UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

Form 10-K

 

 

 

COMMISSION FILE NUMBER 000-50667

 

 

INTERMOUNTAIN COMMUNITY BANCORP

(Exact name of registrant as specified in its charter)

 

 

 

 

414 Church Street, Sandpoint, ID 83864

(Address of principal executive offices) (Zip code)

 

Registrant’s telephone number, including area code:

(208) 263-0505

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act:

Common Stock (no par value)

(Title of class)

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o  No þ

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o  No þ

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ  No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o  No o

 

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 amendment to this Form 10-K.  þ

 

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. (Check one):

 

(Do not check if a smaller reporting company)

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes o  No þ

 

As of June 30, 2009, the aggregate market value of the common equity held by non-affiliates of the registrant, computed by reference to the average of the bid and asked prices on such date as reported on the OTC Bulletin Board, was $23,200,000.

 

The number of shares outstanding of the registrant’s Common Stock, no par value per share, as of March 5, 2010 was 8,383,379.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Specific portions of the registrant’s Proxy Statement for the 2010 Annual Meeting of Shareholders are incorporated by reference into Part III hereof.

 

 

TABLE OF CONTENTS

 

 

Forward-Looking Statements

 

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

This report may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include, but are not limited to, statements about our plans, objectives, expectations and intentions that are not historical facts, and other statements identified by words such as “expects,” “anticipates,” “intends,” “plans,” “believes,”, “will likely”, “should,” “projects,” “seeks,” “estimates” or words of similar meaning. These forward-looking statements are based on current beliefs and expectations of management and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change. In addition to the factors set forth in the sections titled “Risk Factors,” “Business” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, as applicable, in this report, the following factors, among others, could cause actual results to differ materially from the anticipated results:

 

 

 

Please take into account that forward-looking statements speak only as of the date of this report. We do not undertake any obligation to publicly correct or update any forward-looking statement whether as a result of new information, future events or otherwise.

 

 

Overview & History

 

Intermountain Community Bancorp (“Intermountain” or the “Company”) is a bank holding company registered under the Bank Holding Company Act of 1956, as amended. The Company was formed as Panhandle Bancorp in October 1997 under the laws of the State of Idaho in connection with a holding company reorganization of Panhandle State Bank (the “Bank”) that was approved by the shareholders on November 19, 1997 and became effective on January 27, 1998. In June 2000, Panhandle Bancorp changed its name to Intermountain Community Bancorp.

 

Panhandle State Bank, a wholly owned subsidiary of the Company, was first opened in 1981 to serve the local banking needs of Bonner County, Idaho. Panhandle State Bank is regulated by the Idaho Department of Finance, the State of Washington Department of Financial Institutions, the Oregon Division of Finance and Corporate Securities and by the Federal Deposit Insurance Corporation (“FDIC”), its primary federal regulator and the insurer of its deposits.

 

Since opening in 1981, the Bank has continued to grow by opening additional branch offices throughout Idaho and has also expanded into the states of Oregon and Washington. During 1999, the Bank opened its first branch under the name of Intermountain Community Bank, a division of Panhandle State Bank, in Payette, Idaho. Over the next several years, the Bank continued to open branches under both the Intermountain Community Bank and Panhandle State Bank names. In January 2003, the Bank acquired a branch office from Household Bank F.S.B. located in Ontario, Oregon, which is now operating under the Intermountain Community Bank name. In 2004, Intermountain acquired Snake River Bancorp, Inc. (“Snake River”) and its subsidiary bank, Magic Valley Bank, and the Bank now operates three branches under the Magic Valley Bank name in south central Idaho. In 2005 and 2006, the Company opened branches in Spokane Valley and downtown Spokane, Washington, respectively, and operates these branches under the name of Intermountain Community Bank of Washington. It also opened branches in Kellogg under the Panhandle State Bank name and Fruitland, Idaho under the Intermountain Community Bank name.

In 2006, Intermountain also opened a Trust & Wealth Management division, and purchased a small investment company, Premier Alliance. The combined unit now operates as Intermountain’s Trust & Investment Services division. The acquisition and development of these services improves the Company’s ability to provide a full-range of financial services to its targeted customers. In 2007, the Company relocated its Spokane Valley office to a larger facility housing retail, commercial, and mortgage banking functions and administrative staff. In the second quarter of 2008, the Bank completed the Sandpoint Center, its new corporate headquarters, and relocated the Sandpoint branch and administrative staff into the building.

 

Intermountain offers banking and financial services that fit the needs of the communities it serves. Lending activities include consumer, commercial, commercial real estate, residential construction, mortgage and agricultural loans. A full range of deposit services are available including checking, savings and money market accounts as well as various types of certificates of deposit. Trust and wealth management services, investment and insurance services, and business cash management solutions round out the Company’s product offerings.

 

The Company’s equity investments include Panhandle State Bank, as previously noted, and Intermountain Statutory Trust I and Intermountain Statutory Trust II, financing subsidiaries formed in January 2003 and March 2004, respectively. Each Trust has issued $8.0 million in preferred securities, the purchasers of which are entitled to receive cumulative cash dividends from the Trusts. The Company has issued junior subordinated debentures to the Trusts, and payments from these debentures are used to make the cash dividends to the holders of the Trusts’ preferred securities.

 

Business Strategy & Opportunities

 

Intermountain seeks to differentiate itself by attracting, retaining and motivating highly experienced employees who are local market leaders, and supporting them with advanced technology, training and compensation systems. This approach allows the Bank to provide local marketing and decision-making to respond quickly to customer opportunities and build leadership in its communities. Simultaneously, the Bank has focused on standardizing and centralizing administrative and operational functions to improve risk management, efficiency and the ability of the branches to serve customers effectively.

 

Intermountain is positioning itself to prosper in the new economy arising from the prolonged economic downturn. Its strengths provide the foundation for growth and profitability in the future. These include the following:

 

 

Management anticipates that banking in the future will be similar in some ways to the past, and very different in other ways. Management has defined potential opportunities in terms of prospects within its core markets of north, southwest rural, and south central Idaho, and within its growth markets of Spokane, Boise, and contiguous eastern Washington and northern Idaho counties. While it cannot guarantee that it will pursue, or be successful in pursuing opportunities in this new environment, it believes the following represent potential prospects.

 

In respect to lending, a return to more conservative credit management, underwriting and structuring and the exit of a number of distressed competitors may lead to better pricing opportunities and lower future credit risk for the Company. Management is responding by diversifying its current portfolio and positioning for prudent growth opportunities. It believes these prospects will include pursuing attractive mid-market commercial credits in its markets, originating commercial real estate loans to strong borrowers at lower real estate prices, originating and seasoning mortgage loans to strong borrowers at conservative loan-to-values in rural and smaller suburban areas not well-served by current secondary market appraisal standards, expanding and diversifying its agricultural portfolio, and expanding its already strong government-guaranteed loan marketing efforts. Management also believes that credit spreads may generally be wider, and when combined with the Company’s high proportion of variable rate loans, should lead to improved asset yields in the future.

 

Deposit growth and pricing will continue to be a cornerstone of the Company’s success. As demonstrated by its past successes, the growth of low-cost core deposits has always been a focus. Management will continue this core focus, while pursuing opportunities to gain additional market share from stressed competitors in its defined core and growth markets. Based on FDIC call report data, the Company has identified approximately $1 billion in deposits at banks in its core markets that are exhibiting relatively high levels of distress, and another $3 billion in its growth markets. When combined with potential organic growth, a relatively small capture of these distressed deposits over the next few years would allow the Bank to double its total deposits.

