loss (in thousands) U.S. Treasury and agency securities $ - $ - $ - $ - $ - $ - Municipal bonds Mutual funds 499 (1) (1) $ 499 $ (1) $ - $ - $ 499 $ (1) Less Than 12 Months 12 Months or More Total December 31, 2009 Fair Value Unrealized Loss Fair Value Unrealized Loss Fair Value Unrealized Loss (in thousands) U.S. Treasury and agency securities $ 499 $ (1) $ - $ - $ 499 $ (1) Municipal bonds Mutual funds 494 (6) (6) $ 993 $ (7) $ - $ - $ 993 $ (7) Note 4 - Earnings (Loss) Per Share Earnings (Loss) per share ( EPS ) are computed using the basic and the diluted weighted average number of common shares outstanding during the period. Basic EPS is computed by dividing the Bank s net income or loss available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted EPS is computed by dividing net income or loss by diluted weighted average shares outstanding, which include common stock equivalent shares outstanding, determined by using the treasury stock method, unless such shares are anti-dilutive. Common stock equivalents represent the number of shares underlying outstanding stock options awarded under the Bank s Stock Option Plans. 8

11 The following table presents the computation of basic and diluted earnings (loss) per share for the period indicated. Three Months Ended March 31, (in thousands, except share and per share data) Basic EPS: Net income (loss) $101 $(2,979) Weighted average common shares outstanding 6,357,112 6,194,380 Basic EPS $0.02 $(0.48) Diluted EPS: Net income (loss) $101 $(2,979) Weighted average common shares outstanding 6,357,112 6,194,380 Net effect of dilutive stock options (1) - - Weighted average common shares outstanding and common stock equivalents 6,357,112 6,194,380 Diluted EPS $0.02 $(0.48) (1) Common stock equivalents are excluded from the per share calculation if a net loss Note 5 - Treasury Stock Treasury stock is recorded at cost. In the event of a subsequent reissuance of the stock, the treasury stock account will be reduced by the cost of such stock on the average cost basis with any excess proceeds credited to capital surplus. Treasury stock is available for general corporate purposes. On March 23, 2007, the Board of Directors approved the purchase of $2.0 million of the Bank s common stock over a period of up to three years (the 2007 Buyback Plan ), beginning with the completion of the 2004 Buyback Plan. The Bank commenced the purchase of its common stock under the 2007 Buyback Plan on April 17, On June 15, 2007, the Board of Directors approved an amendment to the 2007 Buyback Plan that, subject to regulatory approval that was subsequently received, increased the amount that may be expended for the repurchase of common stock under the 2007 Buyback Plan from $2.0 million to $7.0 million. The three year term for repurchase of shares under the 2007 Buyback Plan expired on April 17, 2010, and therefore there will be no further repurchases under the plan. As of March 31, 2010, the Bank had repurchased $5.0 million of its common stock under the 2007 Buyback Plan and there were no repurchases between March 31, 2010, and April 17, Note 6 - Stock Options Prior to 2004, the Bank granted nonstatutory stock options and incentive stock options under its 1993 Employee Stock Option Plan, as amended in 1997 and 1999 (the 1993 Plan ), and directors nonstatutory stock options under its 1997 Directors Stock Option Plan, as amended in 1999 (the Directors Plan ). The employee stock options are exercisable at any time after they become vested. The directors stock options were exercisable beginning January 1, 1999, and typically were subject to vesting requirements, in accordance with the Directors Plan. The 1993 Plan expired during 2003 and the Directors Plan expired during 2006; therefore, no further options will be granted under these Plans. As of March 31, 2010, options to purchase 110,635 shares remain outstanding from grants made in 2003 and earlier years under these plans. On May 21, 2004, the shareholders of the Bank approved the Idaho Independent Bank 2004 Long-Term Equity Incentive Plan (the 2004 Plan ). The 2004 Plan has a total of 611,587 shares of common stock authorized to be granted as equity incentive awards. As of March 31, 2010, options to purchase 390,053 shares have been granted under the Plan to employees and directors, leaving 221,534 shares available for future grants. The options granted under the 2004 Plan may be exercised at any time after they have vested. Options granted under the 2004 Plan that 9

