UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington D.C. 20549

FORM 10-K

(Mark One)

þ		Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the fiscal year ended December 31, 2006, or

o		Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from                      to                     .

Commission File Number: 000-49733

FIRST INTERSTATE BANCSYSTEM, INC.

(Exact name of registrant as specified in its charter)

Montana (State or other jurisdiction of incorporation or organization)		81-0331430 (IRS Employer Identification No.)
401 North 31st Street Billings, Montana (Address of principal executive offices)		59116 (Zip Code)

(406) 255-5390
(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act: Common stock without par value per share

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

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

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. þ Yes o No

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the 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. o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

o Large accelerated filer      o Accelerated filer      þ Non-accelerated filer

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

Aggregate market value (appraised minority value) of voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter, June 30, 2006, was $47,096,814.

The number of shares outstanding of the registrant’s common stock as of February 28, 2007 was 8,186,709.

Documents Incorporated by Reference

The registrant intends to file a definitive Proxy Statement for the Annual Meeting of Shareholders scheduled to be held May 4, 2007. The information required by Part III of this Form 10-K is incorporated by reference from such Proxy Statement.

 

 

PART I

Cautionary Note Regarding Forward-Looking Statements

     This report contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Rule 175 promulgated thereunder, and Section 21E of the Securities Exchange Act of 1934, as amended, and Rule 3b-6 promulgated thereunder, that involve inherent risks and uncertainties. Any statements about our plans, objectives, expectations, strategies, beliefs, or future performance or events constitute forward-looking statements. Such statements are identified as those that include words or phrases such as “believes,” “expects,” “anticipates,” “plans,” “trend,” “objective,” “continue” or similar expressions or future or conditional verbs such as “will,” “would,” “should,” “could,” “might,” “may” or similar expressions. Forward-looking statements involve known and unknown risks, uncertainties, assumptions, estimates and other important factors that could cause actual results to differ materially from any results, performance or events expressed or implied by such forward-looking statements. All forward-looking statements are qualified in their entirety by reference to the factors discussed in this report including, among others, the following risk factors discussed more fully in Item 1A hereof: (i) credit risk; (ii) business concentration and economic conditions in Montana and Wyoming; (iii) declines in real estate values; (iv) changes in interest rates; (v) inability to meet liquidity requirements; (vi) competition; (vii) failure of technology; (viii) breach in information system security; (ix) ineffective internal operational controls; (x) difficulties in execution of business strategy; (xi) disruption of vital infrastructure and other business interruptions; (xii) litigation pertaining to fiduciary responsibilities; (xiii) changes in or noncompliance with governmental regulations; (xiv) restrictions on dividends and stock redemptions; (xv) capital required to support our bank subsidiary; and (xvi) investment risks affecting holders of common stock. Because the foregoing factors could cause actual results or outcomes to differ materially from those expressed or implied in any forward-looking statements, undue reliance should not be placed on any forward-looking statements. Further, any forward-looking statement speaks only as of the date on which it is made, and we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of future events or developments.

Item 1. Business

Overview

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

     We are a financial and bank holding company that was incorporated in Montana in 1971. We are headquartered in Billings, Montana. As of December 31, 2006, we had assets of $5.0 billion, deposits of $3.7 billion and total stockholders’ equity of $410 million. Our wholly-owned bank subsidiary, First Interstate Bank, has 49 banking offices in 29 Montana and Wyoming communities. Through the Bank, we deliver a comprehensive range of banking products and services, including demand and savings deposits; commercial, consumer, agricultural and real estate loans; mortgage loan origination and servicing; and, trust, employee benefit, investment and insurance services. We serve individuals, businesses, municipalities and other entities throughout our market areas. We are the largest banking organization in Montana and Wyoming.

     We also conduct other financial activities through wholly-owned nonbank subsidiaries. Our principal consolidated nonbank subsidiaries include the following companies:

	•		i_Tech Corporation, or i_Tech, which provides technology services to the Bank and other non-affiliated customers in Montana, Wyoming and seven additional states. i_Tech also provides processing support for 2,337 ATM locations in 32 states.
	•		FIBCT, LLC, which provides internet-based products and services to financial institutions and small to medium-sized businesses, including web page design, development and hosting; logo design; domain registration; development of internet-based training, marketing and e-commerce products; and, software development.
	•		First Interstate Insurance Agency, Inc., which provides insurance products to individual and business customers.
	•		FI Reinsurance, Ltd., domiciled in Nevis Island, West Indies, which underwrites, as reinsurer, credit-related life and disability insurance.

     We are the licensee under a perpetual trademark license agreement granting us an exclusive, nontransferable license to use the “First Interstate” name and logo in Montana, Wyoming and surrounding states.

     We derive our income principally from interest charged on loans, and to a lesser extent, from interest and dividends earned on investments. We also derive income from noninterest sources such as fees received in connection with various banking and financial related services. Our principal expenses include interest expense on deposits and borrowings, operating expenses, provisions for loan losses and income tax expense.

Strategic Vision

     The banking industry continues to experience change with respect to regulatory matters, consolidation, consumer needs and economic and market conditions. We believe we can best address this changing environment through our “Strategic Vision.” Our Strategic Vision is to maintain and enhance our leadership in the financial and social fabrics of the communities we serve through a commitment to customer satisfaction, innovative management, employee development and community involvement.

Operating Segments

     Our business consists of two reportable operating segments, Community Banking and Technology Services. Financial information and analysis of our reportable operating segments is included in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Results of Operations – Operating Segment Results” included in Part II, Item 7 of this report and in Note 24 of the “Notes to Consolidated Financial Statements” included in Part IV, Item 15 of this report.

Community Banking

     Our principal operating segment, Community Banking, encompasses commercial and consumer banking services provided through our Bank, primarily the acceptance of deposits; extensions of credit; mortgage loan origination and servicing; and, trust, employee benefit, investment and insurance services. We believe the communities we serve provide a stable core deposit and funding base, and are economically diversified across a number of industries, including agriculture, energy, mining, timber processing, tourism, government services, education, retail, and professional and medical services. Our community banking philosophy emphasizes providing customers with commercial and consumer banking products and services locally using a personalized service approach while strengthening the communities in our market areas through community service activities. We grant our banking offices significant autonomy in delivering and pricing products in response to local market considerations and customer needs. This autonomy enables our banking offices to remain competitive and enhances their relationships with the customers they serve. We also emphasize accountability, however, by establishing performance and incentive standards that are tied to net income and other success measures at the individual banking office and market levels. We believe this combination of autonomy and accountability allows our banking offices to provide personalized customer service while remaining attentive to financial performance. Our profitability, market share and asset size have been enhanced in recent years principally through organic loan and deposit growth in market areas served by our existing banking offices.

Lending Activities

     We have comprehensive credit policies establishing company-wide underwriting and documentation standards to assist management in the lending process and to limit our risk. These credit policies establish lending guidelines based on the experience and authority levels of the personnel located in each banking office and market. The policies also establish thresholds at which loan requests must be recommended by our credit committee and/or approved by the Bank’s board of directors.

     We offer short and long-term real estate, consumer, commercial, agricultural and other loans to individuals and businesses in our market areas. While each loan must meet minimum underwriting standards established in our credit policies, lending officers are granted certain levels of autonomy in approving and pricing loans to assure that the banking offices are responsive to competitive issues and community needs in each market area.

     Additional information about our loan portfolio is included in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Financial Condition – Loans,” included in Part II, Item 7 of this report.

Deposit Products

     We offer traditional depository products including checking, savings and time deposits. Deposits at the Bank are insured by the Federal Deposit Insurance Corporation, or FDIC, up to statutory limits. We also offer repurchase agreements primarily to commercial and municipal depositors. Under repurchase agreements, we sell investment securities held by the

Bank to our customers under an agreement to repurchase the investment securities at a specified time or on demand. The Bank does not, however, physically transfer the investment securities. As of December 31, 2006, all outstanding repurchase agreements were due in one business day.

     Additional information about our deposits, repurchase agreements and other funding sources is included in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Financial Condition – Deposits,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Financial Condition – Other Borrowed Funds,” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Financial Condition – Federal Funds Purchased and Securities Sold Under Repurchase Agreements,” included in Part II, Item 7 of this report.

Financial Services

     We provide a wide range of trust, employee benefit, investment management, insurance, agency and custodial services to individuals, businesses and nonprofit organizations. These services include the administration of estates and personal trusts; management of investment accounts for individuals, employee benefit plans and charitable foundations; and, insurance planning. At December 31, 2006, the estimated fair value of trust assets held in a fiduciary or agent capacity was $3.1 billion.

Centralized Services

     We have centralized certain operational activities to provide consistent service levels to our customers company-wide, to gain efficiency in management of those activities and to ensure regulatory compliance. Centralized operational activities generally support our banking offices in the delivery of products and services to customers and include marketing; credit review; credit cards; mortgage loan sales and servicing; indirect consumer loan purchasing and processing; loan collections; and, other operational activities. Additionally, policy and management direction and specialized staff support services have been centralized to enable the Bank to serve its markets more effectively. These services include credit administration, finance, accounting, human resource management, internal audit and other support services.

Competition

     Commercial banking is highly competitive. We compete with other financial institutions located in Montana and Wyoming and adjoining states for deposits, loans and trust, employee benefit, investment and insurance accounts. We also compete with savings and loan associations, savings banks and credit unions for deposits and loans. In addition, we compete with large banks in major financial centers and other financial intermediaries, such as consumer finance companies, brokerage firms, mortgage banking companies, insurance companies, securities firms, mutual funds and certain government agencies as well as major retailers, all actively engaged in providing various types of loans and other financial services. We generally compete on the basis of customer service and responsiveness to customer needs, available loan and deposit products, rates of interest charged on loans, rates of interest paid for deposits and the availability and pricing of trust, employee benefit, investment and insurance services.

Technology Services

     The Technology Services operating segment encompasses services provided by i_Tech to affiliated and non-affiliated customers, including core application data processing; ATM and debit card processing; item proof and capture; wide area network services and system support; and, processing support for a network of ATM locations.

     i_Tech, provides centralized technology support services to the Bank, including system support of the general ledger, investment security, loan, deposit, web banking, document imaging, management reporting and cash management systems. i_Tech also manages our wide-area network and the ATM network used by the Bank and provides item proof and capture services. These technology services are performed through the use of computer hardware owned by the Bank and leased to i_Tech and software licensed by i_Tech.

     While historically the technology services industry has been highly decentralized, there is an accelerating trend toward consolidation resulting in fewer companies competing over larger geographic regions. i_Tech’s competitors vary in size and include national and regional operations. i_Tech generally competes on the basis of customer service, price, product offering, reliability and available technology.

Employees

     At December 31, 2006, we employed 1,608 full-time equivalent employees, none of whom are represented by a collective bargaining agreement. We strive to be the employer of choice in the markets we serve and consider our employee relations to be good.

Regulation and Supervision

Regulatory Authorities

     We are subject to extensive regulation under federal and state laws. A description of the significant elements of the laws and regulations applicable to us is summarized below. This summary is not intended to include a summary of all laws applicable to us, and the description is qualified in its entirety by reference to the full text of the applicable statutes, regulations and policies. In addition to laws and regulations, state and federal banking regulatory agencies may issue policy statements, interpretive letters and similar written guidance applicable to us. Those issuances may affect the conduct of our business or impose additional regulatory obligations.

     As a bank and financial holding company, we are subject to regulation under the Bank Holding Company Act of 1956 and to supervision, regulation and regular examination by the Federal Reserve. Because we are a public company, we are also subject to the disclosure and regulatory requirements of the Securities Act of 1933 and the Securities Exchange Act of 1934 as administered by the Securities and Exchange Commission.

     The Bank is subject to supervision and regular examination by its primary banking regulators, the Federal Reserve and the State of Montana, Division of Banking and Financial Institutions, and, with respect to its activities in Wyoming, the State of Wyoming, Department of Audit. The Bank’s deposits are insured by the deposit insurance fund of the FDIC in the manner and to the extent provided by law. The Bank is subject to the Federal Deposit Insurance Act, or FDIA, and FDIC regulations relating to deposit insurance and may also be subject to supervision and examination by the FDIC.

     The extensive regulation of the Bank limits both the activities in which the Bank may engage and the conduct of its permitted activities. Further, the laws and regulations impose reporting and information collection obligations on the Bank. The Bank incurs significant costs relating to compliance with the various laws and regulations and the collection and retention of information.

     First Interstate Insurance Agency, a wholly-owned nonbank subsidiary of ours, is subject to regulation and supervision by the Montana State Auditor’s Office and laws and regulations affecting the insurance industry generally.

Financial Holding Company

     As a matter of policy, the Federal Reserve expects a bank holding company to act as a source of financial and managerial strength to its subsidiary banks and to commit resources to support its subsidiary banks. Under this source of strength doctrine, the Federal Reserve may require a bank holding company to make capital injections into a troubled subsidiary bank. They may also claim that the bank holding company is engaging in unsafe and unsound practices if it fails to commit resources to such a subsidiary bank. A capital injection may be required at times when the bank holding company does not have the resources to provide it.

     We are required by the Bank Holding Company Act to obtain Federal Reserve approval prior to acquiring, directly or indirectly, ownership or control of voting shares of any bank, if, after such acquisition, we would own or control more than 5% of its voting stock.