 

The Company also sees additional opportunities in improving its efficiency. The last three years have been challenging for the Company as it first sought to build operational infrastructure for a larger institution, then faced very significant credit-related costs. These costs masked underlying improvement in operating expenses. In the future, management believes the infrastructure that has been built will allow the Company to expand its assets and revenues to a great extent without corresponding increases in expenses. When combined with lower anticipated credit costs, this could lead to relatively rapid improvement in efficiency for the Company. During 2010, it will continue to focus on rationalizing its cost structure and has already made significant additional expense reduction moves, including reducing staff and executing additional outsourcing contracts.

 

Management believes that non-interest revenue growth may be challenging in the near-term because of additional regulatory restrictions, particularly on overdraft income. However, it continues to take steps to expand and diversify its revenue sources. These include expanding its trust and investment service opportunities to both new and existing customers, increasing debit and credit card revenues, pursuing other partners to work with on its secured savings credit card program, and reorganizing and enhancing its mortgage banking operation.

 

In addition to the above, management believes that disruption and consolidation in the market may lead to other opportunities as well. Subject to regulatory and capital constraints, management believes that there may be attractive acquisition opportunities within its footprint that the Company may be in a unique position to capitalize on. Intermountain is the largest publicly traded bank holding company headquartered in Idaho, and has existing branches in Washington and Oregon, which may help facilitate future transactions. Even if these opportunities are not available, large disruptions create potential opportunities to attract strong new employees and customers.

 

Primary Market Area

 

The Company conducts its primary banking business through its bank subsidiary, Panhandle State Bank. The Bank maintains its main office in Sandpoint, Idaho and has 18 other branches. In addition to the main office, seven branch offices operate under the name of Panhandle State Bank. Eight branches are operated under the name Intermountain Community Bank, a division of Panhandle State Bank, and three branches operate under the name Magic Valley Bank, a division of Panhandle State Bank. Sixteen of the Company’s branches are located throughout Idaho in the cities of Bonners Ferry, Caldwell, Coeur d’Alene, Fruitland, Gooding, Kellogg, Nampa, Payette, Ponderay, Post Falls, Priest River, Rathdrum, Sandpoint, Twin Falls (2) and Weiser. One branch is located in

Spokane Valley, Washington and one branch is located in downtown Spokane, Washington. In addition, the Company has one branch located in Ontario, Oregon. The Company focuses its banking and other services on individuals, professionals, and small to medium-sized businesses throughout its market area.

 

Based on asset size and deposits, Intermountain is the largest independently owned bank holding company headquartered in Idaho. After two decades of almost uninterrupted economic and population growth, the Idaho economy slowed significantly in 2009. Population growth in the state was the 5th fastest of any state over the period from 2000 to 2008, and dropped to the 12th fastest in 2009. Based on U.S. Census Bureau estimates, the State is projected to sustain future population growth rates well in excess of the national average. Idaho experienced rapid employment growth during the period of 2000 to 2008 (14% versus U.S. 8%), then sustained net job losses in 2009 (Source: Idaho Department of Labor). The unemployment rate at the end of 2009 was 9.1% versus a national average of 9.7%. However, job losses appear to be moderating and longer-term prospects for the economy are still strong. These prospects are based on a diverse economic base, including government, agriculture, health care, technology, light manufacturing, retirement, tourism, and professional services segments, a low-cost of living and doing business, favorable state government policies, and a strong quality of life. The Oregon, Washington and California governments have all recently enacted unfriendly business policies, which should increase the attractiveness of doing business in Idaho. While Idaho faces difficult state budget issues as well, the conservative legislature and governor have indicated a strong reluctance to implement any proposals that would increase taxes or otherwise harm businesses. The Idaho Department of Labor forecasts unemployment at 8.5% at the end of 2010, then dropping to around 8.0% in 2011.

 

Real estate valuations throughout the state have shown considerable variability, based on specific geographical location and type of property. In general, while Idaho has experienced higher than average foreclosure rates over the past year, price declines at 5.6% (Source: FDIC Fourth Quarter, 2009 State Profile) on finished residential property have been lower than average. The Boise area has been hit harder than the rest of the State, with price declines on finished properties averaging 10% to 30% as a result of increasing unemployment and substantial overbuilding. While the slowing economy has hurt other areas as well, the amount of available inventory was generally smaller, resulting in smaller price declines, mostly in the 5% to 20% percent range. Generally, residential land prices have dropped more throughout the state, as available residential supply far exceeded the demand for it. As such, price declines in land have ranged anywhere from 15% on the low end to 85% on the high end, depending on location (Source: Auble Idaho and Eastern Washington Real Estate Report). It is too early to determine whether stabilization has occurred statewide, although various areas, including Boise, southwest rural Idaho, and parts of north Idaho appear to have bottomed out.

 

The Bank’s primary service area covers four distinct geographical regions. The north Idaho and eastern Washington region encompasses the four northernmost counties in Idaho, including Boundary County, Bonner County, Shoshone County and Kootenai County and Spokane County in eastern Washington. Bonner and Boundary Counties are heavily forested and contain numerous lakes. As such, the economies of these counties are primarily based on tourism, real estate development and natural resources, including logging, mining and agriculture. Bonner County has also experienced expansion in the areas of light industrial, commercial, retirement and retail development over the past ten years, and management believes both counties are likely to benefit from Canadian spending and investment as the dollar has weakened against the Canadian currency. Shoshone County continues to experience expansion in the areas of residential and tourism development relating to the outdoor recreation industry in the area and has seen a strong resurgence in mining activity as mineral prices have rebounded. Kootenai County is more diverse than the other north Idaho counties, with light industrial, high-tech, commercial, retail, medical, tourism and real estate development all contributing to the economic base. It, along with Spokane County in Washington, should also benefit from additional Canadian investment.

 

In general, the north Idaho and eastern Washington economy has been impacted less by the recession than other areas of the Pacific Northwest. While unemployment rates have risen to an average of 10% for the region in December 2009, and real estate values have declined, the changes are not as dramatic throughout this region as in many other areas. Diversification, strengthening mining prices, less aggressive development in earlier periods, favorable business cost structures, continuing tourism activity and Canadian investment have helped cushion the downturns experienced in the real estate development, retail and service industries. Although unemployment rates are high in some north Idaho counties, they have historically been high, so the relative impact is not as significant.

Data on real estate activity is limited for a good part of this region, but it generally appears that residential home price declines have ranged from 5% to 20%, while lot prices are down 20% to 50% based on location. Commercial real estate activity and pricing appear to be softening, although there is not a significant overhang of commercial properties in this region. Intermountain holds 55% of its loans and 49% of its deposits in this region.

 

The second region served by the Bank encompasses two counties in southwestern Idaho (Payette, and Washington) and one county in southeastern Oregon (Malheur). The economies of these counties are primarily based on agriculture and related or supporting businesses. A variety of crops are grown in the area including beans, onions, corn, apples, peaches, cherries and sugar beets. Livestock, including cattle, sheep and pigs, are also raised. Agriculture has been strong over the past several years which has cushioned the impact of the downturn on these counties. Unemployment is historically high in this area, and stood at 11.2% in December 2009, but real estate values have held up much better, given the predominance of agricultural land in the region. Commercial real estate property is relatively limited and has not grown significantly. The Company holds 20% of its loans and 19% of its deposits in this region.