12 expire or terminate for any reason without being exercised or paid are available for grant in connection with grants of subsequent incentive awards. The exercise price for options granted under all plans is at least the fair market value of the optioned shares on the date of grant. The following table presents the activity related to options under all plans for the three months ended March 31, Stock Options Number of Shares Weighted Average Exercise Price Outstanding at December 31, ,436 $12.42 Forfeited (748) Weighted Average Remaining Contractual Term (yrs) Aggregate Intrinsic Value (in thousands) Outstanding at March 31, ,688 $ $2 Vested at March 31, ,019 $ $2 - The Bank s reported net income before income taxes for the three months ended March 31, 2010, included $76,000 of expense that was the result of the adoption of FASB ASC 718. The after-tax effect of the ASC 718 adjustment reduced the reported basic and diluted earnings per share for the three months ended March 31, 2010, by less than $0.01 per share. ASC 718 requires that cash flows resulting from the tax benefits related to tax deductions in excess of the compensation cost be classified as financing cash flows. For the three months ended March 31, 2010, none of the options previously granted were exercised and no shares of the Bank s common stock were issued to current and/or former employees and/or directors. Although subject to change without notice, the Bank s practice has been to issue new shares for the exercise of stock options. The Board of Directors has authorized the payment of a cash bonus equal to the marginal amount of the federal and state income taxes, Medicare taxes, and federal and state payroll taxes, if any, payable by any officer or director of the Bank by reason of the exercise of nonstatutory stock options to purchase shares of the Bank s common stock under the Directors Plan and/or the 1993 Plan granted to such officer or director prior to January 18, As of March 31, 2010, grants for the purchase of 6,862 shares that expire in 2012 remain eligible for a tax bonus payment. The maximum amount of the tax payment bonus on these share grants is limited to an amount not to exceed $2.13 per share. As of March 31, 2010, the Bank had accrued $15,000 in anticipation of the approximate total payments resulting from the exercise of nonstatutory options in 2009 and from the future exercise of options that remain eligible for the tax bonus payment. The accrued amount is an estimate that is based on current federal and state income tax rates, and as such, the amount that will actually be paid when the options are exercised is uncertain at this time. During the first three months of 2010, none of the eligible nonstatutory stock options were exercised. The tax bonus payment from the exercise of any of the eligible options in 2010, if any, is expected to be paid in Under current income tax law, the Bank will recognize a tax benefit from the exercise of nonstatutory stock options; however, this benefit will be recognized in the year of exercise as an increase to the Bank s capital account and will not impact reported earnings. The amount of such tax benefit, if any, from the exercise of all of the outstanding nonstatutory stock options eligible for a tax bonus cannot be reliably determined at this time. 10

13 Note 7 - Fair Value of Financial Instruments The estimated fair values of the Bank s financial instruments are as follows: March 31, 2010 December 31, 2009 Fair Carrying Fair Value Amount Value (in thousands) Carrying Amount Financial Assets: Cash and due from banks $ 31,254 $ 31,254 $ 17,895 $ 17,895 Federal funds sold Deposits held with other financial institutions 51,807 51,807 52,562 52,562 Trading securities 2,619 2,619 2,540 2,540 Securities available for sale 1,545 1,545 1,535 1,535 FHLB stock 1,503 1,503 1,503 1,503 Loans held for sale 2,771 2,771 2,350 2,350 Loans receivable, net 342, , , ,778 Financial Liabilities: Deposits 380, , , ,555 Securities sold under agreements to repurchase 26,536 26,536 26,258 26,258 Notes payable 9,000 9,481 9,000 9,405 The following methods and assumptions were used to estimate the fair value of each class of financial instruments: Cash and due from banks, federal funds sold, and deposits held with other financial institutions: The carrying amount approximates fair value. Trading securities and securities available for sale: The fair values of securities, excluding restricted equity securities, are determined, when possible, by obtaining quoted prices on nationally recognized securities exchanges. If quoted prices are not available, then fair values are estimated using quoted prices of securities with similar characteristics. Federal Home Loan Bank stock: The carrying value of FHLB stock approximates fair value based on the respective redemption provisions. Loans held for sale: The fair value of mortgage loans held for sale is based on commitments on hand from investors or prevailing market prices. Loans receivable: Fair values for variable-rate loans that reprice frequently and have no significant change in credit risk are based on carrying values. For commercial real estate and commercial loans with maturities beyond one year, fair values are estimated using a discounted cash flow analysis, utilizing interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Loans with maturities of less than one year are estimated to have a fair value equal to the carrying value. Fair values for impaired loans are estimated using discounted cash flow analyses or underlying collateral values, where applicable. Deposits: The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit maturing beyond one year is estimated using discounted cash flow analyses with rates currently offered for deposits of similar remaining maturities. Certificates with maturities less than one year are valued at carrying values. Notes payable, securities sold under repurchase agreements, and other borrowed funds: The carrying amounts of federal funds purchased, securities sold under repurchase agreements, and other borrowed funds maturing within 90 days approximate their fair values. Fair values of notes payable to the FHLB and 11

14 securities sold under repurchase agreements, maturing beyond 90 days, are estimated using discounted cash flow analyses based on the Bank s current incremental borrowing rates for similar types of borrowing arrangements. Off-balance-sheet instruments: Fair values of off-balance-sheet lending commitments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the borrower s credit standing. The fair value of such fees at March 31, 2010, and December 31, 2009, was not significant. Fair Value Measurements FASB ASC , Fair Value Measurements and Disclosures, establishes a framework for measuring fair value. That framework provides a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to quoted prices for identical instruments in active markets (level 1 measurements) and the lowest priority to unobservable inputs (level 3 measurements). The three levels of the fair value hierarchy under FASB ASC are described below: Level 1 - Quoted prices for identical instruments in active markets. Level 2 - Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable. Level 3 - Instruments whose significant value drivers are unobservable. 12

15 The following table summarizes the Bank s financial instruments that were measured at fair value at March 31, 2010, and December 31, Description of Financial Instrument At March 31, 2010 Fair Value Level 1 Level 2 Level 3 (dollars in thousands) Recurring: Trading securities held in a Rabbi Trust $ 2,619 $2,619 $ - $ - U.S. Treasury and agency securities 1,000 1, Municipal bonds Mutual funds Nonrecurring: Impaired loans (1) 20, ,705 Other real estate owned 2, ,699 Description of Financial Instrument At December 31, 2009 Fair Value Level 1 Level 2 Level 3 (dollars in thousands) Recurring: Trading securities held in a Rabbi Trust $ 2,540 $2,540 $ - $ - U.S. Treasury and agency securities Municipal bonds Mutual funds Nonrecurring: Impaired loans (1) 23, ,287 Other real estate owned 2, ,310 (1) Impaired loans that have been written down to fair value or for which a specific reserve has been established. The Bank used the following methods and significant assumptions to estimate fair value: Securities. The fair values of trading securities and securities available for sale are determined, when possible, by obtaining quoted prices on nationally recognized securities exchanges. If quoted prices are not available, then fair values are estimated using quoted prices of securities with similar characteristics. Impaired loans. The fair values of impaired loans are determined using the present value of the expected cash flows or the estimated fair value of the collateral if the loan is collateral-dependent. The fair value is determined, when possible, by an appraisal of the property less estimated costs related to liquidation of the collateral. The appraisal amount may also be adjusted for current market conditions. Adjustments to reflect the fair value of collateraldependent loans are a component in determining an appropriate ALLL. As a result, adjustments to the fair value of impaired loans may result in increases or decreases to the provision for loan losses in current and future earnings. Impaired loans that are measured for impairment using the fair value of the collateral at March 31, 2010, had a carrying amount of $20.7 million, net of an allowance for loan losses of $1.1 million. 13

