First Interstate BancSystem
Annual Report 2011

Plain-text annual report

FIBK 10-K 12/31/2011 Section 1: 10-K UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington D.C. 20549 FORM 10-K (Mark One) þ o Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year ended December 31, 2011 or 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: 001-34653 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: Class A common stock (Title of each class) NASDAQ Stock Market (Name of each exchange on which registered) Securities registered pursuant to Section 12(g) of the Act: Class B common stock (Title of class) Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. 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 whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§223.405 of this chapter) during the preceding 12 months (or for such shorter period that registrant was required to submit and post such files). 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, a non-accelerated filer, or a smaller reporting company. See the definitions of “ large accelerated filer,” “ accelerated filer” and “ smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one): o Large accelerated filer þ Accelerated filer o Non-accelerated filer (Do not check if a smaller reporting company) o Smaller reporting company Indicate by check mark if the registrant is a shell company (as defined in Rule 12b-2 of the Act.) o Yes þ No The aggregate market 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, was $275,147,011. Indicate the number of shares outstanding of each of the registrant’s classes of common stock as of January 31, 2012: Class A common stock Class B common sock 16,477,353 26,544,097 Documents Incorporated by Reference The registrant intends to file a definitive Proxy Statement for the Annual Meeting of Shareholders scheduled to be held May 23, 2012. The information required by Part III of this Form 10-K is incorporated by reference from such Proxy Statement. PART I Item 1. Business Item 1A. Risk Factors Item 1B. Unresolved Staff Comments Item 2. Properties Item 3. Legal Proceedings Item 4. Mine Safety Disclosure PART II Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Item 6. Selected Consolidated Financial Data Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations Item 7A. Quantitative and Qualitative Disclosures About Market Risk Item 8. Financial Statements and Supplementary Data Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure Item 9A. Controls and Procedures Item 9B. Other Information PART III Item 10. Directors, Executive Officers and Corporate Governance. Item 11. Executive Compensation Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters Item 13. Certain Relationships and Related Transactions and Director Independence Item 14. Principal Accountant Fees and Services PART IV Item 15. Exhibits and Financial Statement Schedules EX-21.1 EX-23.1 EX-31.1 EX-31.2 EX-32 Table of Contents PART I Item 1. Business The disclosures set forth in this report are qualified by Item 1A. Risk Factors included herein and the section captioned “Cautionary Note Regarding Forward-Looking Statements and Factors that Could Affect Future Results” included in Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. When we refer to “we,” “our,” “us” or the “Company” in this annual report, we mean First Interstate BancSystem, Inc. and our consolidated subsidiaries, including our wholly-owned subsidiary, First Interstate Bank, unless the context indicates that we refer only to the parent company, First Interstate BancSystem, Inc. When we refer to the “Bank” in this annual report, we mean First Interstate Bank. Our Company We are a financial and bank holding company incorporated as a Montana corporation in 1971. We are headquartered in Billings, Montana. As of January 31, 2012, we had consolidated assets of $7.3 billion, deposits of $5.8 billion, loans of $4.2 billion and total stockholders’ equity of $770 million. We currently operate 71 banking offices in 42 communities located in Montana, Wyoming and western South Dakota. Through our wholly-owned subsidiary, First Interstate Bank we deliver a comprehensive range of banking products and services to individuals, businesses, municipalities and other entities throughout our market areas. Our customers participate in a wide variety of industries, including energy, healthcare and professional services, education and governmental services, construction, mining, agriculture, retail and wholesale trade and tourism. Our principal markets range in size from 23,000 to 150,000 people, have diversified economic characteristics and favorable population growth prospects and usually serve as trade centers for larger rural areas. 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 the six neighboring states of Idaho, Utah, Colorado, Nebraska, South Dakota and North Dakota. We have grown our business by adhering to a set of guiding principles and a long-term disciplined perspective that emphasizes our commitment to providing high-quality financial products and services, delivering quality customer service, effecting business leadership through professional and dedicated managers and employees, assisting our communities through socially responsible leadership and cultivating a strong and positive corporate culture. In the future, we intend to remain a leader in our markets by continuing to adhere to the core principles and values that have contributed to our growth and success and by continuing to follow our community banking model. In addition, we plan to continue to expand our business in a disciplined and prudent manner, including organic growth in our existing market areas and expansion into new and complementary markets when appropriate opportunities arise. Community Banking 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. 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 authority in delivering and pricing products in response to local market considerations and customer needs. This authority enables our banking offices to remain competitive by responding quickly to local market conditions and enhances their relationships with the customers they serve by tailoring our products and price points to each individual customer’s needs. We also require accountability by having company-wide standards and established limits on the authority and discretion of each banking office. This combination of authority and accountability allows our banking offices to provide personalized customer service and be in close contact with our communities, while at the same time promoting strong performance at the branch level and remaining focused on our overall financial performance. Lending Activities We offer short and long-term real estate, consumer, commercial, agricultural and other loans to individuals and businesses in our market areas. We have comprehensive credit policies establishing company-wide underwriting and documentation standards to assist management in the lending process and to limit our risk. Each loan must meet minimum underwriting standards specified