 

The third region, known as the greater Boise area, is comprised of two counties, Ada and Canyon. The cities of Boise, Nampa and Caldwell have been hit hard because of excessive residential and commercial real estate development, volatility in the area’s high-tech industries, and reductions in other corporate and state and local government activity. Unemployment in the area appears to have stabilized at 9.2% in December 2009, and some forecasters expect improvement in 2010 as the area’s technology industry possibly recovers. Real estate price declines have been the steepest of any in the Company’s market areas, ranging from 20% to 30% drops in finished residential home prices to 50% to 75% in bare land and subdivision developments. Although recent indicators, including real estate inventory levels and valuations may indicate a bottoming, the recovery is likely to be slow in these two counties. 12% of the Company’s loans and 9% of its deposits are in this region.

 

The fourth region served by the Bank encompasses two counties in south central Idaho (Twin Falls and Gooding), also known as the Magic Valley region. The economies of these counties are primarily based on agriculture and related or supporting businesses. A variety of crops are grown in the area including beans, peas, corn, hay, sugar beets and potatoes. Fish farms, dairies and beef cattle are also contributors to the local economy. Twin Falls County has experienced significant commercial growth over the past 10 years, and as a result, residential and commercial construction has been a much larger driver of the local economy. The area is also experiencing growth in light manufacturing and retail development.

 

Twin Falls’ strong agricultural base, along with its status as the commercial, medical, retail, retirement and services hub for the area, has cushioned it somewhat from the impacts of the recession, resulting in a December 2009 unemployment rate of 7.8%. Several large commercial projects have also contributed to the economy over the past several years. With the completion of these projects, the next several years are likely to be slower for the area, but still better than many other areas that lack similar diversity. In addition, the region maintains a conservative character with little evidence of significant overbuilding or excess inventory. The Company has little exposure to the dairy industry, which has been the one significantly weaker sector in agriculture. Residential valuation declines have been relatively moderate, in the 5% to 15% range for homes and 20% to 50% range for development land. The Company has 8% of its loans and 9% of its deposits in the Magic Valley region.

 

As demonstrated by the loan and deposit totals in each market, Intermountain pursues a long-term strategy of balancing loan and deposit balances in each of its regions. As it enters new markets, it may lead with either a heavier emphasis on loans or deposits depending on specific market opportunities. Over the long-term, however, management believes that both Intermountain and the local markets are well-served by pursuing a balanced strategy and the discipline this requires.

 

Intermountain has also segmented its market area into core and growth markets to facilitate future planning activities. The Company defines its core market as including the four counties of northern Idaho listed above, Canyon, Payette and Washington Counties in southwestern Idaho, Malheur County in eastern Oregon, and Gooding and Magic Valley Counties in Southwest Idaho. Deposits in this market totaled $5.8 billion, of which Intermountain held $796 million, or 14% (Source: FDIC Survey of Banking Institutions). The Company’s growth markets consist of Spokane County in Washington, and Ada County in Idaho (where Boise is located), as well as counties contiguous to its existing markets in north Idaho and eastern Washington. Deposits in Ada and Spokane County

totaled $13.2 billion at June 30, 2009 and Intermountain held $35 million or 0.3% of deposits in this market at the time. The Company believes that it has significant future opportunities in these growth markets, because of an established brand presence, strong market contacts in other banking institutions, and the presence of larger distressed competitors.

 

Competition

 

As noted previously, based on total asset size and deposit balances as of December 31, 2009, the Company continues to be the largest independent community bank headquartered in Idaho. The Company competes with a number of international banking groups, out-of-state banking companies, state-wide banking organizations, and several local community banks, as well as savings banks, savings and loans, credit unions and other non-bank competitors throughout its market area. Banks and similar financial institutions compete based on a number of factors, including price, customer service, convenience, technology, local market knowledge, operational efficiency, advertising and promotion, and reputation. In competing against other institutions, the Company focuses on delivering highly personalized customer service with an emphasis on local involvement and empowerment. It recruits, retains and motivates seasoned, knowledgeable bankers who have worked in the Company’s market areas for extended periods of time and supports them with current technology. Product offerings, pricing and location convenience are generally competitive with other banks in its market areas. The Company seeks to differentiate itself based on the high skill levels and local knowledge of its staff, combined with sophisticated relationship management and profit systems that pinpoint marketing and service opportunities.

 

The Company has employed these competitive tools to grow market share over the past ten years, since it began expanding beyond its Sandpoint, Idaho base. During this time period, the Company has grown from eighth overall in market share in its defined core markets to second, with a consolidated market share of 13.6%. The chart below shows strong growth in virtually all of the Company’s markets, including continued growth in 2009. Based on the June 2009 FDIC Survey of Banking Institutions, the Company is the market share leader in deposits in five of the eleven counties in which it operates. As noted previously, the Spokane and Boise market areas represent potential future growth markets for the Company, as total market deposits in these two counties exceed by a two-to-one margin the total market deposits in the Company’s core markets. The Company has a relatively small, but growing presence in Spokane County with strong local market talent. The Company does not have any branches in Ada County, which includes Boise, but has a number of key managers who came from or worked in the Boise area.

 

As discussed above, the Company’s principal market area is divided into four separate regions based upon population and the presence of banking offices. In northern Idaho/eastern Washington, the primary competitors include US Bank, Wells Fargo, Washington Trust Bank, Sterling Savings Bank, Banner Bank and Bank of America, all large international or regional banks, and Idaho Independent Bank and Mountain West Bank, both community banks.

 

Primary competitors in the Company’s other regions in southwestern and south central Idaho and eastern Oregon include international or regional banks, US Bank, Wells Fargo, Key Bank, Bank of America, Banner Bank and Zions Bank, and community banks, Bank of the Cascades, Idaho Independent Bank, DL Evans Bank, First Federal Savings Bank and Farmers National Bank.

 

The severe economic downturn and additional regulatory changes are altering Intermountain’s competitive landscape. Many non-FDIC insured competitors, including residential mortgage brokers, commercial finance operations, and commercial real estate mortgage brokers have exited the market, a trend which is likely to continue over the next several years. Additional bank failures and significant consolidation of the banking industry are forecasted as well. These events will likely present both opportunities and challenges to Intermountain. Previous sections have highlighted various opportunities that may arise, such as improved credit structuring and pricing, additional growth through attracting strong employees and customers from disaffected institutions, and potential acquisition opportunities. Potential challenges include stronger remaining competitors, additional credit losses created by market disruption and significant levels of disposition of loan collateral at depressed prices, and additional regulatory constraints.

 

Services Provided

 

Lending Activities

 

The Bank offers and encourages applications for a variety of secured and unsecured loans to help meet the needs of its communities, dependent upon the Bank’s financial condition and size, regulatory restrictions, local economic conditions and consistency with safe and sound operating practices. While specific credit programs may vary from time to time, based on Bank policies and market conditions, the Bank makes every effort to encourage applications for the following credit services throughout its communities.

 

Commercial Loans.  The Bank offers a wide range of loans and open-end credit arrangements to businesses of small and moderate size, from small sole proprietorships to larger corporate entities, with purposes ranging from working capital and inventory acquisition to equipment purchases and business expansion. The Bank also participates in the Small Business Administration (“SBA”) and United States Department of Agriculture (“USDA”) financing programs. Operating loans or lines of credit typically carry annual maturities. Straight maturity notes are also available, in which the maturities match the anticipated receipt of specifically identified repayment sources. Term loans for purposes such as equipment purchases, expansion, term working capital, and other purposes generally carry terms that match the borrower’s cash flow capacity, typically with maturities of three years or longer. Risk is controlled by applying sound, consistent underwriting guidelines, concentrating on relationship loans as opposed to transaction type loans, and requiring sound alternative repayment sources, such as collateral or strong guarantor support. While underwriting guidelines vary, depending on the type of loan, in general businesses are required to maintain a minimum 1.25 debt service coverage (“DSC”). Loan-to-value (“LTV”) guidelines generally range from a low of 40% on illiquid equipment and inventory to a high of 75% of liquidation value on easily convertible accounts receivable, inventory or equipment. Government guaranty programs are also utilized when appropriate, and are currently being emphasized, given favorable changes made by the federal government to the programs and the difficult credit environment.