16 OREO. The fair values of real estate acquired through foreclosure or deeds in lieu of foreclosure are generally based on an appraisal of the property less estimated costs and discounts related to liquidation of the property. The appraisal amount may also be adjusted for current market conditions. Subsequent adjustments to the fair value of OREO are included in noninterest expenses. Item 2. Management s Discussion and Analysis of Financial Condition and Results of Operations The following discussion should be read in conjunction with the audited financial statements and related notes to those statements of the Bank under the heading Financial Statements and Supplementary Data in the Bank's Annual Report on Form 10-K for the year ended December 31, 2009 ( 2009 Form 10-K ). Forward-Looking Statements Statements contained herein concerning future performance, developments or events, expectations for earnings, growth and market forecasts, and any other statements that are not historical facts are forward-looking statements that are intended to be covered by the safe harbor for forward-looking statements provided by the Private Securities Litigation 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: continued declines or worsening in regional and 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. These risks and other factors are described in greater detail in the Bank s filings with the Federal Deposit Insurance Corporation, including, without limitation, the Item 1A Risk Factors section of the Bank s Annual Report on Form 10-K for the year ended December 31, 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. Significant Accounting Policies Significant accounting policies and estimates relating to the Bank s ALLL, valuation of OREO, valuation of stock based compensation expense, and recognition of deferred income tax assets and liabilities are further discussed in our 2009 Form 10-K under Note 1 to the Annual Financial Statements Summary of Significant Accounting Policies. That footnote highlights certain estimates the Bank makes that involve uncertainty or potential for substantial change. There have not been any material changes in our critical accounting policies and estimates relating to our ALLL, OREO, stock compensation expense, and deferred income tax assets and liabilities as compared to the disclosure contained in our 2009 Form 10-K. General IIB was established in 1993 as an Idaho state-chartered, full-service, commercial bank that focuses on small and medium-sized businesses, professionals, and retail customers in the State of Idaho. The Bank currently operates 12 branches in Boise (3), Meridian, Coeur d Alene, Nampa, Mountain Home, Hayden, Caldwell, Star, Eagle, and Sun Valley/Ketchum, Idaho. IIB has approximately 200 employees throughout the State of Idaho. The Bank s common stock is traded on the OTC Bulletin Board under the symbol IIBK. The Bank is subject to competition from a variety of traditional and nontraditional financial service providers both inside and outside of Idaho. The Bank offers its customers a wide range of deposit products; cash management services; nondeposit investment products; commercial, residential, and consumer loans; and other traditional banking products and services. The Bank is subject to regulation by certain federal and state agencies and undergoes periodic examinations by those regulatory authorities. The Bank s deposits are insured by the FDIC, subject to regulatory limits. 14

17 Overview The Bank s net income is derived primarily from net interest income, which is the difference between interest earned on its loan and investment portfolios and its cost of funds, primarily interest paid on deposits and borrowings. The Bank reported net income of $101,000, or $0.02 per diluted share, for the three months ended March 31, 2010, compared to a net loss of $3.0 million, or a loss of $0.48 per diluted share, for the same period a year ago. Total assets decreased $8.2 million, or 1.7%, to $485.0 million at March 31, 2010, from $493.2 million at December 31, Total assets decreased $70.8 million, or 12.7%, from $555.8 million at March 31, Deposits decreased $8.7 million, or 2.2%, to $380.3 million at March 31, 2010, from $389.0 million at December 31, Deposits decreased $30.5 million, or 7.4%, from $410.8 million at March 31, Repurchase agreements increased $278,000, or 1.1%, to $26.5 million at March 31, 2010, from $26.3 million at December 31, By comparison, repurchase agreements were $25.8 million at March 31, Stockholders equity increased $180,000, or less than 1.0%, to $62.3 million at March 31, 2010, from $62.2 million at December 31, The Bank believes that the continued slowdown in economic activity within the communities the Bank serves and the United States in general has been the primary cause of decline in total assets, loans, and deposits, as well as asset quality during the past year, which, in turn, has contributed to the decline in profitability in 2008, 2009, and during the most recent quarter. Trends and Developments Impacting Our Recent Results Certain trends emerged and developments have occurred that are important to understanding our recent results and are also potentially significant in assessing future performance. Declining growth in our market areas. Much of our past performance has been fueled by population and economic growth in the Coeur d Alene and Boise-Nampa areas. This growth brought about considerable activity in residential and commercial development projects, the construction of residential