     Under the Gramm-Leach-Bliley Act of 1999, or GLB Act, we may engage in certain business activities that are determined by the Federal Reserve to be financial in nature or incidental to financial activities as well as all activities authorized to bank holding companies generally. In most circumstances, we must notify the Federal Reserve of our financial activities within a specified time period following our initial engagement in each business or activity. If the type of proposed business or activity has not been previously determined by the Federal Reserve to be financially related or incidental to financial activities, we must receive the prior approval of the Federal Reserve before engaging in the activity.

     We may engage in authorized financial activities, such as providing investment services, provided that we remain a financial holding company and meet certain regulatory standards of being “well-capitalized” and “well-managed.” If we fail to meet the “well-capitalized” or “well-managed” regulatory standards, we may be required to cease our financial holding company activities or, in certain circumstances, to divest of the Bank. We do not currently engage in significant financial holding company businesses or activities not otherwise permitted to bank holding companies generally. Should we engage in certain financial activities currently authorized to financial holding companies, we may become subject to additional laws, regulations, supervision and examination by regulatory agencies.

Restrictions on Transfers of Funds to Us and the Bank

     Dividends from the Bank are the primary source of funds for the payment of our expenses of operating and for the payment of dividends to our shareholders. The Bank is limited, under both state and federal law, in the amount of dividends that may be paid from time to time. In general, the Bank is limited, without the prior consent of its primary state and federal banking regulators, to paying dividends that do not exceed the current year net profits together with retained earnings from the two preceding calendar years.

     A state or federal banking regulator may impose, by regulatory order or agreement of the Bank, specific dividend limitations or prohibitions in certain circumstances. The Bank is not subject to a specific regulatory dividend limitation other than generally applicable limitations. In addition to regulatory dividend limitations, the Bank dividends are, in certain circumstances, limited by covenants in our debt instruments if the Bank fails to meet specified regulatory capital ratios.

     In addition, the Bank may not lend funds to, or otherwise extend credit to or for our benefit or the benefit of our affiliates, except on specified types and amounts of collateral and other terms required by state and federal law. The Federal Reserve also has authority to define and limit the transactions between banks and their affiliates. Federal Reserve Regulation W, among other things, imposes significant additional limitations on transactions in which the Bank may engage with us or other affiliates in addition to the limits under the federal statutes.

Capital Standards and Prompt Corrective Action

     Banks and bank holding companies are subject to various regulatory capital requirements administered by state and federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations, involve quantitative measures of assets, liabilities, and certain off-balance sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weighting and other factors.

     The Federal Reserve Board and the FDIC have substantially similar risk-based capital ratio and leverage ratio guidelines for banking organizations. The guidelines are intended to ensure that banking organizations have adequate capital given the risk levels of assets and off-balance sheet financial instruments. Under the guidelines, banking organizations are required to maintain minimum ratios for Tier 1 capital and total capital to risk-weighted assets (including certain off-balance sheet items, such as letters of credit). For purposes of calculating the ratios, a banking organization’s assets and some of its specified off-balance sheet commitments and obligations are assigned to various risk categories. Generally, under the applicable guidelines, a financial institution’s capital is divided into two tiers. These tiers are:

	•		Core Capital (Tier 1). Tier 1 capital includes common equity, non-cumulative perpetual preferred stock (excluding auction rate issues), and minority interests in equity accounts of consolidated subsidiaries, less both goodwill and, with certain limited exceptions, all other intangible assets. Bank holding companies, however, may include up to a limit of 25% of cumulative preferred stock in their Tier 1 capital.
	•		Supplementary Capital (Tier 2). Tier 2 capital includes, among other things, cumulative and limited-life preferred stock, hybrid capital instruments, mandatory convertible securities, qualifying subordinated debt, and the allowance for loan and lease losses, subject to certain limitations.

     Institutions that must incorporate market risk exposure into their risk-based capital requirements may also have a third tier of capital in the form of restricted short-term subordinated debt.

     We, like other bank holding companies, currently are required to maintain Tier 1 capital and total capital (the sum of Tier 1 and Tier 2 capital) equal to at least 4.0% and 8.0%, respectively, of our total risk-weighted assets. The Bank, like other depository institutions, is required to maintain similar capital levels under capital adequacy guidelines. For a depository institution to be considered “well capitalized” under the regulatory framework for prompt corrective action, its Tier 1 and total capital ratios must be at least 6.0% and 10.0% on a risk-adjusted basis, respectively.

     Bank holding companies and banks are also required to comply with minimum leverage ratio requirements. The leverage ratio is the ratio of a banking organization’s Tier 1 capital to its total adjusted quarterly average assets (as defined for regulatory purposes). The requirements necessitate a minimum leverage ratio of 3.0% for financial holding companies and banks that either have the highest supervisory rating or have implemented the appropriate federal regulatory authority’s risk-adjusted measure for market risk. All other financial holding companies and banks are required to maintain a minimum leverage ratio of 4.0%, unless a different minimum is specified by an appropriate regulatory authority. For a depository institution to be considered “well capitalized” under the regulatory framework for prompt corrective action, its leverage ratio must be at least 5.0%. The Federal Reserve Board has not advised us of any specific minimum leverage ratio applicable to us or the Bank.

     The FDIA requires, among other things, the federal banking agencies to take “prompt corrective action” in respect of depository institutions that do not meet minimum capital requirements. The FDIA sets forth the following five capital tiers: “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” and “critically undercapitalized.” A depository institution’s capital tier will depend upon how its capital levels compare with various relevant capital measures and certain other factors, as established by regulation. The relevant capital measures are the total capital ratio, the Tier 1 capital ratio and the leverage ratio.

     Under the regulations adopted by the federal regulatory authorities, a bank will be: (i) “well capitalized” if the institution has a total risk-based capital ratio of 10.0% or greater, a Tier 1 risk-based capital ratio of 6.0% or greater, and a leverage ratio of 5.0% or greater, and is not subject to any order or written directive by any such regulatory authority to meet and maintain a specific capital level for any capital measure; (ii) “adequately capitalized” if the institution has a total risk-based capital ratio of 8.0% or greater, a Tier 1 risk-based capital ratio of 4.0% or greater, and a leverage ratio of 4.0% or greater (3.0% in certain circumstances ) and is not “well capitalized”; (iii) “undercapitalized” if the institution has a total risk-based capital ratio that is less than 8.0%, a Tier 1 risk-based capital ratio of less than 4.0% or a leverage ratio of less than 4.0% (3.0% in certain circumstances); (iv) “significantly undercapitalized” if the institution has a total risk-based capital ratio of less than 6.0%, a Tier 1 risk-based capital ratio of less than 3.0% or a leverage ratio of less than 3.0%; and (v) “critically undercapitalized” if the institution’s tangible equity is equal to or less than 2.0% of average quarterly tangible assets. An institution may be downgraded to, or deemed to be in, a capital category that is lower than indicated by its capital ratios if it is determined to be in an unsafe or unsound condition or if it receives an unsatisfactory examination rating with respect to certain matters. Throughout 2006, our regulatory capital ratios and those of the Bank were in excess of the levels established for “well-capitalized” institutions. A bank’s capital category is determined solely for the purpose of applying prompt corrective action regulations, and the capital category may not constitute an accurate representation of the bank’s overall financial condition or prospects for other purposes.

     The FDIA generally prohibits a depository institution from making any capital distributions (including payment of a dividend) or paying any management fee to its parent holding company if the depository institution would thereafter be undercapitalized. Undercapitalized institutions are subject to growth limitations and are required to submit a capital restoration plan. The agencies may not accept such a plan without determining, among other things, that the plan is based on realistic assumptions and is likely to succeed in restoring the depository institution’s capital. In addition, for a capital restoration plan to be acceptable, the depository institution’s parent holding company must guarantee that the institution will comply with such capital restoration plan. The aggregate liability of the parent holding company is limited to the lesser of (i) an amount equal to 5.0% of the depository institution’s total assets at the time it became undercapitalized and (ii) the amount which is necessary (or would have been necessary) to bring the institution into compliance with all capital standards applicable with respect to such institution as of the time it fails to comply with the plan. If a depository institution fails to submit an acceptable plan, it is treated as if it is “significantly undercapitalized.”

     “Significantly undercapitalized” depository institutions may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become “adequately capitalized,” requirements to reduce total assets, and cessation of receipt of deposits from correspondent banks. “Critically undercapitalized” institutions are subject to the appointment of a receiver or conservator.

     Safety and Soundness Standards and Other Enforcement Mechanisms

     The federal banking agencies have adopted guidelines establishing standards for safety and soundness, asset quality and earnings, as required by the Federal Deposit Insurance Corporation Improvement Act. These standards are designed to identify potential concerns and ensure that action is taken to address those concerns before they pose a risk to the deposit insurance fund. If a federal banking agency determines that an institution fails to meet any of these standards, the agency may require the institution to submit an acceptable plan to achieve compliance with the standard. If the institution fails to submit an acceptable plan within the time allowed by the agency or fails in any material respect to implement an accepted plan, the agency must, by order, require the institution to correct the deficiency.

     Federal banking agencies possess broad enforcement powers to take corrective and other supervisory action on an insured bank and its holding company. Moreover, federal laws require each federal banking agency to take prompt corrective action to resolve the problems of insured banks. Bank holding companies and insured banks are subject to a wide range of potential enforcement actions by federal regulators for violation of any law, rule, regulation, standard, condition imposed in writing by the regulator, or term of a written agreement with the regulator.

Deposit Insurance

     Deposits in the Bank are insured by the FDIC in accordance with the FDIA. Insurance premiums are assessed semiannually by the FDIC at a level sufficient to maintain the insurance reserves required under the FDIA and relevant regulations. The insurance premium charged to a bank is determined based upon risk assessment criteria, including relevant capital levels, results of bank examinations by state and federal regulators and other information. The Bank currently is assessed the most favorable deposit insurance premiums under the risk-based premium system.

Depositor Preference

     The FDIA provides that, in the event of the “liquidation or other resolution” of an insured depository institution, the claims of depositors of the institution, including the claims of the FDIC as subrogee of insured depositors, and certain claims for administrative expenses of the FDIC as a receiver, will have priority over other general unsecured claims against the institution. If an insured depository institution fails, insured and uninsured depositors, along with the FDIC, will have priority in payment ahead of unsecured, non-deposit creditors, including the parent bank holding company, with respect to any extensions of credit they have made to such insured depository institution.

Liability of Commonly Controlled Institutions

     FDIC-insured depository institutions can be held liable for any loss incurred, or reasonably expected to be incurred, by the FDIC due to the default of an FDIC-insured depository institution controlled by the same bank holding company, or for any assistance provided by the FDIC to an FDIC-insured depository institution controlled by the same bank holding company that is in danger of default. “Default” means generally the appointment of a conservator or receiver. “In danger of default” means generally the existence of certain conditions indicating that default is likely to occur in the absence of regulatory assistance.

Customer Privacy and Other Consumer Protections

     The GLB Act imposes customer privacy requirements on any company engaged in financial activities. Under these requirements, a financial holding company is required to protect the security and confidentiality of customer nonpublic personal information. In addition, for customers who obtain a financial product such as a loan for personal, family or household purposes, a financial holding company is required to disclose its privacy policy to the customer at the time the relationship is established and annually thereafter. The financial holding company must also disclose its policies concerning the sharing of the customer’s nonpublic personal information with affiliates and third parties. Finally, a financial company is prohibited from disclosing an account number or similar item to a third party for use in telemarketing, direct mail marketing or marketing through electronic mail.

     The Bank is subject to a variety of federal and state laws and reporting obligations aimed at protecting consumers including the Home Mortgage Disclosure Act, the Real Estate Settlement Procedures Act, the Equal Credit Opportunity Act, the Truth in Lending Act, the Fair Credit Reporting Act and the Community Reinvestment Act, or CRA. The CRA generally requires the federal banking agencies to evaluate the record of a financial institution in meeting the credit needs of its local communities, including low and moderate income neighborhoods. In addition to substantial penalties and corrective measures that may be required for a violation of fair lending laws, the federal banking agencies may take compliance with such laws and CRA into account when regulating and supervising our other activities or in authorizing expansion activities.

     In connection with its assessment of CRA performance, the appropriate bank regulatory agency assigns a rating of “outstanding,” “satisfactory,” “needs to improve” or “substantial noncompliance.” The Bank received a “satisfactory” rating on its most recent published examination. Although the Bank’s policies and procedures are designed to achieve compliance with all fair lending and CRA laws, instances of non-compliance are occasionally identified through normal operational activities. Bank management responds proactively to correct all instances of non-compliance and implement procedures to prevent further violations from occurring.

Sarbanes-Oxley Act of 2002

     The Sarbanes-Oxley Act of 2002 imposed new or revised corporate governance, accounting, and reporting requirements on us and all other companies having securities registered with the SEC. In addition to a requirement that chief executive officers and chief financial officers certify financial statements in writing, the statute imposed requirements affecting, among other matters, the composition and activities of audit committees, disclosures relating to corporate insiders and insider transactions, codes of ethics, and the effectiveness of internal controls over financial reporting.

USA Patriot Act

     The USA Patriot Act of 2001 amended the Bank Secrecy Act and adopted additional measures requiring insured depository institutions, broker-dealers, and certain other financial institutions to have policies, procedures and controls to detect, prevent and report money laundering and terrorist financing. These acts and their regulations also provide for information sharing, subject to conditions, between federal law enforcement agencies and financial institutions, as well as among financial institutions, for counter-terrorism purposes. Federal banking regulators are required, when reviewing bank holding company acquisition or merger applications, to take into account the effectiveness of the anti-money laundering activities of the applicants. The USA Patriot Improvement and Reauthorization Act of 2005, among other things, made permanent or otherwise generally extended the effectiveness of provisions applicable to financial institutions.