 

The Bank also offers loans for agricultural and ranching purposes. These include expansion loans, short-term working capital loans, equipment loans, cattle or livestock loans, and real estate loans on a limited basis. Terms are generally up to one year for operating loans or lines of credit and up to seven years for term loans. As with other business loans, sound underwriting is applied by a staff of lending and credit personnel seasoned in this line of lending. Underwriting guidelines for agricultural credit lines depend on the type of loan and collateral, but generally require a minimum DSC of 1.25, and hard collateral coverage (collateral other than the crops being grown) of greater than 50% of peak borrowing. Term equipment loans generally require a minimum 1.25 DSC and maximum

75% liquidation LTV. Government guaranteed programs are utilized whenever appropriate and available. Agricultural real estate loans are considered for financially sound borrowers with strong financial and management histories. Many of the Company’s agricultural customers are third or fourth generation family farmers with strong real estate equity and limited real estate debt.

 

Real Estate Loans.  For consumers, the Bank offers first mortgage loans to purchase or refinance homes, home improvement loans and home equity loans and credit lines. Conforming first mortgage loans are offered with up to 30-year maturities, while typical maturities for second mortgages (home improvement and home equity loans and lines) are as stated below under “Consumer Loans.” First mortgage loans are underwritten with the intention to sell the loans on the secondary market, so guidelines generally reflect secondary market standards. Lot acquisition and construction loans are also offered to consumer customers with typical terms up to 36 months (interest only loans are also available) and up to 12 months (with six months’ extension), respectively, and are underwritten to both secondary market standards and with a solid take-out mortgage loan approval required.

 

Loans for purchase, construction, rehabilitation or repurchase of commercial and industrial properties are also available through the Bank. Commercial real estate loans are generally confined to owner-occupied properties unless there is a strong customer relationship or sound business project justifying otherwise. Non-owner occupied commercial real estate loans are restricted to borrowers with established track records and the ability to fund potential project cash flow shortfalls from other income sources or liquid assets. Project due diligence is conducted by the Bank, to help provide for adequate contingencies, collateral and/or government guaranties. General underwriting requirements for owner-occupied loans require a minimum DSC of 1.25 and a maximum LTV of 75%. For non-owner occupied loans, a minimum global DSC of 1.25 is required, excluding rents on the subject property, and the LTV maximum is generally less than 75%, depending on the type of property.

 

With current housing market conditions, the Bank is not currently offering residential land acquisition, development or builder loans, and has significantly reduced its concentrations of these types of loans.

 

Consumer Loans.  The Bank offers a variety of consumer loans, including personal loans, motor vehicle loans, boat loans, recreational vehicle loans, home improvement loans, home equity loans, open-end credit lines, both secured and unsecured, and overdraft protection credit lines. The Bank’s terms and underwriting on these loans are consistent with what is offered by competing community banks and credit unions, which generally require sufficient disposable income, solid credit histories, and equity in the collateral. Generally, underwriting guidelines include a maximum debt to income of 40%, credit scores exceeding 700, and maximum LTVs ranging from 80% on home equity loans and lines to 50% to 90% on other types of consumer collateral. Loans for the purchase of new autos typically range up to 60 months. Loans for the purchase of smaller RV’s, pleasure crafts and used vehicles range up to 60 months. Loans for the purchase of larger RV’s and larger pleasure crafts, mobile homes, and home equity loans range up to 120 months (180 months if credit factors and value warrant). Unsecured loans are usually limited to two years, except for credit lines, which may be open-ended but are reviewed by the Bank periodically. Relationship lending is emphasized, which, along with credit control practices, minimizes risk in this type of lending.

 

Municipal Financing.  Operating and term loans are available to entities that qualify for the Bank to offer such financing on a tax-exempt basis. Operating loans are generally restricted by law to the duration of one fiscal year. Term loans, which under certain circumstances can extend beyond one year, typically range up to five years. Municipal financing is restricted to loans with sound purposes and with established tax bases or other revenue to adequately support repayment.

 

Deposit Services

 

The Bank offers the full range of retail deposit services typically available in most banks and savings and loan associations, including checking accounts, savings accounts, money market accounts and various types of certificates of deposit. The transaction accounts and certificates of deposit are tailored to the Bank’s primary market area at rates competitive with those offered in the area. All deposit accounts are insured by the FDIC to the maximum amount permitted by law. The Bank also offers a number of business-oriented deposit accounts, including various types of FDIC-insured checking, savings, money market and time deposit accounts, and non-FDIC insured alternatives including reverse repurchase agreements and sweep accounts. Its deposit product

offerings are generally competitive with both large and small direct competitors and provide strong opportunities for fee income generation through direct service charges, overdraft fee income, and fees associated with related services (see “Other Services” below).

 

Investment Services

 

The Bank provides non-FDIC insured investment services through its division, Trust and Investment Services. Products offered to its customers include annuities, equity and fixed income securities, mutual funds, insurance products and brokerage services. The Bank offers these products in a manner consistent with the principles of prudent and safe banking and in compliance with applicable laws, rules, regulations and regulatory guidelines. The Bank earns fees for providing these services, either on a per-product basis or through a percentage of the balances invested. The Bank is also authorized to provide investment management services through the Trust & Wealth Management Department to clients in all fifty states.

 

Trust & Wealth Management Services

 

The Bank provides trust and wealth management services to its higher net worth customers to assist them in investment, tax and estate planning and to serve as their trustee or other fiduciary. The Bank offers these services in a manner consistent with the principles of prudent and safe banking and in compliance with applicable laws, rules, regulations and regulatory guidelines. The Bank earns fees for managing client assets and providing trust services. The Company is one of the few smaller banking institutions in the northwest to offer in-house trust services, and activity and income from these services has increased continuously since its beginning in 2006. The Bank’s Trust & Wealth Management Department operates under a Trust Charter through the FDIC and the Idaho Department of Finance. Due to the reciprocity arrangements with the states of Oregon and Washington applicable to the Bank’s general banking business, the Bank is authorized to provide fiduciary services and to serve as a fiduciary in relationships located or sited in any of those three states. The Bank is also authorized to provide investment management services through the Trust & Wealth Management Department to clients in all fifty states.

 

Other Services

 

Other consumer-oriented services include automated teller machines (“ATMs”), debit cards, safe deposit boxes, internet and phone banking services, savings bonds, and VISA/Mastercard credit cards. The Bank is a member of the Star, Plus, Exchange, Interlink and Accell ATM networks. New consumer products and services introduced over the past several years include identity theft protection, Certificate of Deposit Account Registry Service (“CDARS”) certificates of deposit, and EZ Points, a debit and credit card rewards program.

 

The Company also offers numerous business services that improve its customers’ operations. Its Business Smart Online product allows companies to manage their financial operations efficiently from any location, including originating ACH entries for payroll, outgoing tax and other payments, and incoming collections. The system also allows transfers of funds to and from various accounts and operating credit lines. Intermountain’s Business Advantage service improves cash flow and accounts receivable collection activities. Credit card acceptance, remote deposit capture, night deposit and concentration account services make it more convenient for businesses to receive and deposit funds quickly, and the Company’s Check Collect service assists them in collecting on returned checks. Intermountain’s positive pay and credit card monitoring services help reduce fraud, and its employee benefits program enhances business customers’ existing benefits programs by providing valuable banking services to their employees at a reduced cost. These services are generally superior to those offered by similar sized and smaller institutions and competitive with those offered by larger institutions. They provide additional fee income to Intermountain, and management is currently evaluating and adjusting pricing on these services to enhance future revenue.