communities, shopping centers, and office buildings, and the expansion of the businesses and professions that provide goods and services to the growing population. However, beginning in 2008, trends in our local markets have been adversely influenced by macroeconomic forces and disruptions in the capital markets. Specifically, real estate and related activities have slowed significantly, local unemployment rates have increased substantially, and real estate and certain other asset prices have declined appreciably. Likewise, stressed local housing markets, reduced economic activity, and sharply lower interest rates have adversely impacted our credit quality and/or operating results. Asset/Liability sensitivity. Management uses various strategies to manage the repricing characteristics of our assets and liabilities. At March 31, 2010, the Bank s analysis indicated that, largely due to loans that have interest rate floors, the Bank is liability sensitive in the very short term (zero to three months). Further, the analysis suggests the Bank is slightly liability sensitive within one year. Over all periods, however, the Bank continues to be asset sensitive. A bank is considered to be asset sensitive if the amount of its interest-earning assets maturing or repricing within a certain time period exceeds the amount of its interest-bearing liabilities that also mature or reprice within the same period. Being asset sensitive in times of rising interest rates would typically be expected to result in an increase in the Bank s net interest income over time. Since the Bank is liability sensitive within one year, an increase in short-term interest rates may reduce net interest income in the initial year following such increase. Conversely, being asset sensitive in times of falling interest rates would typically be expected to result in a decrease in net interest income. As a result, further decreases in short-term interest rates would be expected to increase the Bank s net interest margin in the initial year and adversely impact future financial performance thereafter. See Quantitative and Qualitative Disclosures about Market Risk. Impact of asset quality deterioration on provision for loan loss expense, interest income, and non-interest expense. The Bank has continued to experience deteriorating asset quality trends that have been observed since This has resulted in increased provisions for loan losses, reduced interest income as a result of loans being placed on non-accrual status, as well as increased operating expenses related to collection activities, costs of maintaining and/or disposing of collateral, and additional collateral valuation allowances. The full impacts of these adverse developments are reflected in current operating results. However, if the economic slowdown accelerates further and/or continues for an extended period of time, we can expect further increases in non-performing assets and loan charge-offs, increased provision for loan loss expense, additional declines in the Bank s net interest margin, and absolute and relative increases in operating costs during future periods. 15

18 Comparison of Financial Condition at March 31, 2010, and December 31, 2009 Investments. Total investments, consisting primarily of federal funds sold, investment securities, deposits with other financial institutions, and stock in the Federal Home Loan Bank ( FHLB ) of Seattle, decreased $618,000, or 1.1%, to $57.8 million at March 31, 2010, from $58.4 million at December 31, Investments accounted for 11.9% of total assets at March 31, 2010, compared to 11.8% of total assets at December 31, The decrease in investments is largely a result of the impact of the scheduled maturities of the investment securities and deposits with other financial institutions. Due to current market conditions, management has elected not to replace certain securities that matured during the period. At March 31, 2010, the Bank s securities available for sale consisted of $1.0 million in U.S. Government agencies, $45,000 in Idaho municipal obligations, and a $500,000 investment in a Community Reinvestment Act ( CRA ) qualified mutual fund. In addition, an unrealized loss of $300 was recorded at March 31, Loans. Total loans, including loans held for sale, decreased $23.7 million, or 6.2%, to $359.3 million at March 31, 2010, from $383.0 million at December 31, The decrease in total loans at March 31, 2010, was primarily due to repayments on loans, lower levels of new loan originations related to reduced economic activity in the Bank s primary markets, and an increase in net charge-offs. Loans held for sale are generally residential real estate loans that the Bank intends to sell into the secondary market, and as such, are loans funded but not yet sold to various investors. These loans are typically sold on a servicingreleased basis, meaning the Bank does not retain mortgage-servicing