Effect of Economic Conditions, Government Policies and Legislation

     Banking depends on interest rate differentials. In general, the difference between the interest rate paid by the Bank on deposits and borrowings and the interest rate received by the Bank on loans extended to customers and on investment securities comprises a major portion of the Bank’s earnings. These rates are highly sensitive to many factors that are beyond the control of the Bank. Accordingly, the earnings and potential growth of the Bank are subject to the influence of domestic and foreign economic conditions, including inflation, recession and unemployment.

     The commercial banking business is not only affected by general economic conditions but is also influenced by the monetary and fiscal policies of the federal government and the policies of regulatory agencies, particularly the Federal Reserve. The Federal Reserve implements national monetary policies (with objectives such as curbing inflation and combating recession) by its open-market operations in United States government securities, by adjusting the required level of reserves for financial institutions subject to the Federal Reserve’s reserve requirements and by varying the discount rates applicable to borrowings by depository institutions. The actions of the Federal Reserve in these areas influence the growth of bank loans, investments and deposits and also affect interest rates charged on loans and paid on deposits. The nature and impact of any future changes in monetary policies cannot be predicted.

     From time to time, legislation is enacted which has the effect of imposing additional operating restrictions and increasing the cost of doing business, as has been the case with relatively recent laws regarding anti-terrorism and consumer privacy. New legislation may also limit or expand permissible activities or affect the competitive balance between banks and other financial service providers. Proposals to change the laws and regulations governing the operations and taxation of banks, bank holding companies and other financial service providers are frequently made in Congress, in the Montana and Wyoming legislatures and before various bank regulatory and other professional agencies. The likelihood of major legislative changes and the impact such changes might have on us are impossible to predict.

Recent Regulatory Developments

     The U.S. Congress approved deposit insurance reform at the beginning of February 2006 and the FDIC adopted amended regulations and new regulations in November 2006 to give effect to the reform. Under the reform and amended regulations, the FDIC has adopted a risk-based premium system and, beginning in 2007, may pay “dividends” to insured depository organizations depending on, among other factors, the reserve ratio of the deposit insurance fund. The dividend will be considered by the FDIC board of directors in each calendar year. The reform also adjusts the deposit insurance coverage levels for certain types of deposit accounts and allows for further future adjustments depending upon, among other things, inflation.

     On September 26, 2006, the federal banking regulators published a notice of proposed rulemaking to implement regulatory capital requirements commonly referred to as the Basel II accord. The notice requested public comment within 120 days of the publication date. On the basis of the published notice, it does not appear that we would meet the asset size criteria to be included among the U.S. banking organizations affected by Basel II or the proposed new capital regulations.

     On December 28, 2006, the federal banking regulators also published a notice of proposed rulemaking, referred to as Basel IA, to implement proposed changes to the risked-based capital rules for banking organizations not affected by Basel II. As proposed in the recently published notice, all banking organizations not subject to Basel II could elect to be governed by Basel IA or elect to remain subject to existing risked-based capital rules. If the Basel IA proposed rules become final, we may be affected by or elect to be subject to different risked-based capital rules than those currently applicable to us. We have not evaluated the proposed rules nor considered any election to be subject to any final Basel IA rules.

Website Access to SEC Filings

     All of our reports filed electronically with the SEC, including the Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and Proxy Statements, as well as amendments to these reports and statements filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, are accessible at no cost through our website at www.firstinterstatebank.com as soon as reasonably practicable after they have been filed with the SEC. These reports are also accessible on the SEC’s website at www.sec.gov. The public may read and copy materials we file with the SEC at the public reference facilities maintained by the SEC at Room 1580, 100 F Street N.E., Washington, DC 20549. The public may obtain information on the operation of the public reference room by calling the SEC at 1-800-SEC-0330. Our website and the information contained therein or connected thereto is not intended to be incorporated into this report and should not be considered a part of this report.

Item 1A. Risk Factors

     Like other financial and bank holding companies, we are subject to a number of risks, some of which are outside of our control, including: (1) credit risks; (2) market risks; (3) liquidity risks; and, (4) operational risks. In addition, investors who purchase shares of our common stock are subject to (5) investment risks. Readers should consider carefully the following important factors in evaluating us, our business and an investment in our securities.

(1) Credit Risks:

     We extend credit to a variety of customers based on internally set standards and judgment. We manage the credit risk through a program of underwriting standards, the review of certain credit decisions, and an on-going process of assessment of the quality of the credit already extended. Our credit standards, the nature of our loan portfolio and on-going process of credit management and assessment might not protect us from significant credit losses.

     We take credit risk by virtue of making loans and extending loan commitments and letters of credit. Our exposure to credit risk is managed through the use of consistent underwriting standards that emphasize “in-market” lending. Our credit administration function employs risk management techniques designed to ensure that loans adhere to corporate policy and problem loans are promptly identified. We have adopted underwriting and credit monitoring procedures and policies, including the establishment and review of the allowance for loan losses, which we believe are appropriate to mitigate the risk of loss by assessing the likelihood of non-performance and the value of available collateral, monitoring loan performance and diversifying our credit portfolio. These procedures provide us with the information necessary to implement policy adjustments where necessary and to take proactive corrective actions. Our credit standards, procedures and policies may not prevent us from incurring substantial credit losses.

     As of December 31, 2006, approximately 62% of our loan portfolio consisted of commercial, construction and commercial real estate loans. These types of loans are generally viewed as having more risk and are typically larger than residential real estate loans or consumer loans and, therefore, have a higher risk of loss. Because our loan portfolio contains a significant number of commercial, construction and commercial real estate loans with relatively large balances, the deterioration of one or a few of these loans could cause a significant increase in non-performing loans. An increase in non-performing loans could result in a loss of earnings from these loans, an increase in the provision of loan losses and an increase in loan charge-offs.

     Our loans and deposits are focused in Montana and Wyoming. Adverse economic conditions in these states could adversely impact our results from operations, cash flows, and financial condition.

     Our customers with loan and/or deposit balances are located predominantly in Montana and Wyoming. Because of the concentration of loans and deposits in these states, in the event of adverse economic conditions in Montana or Wyoming, we could experience higher rates of loss and delinquency on our loans than if the loans were more geographically diversified. Adverse economic conditions, including inflation, recession and unemployment, and other factors, such as political or business developments, natural disasters, wide-spread disease, terrorist activity, environmental

contamination and other unfavorable conditions and events that affect these states, could reduce demand for credit or fee-based products and may delay or prevent borrowers from repaying their loans. Adverse conditions and other factors identified above could also negatively affect real estate and other collateral values, interest rate levels, and the availability of credit to refinance loans at or prior to maturity. These results could adversely impact our results of operations, cash flows and financial condition.

     Declines in real estate values in our markets could adversely impact our business.

     Like all banks, we are subject to the effects of any economic downturn. In particular, a significant decline in real estate property values in our markets could have a negative effect on results of operations. A significant decline in real estate values could lead to higher charge-offs in the event of defaults in our real estate loan portfolio. At December 31, 2006, we had $2.1 billion of commercial, agricultural, construction, residential and other real estate loans representing 63% of our total loan portfolio.

(2) Market Risks:

     Changes in interest rates could negatively impact our net interest income.

     Our results of operations depend substantially on net interest income, which is the difference between interest earned on interest-earning assets (such as investments and loans) and interest paid on interest-bearing liabilities (such as deposits and borrowings). Interest rates are highly sensitive to many factors, including governmental monetary policies and domestic and international economic and political conditions. Conditions such as inflation, recession, unemployment, money supply, and other factors beyond our control may also affect interest rates. In both rising and declining interest rate environments, our net interest income could be adversely impacted.

     Changes in interest rates may weaken demand for our products and services and harm our results of operations and cash flows.

     Changes in interest rates can affect customers’ demand for our products and services. Interest rate changes may also impact the value of our loans and other assets, including mortgage servicing rights, and our ability to realize gains on the sale of assets. A portion of our earnings result from transactional income. An example of this type of transactional income is gain on sales of loans and investment securities. This type of income can vary significantly from quarter-to-quarter and year-to-year based on a number of different factors, including the interest rate environment. An increase in interest rates that adversely affects the ability of borrowers to pay the principal or interest on loans may lead to an increase in non-performing assets and a reduction of income recognized, which could harm our results of operations and cash flows. In contrast, decreasing interest rates have the effect of causing customers to refinance mortgage loans faster than anticipated. This causes the value of assets related to the servicing rights on mortgage loans sold to be lower than originally recognized. If this happens, we may need to write down our mortgage servicing rights asset faster, which would accelerate expense and lower our earnings.

(3) Liquidity Risks:

     We may not be able to meet the cash flow requirements of our depositors and borrowers unless we obtain sufficient liquidity.

     Liquidity is the ability to meet current and future cash flow needs on a timely basis at a reasonable cost. Our liquidity is used to make loans and to repay deposit liabilities as they become due or are demanded by customers. We regularly monitor our overall liquidity position to ensure that various alternative strategies exist to cover unanticipated events that could affect liquidity. Potential alternative sources of liquidity include Federal funds purchased and securities sold under repurchase agreements. We maintain a portfolio of investment securities that may be used as a secondary source of liquidity to the extent the securities are not pledged for collateral. We believe there are other sources of liquidity available to us should they be needed. These sources include the drawing of additional funds on our unsecured revolving term loan, the sale of loans, the ability to acquire national market, non-core deposits, the issuance of additional collateralized borrowings such as Federal Home Loan Bank, or FHLB, advances, the issuance of debt securities, and the issuance of preferred or common securities. We may also be able to borrow through the Federal Reserve’s discount window. Without sufficient liquidity, we may not be able to meet the cash flow requirements of our depositors and borrowers.

     If our funding sources are inadequate, we may be unable to continue expanding our business, funding our operations, paying dividends or repurchasing stock.

     If we are unable to access adequate funding sources when needed, we may be unable to continue expansion of our business or fund operations. Inadequate funding sources could also prevent us from paying dividends and repurchasing stock. Accordingly, it is critical we maintain adequate liquidity to avoid an adverse impact on our financial condition and level of regulatory-qualifying capital.

(4) Operational Risks:

     We have significant competition in both attracting and retaining deposits and in originating loans.

     Competition is intense in most of our markets. We compete on price, product availability, customer service and responsiveness to customer needs with other banks and financial services companies such as brokerage firms, finance companies, mortgage banking companies, insurance companies and credit unions. Competition could intensify in the future as a result of industry consolidation, the increasing availability of products and services from larger, multi-state financial holding companies and their bank and non-bank subsidiaries, greater technological developments in the industry, and banking reform.

     A failure of the technology we use could harm our business.

     We depend heavily upon data processing, software, communication and information exchange on a variety of computing platforms and networks and over the internet. Despite instituted safeguards, we cannot be certain that all of our systems are entirely free from vulnerability to breaches of security or other technological difficulties or failures. Our wholly-owned subsidiary, i_Tech, provides technology services to the Bank and other non-affiliated customers. In addition, we rely on the services of a variety of vendors to meet our data processing and communication needs. If information security is breached or other technology difficulties or failures occur, information may be lost or misappropriated, services and operations may be interrupted, and we could be exposed to claims from customers and related legal actions. Any of these results could harm our business.

     Our information systems may experience a breach in security.

     We rely heavily on communications and information systems to conduct our business. A breach in the security of these systems could result in failures or disruptions in our customer relationship management, general ledger, deposit, loan, investment and other information systems. A breach of the security of our information systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny and expose us to civil litigation and possible financial liability.

     Our systems of internal operating controls may not be effective.

     We establish and maintain systems of internal operational controls that provide us with critical information used to manage our business. These systems are not foolproof, and are subject to various inherent limitations, including cost, judgments used in decision-making, assumptions about the likelihood of future events, the soundness of our systems, the possibility of human error, and the risk of fraud. Moreover, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions and the risk that the degree of compliance with policies or procedures may deteriorate over time. Because of these limitations, any system of internal operating controls may not be successful in preventing all errors or fraud or in making all material information known in a timely manner to the appropriate levels of management. From time to time, losses from operational malfunctions or fraud may occur. These losses are recorded as noninterest expense. Any future losses related to internal operating control systems could have an adverse effect on our business.

     We may encounter unforeseen difficulties executing our business strategy, including unanticipated integration problems, business disruption in connection with expansions and loss of key personnel.

     Our financial performance and profitability will depend on our ability to execute our business strategy and manage our anticipated future growth. We may experience unforeseen problems as we integrate new banking offices and expand into new markets. In addition, any future acquisitions or other future growth may present operating and other problems that could negatively affect our business. Our financial performance will also depend on our ability to maintain profitable operations through implementation of our Strategic Vision. Decisions to sell or close units or otherwise change the business mix may adversely impact our financial performance.

     Our success depends to a significant extent on the management skills of our existing executive officers and directors, many of whom have held officer and director positions with us for many years. The loss or unavailability of key executives, including Lyle R. Knight, President and Chief Executive Officer, Terrill R. Moore, Executive Vice President and Chief Financial Officer, Robert A. Jones, Executive Vice President and Chief Administrative Officer, or Edward Garding, Executive Vice President and Chief Credit Officer, could harm our ability to operate our business or execute our business strategy.