Loan Portfolio

 

The loan portfolio is the largest component of earning assets, and is comprised of net loans receivable and loans held for sale. In 2009, net loans receivable, which includes loans the Company generally intends to keep until repayment or maturity, decreased by 12.9% or $97.0 million. The majority of the decline was in land and land development loans, down $47.9 million, residential construction loans, down $23.4 million, and commercial construction loans, down $14.5 million. Loans held for sale, primarily residential real estate loans originated for sale in the secondary market, increased by 604.6% or $5.6 million.

 

During the past several years, the Company continued to respond to the effects of the economic downturn by tightening underwriting standards and aggressively resolving problem loans through workouts with borrowers, refinances from other sources, and/or collateral liquidation. The Company significantly tightened standards so that new funding for residential land, subdivision and development, and construction lending has generally ceased. Any future lending in this area would require very low loan-to-value ratios and significant outside support from the borrowers. Management also changed underwriting standards on both owner and non-owner occupied commercial real estate loans to require additional hard equity, lower LTVs, and higher DSC ratios, and as part of its underwriting process, subjects commercial real estate loan requests to stress testing using relatively severe scenarios. Commercial and consumer standards were also tightened to reflect tougher economic conditions and generally reduced borrower strength.

 

Overall demand for agriculture, commercial and commercial real estate loans softened, leading to relatively static balances in these types as well. In a difficult economic climate, the Bank continues to pursue quality loans using conservative underwriting and control practices, and is expanding its emphasis on SBA, USDA and other financing assistance programs.

 

The Company has also responded to declining economic conditions by more aggressively monitoring and managing its existing loan portfolio, and adding expertise and resources to these efforts. Additional steps the Company has taken include hiring an in-house appraiser, developing a weekly senior management review of all credit requests over $250,000, increasing the staffing and scope of its internal credit review team, hiring a highly experienced external review team to evaluate the Company’s portfolio, and conducting more rigorous annual evaluations of its home equity credit line portfolio. Bank lending staff continues to utilize relationship pricing models and other techniques to manage interest rate risk and increase customer profitability.

 

The Company’s average loan yield fell from 7.13% in 2008 to 5.92% in 2009 as the Federal Reserve reduced its target rate to a range between 0.00% and 0.25% at the end of 2008 and maintained it there throughout 2009. Other market rates, including the Wall Street Journal prime lending rate, the London Interbank Offered Rate (“LIBOR”) and Federal Home Loan Bank Advance rates also declined, reducing the Company’s loan yields in 2009. In addition, the reversal of interest on non-accrual and charged off loans, totaling $1.9 million in 2009, had a substantial impact on loan yields, reducing the overall loan yield by 0.26%.

 

In 2008, the Company’s net loans receivable declined by $3.9 million or 0.5%. Commercial real estate, commercial construction, multifamily and residential real estate loans all increased, but were offset by significant declines in residential construction, land and land development, and commercial loans.

 

In 2007, the Company increased net loans receivable by 13.9%, or $91.7 million. Increases in commercial real estate and construction and development loans comprised most of the growth.

The following table contains information related to the Company’s total loans and net loans receivable portfolio for the five-year period ended December 31, 2009 (dollars in thousands).

 

 

 

 

Loan Portfolio Concentrations

 

The Bank continuously monitors concentrations of loan categories in regards to industries, loan types and market areas. Concentration guidelines are established and then approved by the Board of Directors at least annually, and are reviewed by management and the Board monthly. Circumstances affecting industries and market areas involved in loan concentrations are reviewed as to their impact as they occur, and appropriate action is determined regarding the loan portfolio and/or lending strategies and practices.

 

As of December 31, 2009, the Bank’s loan portfolio by loan type and geographical market area was:

 

 

Construction and Development Loans

 

Management has focused over the past couple of years on shifting the mix of the loan portfolio away from residential construction, acquisition and development loans to a more balanced mix of commercial, commercial real estate, and residential real estate. It has done this through a combination of more conservative underwriting practices on construction and land development lending, limited marketing, and aggressive resolution and disposal of loans in these categories. As a result, combined loan balances in the commercial, land and land development, and residential construction categories have fallen by $85.8 million, or 36% in 2009.

 

Still, the land development and construction loan components continue to pose higher levels of “loan-type” concentration risk, and continue to comprise the majority of the Company’s problem loans and other real estate owned (“OREO”) properties. Residential real estate values tend to fluctuate with economic conditions, and have been falling rapidly in many of the Bank’s markets for the last two years, although the rate of decline is generally slowing. Management plans to continue curtailing new lending in this segment, and maintaining its aggressive resolution efforts to further reduce risk in this segment.

 

Within this segment, the Bank has lent to contractors and developers, and has also been active in custom construction lending, where the loan is made to the individual consumer who will occupy the home. The Bank is committed to reducing and maintaining its real estate lending concentrations to levels that are below the interagency regulatory guidelines issued in late 2007. Institutions that exceed the levels established in the guidelines are subject to greater supervisory scrutiny. These guidelines established concentration limits as measured against Total Risk

Based Capital (generally, the Company’s common stock, non-cumulative perpetual preferred stock and a portion of its loan loss reserves). The first regulatory guideline establishes the limit for construction, land development and other land loan balances to total risk-based capital not to exceed 100%. Company totals for this category were 151.86%, 183.26% and 270.95% for 2009, 2008 and 2007, respectively, demonstrating the Company’s significant progress toward meeting this guideline. The second guideline establishes the limit for total commercial real estate loans, defined as including the above categories plus loans secured by multifamily and non-farm nonresidential property but excluding loans secured by owner-occupied properties, not to exceed 300% of total risk-based capital. Accordingly, the Company has decreased these balances from 348.78% in 2007 to 254.93% in 2008 and to 214.29% at the end of 2009. As a result, Intermountain is now below the regulatory guideline.

 

Commercial Loans

 

Although the impacts of the economic downturn are increasing risk in the commercial portfolio, management does not consider this portfolio to present a particular “concentration risk” at this time. Management believes there is adequate diversification by type, industry, and geography to mitigate excessive risk. The commercial portfolio includes a mix of term loan facilities and operating loans and lines made to a variety of different business types in the markets it serves. The Company utilizes SBA, USDA and other government-assisted or guaranteed financing programs whenever advantageous to further mitigate risk in this area. With the exception of the agricultural portfolio, there is no other significant concentration of industry types in its loan portfolio, and no dominant employer or industry across all the markets it serves. Underwriting focuses on the evaluation of potential future cash flows to cover debt requirements, sufficient collateral margins to buffer against devaluations, credit history of the business and its principals, and additional support from willing and capable guarantors.

 

Agricultural Loans

 

The agricultural portfolio represents a larger percentage of the loans in the Bank’s southern Idaho region. At December 31, 2009, agricultural loans and agricultural real estate loans totaled $110.3 million or 16.4% of the total loan portfolio. The agricultural portfolio consists of loans secured by livestock, crops and real estate. To mitigate credit risk, specific underwriting is applied to retain only borrowers that have proven track records in the agricultural industry. Many of Intermountain’s agricultural borrowers are third or fourth generation farmers and ranchers with limited real estate debt, which reduces overall debt coverage requirements and provides extra flexibility and collateral for equipment and operating borrowing needs. In addition, the Bank has hired senior lenders with significant experience in agricultural lending to administer these loans. Further mitigation is provided through frequent collateral inspections, adherence to farm operating budgets, and annual or more frequent review of financial performance. The Company has minimal exposure to the dairy industry, the one significant agricultural segment that has been under extreme pressure for the last couple of years.