responsibilities or the income and expense associated therewith. Loans held for sale increased $421,000, or 17.5%, to $2.8 million at March 31, 2010, from $2.4 million at December 31, The amount of loans held for sale can vary significantly from period to period reflecting loan demand by borrowers, timing of sales, current interest rates, and the economic environment. The following table sets forth the composition of the Bank s loan portfolio, excluding loans held for sale: March 31, 2010 December 31, 2009 Percent Percent Balance of Total Balance of Total (dollars in thousands) Commercial $ 63, % $ 66, % Agriculture 5, , Real estate 241, , Real estate construction 11, , Consumer 33, , Other 2, , Total loans 356, % 380, % Less: Deferred loan fees Allowance for loan losses 14,303 17,140 Loans receivable, net $342,217 $363,499 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 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. Real estate loans include various types of loans in which the Bank holds real property as collateral, including land acquisition and land development loans. Real estate term loans held in the Bank s portfolio typically have maturities from 1 to 10 years with amortization schedules ranging up to 30 years. 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 1 to 24 months. 16

19 Consumer loans are primarily unsecured, automobile, bankcard, home equity, and closed-end home equity loans. Consumer loans generally have maturities of 10 years or less with fixed or variable interest rates. Personal lines of credit and home equity lines generally carry maturities from 1 to 10 years and have variable interest rates. Credit card loans generally require monthly payments and bear interest at rates that vary from time-to-time. Deposits and Borrowings. Total deposits decreased $8.7 million, or 2.2%, to $380.3 million at March 31, 2010, from $389.0 million at December 31, Total deposits at month-end typically reflect somewhat higher balances than the average for the month due to higher month-end activity in commercial accounts. The Bank s borrowings, consisting of customer repurchase agreements, fixed-rate notes, and overnight advances from the FHLB of Seattle, Federal Reserve Bank, and other correspondent banks, increased $278,000, or less than 1.0%, to $35.5 million at March 31, 2010, from $35.3 million at December 31, The change consisted of a $278,000 increase in customer repurchase agreements. Interest rates paid by the Bank on repurchase agreements generally range from 0.25% to 2.00% below the federal funds rate, but above a floor that is set at the discretion of the Bank from time-to-time. The average interest rate paid on repurchase agreements was 0.43% during the months of March 2010 and December The Bank borrowed $9.0 million from the FHLB of Seattle on February 20, 2005, consisting of a $5.0 million 10- year note bearing interest at 4.79% per annum, and a $4.0 million 15-year note bearing interest at 5.08% per annum. Both notes require the payment of monthly interest with the principal due upon maturity. The 10-year note matures on February 20, 2015, and the 15-year note matures on February 21, The following table sets forth the average balances for each major category of deposits, the percent of total deposits for each category, and the average interest rate paid during the months of March 2010 and December Average Balance Month of March 2010 Month of December 2009 Weighted Percent of Average Average Percent of Total Rate Balance Total (dollars in thousands) Weighted Average Rate Interest-bearing transaction accounts $ 70, % 0.38% $ 72, % 0.41% Certificates of deposit 77, , Savings accounts 144, , Noninterest-bearing demand accounts 90, , Totals $382, % $401, % The Bank, through its membership in the FHLB of Seattle, has access to a variety of borrowing alternatives. In addition, the Bank has credit lines established with the Federal Reserve Bank and various correspondent banks. Asset Quality The definition of nonperforming assets includes nonperforming loans and OREO. Nonperforming loans are generally defined as nonaccrual loans and loans past due 90 days or more, but still accruing interest. Under certain circumstances, the Bank may restructure the terms of a loan as a concession to a borrower. OREO includes real estate acquired through foreclosure proceedings and real estate acquired through acceptance of deeds in lieu of foreclosure. Nonperforming Assets. At March 31, 2010, the level of nonperforming assets was $43.5 million, compared to $39.4 million at December 31, 2009, and $30.4 million at March 31, The level of nonperforming assets has increased due to the ongoing effects of the deterioration of the real estate markets within the communities the Bank serves as well as the downturn in the local and national economies. Nonperforming assets at March 31, 2010, consisted primarily of nonperforming