     An extended disruption of vital infrastructure and other business interruptions could negatively impact our business.

     Our operations depend upon vital infrastructure components including, among other things, transportation systems, power grids and telecommunication systems. A disruption in our operations resulting from failure of transportation and telecommunication systems, loss of power, interruption of other utilities, natural disaster, fire, global climate changes, computer hacking or viruses, failure of technology, terrorist activity or the domestic and foreign response to such activity, or other events outside of our control could have an adverse impact on the financial services industry as a whole and/or on our business. Our business recovery plan may not be adequate and may not prevent significant interruptions of our operations or substantial losses.

     We are subject to claims and litigation pertaining to our fiduciary responsibilities.

     Some of the services we provide, such as trust and investment services, require us to act as fiduciaries for our customers and others. From time to time, third parties make claims and take legal action against us pertaining to the performance of our fiduciary responsibilities. If these claims and legal actions are not resolved in a manner favorable to us, we may be exposed to significant financial liability and/or our reputation could be damaged. Either of these results may adversely impact demand for our products and services or otherwise have a harmful effect on our business.

     New or changes in existing tax, accounting, and regulatory rules and interpretations could significantly harm our business.

     The financial services industry is extensively regulated. Federal and state banking regulations are designed primarily to protect the deposit insurance funds and consumers, not to benefit a financial company’s shareholders. These regulations may sometimes impose significant limitations on operations. The significant federal and state banking regulations that affect us are described in this report under the heading “Business – Regulation and Supervision” above. These regulations, along with the currently existing tax, accounting, securities, insurance and monetary laws, and regulations, rules, standards, policies, and interpretations control the methods by which we conduct business, implement strategic initiatives and tax compliance, and govern financial reporting and disclosures. These laws, regulations, rules, standards, policies, and interpretations are constantly evolving and may change significantly over time.

     Events that may not have a direct impact on us, such as the bankruptcy of major U.S. companies, have resulted in legislators, regulators and authoritative bodies, such as the Financial Accounting Standards Board, the SEC, the Public Company Accounting Oversight Board, and various taxing authorities responding by adopting and/or proposing substantive revisions to laws, regulations, rules, standards, policies and interpretations. Further, federal monetary policy as implemented through the Federal Reserve System can significantly affect credit conditions in our markets.

     The nature, extent, and timing of the adoption of significant new laws and regulations, or changes in or repeal of existing laws and regulations or specific actions of regulators, may have a negative impact on our business. It is impossible for us to predict accurately at this time the extent of any impact from these items.

     Non-compliance with USA Patriot Act, Bank Secrecy Act, or other laws and regulations could result in fines, sanctions and other enforcement actions.

     The USA Patriot and Bank Secrecy Acts require us to develop programs to prevent us from being used for money laundering and terrorist activities. If such activities are detected, we are obligated to file suspicious activity reports with the U.S. Treasury Department’s Office of Financial Crimes Enforcement Network. These rules require us to establish procedures for identifying and verifying the identity of customers seeking to open new financial accounts. Failure to comply with these regulations could result in fines or sanctions.

     Federal and state regulators have broad enforcement powers. If we fail to comply with any laws, regulations, rules, standards, policies or interpretations applicable to us, we could face enforcement actions, which include the appointment of a conservator or receiver for us; the issuance of a cease and desist order that can be judicially enforced; the termination of our deposit insurance; the imposition of civil monetary penalties; the issuance of directives to increase capital; the issuance of formal and informal agreements; the issuance of removal and prohibition orders against officers, directors, and other institution-affiliated parties; and the enforcement of such actions through injunctions or restraining orders.

     In 2004, the Federal Reserve required us to adopt a resolution obligating the Bank to develop and implement a comprehensive action plan designed to enhance our policies, procedures and data processing systems used in identifying and verifying the identity of our customers and in reporting suspicious activities in accordance with the USA Patriot and Bank Secrecy Acts. The resolution required us to submit written progress reports to the Federal Reserve and have the enhanced policies, procedures and data processing systems fully operational in 2006. As of December 31, 2006, our action plan was completed and our enhanced policies, procedures and data processing systems were fully operational.

     Regulators may impose dividend payment and other restrictions on the Bank which would impact our ability to pay dividends to shareholders or repurchase stock.

     The Federal Reserve and the State of Montana, Division of Banking and Financial Institutions, are the primary regulatory agencies that examine us and our activities. Under certain circumstances, including any determination that the activities of the Bank constitute an unsafe and unsound banking practice, the regulatory agencies have the authority by statute to restrict the Bank’s ability to transfer assets and make distributions to us as the holding company.

     Under applicable statutes and regulations, dividends may be paid out of current or retained net profits, but prior approval of the regulatory agencies is required for the payment of a dividend if the total of all dividends declared by the Bank in any calendar year would exceed the total of its net profits for the year combined with its undistributed net profits for the two preceding years.

     Payment of dividends could also be subject to regulatory limitations if the Bank became “under-capitalized” for purposes of regulatory guidelines. “Under-capitalized” is currently defined as having a total risk-based capital ratio of less than 8.0%, a Tier 1 risk-based capital ratio of less than 4.0%, or a core capital, or leverage, ratio of less than 4.0%. If the Bank were unable to pay dividends to us as the parent company, it would impact our ability to pay dividends to shareholders and repurchase stock.

     The Federal Reserve may require us to commit capital resources to support the Bank.

     The Federal Reserve, which examines us and our non-bank subsidiaries, has a policy stating that a bank holding company is expected to act as a source of financial and managerial strength to a subsidiary bank and to commit resources to support such subsidiary bank. Under the source of strength doctrine, the Federal Reserve may require a bank holding company to make capital injections into a troubled subsidiary bank, and may charge the bank holding company with engaging in unsafe and unsound practices for failure to commit resources to such a subsidiary bank. A capital injection may be required at times when the holding company may not have the resources to provide it, and therefore may be required to borrow the funds. Any loans by a holding company to its subsidiary bank are subordinate in right of payment to deposits and to certain other indebtedness of such subsidiary bank. In the event of a bank holding company’s bankruptcy, the bankruptcy trustee will assume any commitment by the holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank. Moreover, bankruptcy law provides that claims based on any such commitment will be entitled to a priority of payment over the claims of the institution’s general unsecured creditors, including the holders of its note obligations. Thus, any borrowing that must be done by the holding company in order to make the required capital injection becomes more difficult and expensive and will adversely impact the holding company’s results of operations and cash flows.

(5) Investment Risks:

     Our common stock is not publicly traded.

     Shares of our common stock are not publicly traded. Our common stock is not listed, quoted or traded on any securities exchange, market, bulletin board, quotation system or listing service. Because there is no established market for our common stock, there are limited opportunities for shareholders to resell their shares. In the event shareholders desire to sell or otherwise dispose of their shares, they may not be able to do so.

     Shares of our common stock are subject to contractual transfer restrictions, and we have no obligation to repurchase outstanding shares of common stock.

     With respect to our outstanding common stock, approximately 90% of the shares are subject to contractual transfer restrictions set forth in shareholder agreements. Except as described below, purchasers of our common stock are required to enter into shareholder agreements. We have a right of first refusal to repurchase the restricted stock at fair market value currently determined as the minority appraised value per share based upon the most recent quarterly appraisal. Additionally, restricted stock held by our officers, directors and employees may be called by us under certain conditions. All stock not subject to such restrictions may be sold at a price per share that is negotiated between the shareholder and a prospective buyer, which may vary substantially from our appraised minority value.

     Shares of our stock held by participants in the savings and profit sharing plan, or Savings Plan, established for our employees are not subject to contractual transfer restrictions set forth in shareholder agreements due to requirements of the Employee Retirement Income Security Act, or ERISA, and the Internal Revenue Code, or IRC. Since the Savings Plan does not allow distributions “in kind,” distributions from participants’ Savings Plan accounts require the Bank, as trustee for the Savings Plan, to sell our stock. In the event we do not elect to purchase the unrestricted stock, the Bank will be obligated to seek alternative purchasers.

     We have no obligation, by contract, policy or otherwise, to purchase restricted or unrestricted shares of our common stock. Any shares we may repurchase are priced at the most recent minority appraised value at the repurchase date. The appraised minority value of our common stock represents the estimated fair market valuation of a minority ownership interest, taking into account adjustments for the lack of marketability of the stock and other factors. This value does not represent an actual trading price between a willing buyer and seller of our shares in an informed, arm’s-length transaction. As such, the appraised minority value is only an estimate as of a specific date, and such appraisal may not be an indication of the actual value owners may realize with respect to shares they hold. Moreover, the estimated fair market value of our common stock may be materially different at any date other than the valuation dates.

     Existing shareholders will be diluted by future issuances of common stock, and the valuation of our common stock could decrease.

     Future issuances of stock pursuant to our equity incentive plans or in connection with future financings or acquisitions could cause dilution to our existing shareholders. This dilution could cause the valuation of our common stock to decline and also decrease the per share amount of any cash dividends. Furthermore, a variety of other factors discussed in this report could have a negative impact on our business, thereby resulting in a decrease in the value of our common stock.

     Affiliates of our company own a controlling interest and are able to control the election of directors and future direction of our business.

     The directors and executive officers beneficially own approximately 61% of our outstanding common stock. Many of these directors and executive officers are members of the Scott family, which collectively owns approximately 75% of our common stock. By virtue of such ownership, these affiliates are able to control the election of directors and the determination of our business, including transactions involving dividends, stock repurchases, and any potential acquisition, merger or other business combination.

Item 1B. Unresolved Staff Comments

     We are not an accelerated filer or a large accelerated filer, as defined in Rule 12b-2 of the Exchange Act, or a well-known seasoned issuer as defined in Rule 405 of the Securities Act. We have not received any written comments from the SEC staff regarding our periodic or current reports filed under the Exchange Act.

Item 2. Properties

     Our principal executive offices and a banking office are anchor tenants in an eighteen story commercial building located in Billings, Montana. The building is owned by a joint venture partnership in which the Bank is one of two partners, owning a 50% interest in the partnership. We lease approximately 91,997 square feet of office space in the building. We also lease approximately 24,368 square feet of office space for our operations center, also located in Billings, Montana, and an aggregate of approximately 68,276 square feet of office space in Montana, Colorado, Idaho and Oregon for our technology services subsidiary. As of December 31, 2006, we also provided banking services at 48 additional locations in Montana and Wyoming, of which 9 properties are leased from independent third parties and 39 properties are owned by us. We believe each of our facilities is suitable and adequate to meet our current operational needs.

Item 3. Legal Proceedings

     In the normal course of business, we are named or threatened to be named as a defendant in various lawsuits. Management, following consultation with legal counsel, does not expect the ultimate disposition of these matters to have a material adverse effect on our business.

Item 4. Submission of Matters to a Vote of Security Holders

     No matters were submitted to a vote of security holders during the fourth quarter of 2006.

PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters
and Issuer Purchases of Equity Securities

Description of Our Capital Stock

     Our authorized capital stock consists of 20,000,000 shares of common stock without par value, of which 8,186,709 shares were outstanding as of February 28, 2007, and 100,000 shares of preferred stock without par value, none of which were outstanding as of February 28, 2007.

Common Stock

     Each share of the common stock is entitled to one vote in the election of directors and in all other matters submitted to a vote of shareholders. Accordingly, holders of a majority of the shares of common stock entitled to vote in any election of directors may elect all of the directors standing for election if they choose to do so, subject to the rights of the holders of the preferred stock. Voting for directors is noncumulative.

     Subject to the preferential rights of any preferred stock that may at the time be outstanding, each share of common stock has an equal and ratable right to receive dividends when, if and as declared by the board of directors out of assets legally available. In the event of our liquidation, dissolution or winding up, the holders of common stock will be entitled to share equally and ratably in the assets available for distribution after payments to creditors and to the holders of any preferred stock that may at the time be outstanding. Holders of common stock have no conversion rights or preemptive or other rights to subscribe for any additional shares of common stock or for other securities. All outstanding common stock is fully paid and non-assessable.

     Our common stock is not actively traded, and there is no established trading market for the stock. There is only one class of common stock. As of February 28, 2007, 90.4% of our shares of common stock were subject to contractual transfer restrictions set forth in shareholder agreements and 9.6% were held by 17 shareholders without such restrictions, including our 401(k) plan, or Savings Plan, which holds 80.6% of the unrestricted shares. See also Part I, Item 1, “Risk Factors – Liquidity Risks.”

     Minority appraisal values as of each calendar quarter end for the past two years, determined by an independent valuation expert, follow:

Valuation Based on				Appraised
Financial Data As of		Valuation Effective Date		Minority Value
December 31, 2004		February 14, 2005		$63.00
March 31, 2005		May 19, 2005		63.50
June 30, 2005		August 12, 2005		65.50
September 30, 2005		November 10, 2005		68.00
December 31, 2005		February 23, 2006		71.00
March 31, 2006		May 19, 2006		74.50
June 30, 2006		August 9, 2006		77.25
September 30, 2006		November 14, 2006		82.50
December 31, 2006		February 15, 2007		89.00

     Resale of our stock may be restricted pursuant to the Securities Act of 1933 and applicable state securities laws. In addition, most shares of our stock are subject to shareholder’s agreements:

	•		Members of the Scott family, as majority shareholders, are subject to a shareholder’s agreement. Under this agreement, the Scott family has agreed to limit the transfer of shares owned by members of the Scott family to family members or charities, or with our approval, to our officers, directors, advisory directors or to our Savings Plan.
	•		Shareholders who are not Scott family members, with the exception of 17 shareholders who own an aggregate of 786,614 shares of unrestricted stock, are subject to shareholder’s agreements. Stock subject to these agreements may not be sold or transferred without triggering our option to acquire the stock in accordance with the terms of these agreements. In addition, the agreements grant us the right to repurchase all or some of the stock under certain conditions.