 

Commercial Real Estate Loans

 

Difficult economic conditions are increasing risk in the non-residential component of the commercial real estate portfolio. However, in comparison to peers, the Company has less overall exposure to commercial real estate and a stronger mix of owner-occupied (where the borrower occupies and operates in at least part of the building) versus non-owner occupied loans. Based on December 31, 2009 UBPR data, the Company’s total commercial real estate exposure excluding construction loans was 25.4% versus the peer group average of 36.7%. Of that total, 45% was owner-occupied or farmland versus 43% of the peer groups (Source: UBPR data from the FFIEC for 12-31-09). The loans represented in this category are spread across the Company’s footprint, and there are no significant concentrations by industry type or borrower. The most significant property types represented in the portfolio are office (17%), industrial (15%), multifamily (10%), health care (6%), and retail (6%). The other 46% is a mix of property types with smaller concentrations, including religious facilities, auto-related properties, restaurants, convenience stores, storage units, motels and commercial investment land. Finished condominiums comprise only

2% of the commercial real estate portfolio, although there are also several unfinished condo projects in the construction and development portfolio.

 

 

While 62% of the Company’s commercial real estate portfolio is in its Northern Idaho/Eastern Washington region, this region is a large and diverse region with differing local economies and real estate markets. Given this diversity, and the diversity of property types and industries represented, management does not believe that this concentration represents a significant concentration risk.

 

Non-owner occupied commercial real estate loans are made only to borrowers with established track records and the ability to fund potential project cash flow shortfalls from other income sources or liquid assets. Project due diligence is conducted by the Bank, to help provide for adequate contingencies, collateral and/or government guaranties. The Company has largely avoided speculative financing of investment properties, particularly of the types most vulnerable in the current downturn, including investment office buildings and retail strip developments. Management believes geographic, borrower and property-type diversification, and prudent underwriting and monitoring standards applied by seasoned commercial lenders mitigate concentration risk in this segment.

 

Residential Real Estate and Consumer

 

Residential real estate and consumer loans comprise smaller segments of the loan portfolio. Management does not believe they represent significant concentration risk. While debt service ability and collateral values have declined in these segments, underwriting has generally been more conservative, with higher debt-to-income and equity requirements than found elsewhere in the financial industry.

 

Geographic Distribution

 

In terms of geographic distribution, 74% of the Company’s loans are in north Idaho, eastern Washington and southwest Idaho outside the Boise area. Although economic trends and real estate valuations have worsened in these market areas, delinquency levels and price declines have been less significant than in Boise or other areas of the country. This reflects the differing economies in these areas, generally more conservative lending and borrowing norms, and more restrained building and development activity. In particular, large national and regional developers and builders did not enter and subsequently exit these markets. The southwest Idaho and Magic Valley markets are largely agricultural areas which have not seen rapid price appreciation or depreciation over the last few years. Through aggressive loan workout efforts, the Company has reduced its exposure to the Boise area market significantly over the past year, resulting in proportionally higher loan balances in the regions outside of Boise

from the prior year. The “Other” category noted above largely represents loans made to local borrowers where the collateral is located outside the Company’s communities. The mix in this category is relatively diverse, with the highest proportions in Oregon, Washington, California, Nevada and Wyoming, but no single state comprising more than 27% of this total or 1.5% of the total loan portfolio.

 

Participation loans where Intermountain purchased part of the loan and was not the lead bank totaled $17.5 million at year end, of which one loan totaling $1.7 million was outside the Company’s footprint. This loan was subsequently paid off after year end. $7.1 million of the remaining total is a condominium project in Boise that is currently classified, but is being managed very closely. The remaining loans are all within the Company’s footprint and considered not to present significant risk at this time.

 

Classification of Loans

 

The Bank is required under applicable law and regulations to review its loans on a regular basis and to classify them as “satisfactory,” “special mention,” “substandard,” “doubtful” or “loss.” A loan which possesses no apparent weakness or deficiency is designated “satisfactory.” A loan which possesses weaknesses or deficiencies deserving close attention is designated as “special mention.” A loan is generally classified as “substandard” if it possesses a well-defined weakness and the Bank will probably sustain some loss if the weaknesses or deficiencies are not corrected. A loan is classified as “doubtful” if a probable loss of principal and/or interest exists but the amount of the loss, if any, is subject to the outcome of future events which are undeterminable at the time of classification. It is a transitional category, and once the amount of the loss is determined, this amount is charged off and the remaining balance of the loan would most likely be classified as “substandard.” The typical duration of a loan in the “doubtful” category would be one to two months. If a loan is classified as “loss,” the Bank either establishes a specific valuation allowance equal to the amount classified as loss or charges off such amount.

 

During 2007, the Company modified its risk grade allocation factors to better reflect varying loss experiences in different types of loans. As of December 31, 2009, the risk factors range from cash equivalent secured loans (Risk Grade “1”) to “loss” (Risk Grade “8”). Risk Grades “3”, “5”, “6”, “7” and “8” closely reflect the FDIC’s definitions for “satisfactory,” “special mention,” “substandard”, “doubtful” and “loss”, respectively. Risk Grade “4” is an internally designated “watch” category. At December 31, 2009, the Company had $6.7 million in the special mention, $75.6 million in the substandard, $1.6 million in the doubtful and $0 in the loss loan categories. At December 31, 2008, the Company had $7.3 million in the special mention, $50.8 million in the substandard, $3.0 million in the doubtful and $0 in the loss loan categories.

 

At December 31, 2009, classified loans (loans with risk grades 6, 7 or 8) by loan type are as follows (dollars in thousands):

 

 

Overall, classified loans (loans with risk grades 6, 7, or 8) increased from $53.8 million at the end of 2008 to $77.2 million at the end of 2009. The increase reflected the impact of the deteriorating economy and real estate conditions throughout the Company’s market area. Unemployment rates increased significantly, placing additional stress on businesses and consumers alike. This resulted in more borrowers facing difficulties in maintaining their ability to service the Company’s debts. At the same time, real estate and other property valuations declined as well,

reducing the ability of borrowers or the Bank to liquidate assets or rely on other repayment sources to cover shortfalls in the cash flow required to service their debts. Construction and land development loans, in which debt repayment is primarily based on liquidation of property, were particularly hard hit, as real estate purchase markets slowed significantly and property values declined. Most of the increase in classified loans between 2008 and 2009 were in loans that were real-estate related, particularly construction and land development.

 

Non-accrual loans are those loans that have become delinquent for more than 90 days (unless well-secured and in the process of collection). Placement of loans on non-accrual status does not necessarily mean that the outstanding loan principal will not be collected, but rather that timely collection of principal and interest is in question. When a loan is placed on non-accrual status, interest accrued but not received is reversed. The amount of interest income which was reversed from income in fiscal years 2009, 2008, 2007, 2006 and 2005 on non-accrual and other problem loans was approximately $1.9 million, $465,000, $161,000, $21,000 and $95,000, respectively. A non-accrual loan may be restored to accrual status if it is brought current and has performed in accordance with contractual terms for a reasonable period of time, and the collectability of the total contractual principal and interest is no longer in doubt. Other problem loans are loans that were not put in the non-accrual status but were charged off or transferred to OREO during the year.