loans secured by developed land or land held for development totaling $33.3 million, nonperforming loans secured by construction property totaling $2.3 million, and $2.7 million in OREO that consisted primarily of 14 residential condominium units located in Bonner County, Idaho, two homes in Kootenai County, Idaho, and various residential building lots located in Idaho, that are owned by the Bank s subsidiary, First Security Corporation. The Bank evaluates the underlying collateral of its nonperforming loans and continues to pursue the collection of interest, principal, and other amounts that are due. The recorded balances of nonperforming loans at March 31, 2010, reflect charge-offs of $14.6 million taken during 2010 and in prior periods to write the 17

20 loans down to their estimated fair value of the collateral securing the loans. The level of nonperforming assets may increase if economic conditions continue to worsen, or if other factors or events adversely impact specific loans or the portfolio in general. Delinquencies. At March 31, 2010, there were 16 loans totaling $5.4 million that were 60 to 89 days past due that continued to accrue interest, compared to 2 loans totaling $4.8 million at December 31, 2009, and 10 loans totaling $9.1 million at March 31, As with nonperforming loans, management believes it is likely that the level of delinquent loans may increase if economic conditions worsen, or if other factors or events adversely impact the portfolio. The following table sets forth information regarding nonperforming assets and loans 90 days past due that continue to accrue interest at the dates indicated. March 31, 2010 December 31, 2009 (dollars in thousands) Loans accounted for on a nonaccrual basis $40,784 $ 36,953 Loans past due 90 days or more but still accruing - 98 Total nonperforming loans 40,784 37,051 Other real estate owned 2,699 2,310 Total nonperforming assets $43,483 $39,361 Nonperforming assets as a percent of total loans 12.20% 10.34% Nonperforming assets as a percent of total assets Delinquent loans days past due, excluding nonaccrual loans, as a percent of total loans Troubled Debt Restructurings. As of March 31, 2010, there were $12.8 million of loans included in the total amount of nonperforming loans on which the Bank has granted certain material concessions to the borrower. The concessions may include an extension of the maturity date with an interest rate lower than the current market rate for new loans with similar risk. These loans are considered Troubled Debt Restructurings as defined in ASU , Troubled Debt Restructuring by Creditors. As of March 31, 2010, all of these loans were accounted for on a nonaccrual basis. Potential Problem Loans. Potential problem loans are those that do not yet meet the criteria for placement on nonaccrual or nonperforming status, but the Bank has information about potential problems that causes management to have concerns about the borrower s ability to substantially comply with existing loan repayment terms. At March 31, 2010, the aggregate amount of potential problems loans was $14.0 million. All of the loans were secured by real estate, except three loans totaling $174,000. Although they have been identified as potential problem loans, it is possible they may never be classified as delinquent, nonaccrual, or nonperforming loans. Potential problem loans are included in the determination of the overall adequacy of the allowance for loan and lease losses. Allowance for Loan and Lease Losses. During the current quarter, the Bank made provisions to the ALLL, including an allowance for overdraft losses totaling $1.3 million, and had $4.2 million in net charge-offs, bringing the balance in the allowance to $14.3 million, compared to $17.1 million at December 31, The allowance, expressed as a percentage of total loans, excluding loans held for sale, was 4.01% at March 31, 2010, compared to 4.50% at December 31, 2009, and 4.12% at March 31, Assessing the adequacy of the ALLL involves substantial uncertainties and is based upon management s evaluation of the amounts required to meet estimated charge-offs in the loan portfolio after weighing numerous factors. Among these factors are the risk characteristics of the loan portfolio, including concentrations by location, type, project, and collateral, the quality and size of individual loans, the level of nonperforming loans, current economic conditions, trends in delinquencies, charge-offs, and adversely classified assets, the value of underlying collateral, and changes in lending procedures and/or staff, all of which can change frequently. Management considers the estimate of losses represented by the ALLL to be adequate and it represents the best estimate of the probable credit losses inherent in the loan portfolio at March 31, However, there can be no assurance that the ALLL will be adequate to cover actual losses. 18