     Purchases of our common stock made through our Savings Plan are not restricted by shareholder agreements, due to requirements of the ERISA and the IRC. However, since the Savings Plan does not allow distributions “in kind,” any distribution from an employee’s account in the Savings Plan will require the Savings Plan administrator to authorize sale of the stock. While we have no obligation to repurchase the stock, it is likely that we will repurchase our stock sold by the Savings Plan.

     As of February 28, 2007, we had 786 record shareholders, including the Financial Services division of the Bank as trustee for 634,222 shares held on behalf of 1,884 individual participants in the Savings Plan. Of such participants, 370 individuals also own shares of our stock outside of the Savings Plan. The Plan Trustee votes the shares based on the instructions of each participant. In the event the participant does not provide the Plan Trustee with instructions, the Plan Trustee votes those shares in accordance with voting instructions received from a majority of the participants in the plan.

Dividends

     It is our policy to pay a dividend to all common shareholders quarterly. Dividends are declared and paid in the month following the calendar quarter. The dividend amount is periodically reviewed and set by our board of directors. Our board of directors has no current intention to change its dividend policy, but no assurance can be given that the board may not, in the future, change or eliminate the payment of dividends.

     During January 2007, our board of directors approved and we paid a special dividend of $0.41 per share. This special dividend reflected approximately 30% of the recent after-tax gain on the sale of our interest in an unconsolidated equity method joint venture in December 2006.

     Recent quarterly and special dividends follow:

		Amount				Total Cash
Month Declared and Paid		Per Share				Dividend
January 2005		$	0.42			$	3,346,726
April 2005			0.48				3,825,415
July 2005			0.48				3,824,652
October 2005			0.50				4,047,869
January 2006			0.50				4,051,636
April 2006			0.58				4,698,081
July 2006			0.58				4,694,141
October 2006			0.61				4,969,757
January 2007			0.61				5,007,153
January 2007 special dividend			0.41				3,363,708

Dividend Restrictions

     For a description of restrictions on the payment of dividends, see Part I, Item 1, “Business – Regulation and Supervision – Restrictions on Transfers of Funds to Us and the Bank,” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Capital Resources and Liquidity Management” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Financial Condition – Long-Term Debt” included in Item 7 herein.

Preferred Stock

     Our authorized capital stock includes 100,000 shares of preferred stock. Our board of directors is authorized, without approval of the holders of common stock, to provide for the issuance of preferred stock from time to time in one or more series in such number and with such designations, preferences, powers and other special rights as may be stated in the resolution or resolutions providing for such preferred stock. Our board of directors may cause us to issue preferred stock with voting, conversion and other rights that could adversely affect the holders of the common stock or make it more difficult to effect a change of control.

Securities Authorized for Issuance Under Equity Compensation Plans

     The following table provides information, as of December 31, 2006, regarding our equity compensation plans.

Equity Compensation Plans

Number of Securities

Number of Securities

to be Issued Upon

Weighted Average

Remaining Available

Exercise of

Exercise Price of

For Future Issuance

Outstanding Options,

Outstanding Options,

Under Equity

Plan Category

Warrants and Rights

Warrants and Rights

Compensation Plans (1)

Equity compensation plans approved by shareholders(2)

840,199

$  50.00

737,254

Equity compensation plans not approved by shareholders

N/A

N/A

N/A

Sales of Unregistered Securities

     We issued no unregistered shares of common stock during the three months ended December 31, 2006.

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

     The following table provides information with respect to purchases made by or on behalf of us or any “affiliated purchasers” (as defined in Rule 10b-18(a)(3) under the Exchange Act), of our common stock during the three months ended December 31, 2006.

Purchases of Equity Securities by Issuer

 

Maximum Number

Maximum Number

of Shares That

of Shares That

Total Number

May Yet Be

May Yet Be

of Shares

Average Price

Purchased Under the

Purchased Under the

Period

Purchased

Paid Per Share

Plans or Programs (1)

Plans or Programs

October 2006

3,144

$

77.25

—

Not Applicable

November 2006

5,566

80.55

—

Not Applicable

December 2006

17,052

82.50

—

Not Applicable

Total

25,762

$

81.44

—

Not Applicable

Performance Graph

     The performance graph below compares the cumulative total shareholder return of our common stock with the Russell 2000 Index and SNL $1B-$5B Bank Index. The Russell 2000 Index is comprised of U.S. publicly-owned companies with market capitalizations that are comparable to ours. The SNL $1B-$5B Bank Index is comprised of publicly-owned banks or bank holding companies with total assets between $1 billion and $5 billion. The graph assumes an investment of $100 on December 31, 2001 and reinvestment of dividends on the date of payment without commissions. The plot points on the graph were provided by SNL Financial LC, Charlottesville, VA.

     Our common stock is not actively traded, and there is no established trading market for our stock. The cumulative total shareholder return for our common stock is based on the most recent minority appraised value of the common stock, which represents the estimated fair market valuation of a minority interest at a specific date, taking into account adjustments for the lack of marketability and other factors. Valuations are performed on a quarterly basis and are generally received approximately 45 days after each quarter end. As such, year end valuations used in the performance graph are based on financial data as of September 30^th for each year. The performance graph represents past performance, which may not be indicative of the future performance of our common stock.

														Period Ending
	Index			12/31/01					12/31/02					12/31/03					12/31/04					12/31/05					12/31/06
	First Interstate BancSystem, Inc.			$	100.00				110.13					125.56					159.68					185.48					222.33
	Russell 2000				100.00				79.52					117.09					138.55					144.86					171.47
	SNL $1B- $5B Bank Index				100.00				115.44					156.98					193.74					190.43					220.36

Item 6. Selected Consolidated Financial Data

     The following selected consolidated financial data with respect to our consolidated financial position as of December 31, 2006 and 2005, and the results of our operations for the fiscal years ended December 31, 2006, 2005 and 2004, has been derived from our audited consolidated financial statements included in Part IV, Item 15. This data should be read in conjunction with Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and such consolidated financial statements, including the notes thereto. The selected consolidated financial data with respect to our consolidated financial position as of December 31, 2004, 2003 and 2002, and the results of our operations for the fiscal years ended December 31, 2003 and 2002, has been derived from our audited consolidated financial statements not included herein.

Five Year Summary

 

(Dollars in thousands except share and per share data)

Year ended December 31,		2006				2005				2004				2003				2002
Operating Data:
Interest income		$	293,423			$	233,857			$	192,840			$	189,258			$	201,306
Interest expense			105,960				63,549				42,421				48,614				65,459
Net interest income			187,463				170,308				150,419				140,644				135,847
Provision for loan losses			7,761				5,847				8,733				9,852				9,191
Net interest income after provision for loan losses			179,702				164,461				141,686				130,792				126,656
Noninterest income			101,548				70,290				70,644				70,152				60,901
Noninterest expense			164,142				150,726				142,980				137,925				133,816
Income before income taxes			117,108				84,025				69,350				63,019				53,741
Income tax expense			41,499				29,310				23,929				22,267				19,247
Net income		$	75,609			$	54,715			$	45,421			$	40,752			$	34,494
Basic earnings per common share		$	9.32			$	6.84			$	5.74			$	5.18			$	4.41
Diluted earnings per common share			9.11				6.71				5.68				5.15				4.41
Dividends per common share			2.27				1.88				1.56				1.32				1.29
Weighted average common shares outstanding — diluted			8,302,056				8,149,337				7,997,579				7,909,947				7,830,429
Ratios:
Return on average assets			1.60	%			1.26	%			1.14	%			1.09	%			1.03	%
Return on average common stockholders’ equity			20.38				16.79				15.75				15.79				14.86
Average stockholders’ equity to average assets			7.85				7.52				7.22				6.93				6.91
Net interest margin			4.47				4.48				4.34				4.37				4.66
Net interest spread			3.89				4.13				4.12				4.14				4.33
Common stock dividend payout ratio (1)			24.36				27.49				27.18				25.48				29.25
Balance Sheet Data at Year End:
Total assets		$	4,974,134			$	4,562,313			$	4,217,293			$	3,879,744			$	3,558,968
Loans			3,310,363				3,034,354				2,739,509				2,554,899				2,236,550
Allowance for loan losses			47,452				42,450				42,141				38,940				36,309
Investment securities			1,124,598				1,019,901				867,315				799,587				799,292
Deposits			3,708,511				3,547,590				3,321,681				3,156,721				2,911,847
Other borrowed funds			5,694				7,495				7,995				7,137				7,970
Long-term debt			21,601				54,654				61,926				47,590				23,645
Subordinated debenture held by subsidiary trust/trust preferred securities			41,238				41,238				41,238				41,238				40,000
Stockholders’ equity			410,375				349,847				308,326				274,226				243,854

Five Year Summary (continued)

 

(Dollars in thousands except share and per share data)

Year ended December 31,		2006				2005				2004				2003				2002
Asset Quality Ratios at Year End:
Nonperforming assets to total loans and other real estate owned (“OREO”) (2)			0.55	%			0.67	%			0.79	%			1.30	%			1.51	%
Allowance for loan losses to total loans			1.43				1.40				1.54				1.52				1.62
Allowance for loan losses to nonperforming loans (3)			269.72				236.17				212.04				124.53				109.23
Net charge-offs to average loans			0.09				0.19				0.21				0.31				0.32
Regulatory Capital Ratios at Year End:
Tier 1 risk-based capital			10.71	%			10.07	%			9.67	%			9.30	%			9.17	%
Total risk-based capital			11.93				11.27				10.95				10.64				10.62
Leverage ratio			8.61				7.91				7.49				7.13				6.90

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Executive Overview

     We are a financial and bank holding company with 49 banking offices in 29 communities throughout Montana and Wyoming. Our principal operating segments are Community Banking and Technology Services. We differentiate ourselves from competitors by providing superior service to our banking and technology services customers and emphasizing community involvement to improve the communities we serve.

     Our principal business activity is lending to and accepting deposits from individuals, businesses, municipalities and other entities. We derive our income principally from interest charged on loans, and to a lesser extent, from interest and dividends earned on investments. We also derive income from noninterest sources such as fees received in connection with various lending and deposit services; trust, employee benefit, investment and insurance services; mortgage loan originations, sales and servicing; merchant and electronic banking services; technology services; and, from time to time, gains on sales of assets. Our principal expenses include interest expense on deposits and borrowings, operating expenses, provisions for loan losses and income tax expense.

     Our business strategy in recent years has been to profitably grow our business organically and through selective acquisitions. During the previous five years, we have used de novo banking offices to better serve existing customers and to attract new customers in our existing market areas. In addition, during the previous three years we have focused on improving efficiency through control of operating expenses, implementation of new technologies, consolidation of like operational and administrative functions where appropriate, and identification and implementation of strategies to increase noninterest income. During 2007 and subsequent years, we plan to make additional investments in technology and personnel to support our core community banking activities and to enhance our financial services product offerings. Longer-term, we intend to continue looking for profitable expansion opportunities.

     During 2006, our continuing focus on improving operating efficiency and identifying opportunities to generate additional noninterest income resulted in increased earnings. Net income increased $20.9 million, or 38.2%, to $75.6 million, or $9.11 per diluted share in 2006, as compared to $54.7 million, or $6.71 per diluted share in 2005. Included in 2006 net income was a one-time gain on the sale of our minority interest in an unconsolidated internet bill payment joint venture of $12.3 million, or $1.48 per diluted share, after income tax. Exclusive of this one-time gain, net income for 2006 of $63.3 million increased $8.6 million, or 15.7%, from $54.7 million in 2005.

     Net interest income, on a fully taxable-equivalent basis, increased 10.1% to $191.3 million in 2006, from $173.7 million in 2005, primarily due to growth in average earning assets. Average earning assets grew 10.4% and comprised a larger percentage of total assets in 2006, as compared to 2005. In addition, interest-free funding sources, including noninterest-bearing deposits, other liabilities and common equity, contributed an additional $112.7 million in 2006, as compared to 2005, allowing us to be slightly less reliant on higher costing funding sources in 2006.

     Net income in 2006 was also positively impacted by reductions in expenses associated with discontinuation of operations at Wal-Mart in-store banking offices described below; decreases in net losses on sales of investment securities; increases in fee income from higher debit and credit card transaction volumes; and, increases in revenues from technology and financial services. Increases in net income in 2006 were partially offset by additional impairment charges related to mortgage servicing rights; inflationary increases in salaries, wages and benefits expenses; and higher incentive bonus and profit sharing accruals. In addition, on January 1, 2006, we adopted SFAS No. 123 (revised), “Share-Based Payments,” which requires all share-based payments to be recognized in the financial statements based on the fair value of the award at the date of grant. Adoption of SFAS No. 123 (revised) resulted in the recognition of additional compensation expense related to stock option and restricted stock awards, net of related income tax benefits, of $543 thousand in 2006.