 

Information with respect to non-performing loans and other non-performing assets is as follows (dollars in thousands):

 

Non-Accrual Trending

 

 

Credit Quality Trending

 

 

 

 

The $7.9 million decrease in non-accrual loans from December 31, 2008 to December 31, 2009 resulted from a combination of aggressive efforts by our special assets team to work out or liquidate these loans and chargedowns in cases where there was a collateral deficiency. This team continued to move properties through the collections process and made steady progress in reducing overall levels of both classified and non-accrual loans through multiple management strategies, including borrower workouts, individual asset sales to local and national investors, and bulk sales and auctions of like properties. NPAs fell $6.1 million from the third quarter of 2009, and totaled 2.83% of total assets at December 31, 2009, down from 3.47% in the preceding quarter. NPAs reached their peak of $47.7 million in May 2009 and have trended down since then. Loan delinquencies (30 days or more past due) also declined during the fourth quarter to 0.93% from 1.48% of total loans at the end of the third quarter, although they were up slightly from the fourth quarter 2008 level of 0.90%. Loan delinquencies (30 days or more past due) reached their peak in April 2009 at a rate of 3.10%. The $20.8 million increase in non-accrual loans from December 31, 2007 to December 31, 2008 consisted primarily of residential land, subdivision and construction loans where repayment was primarily reliant on selling the asset. The Company continues to monitor its non-accrual loans closely and revalue the collateral on a periodic basis. This re-evaluation may create the need for additional write-downs or additional loss reserves on these assets.

 

Other Real Estate Owned Activity

 

 

 

 

The balance of OREO increased by $7.0 million during 2009, as the Bank worked higher levels of non-performing loans through the collection and foreclosure process. Disposition of OREO assets increased markedly in the latter half of 2009, resulting in a reduction between the end of the third and fourth quarters of $2.9 million. At year end, OREO assets consisted of commercial land (25%), developed residential lots (23%), raw land (23%), commercial buildings (17%), and single family residences (12%). The Credit Risk Management and Asset Disposition groups continue to work rapidly to dispose of OREO properties through a combination of individual sales to homeowners and investors, bulk sales to investors, and auction sales, generally as a last resort.

December 31, 2009 Non-Performing Assets by Loan/Property Type and Location

 

 

 

 

Residential land, commercial construction and residential construction loans continue to comprise most of the nonperforming asset totals, reflecting continuing weakness in the real estate markets. The top 10 non-performing loans totaled $7.6 million, or 40% of total non-performing loans and the top 6 OREO properties accounted for 59% of the OREO balance. The geographic distribution of NPAs generally correlates with the distribution of the overall loan portfolio, except that the percent of total NPAs in the “North Idaho — Eastern Washington region” is slightly higher than the percent of the loan portfolio in this region, and correspondingly, the percent of total NPAs in the “E. Oregon, SW Idaho excluding Boise” is lower. This reflects generally stronger economic conditions in the Southwest Idaho market outside Boise, as a result of its agricultural base. The “Other” NPAs total is largely comprised of one commercial property in western Washington. All NPAs are reported at the Company’s best estimate of net realizable value, and are frequently re-evaluated for changes that would require additional write downs.

 

Management continues to focus its efforts on managing down the level of non-performing assets, classified loans and delinquencies. It uses a variety of analytical tools and an integrated stress testing program involving both qualitative and quantitative modeling to assess the current and projected state of its credit portfolio. The results of this program are integrated with the Company’s capital and liquidity modeling programs to manage and mitigate future risk in these areas as well. In early 2010, the Company contracted with an independent loan review firm to further evaluate and provide independent analysis of its portfolio and make recommendations for portfolio management improvement. In particular, the review quantified and stratified the loans in the Bank’s portfolio based upon layered risk, product type, asset class, loans — to-one borrower, and geographic location. The purpose of the review was to provide an independent assessment of the potential imbedded risks and dollar exposure within the Bank’s loan portfolio. The scope included 1,000 loans representing over 80% of the total loan portfolio and included specific asset evaluations and loss forecasts for the majority of the loan portfolio. The firm employed seasoned financial and commercial lending personnel to complete the individual loan reviews. Based on its evaluation of both external and internal loan review results, management does not believe that it needs to materially alter its 12-month forward loss projections. It has and continues to incorporate a number of the recommendations made by the review firm into its ongoing credit management process.

Allowance for Loan Losses

 

The allowance for loan losses is based upon management’s assessment of various factors including, but not limited to, current and future economic trends, historical loan losses, delinquencies, and underlying collateral values, as well as current and potential risks identified in the loan portfolio. The allowance is evaluated on a monthly basis by management. The methodology for calculating the allowance is discussed in more detail below. An allocation is also included for unfunded loan commitments. However, this allocation is recorded as a liability, as required by bank regulatory guidance issued in early 2007.

 

Allocation of the Allowance for Loan Losses
and Non-Accrual Loans Detail
(Dollars in thousands)

 

 

 

 

 

 

In the table above, commercial loans for the periods 2005-2008 include commercial real estate loans, as well as residential land, subdivision acquisition and development, and builder loans, where the borrower is not a consumer.

 

During 2007, the Company changed its method of calculating its loan loss allowance in line with bank regulatory guidance issued earlier that year. It continued to refine this methodology in 2008 and 2009 with improved modeling and collateral valuation analysis. The loan portfolio is segregated into loans for which a specific reserve is calculated by management, and loans for which a reserve is calculated using an allowance model. For loans with a specific reserve, management evaluates each loan and derives the reserve based on such factors as expected collectability, collateral value and guarantor support. For loans with reserves calculated by the model, the model mathematically derives a base reserve allocation for each loan using probability of default and loss given default rates based on both historical company and industry experience. This base reserve allocation is then modified by management considering factors such as the current economic environment, portfolio delinquency trends, collateral valuation trends, quality of underwriting and quality of collection activities. The reserves derived from the model are modified by management, then added to the reserve for specifically identified loans to produce the total reserve. Management believes that this methodology provides a more accurate, reliable and verifiable reserve calculation and is in compliance with recent regulatory guidance. The Bank’s total allowance for loan losses was 2.47% of total

loans at December 31, 2009 and 2.14% of total loans at December 31, 2008. The following table provides additional detail on the allowance.

 

Trend Analysis of the Allowance for Loan Losses

 

 

 

 

Management’s general policy is to charge off loans or portions of loans as soon as an identifiable loss amount can be determined from evidence obtained, such as updated appraisals or similar real estate evaluations, equipment, inventory or similar collateral evaluations, or accepted offers on loan sales or negotiated discounts. In situations where problem loans are dependent on collateral liquidation for repayment, management obtains updated independent valuations, generally no less frequently than once every six months and more frequently for larger or more troubled loans. In the time period between these independent valuations, it monitors market conditions for any significant event or events that would materially change the valuations, and updates them as appropriate.

 

The following table details loan maturity and repricing information for fixed and variable rate loans.

 

Maturity and Repricing for the Bank’s
Loan Portfolio at December 31, 2009

 

 

The Company has traditionally maintained a high level of variable rate loans as part of its overall balance sheet management approach. The significant unanticipated decrease in market rates experienced during the economic downturn and financial turmoil of the past several years impacted these loans negatively and created additional pressure on the Company’s asset yields and net interest margin. However, this approach positions the Company well for a rising rate environment, in which event the Company may experience improvement in margin.

 

Investments

 

The investment portfolio is the second largest earning asset category and is comprised mostly of securities categorized as available-for-sale. These securities are carried at fair value. Unrealized gains and losses that are considered temporary are recorded as a component of accumulated other comprehensive income or loss.