     We not only grew in terms of net income but also in terms of asset size, reaching nearly $5.0 billion in total assets in 2006. The increase in total assets was attributable to organic loan growth and increases in investment securities, funded by increases in customer deposits and securities sold under repurchase agreements.

     During 2005, we made a strategic decision to discontinue the operation of nine Wal-Mart in-store banking offices. As of December 31, 2006, operations at eight Wal-Mart in-store banking offices had been discontinued and customer loan and deposit accounts had been transferred to our existing banking offices located within the same communities. We recorded expenses directly related to the discontinuation of operations of $23 thousand in 2006 and $1.1 million in 2005. The assets and liabilities of our one remaining Wal-Mart in-store banking office were sold during 2006 at a $78 thousand gain.

     We act as transfer agent solely for our own common stock. In 2006, we received examination reports on our transfer agent function from the Federal Reserve Bank and the SEC noting certain operating deficiencies. All noted deficiencies were corrected prior to December 31, 2006, and we were informed by the SEC that no further action would be taken regarding the deficiencies.

     The following discussion and analysis is intended to provide greater details of the results of our operations and financial condition. It should be read in conjunction with the information under Part II, Item 6, “Selected Consolidated Financial Data” and the consolidated financial statements, including the notes thereto, and other financial data appearing elsewhere in this document.

Critical Accounting Estimates and Significant Accounting Policies

     Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States and follow general practices within the industries in which we operate. Application of these principles requires management to make estimates, assumptions and judgments that affect the amounts reported in the consolidated financial statements and accompanying notes. Our significant accounting policies are summarized in “Notes to Consolidated Financial Statements – Summary of Significant Accounting Policies” included in Part IV, Item 15.

     Our critical accounting estimates are summarized below. Management considers an accounting estimate to be critical if: (1) the accounting estimate requires management to make particularly difficult, subjective and/or complex judgments about matters that are inherently uncertain, and (2) changes in the estimate that are reasonably likely to occur from period to period, or the use of different estimates that management could have reasonably used in the current period, would have a material impact on our consolidated financial statements, results of operations or liquidity.

Allowance for Loan Losses

     The allowance for loan losses represents management’s estimate of probable credit losses inherent in the loan portfolio. Determining the amount of the allowance for loan losses is considered a critical accounting estimate because it requires significant judgment and the use of subjective measurements, including management’s assessment of the internal risk classifications of loans, changes in the nature of the loan portfolio, industry concentrations and the impact of current local, regional and national economic factors on the quality of the loan portfolio. Changes in these estimates and assumptions are reasonably possible and may have a material impact on our consolidated financial statements, results of operations or liquidity. The allowance for loan losses is maintained at an amount we believe is sufficient to provide for estimated losses inherent in our loan portfolio at each balance sheet date. Management continuously monitors qualitative and quantitative trends in the loan portfolio, including changes in the levels of past due, internally classified and non-performing loans. As a result, our historical experience has provided for an adequate allowance for loan losses. For additional information regarding the allowance for loan losses, its relation to the provision for loan losses and risk related to asset quality, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Results of Operations – Provision for Loan Losses” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Financial Condition – Allowance for Loan Losses” below, and “Notes to Consolidated Financial Statements – Allowance for Loan Losses” included in Part IV, Item 15. See also Part I, Item 1A, “Risk Factors – Credit Risks.”

Valuation of Mortgage Servicing Rights

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

     Determining the fair value of mortgage servicing rights is considered a critical accounting estimate because of the assets’ sensitivity to changes in estimates and assumptions used, particularly loan prepayment speeds and discount rates. Changes in these estimates and assumptions are reasonably possible and may have a material impact on our consolidated financial statements, results of operations or liquidity.

     At December 31, 2006, the consultant’s valuation model indicated that an immediate 25 basis point decrease in mortgage interest rates would result in a reduction in fair value of mortgage servicing rights of $3.9 million and an immediate 50 basis point decrease in mortgage interest rates would result in a reduction in fair value of $8.9 million.

     For additional information regarding mortgage servicing rights, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Financial Condition – Mortgage Servicing Rights” included below, and “Notes to Consolidated Financial Statements – Mortgage Servicing Rights,” included in Part IV, Item 15. See also Part I, Item 1A, “Risk Factors – Market Risks.”

Results of Operations

Net Interest Income

     Net interest income, the largest source of our operating income, is derived from interest, dividends and fees received on interest earning assets, less interest expense incurred on interest bearing liabilities. Interest earning assets primarily include loans and investment securities. Interest bearing liabilities include deposits and various forms of indebtedness. Net interest income is affected by the level of interest rates, changes in interest rates and changes in the composition of interest earning assets and interest bearing liabilities.

     The most significant impact on our net interest income between periods is derived from the interaction of changes in the volume of and rates earned or paid on interest earning assets and interest bearing liabilities. The volume of loans, investment securities and other interest earning assets, compared to the volume of interest bearing deposits and indebtedness, combined with the interest rate spread, produces changes in the net interest income between periods.

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

 

(Dollars in thousands)

		Year Ended December 31,
		2006												2005												2004
		Average								Average				Average								Average				Average								Average
		Balance				Interest				Rate				Balance				Interest				Rate				Balance				Interest				Rate
Interest earning assets:
Loans (1)(2)		$	3,208,102			$	246,861				7.69	%		$	2,874,723			$	196,453				6.83	%		$	2,629,474			$	162,598				6.18	%
U.S. and agency securities			915,844				40,985				4.48				779,369				30,054				3.86				715,363				25,272				3.53
Federal funds sold			43,726				2,196				5.02				83,156				2,766				3.33				69,225				1,071				1.55
Other securities			1,059				6				0.57				7,599				201				2.65				12,825				315				2.46
Tax exempt securities (2)			105,209				6,832				6.49				103,364				6,744				6.53				95,376				6,489				6.80
Interest bearing deposits in banks			8,190				360				4.40				31,325				1,021				3.26				14,411				281				1.95
Total interest earnings assets			4,282,130				297,240				6.94				3,879,536				237,239				6.12				3,536,674				196,026				5.54
Nonearning assets			444,702												454,545												460,327
Total assets		$	4,726,832											$	4,334,081											$	3,997,001
Interest bearing liabilities:
Demand deposits			850,925				15,852				1.86	%		$	667,668			$	4,795				0.72	%		$	576,909			$	1,618				0.28	%
Savings deposits			845,967				17,424				2.06				902,749				11,151				1.24				898,631				6,664				0.74
Time deposits			1,010,820				39,991				3.96				1,013,159				29,641				2.93				1,027,096				26,022				2.53
Borrowings (3)			683,776				27,636				4.04				507,131				12,750				2.51				387,609				3,814				0.98
Long-term debt			40,320				1,576				3.91				61,055				2,480				4.06				52,732				2,329				4.42
Subordinated debenture held by subsidiary trust/trust preferred securities			41,238				3,481				8.44				41,238				2,732				6.62				41,238				1,974				4.79
Total interest bearing liabilities			3,473,046				105,960				3.05				3,193,000				63,549				1.99				2,984,215				42,421				1.42
Noninterest bearing deposits			837,909												780,427												693,705
Other liabilities			44,860												34,854												30,655
Stockholders’ equity			371,017												325,800												288,426
Total liabilities and stockholders’ equity		$	4,726,832											$	4,334,081											$	3,997,001
Net FTE interest income						$	191,280											$	173,690											$	153,605
Less FTE adjustments (2)							(3,817	)											(3,382	)											(3,186	)
Net interest income from consolidated statements of income						$	187,463											$	170,308											$	150,419
Interest rate spread											3.89	%											4.13	%											4.12	%
Net FTE interest margin (4)											4.47	%											4.48	%											4.34	%

     Although faced with a continuing yield-rate environment in which short-term interest rates are higher than long-term interest rates, which typically constrains a bank’s ability to maintain its net interest margin, our net interest income, on a fully taxable equivalent, or FTE, basis, increased $17.6 million, or 10.1% to $191.3 million in 2006 from $173.7 million in 2005, and $20.1 million, or 13.1%, to $173.7 million in 2005 from $153.6 million in 2004 primarily due to organic growth in earning assets. Average earning assets grew 10.4% in 2006 as compared to 2005, and 9.7% in 2005 as compared to 2004.

In addition, interest-free funding sources, including noninterest-bearing deposits, other liabilities and common equity, contributed more of our funding base in 2006 and 2005, allowing us to be less reliant on higher costing funding sources such as time deposits, short-term borrowings and long-term debt. Further contributing to improvements in net FTE interest income in 2006 and 2005 were increases in earning assets as a percentage of total assets.

     The net FTE interest margin for 2006 remained stable at 4.47% in 2006, a one basis point decline from 4.48% in 2005, and increased 14 basis points to 4.48% in 2005, as compared to 4.34% in 2004. The net FTE interest margin for fourth quarter 2006 decreased 11 basis points to 4.38%, as compared to 4.49% for the same period in 2005, primarily the result of competitive pressure to raise interest rates paid on deposit accounts and repurchase agreements during the last half of 2006, while yields on interest earning assets increased at a slower pace.

     The table below sets forth, for the periods indicated, a summary of the changes in interest income and interest expense resulting from estimated changes in average asset and liability balances (volume) and estimated changes in average interest rates (rate). Changes which are not due solely to volume or rate have been allocated to these categories based on the respective percent changes in average volume and average rate as they compare to each other.

 

(Dollars in thousands)

		Year Ended December 31, 2006												Year Ended December 31, 2005												Year Ended December 31, 2004
		compared with												compared with												compared with
		December 31, 2005												December 31, 2004												December 31, 2003
		Volume				Rate				Net				Volume				Rate				Net				Volume				Rate				Net
Interest earning assets:
Loans (1)		$	22,782			$	27,626			$	50,408			$	15,165			$	18,690			$	33,855			$	11,797			$	(8,699	)		$	3,098
U.S. and agency securities			5,263				5,668				10,931				2,261				2,521				4,782				1,355				(1,429	)			(74	)
Federal funds sold			(1,312	)			742				(570	)			216				1,479				1,695				212				314				526
Other securities (2)			(173	)			(22	)			(195	)			(128	)			14				(114	)			(179	)			(46	)			(225	)
Tax exempt securities (1)(2)			120				(32	)			88				543				(288	)			255				453				(201	)			252
Interest bearing deposits in banks			(754	)			93				(661	)			343				397				740				192				70				262
Total change			25,926				34,075				60,001				18,400				22,813				41,213				13,830				(9,991	)			3,839
Interest bearing liabilities:
Demand deposits			1,316				9,741				11,057				255				2,922				3,177				136				(215	)			(79	)
Savings deposits			(701	)			6,974				6,273				30				4,457				4,487				618				(466	)			152
Time deposits			(68	)			10,418				10,350				(353	)			3,972				3,619				(993	)			(6,164	)			(7,157	)
Borrowings (3)			4,441				10,445				14,886				1,176				7,760				8,936				450				1,040				1,490
Long-term debt			(842	)			(62	)			(904	)			368				(217	)			151				188				(233	)			(45	)
Subordinated debenture held by subsidiary trust/trust preferred securities			—				749				749				—				758				758				(166	)			(388	)			(554	)
Total change			4,146				38,265				42,411				1,476				19,652				21,128				233				(6,426	)			(6,193	)
Increase (decrease) in FTE net interest income (1)		$	21,780			$	(4,190	)		$	17,590			$	16,924			$	3,161			$	20,085			$	13,597			$	(3,565	)		$	10,032

Provision for Loan Losses

     The provision for loan losses creates an allowance for loan losses known and inherent in the loan portfolio at each balance sheet date. We perform a quarterly assessment of the risks inherent in our loan portfolio, as well as a detailed review of each significant asset with identified weaknesses. Based on this analysis, we record a provision for loan losses in order to maintain the allowance for loan losses at appropriate levels. In determining the allowance for loan losses, we estimate losses on specific loans, or groups of loans, where the probable loss can be identified and reasonably determined. The balance of the allowance for loan losses is based on internally assigned risk classifications of loans, historical loan loss rates, changes in the nature of the loan portfolio, overall portfolio quality, industry concentrations, delinquency trends, current economic factors and the estimated impact of current economic conditions on certain historical loan loss rates. Fluctuations in the provision for loan losses result from management’s assessment of the adequacy of the allowance for loan losses. Ultimate loan losses may vary from current estimates. For additional information concerning the provision for loan losses, see “Critical Accounting Estimates and Significant Accounting Policies” above.

     The provision for loan losses increased 32.7% to $7.8 million in 2006, from $5.8 million in 2005 primarily due to higher levels of internally classified loans in 2006 and refinement of our process for assessing risk known and inherent in our loan portfolio. The provision for loan losses decreased 33.0% to $5.8 million in 2005, from $8.7 million in 2004 primarily due to lower levels of non-performing loans, net charge-offs and internally classified loans in 2005.

Noninterest Income

     Principal sources of noninterest income include other service charges, commissions and fees; service charges on deposit accounts; technology services revenues; income from the origination and sale of loans; and, revenues from financial services. Noninterest income increased 44.5% to $101.5 million in 2006, from $70.3 million in 2005, and decreased less than 1%, to $70.3 million in 2005, from $70.6 million in 2004. Fluctuations in noninterest income are a function of changes in each of the principal categories discussed below.

     Other service charges, commissions and fees primarily include debit and credit card interchange income; mortgage servicing fees; investment services revenues; and, ATM service charge revenues. Other service charges, commissions and fees increased 13.0% to $21.9 million in 2006, from $19.4 million in 2005, and 20.3% to $19.4 million in 2005, from $16.1 million in 2004. These increases are primarily attributable to additional fee income from higher volumes of credit and debit card transactions and increases in mortgage servicing revenues, the result of increases in the principal balances of loans serviced.

     Technology services revenues increased 19.1% to $15.8 million in 2006, from $13.3 million in 2005, and 5.8% to $13.3 million in 2005, from $12.6 million in 2004, primarily due to increases in the number of customers using core date processing services and the volume of core data and debit card transactions processed.

     Financial services revenues, comprised principally of fees earned for management of trust assets and investment services revenues, increased 11.3% to $10.6 million in 2006, from $9.5 million in 2005, and 7.8% to $9.5 million in 2005, from $8.8 million in 2005, primarily due to higher asset management fees resulting from the improved market performance of underlying trust account assets and the addition of new trust and investment services customers.

     Income from the origination and sale of loans includes origination and processing fees on residential real estate loans held for sale and gains on residential real estate loans sold to third parties. Fluctuations in market interest rates have a significant impact on the level of income generated from the origination and sale of loans. Higher interest rates can substantially reduce the demand for home loans and loans to refinance existing mortgages. Conversely, lower interest rates generally stimulate refinancing and home loan origination. Income from the origination and sale of loans increased 11.5% to $9.6 million in 2006, from $8.6 million in 2005, and 2.9% to $8.6 million in 2005, from $8.4 million in 2004.

     We recorded net losses of $722 thousand on sales of investment securities in 2006, as compared to $3.7 million in 2005, and $797 thousand in 2004. During 2005 and continuing in 2006, we partially restructured our investment security portfolio by selling lower yielding U.S. government agency securities and reinvesting the proceeds in higher yielding mortgage-backed and U.S. government agency securities.

     During fourth quarter 2006, we recorded a one-time gain of $19.8 million on the sale of our minority interest in an unconsolidated internet bill payment joint venture. Aggregate consideration for the sale was $21.2, of which $19.9 was received in cash and $1.4 was placed in escrow to offset purchase price adjustments related to working capital and indemnify potential loss claims. For additional information concerning this sale and the resulting gain, see “Notes to Consolidated Financial Statements – Acquisitions and Dispositions” included in Part IV, Item 15.

     Other income primarily includes increases in company-owned life insurance revenues, check printing income and agency stock dividends and gains on sales of assets other than investment securities. Noninterest income increased 18.7% to $6.9 million in 2006, from $5.8 million in 2005, primarily due to higher earnings on securities held under deferred compensation plans, higher earnings of unconsolidated equity method joint ventures and increases in the cash surrender value of life insurance. Exclusive of a $1.7 million gain on the sale of a banking office recorded during third quarter 2004, other income increased 17.9% to $5.8 million in 2005, from $4.9 million in 2004, primarily due to increases in check printing income, higher earnings on securities held under deferred compensation plans and gains on the sale of other real estate owned.

Noninterest Expense

     Noninterest expense increased 8.9% to $164.1 million in 2006, from $150.7 million in 2005, and 5.4% to $150.7 million in 2005, from $143.0 million in 2004. Significant components of these increases are discussed below.

     During 2005, we recorded expenses of $1.1 million directly related to the discontinuation of operations of our Wal-Mart in-store banking offices, including lease termination fees and estimated costs to restore leased facilities to their original condition of $375 thousand; acceleration of depreciation on leasehold improvements and equipment attached to the premises of $620 thousand; and, accruals for employment incentive awards of $92 thousand.

     Salaries, wages and employee benefits expense increased 11.1% to $88.9 million in 2006, from $80.0 million in 2005, primarily due to inflationary wage increases, higher incentive compensation and profit sharing contributions reflective of operating results in 2006 and increases in group medical insurance costs. In addition, we adopted SFAS No. 123 (revised), “Share-Based Payments,” on January 1, 2006. We recognized compensation expense for stock option and restricted stock awards of $1.3 million in 2006, as compared to $289 thousand in 2005.

     Salaries, wages and employee benefits expense increased 8.2% to $80.0 million in 2005, from $74.0 million in 2004, primarily due to inflationary wage increases; and, higher incentive compensation and profit sharing contributions reflective of operating results in 2005.

     Mortgage servicing rights are amortized in proportion to and over the period of estimated net servicing income. Changes in estimated servicing period and growth in the serviced loan portfolio cause amortization expense to vary between periods. Mortgage servicing rights amortization decreased 12.8% to $4.0 million in 2006, from $4.6 million in 2005, and increased 15.8% to $4.6 million in 2005, from $4.0 million in 2004.

     Mortgage servicing rights are evaluated quarterly for impairment by discounting the expected future cash flows, taking into consideration the estimated level of prepayments based on current industry expectations and the predominant risk characteristics of the underlying loans. Impairment adjustments are recorded through a valuation allowance. The valuation allowance is adjusted for changes in impairment through a charge to current period earnings. We recorded impairment charges of $1.7 million in 2006 and reversed previously recorded impairment of $2.2 million and $263 thousand in 2005 and 2004, respectively.

     Professional fees increased 11.4% to $3.2 million in 2006, from $2.8 million in 2005, primarily due to consulting fees related to evaluation of software and implementation of a company-wide data warehousing system. Professional fees decreased 10.5% to $2.8 million in 2005, from $3.2 million in 2004, primarily due to additional fees incurred in 2004 related to the implementation of automated overdraft processing and account reconciliation systems.

     Outsourced technology services principally include ATM network expense and costs of data processing consulting and other services provided by third parties. Outsourced technology services expense increased 37.6% to $3.2 million in 2006, from $2.3 million in 2005, and decreased 2.7% to $2.3 million in 2005, from $2.4 million in 2004. Increases in 2006 are primarily due to expenses related to the development of a new internet-based corporate cash management product and the redesign and customization of our corporate internet banking site.

     Other expenses primarily include advertising and public relations costs; office supply, postage, freight, telephone and travel expenses; donations expense; board of director fees; and, other losses. Other expenses remained relatively constant at $32.8 in 2006 and 2005. Increases in travel expense in 2006 were largely offset by decreases in losses on the disposal of fixed assets. Other expenses increased 3.6% to $32.8 million in 2005, from $31.7 million in 2004, primarily due to recognition of approximately $430 thousand of expense related to multi-year donations expensed in 2005; recognition of a $313 thousand loss on the disposal of obsolete mainframe equipment; and, inflationary increases in other expenses. These increases were partially offset by lower Federal Reserve service fees resulting from implementation of electronic item submission to accelerate item clearing and lower required compensating balances.

Income Tax Expense

     Our effective federal tax rate was 31.6% for the year ended December 31, 2006; 31.0% for the year ended December 31, 2005; and, 30.6% for the year ended December 31, 2004. Increases in federal income tax rates during 2006 and 2005 are primarily due to decreases in tax exempt interest income as a percentage of total income. State income tax applies primarily to pretax earnings generated within Montana, Colorado, Idaho and Oregon. Our effective state tax rate was 3.8% for the years ended December 31, 2006 and 2005, and 3.9% for year ended December 31, 2004.

Operating Segment Results

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

 

(Dollars in thousands)

		Net Income (Loss)
Year ended December 31,		2006				2005				2004
Community Banking		$	66,691			$	57,144			$	47,579
Technology Services			3,761				4,193				3,962
Other			5,157				(6,622	)			(6,120	)
Consolidated		$	75,609			$	54,715			$	45,421

     Our principal operating segment is Community Banking, which encompasses commercial and consumer banking services offered to individuals, businesses, municipalities and other entities. The Community Banking segment represented over 88% of our combined revenues and income during 2006, 2005 and 2004, and our consolidated assets as of December 31, 2006 and 2005. Components of the changes in Community Banking net income in 2006 as compared to 2005, and in 2005 as compared to 2004, are discussed above.

     The Technology Services operating segment encompasses services provided through i_Tech to affiliated and non-affiliated customers including core application data processing, ATM and debit card processing, item proof and capture, wide area network services and system support. Technology Services net income decreased 10.3% to $3.8 million in 2006, from $4.2 million in 2005. Higher revenues from increases in the number of customers using core date processing services and the volume of core data and debit card transactions processed in 2006 were offset primarily by increases in salary and benefits expenses due to higher staffing levels and increases in equipment maintenance and repair expense.

     Included in Other is the net funding cost and other expenses of the parent holding company, compensation expense or benefit related to equity-based employee compensation, the operational results of consolidated nonbank subsidiaries (except i_Tech) and intercompany eliminations. During 2006, the parent holding company recorded a one-time after tax gain of $12.3 million on the sale of its equity interest in an unconsolidated joint venture. This gain was partially offset by additional after tax compensation expense for stock options and restricted stock awards of $621 thousand resulting from the adoption of SFAS No. 123 (revised) on January 1, 2006.

     For additional information regarding the our operating segments, see “Business — Operating Segments” included in Part I, Item 1, and “Notes to Consolidated Financial Statements — Segment Reporting” included in Part IV, Item 15.

Summary of Quarterly Results

     The following table presents unaudited quarterly results of operations for the fiscal years ended December 31, 2006 and 2005.

Quarterly Results

 

(Dollars in thousands except per share data)

		First				Second				Third				Fourth
		Quarter				Quarter				Quarter				Quarter				Total
Year Ended December 31, 2006:
Interest income		$	66,969			$	71,558			$	76,416			$	78,480			$	293,423
Interest expense			21,354				25,594				28,614				30,398				105,960
Net interest income			45,615				45,964				47,802				48,082				187,463
Provision for loan losses			1,753				2,578				2,029				1,401				7,761
Net interest income after provision for loan losses			43,862				43,386				45,773				46,681				179,702
Noninterest income			19,120				20,059				21,378				40,991				101,548
Noninterest expense			38,194				38,717				41,300				45,931				164,142
Income before income taxes			24,788				24,728				25,851				41,741				117,108
Income tax expense			8,654				8,591				9,105				15,149				41,499
Net income		$	16,134			$	16,137			$	16,746			$	26,592			$	75,609
Basic earnings per common share		$	1.99			$	1.99			$	2.07			$	3.27			$	9.32
Diluted earnings per common share			1.95				1.95				2.02				3.18				9.11
Dividends per common share			0.50				0.58				0.58				0.61				2.27
Year Ended December 31, 2005:
Interest income		$	51,967			$	55,544			$	61,423			$	64,923			$	233,857
Interest expense			12,634				14,672				16,806				19,437				63,549
Net interest income			39,333				40,872				44,617				45,486				170,308
Provision for loan losses			1,625				1,365				1,375				1,482				5,847
Net interest income after provision for loan losses			37,708				39,507				43,242				44,004				164,461
Noninterest income			16,949				17,739				17,563				18,039				70,290
Noninterest expense			36,396				37,542				37,243				39,545				150,726
Income before income taxes			18,261				19,704				23,562				22,498				84,025
Income tax expense			6,302				6,824				8,288				7,896				29,310
Net income		$	11,959			$	12,880			$	15,274			$	14,602			$	54,715
Basic earnings per common share		$	1.50			$	1.62			$	1.91			$	1.78			$	6.84
Diluted earnings per common share			1.48				1.59				1.88				1.77				6.71
Dividends per common share			0.42				0.48				0.48				0.50				1.88

Financial Condition

     Total assets increased 9.0% to $4,974 million as of December 31, 2006, from $4,562 million as of December 31, 2005, primarily due to organic loan growth and increases in available-for-sale investment securities. Asset growth was primarily funded by increases in customer deposits and securities sold under repurchase agreements.

Loans

     Our loan portfolio consists of a mix of real estate, consumer, commercial, agricultural and other loans, including fixed and variable rate loans. Fluctuations in the loan portfolio are directly related to the economies of the communities we serve. While each loan originated generally must meet minimum underwriting standards established in our credit policies, lending officers are granted certain levels of autonomy in approving and pricing loans to assure that the banking offices are responsive to competitive issues and community needs in each market area.

     Real Estate Loans. We provide interim construction and permanent financing for both single-family and multi-unit properties, medium-term loans for commercial, agricultural and industrial property and/or buildings and equity lines of credit secured by real estate. Residential real estate loans are typically sold in the secondary market. Those residential real estate loans not sold are typically secured by first liens on the financed property and generally mature in less than 10 years. Commercial, agricultural and industrial loans are generally secured by first liens on income-producing real estate and generally mature in less than five years.

     Consumer Loans. Our consumer loans include direct personal loans, credit card loans and lines of credit; and, indirect loans created when we purchase consumer loan contracts advanced for the purchase of automobiles, boats and other consumer goods from consumer product dealers. Personal loans and indirect dealer loans are generally secured by automobiles, boats and other types of personal property and are made on an installment basis. Credit cards are offered to individual and business customers in our market areas. Lines of credit are generally floating rate loans that are unsecured or secured by personal property. Approximately 61% of our consumer loans as of December 31, 2006, are indirect dealer loans.

     Commercial Loans. We provide a mix of variable and fixed rate commercial loans. The loans are typically made to small and medium-sized manufacturing, wholesale, retail and service businesses for working capital needs and business expansions. Commercial loans generally include lines of credit and loans with maturities of five years or less. The loans are generally made with business operations as the primary source of repayment, but also include collateralization by inventory, accounts receivable, equipment and/or personal guarantees.