 

The carrying value of the available-for-sale securities portfolio increased 23.1% to $181.8 million at December 31, 2009 from $147.6 million at December 31, 2008. The carrying value of the held-to-maturity securities portfolio decreased 13.8% to $15.2 million at December 31, 2009 from $17.6 million at December 31, 2008. During 2009, the Company deployed funds from reductions in the Company’s loan portfolio and increases in deposits into the investment portfolio. In addition, market conditions caused a slight increase in the carrying value of some of the Company’s available-for-sale securities. In a generally stable rate environment, the Company sought to maintain the yield on the investment portfolio, position it for potentially higher rates in the future, and otherwise use it to limit the Bank’s overall interest rate risk during the year. In doing so, the Company shortened the duration of its portfolio in anticipation of future higher rates. The Company used a combination of U.S. agency debentures and mortgage-backed securities, whole loan collateralized mortgage obligations (“CMOs”), and municipal bonds to accomplish this positioning. The average duration of the available for sale and the held-to-maturity portfolios was approximately 2.8 years and 8.5 years, respectively on December 31, 2009, compared to 4.9 years and 9.2 years, respectively on December 31, 2008. The average duration differs from the investments contractual maturity as average duration takes into account estimated prepayments.

 

As noted above, available-for-sale securities are required by generally accepted accounting principles to be accounted for at fair value (See Note 20 “Fair Value of Financial Instruments” in the Company’s Consolidated Financial Statements for more information.

 

Active markets exist for securities totaling $149.6 million classified as available for sale as of December 31, 2009. For these securities, the Company obtained fair value measurements from an independent pricing service and internally validated these measurements. The fair value measurements consider observable data that may include

dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus, prepayment speeds, credit information and the bond’s terms and conditions, among other things.

 

The available for sale portfolio also includes $32.2 million in super senior or senior tranche collateralized mortgage obligations not backed by a government or other agency guarantee. These securities are collateralized by fixed rate prime or Alt A mortgages, are structured to provide credit support to the senior tranches, and are carefully analyzed and monitored by management. Because of disruptions in the current market for non-government agency guaranteed mortgage-backed securities and CMOs, an active market did not exist for these securities at December 31, 2009. This is evidenced by a significant widening in the bid-ask spread for these types of securities and the limited volume of actual trades made. As a result, less reliance can be placed on easily observable market data, such as pricing on transactions involving similar types of securities, in determining their current fair value. As such, significant adjustments were required to determine the fair value at the December 31, 2009 measurement date.

 

In valuing these securities, the Company utilized the same independent pricing service as for its other available-for-sale securities. In addition, it utilized a second pricing service that specializes in whole-loan obligation CMO valuation and Federal Home Loan Bank pricing indications to derive independent valuations and used this data to evaluate and adjust the values derived from the original independent pricing service. In addition to the observable market-based input including dealer quotes, market spreads, live trading levels and execution data, both services also employed a present-value income model that considered the nature and timing of the cash flows and the relative risk of receiving the anticipated cash flows as agreed. The discount rates used were based on a risk-free rate, adjusted by a risk premium for each security. In accordance with accounting guidance, the Company has determined that the risk-adjusted discount rates utilized appropriately reflect the Company’s best estimate of the assumptions that market participants would use in pricing the assets in a current transaction to sell the asset at the measurement date. Risks include nonperformance risk (that is, default risk and collateral value risk) and liquidity risk (that is, the compensation that a market participant receives for buying an asset that is difficult to sell under current market conditions). To the extent possible, the pricing services and the Company validated the results from these models with independently observable data.

 

Two securities, with a book value of $7.5 million were rated as “substandard” assets by the Company at December 31, 2009 based on the delinquency and default characteristics of the underlying mortgages and the ratings assigned by independent rating agencies. Both carry ratings that are below “investment grade,” as commonly defined with the securities industry. As with classified loans, the “substandard” rating does not mean that the Company will incur a loss on either security, particularly if the securities are held to maturity. Both these securities are monitored closely and evaluated periodically for other-than-temporary impairment. The following table summarizes the value of the “substandard” assets at December 31, 2009 (in thousands):

 

 

Other-than-Temporary Impairment

 

As noted above, the Company evaluated these and other securities in the investment portfolio for “Other-than-Temporary Impairment” per accounting guidance. In conducting this evaluation, the Company analyzed the following factors:

 

 

 

At March 31, 2009, one of the “substandard securities” noted above was considered to be other than temporarily impaired. Due to the lack of an orderly market for the security and the declining national economic and housing market, its fair value was determined to be $2.5 million at that time based on analytical modeling taking into consideration a range of factors normally found in an orderly market. Of the $1.7 million original other-than-temporary impairment (“OTTI”) on this security, based on an analysis of projected cash flows, $244,000 was charged to earnings as a credit loss and $1.5 million was recognized in other comprehensive income. The Company recorded additional credit loss impairments of $198,000 and $84,000, respectively in the third and fourth quarters of 2009, reducing the non-credit value impairment to $1.2 million. The reduction of the non-credit impairment during the year is due to the fact that while the present value of the cash flows expected to be collected deteriorated, the overall estimated market value of the security improved. The credit loss on a security is measured as the difference between the amortized cost basis and the present value of the cash flows expected to be collected. Projected cash flows are discounted by the original or current effective interest rate depending on the nature of the security being measured for potential OTTI. The remaining impairment related to all other factors, the difference between the present value of the cash flows expected to be collected and fair value, is recognized as a charge to other comprehensive income (“OCI”). Impairment losses related to all other factors are presented as separate categories within OCI. At this time, the Company anticipates holding the security until its value is recovered or until maturity, and will continue to adjust its net income and other comprehensive income to reflect potential future credit loss impairments and the security’s market value. The Company calculated the credit loss charges against earnings each quarter by subtracting the estimated present value of future cash flows on the security from its amortized cost at the end of each period.

 

The following table displays investment securities balances and repricing information for the total portfolio:

 

Investment Portfolio Detail
As of December 31, 2009

 

Investments held as of December 31, 2009
Mature as follows:

 

 

Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

Intermountain’s investment portfolios are managed to provide and maintain liquidity; to maintain a balance of high quality, diversified investments to minimize risk; to offset other asset portfolio elements in managing interest rate risk; to provide collateral for pledging; and to maximize returns. At December 31, 2009, the Company does not intend to sell any of its available-for-sale securities that have a loss position and it is not likely that it will be required to sell the available-for-sale securities before the anticipated recovery of their remaining amortized cost. However, unforeseen changes in credit risk or other types of portfolio risk could cause management to change its position and sell individual securities on a case-by-case basis. The unrealized losses on residential mortgage-backed securities without other-than-temporary impairment were considered by management to be temporary in nature.

 

See Note 20 “Fair Value of Financial Instruments” in the Company’s Consolidated Financial Statements for more information on the calculation of fair or carrying value for the investment securities.

 

Fed Funds Sold & Cash Equivalents

 

The Bank held $81.7 million in excess funds at the Federal Reserve at December 31, 2009, as compared to $71.5 million in Fed Funds Sold at December 31, 2008. At December 31, 2009, excess funds were held at the Federal Reserve as opposed to Fed Funds Sold at a correspondent bank as there was a higher yield on the excess funds at the Federal Reserve. During 2009, the Company maintained an average balance of Fed Funds Sold and interest-bearing unrestricted cash equivalents (referred to in subsequent references as “Fed Funds Sold” for ease of reference and because the instruments are not materially different) of $43.9 million as a strategy to preserve and enhance liquidity during a period of extreme market turmoil. This compares to an average balance of Fed Funds Sold in 2008 of $17.7 million. The higher level of Fed Funds Sold maintained during 2009 resulted in a decrease in interest income and net interest income as the Fed Funds Sold yield during 2009 was at historically low levels of between 0.00% and 0.25%.

Deposits