     Agricultural Loans. Our agricultural loans generally consist of short and medium-term loans and lines of credit that are primarily used for crops, livestock, equipment and general operations. Agricultural loans are ordinarily secured by assets such as livestock or equipment and are repaid from the operations of the farm or ranch. Agricultural loans generally have maturities of five years or less, with operating lines for one production season.

     Total loans increased 9.1% to $3,310 million as of December 31, 2006, from $3,034 million as of December 31, 2005, and 10.8% to $3,034 million as of December 31, 2005, from $2,740 as of December 31, 2004, due to organic growth within our market areas.

     The following table presents the composition of our loan portfolio as of the dates indicated:

 

(Dollars in thousands)

		As of December 31,
		2006				Percent				2005				Percent				2004				Percent				2003				Percent				2002				Percent
Loans
Real estate:
Commercial		$	919,912				27.8	%		$	907,041				29.8	%		$	838,858				30.6	%		$	753,551				29.4	%		$	652,606				29.1	%
Residential			420,251				12.7				427,808				14.1				379,998				13.9				348,901				13.7				287,996				12.9
Construction			579,603				17.5				403,751				13.3				296,773				10.8				244,784				9.6				127,102				5.7
Other			163,019				4.9				135,469				4.5				129,600				4.7				149,963				5.9				147,026				6.6
Consumer			605,858				18.3				587,895				19.4				514,045				18.8				491,938				19.3				470,668				21.0
Commercial			542,325				16.4				494,848				16.3				500,611				18.3				480,725				18.8				460,536				20.6
Agricultural			76,644				2.3				74,561				2.5				74,303				2.7				82,634				3.2				87,144				3.9
Other loans			2,751				0.1				2,981				0.1				5,321				0.2				2,403				0.1				3,472				0.2
Total loans			3,310,363				100.0	%			3,034,354				100.0	%			2,739,509				100.0	%			2,554,899				100.0	%			2,236,550				100.0	%
Less allowance for loan losses			47,452								42,450								42,141								38,940								36,309
Net loans		$	3,262,911							$	2,991,904							$	2,697,368							$	2,515,959							$	2,200,241
Ratio of allowance to total loans			1.43	%											1.40	%							1.54	%							1.52	%							1.62	%

     Construction loans increased 43.6% to $580 million as of December 31, 2006, from $404 million as of December 31, 2005, and 36.0% to $404 million as of December 31, 2005, from $297 million as of December 31, 2004. Construction loans are primarily to commercial builders for the construction of single-family residences and commercial real estate properties. Construction loans are generally underwritten pursuant to the same guidelines used for originating permanent commercial and residential mortgage loans. Terms and rates typically match those of permanent commercial and residential mortgage loans, except that during the construction phase the borrower pays interest only. Growth in construction loans in 2006 and 2005 was primarily the result of strong demand for housing in our market areas.

     Other real estate loans are comprised primarily of agricultural real estate loans. Other real estate loans increased 20.3% to $163 million as of December 31, 2006, from $135 million as of December 31, 2005, primarily due to the addition of one new loan and the reclassification of one existing loan from commercial real estate to agricultural real estate in 2006.

     Consumer loans increased 3.1% to $606 million as of December 31, 2006, from $588 million as of December 31, 2005, and 14.4% to $588 million a of December 31, 2005, from $514 million as of December 31, 2004, primarily due to increases in indirect consumer loans, the result of a strategic management decision to implement a centralized approach to indirect lending decisions and product pricing in 2005.

     Commercial loans increased 9.6% to $542 million as of December 31, 2006, from $495 million as of December 31, 2005, due to a favorable economy and growth in our existing market areas and an increase in overall borrowing activity.

     Residential real estate loans decreased 1.8% to $420 million as of December 31, 2005, from $428 million as of December 31, 2005. During 2006, we retained fewer of the residential real estate loans we originated to take advantage of generally favorable pricing for loans on the secondary market.

     The following table presents the maturity distribution of our loan portfolio and the sensitivity of the loans to changes in interest rates as of December 31, 2006:

 

(Dollars in thousands)

		Within				One Year to				After
		One Year				Five Years				Five Years				Total
Real estate		$	1,002,905			$	719,071			$	360,809			$	2,082,785
Consumer			319,040				269,263				17,555				605,858
Commercial			430,845				104,210				7,270				542,325
Agricultural			68,526				8,042				76				76,644
Other loans			2,751				—				—				2,751
Total loans		$	1,824,067			$	1,100,586			$	385,710			$	3,310,363
Loans at fixed interest rates		$	702,426			$	920,732			$	159,528			$	1,782,686
Loans at variable interest rates			1,106,877				179,854				226,182				1,512,913
Nonaccrual loans			14,764				—				—				14,764
Total loans		$	1,824,067			$	1,100,586			$	385,710			$	3,310,363

Investment Securities

     We manage our investment portfolio to obtain the highest yield possible, while meeting our risk tolerance and liquidity guidelines and satisfying the pledging requirements for deposits of state and political subdivisions and securities sold under repurchase agreements. The portfolio is comprised of mortgage-backed securities, U.S. government agency securities, tax exempt securities, corporate securities and mutual funds. Federal funds sold are additional investments that are classified as cash equivalents rather than as investment securities. Investment securities classified as available-for-sale are recorded at fair value, while investment securities classified as held-to-maturity are recorded at amortized cost. Unrealized gains or losses, net of the deferred tax effect, on available-for-sale securities are reported as increases or decreases in accumulated other comprehensive income or loss, a component of stockholders’ equity.

     Investment securities increased 10.3% to $1,125 million as of December 31, 2006, from $1,020 million as of December 31, 2005, and 17.6% to $1,020 million as of December 31, 2005, from $867 million as of December 31, 2004. During 2006 and 2005, we purchased short-term available-for-sale investment securities to provide the collateral necessary to support growth in securities sold under repurchase agreements. As of December 31, 2006, investment securities with amortized costs and fair values of $1,040 million and $1,029 million, respectively, were pledged to secure public deposits and securities sold under repurchase agreements, as compared to $916 million and $903 million, respectively, as of December 31, 2005. The weighted average yield on investment securities increased 52 basis points to 4.68% in 2006, from 4.16% in 2005, and 27 basis points to 4.16% in 2005, from 3.89% in 2004. Proceeds from maturities and sales of lower yielding available-for-sale U.S. agency investment securities during 2006 and 2005 were reinvested in higher-yielding mortgage-backed and U.S. agency investment securities. For additional information concerning securities sold under repurchase agreements, see “Federal Funds Purchased and Securities Sold Under Repurchase Agreements” included herein.

     The following table sets forth the book value, percentage of total investment securities and average yield on investment securities as of December 31, 2006:

 

(Dollars in thousands)

						% of Total				Weighted
		Book				Investment				Average
		Value				Securities				Yield (1)
U.S. Government agency securities
Maturing within one year		$	304,630				27.1	%			5.01	%
Maturing in one to five years			262,388				23.3				4.56
Mark-to-market adjustments on securities available-for-sale			(2,862	)
Total			564,156				50.2				4.81
Mortgage-backed securities
Maturing within one year			96,050				8.5				4.62
Maturing in one to five years			228,692				20.3				4.47
Maturing in five to ten years			64,033				5.7				4.71
Maturing after ten years			68,607				6.1				5.11
Mark-to-market adjustments on securities available-for-sale			(8,920	)
Total			448,462				39.9				4.63
Tax exempt securities
Maturing within one year			12,040				1.1				6.53
Maturing in one to five years			47,111				4.2				6.66
Maturing in five to ten years			19,781				1.8				6.52
Maturing after ten years			32,090				2.8				6.20
Total			111,022				9.9				6.49
Other securities (2)
Maturing within one year			—				0.0				0.0
Maturing in one to five years			396				0.0				0.0
Maturing in five to ten years			432				0.0				0.0
Maturing after ten years			90				0.0				0.0
Total			918				0.0				0.0
Mutual funds with no stated maturity			40				0.0				4.77
Total			40				0.0				4.77
Total		$	1,124,598				100.0	%			4.68	%

     The maturities noted above reflect $105 million of investment securities at their final maturities although they have call provisions within the next year. Mortgage-backed securities, and to a limited extent other securities, have uncertain cash flow characteristics that present additional interest rate risk in the form of prepayment or extension risk primarily caused by changes in market interest rates. This additional risk is generally rewarded in the form of higher yields. Maturities of mortgage-backed securities presented above are based on prepayment assumptions at December 31, 2006.

     There were no significant concentrations of investments at December 31, 2006, (greater than 10% of stockholders’ equity) in any individual security issuer, except for U.S. Government or agency-backed securities.

     As of December 31, 2005, we had U.S. Government agency securities with carrying values of $507 million and a weighted average yield of 4.15%; mortgage-backed securities with carrying values of $409 million and a weighted average yield of 4.41%; tax exempt securities with carrying values of $102 million and a weighted average yield of 6.53%; other securities with carrying values of $1 million and a weighted average yield of 0.00%; and, mutual funds with carrying values of $9 thousand and a weighted average yield of 3.56%.

     As of December 31, 2004, we had U.S. Government agency securities with carrying values of $356 million and a weighted average yield of 3.13%; mortgage-backed securities with carrying values of $101 million and a weighted average yield of 4.31%; tax exempt securities with carrying values of $100 million and a weighted average yield of 6.58%; corporate securities with carrying values of $11 million and a weighted average yield of 2.78%; and, mutual funds with carrying values of $183 thousand and a weighted average yield of 1.58%.

     We evaluate our investment portfolio quarterly for other-than-temporary declines in the market value of individual investment securities. This evaluation includes monitoring credit ratings; market, industry and corporate news; volatility in market prices; and, determining whether the market value of a security has been below its cost for an extended period of time. As of December 31, 2006, we had investment securities with fair values of $547 million that had been in a continuous loss position more than twelve months. Gross unrealized losses on these securities totaled $12 million as of December 31, 2006, and were primarily attributable to changes in interest rates. We recorded no impairment losses during 2006, 2005 or 2004.

     For additional information concerning investment securities, see “Notes to Consolidated Financial Statements – Investment Securities” included in Part IV, Item 15.

Mortgage Servicing Rights

     We recognize the rights to service mortgage loans for others whether acquired or internally originated. Net mortgage servicing rights increased 2.4% to $23 million as of December 31, 2006, from $22 million as of December 31, 2005, and 25.5% to $22 million as of December 31, 2005, from $18 million as of December 31, 2004, primarily due to internal loan origination. Impairment reserves for mortgage servicing rights were $4 million as of December 31, 2006, $2 million as of December 31, 2005, and $5 million as of December 31, 2004. For additional information regarding the mortgage servicing rights, see “Notes to Consolidated Financial Statements – Mortgage Servicing Rights” included in Part IV, Item 15.

Deposits

     We emphasize developing total client relationships with our customers in order to increase our core deposit base, which is our primary funding source. Our deposits consist of noninterest-bearing and interest-bearing demand, savings, individual retirement and time deposit accounts.

     Deposits increased 4.5% to $3,709 million as of December 31, 2006, from $3,548 million as of December 31, 2005, primarily due to organic growth. All deposit categories demonstrated growth during 2006 with the exception of savings deposits and other time deposits, which decreased 9.2% and 1.7%, respectively, in 2006, as compared to 2005. As of December 31, 2006, noninterest bearing demand deposits, interest bearing demand deposits, savings deposits and time deposits comprised 24.0%, 26.0%, 21.5% and 28.5%, respectively, of total deposits, as compared to 24.4%, 22.3%, 24.8% and 28.5%, respectively, as of December 31, 2005. Deposits increased 6.8% to $3,548 million as of December 31, 2005, from $3,322 as of December 31, 2004, despite the sale of a banking office with $33 million of deposits in 2004. This increase was due to organic growth, primarily in noninterest-bearing demand, interest-bearing demand and savings deposits.

For additional information concerning customer deposits, including the use of repurchase agreements, see Part I, Item 1, “Business – Deposit Products” and “Notes to Consolidated Financial Statements – Deposits” included in Part IV, Item 15.

Other Borrowed Funds

     Other borrowed funds decreased 24.0% to $6 million as of December 31, 2006, from $7 million as of December 31, 2005, and 6.3% to $7 million as of December 31, 2005, from $8 million as of December 31, 2004. Fluctuations in other borrowed funds are generally due to timing of tax deposits made by customers and the subsequent withdrawal of funds by the federal government. For additional information on other borrowed funds as of December 31, 2006 and 2005, see “Notes to Consolidated Financial Statements – Long-Term Debt and Other Borrowed Funds” included in Part IV, Item 15.

Federal Funds Purchased and Securities Sold Under Repurchase Agreements

     The following table sets forth certain information regarding federal funds purchased and repurchase agreements as of the dates indicated:

 

(Dollars in thousands)

As of and for the year ended December 31,		2006				2005				2004
Federal funds purchased:
Balance at period end		$	—			$	1,500			$	—
Average balance			31,579				836				3,437
Maximum amount outstanding at any month-end			87,810				1,500				42,885
Average interest rate:
During the year			5.22	%			3.11	%			1.00	%
At period end			—				3.81				—
Securities sold under repurchase agreements:
Balance at period end		$	731,548			$	518,718			$	449,699
Average balance			638,686				502,177				378,839
Maximum amount outstanding at any month-end			731,548				539,838				453,651
Average interest rate:
During the year			3.96	%			2.51	%			0.98	%
At period end			4.15				3.46				1.68