in our credit policies. Minimum underwriting standards generally specify that loans (i) are made to 1 Table of Contents borrowers located within a designated geographical lending area with the exception of participation loans and loans to national accounts; (ii) are made only for identified legal purposes; (iii) have specifically identified sources of repayment; (iv) mature within designated maximum maturity periods that coincide with repayment sources; (v) are appropriately collateralized whenever possible, (vi) are supported by current credit information; (vii) do not exceed the Bank's legal lending limit; (viii) with fixed interest rates are adjusted within designated time frames; and (ix) require a flood determination prior to closing. In addition, our minimum underwriting standards include lending limitations to prevent concentrations of credit in agricultural, commercial, real estate or consumer loans. Further, each minimum underwriting standard must be documented as part of the loan approval process. While each loan must meet minimum underwriting standards established in our credit policies, lending officers are granted certain levels of authority in approving and pricing loans to assure that the banking offices are responsive to competitive issues and community needs in each market area. Lending authorities are established at individual, branch and market levels. Branch and market lending authorities are assigned annually by the Company's chief executive officer and chief credit officer based on the size of the branch or market's loan portfolio and the branch or market's historical credit performance. Individual lending limits are approved annually by branch or market management and are based on the credit ability and experience of each individual officer. Branch and market lending limits and aggregate lending relationships in excess of $10 million are approved by the Bank's board of directors after review by the Credit Committee of the Company's board of directors. 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. All outstanding repurchase agreements are due in one business day. Wealth Management 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. As of January 31, 2012, the estimated fair value of trust assets held in a fiduciary or agent capacity was in excess of $3 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, specialized staff support services have been centralized to enable our branches to serve their markets more efficiently. These services include credit administration, finance, accounting, human resource management, internal audit, technology and other support services. Competition Commercial banking is highly competitive. We compete with other financial institutions located in Montana, Wyoming, South Dakota 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. 2 Table of Contents Employees At January 31, 2012, we employed 1,677 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 material laws and regulations applicable to us is summarized below. This description is not intended to include a summary of all laws and regulations applicable to us. 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 financial and bank holding company, we are subject to regulation under the Bank Holding Company Act of 1956, as amended, or the Bank Holding Company Act, 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 Exchange Act of 1934, as amended, or Exchange Act, as administered by the Securities and Exchange Commission, or SEC. The Bank is subject to supervision and regular examination by its primary banking regulators, the Federal Reserve and the State of Montana, Department of Administration, Division of Banking and Financial Institutions, with respect to its activities in Wyoming the State of Wyoming, Department of Audit, and with respect to its activities in South Dakota, the State of South Dakota Department of Revenue & Regulation, Division of Banking. 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 various laws and regulations and the collection and retention of information. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, or the Dodd-Frank Act, enacts significant changes in federal statutes governing banks and bank holding companies generally as well as other entities. Some of the significant changes are already in effect, additional significant changes will become effective in the near-term and other significant changes require action by federal banking agencies, including the Federal Reserve, the principal federal regulator of the Company. Except as otherwise noted, the following discussion assumes that provisions of the Dodd-Frank Act applicable to banks and bank holding companies to become effective in the near-term are currently in effect. Financial and Bank Holding Company The Company is a bank holding company and has registered as a financial holding company under regulations issued by the Federal Reserve. Under federal law, the Company is required to serve as a source of financial strength to the Bank, including providing financial assistance to the Bank if the Bank experiences financial distress. The federal banking agencies are required under the Dodd-Frank Act to issue joint rules to carry out the source of strength requirements. As of December 31, 2011, the federal banking agencies had not issued rules establishing such source of strength requirements applicable to the Company. However, the Federal Reserve has indicated its intent to issue proposed rules to carry out the source of strength requirements in the first calendar quarter of 2012. Under existing Federal Reserve source of strength policies, the Federal Reserve may require a bank holding company to make capital injections into a troubled subsidiary bank. The Federal Reserve may also determine that the bank holding company is engaging in unsafe and unsound practices if it fails to commit resources to such a subsidiary bank. 3 Table of Contents 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 Dodd-Frank Act, when acting on an application for approval the Federal Reserve is required to consider whether the transaction would result in greater or more concentrated risks to the United States banking or financial system. Under federal law and regulations, including the Dodd-Frank Act, a bank holding company may acquire banks in states other than its home state if the bank holding company is both 'well-capitalized' and 'well-managed' both before and after the acquisition. The interstate acquisitions are subject to any state requirement that the bank has been organized and operating for a minimum period of time, not to exceed five years, and the requirement that the bank holding company not control, prior to or following the proposed acquisition, more than 10% of the total amount of deposits of insured depository institutions nationwide or, unless the acquisition is the bank holding company's initial entry into the state, more than 30% of such deposits in the state, or such lesser or greater amount set by state law of such deposits in that state. With additional changes made to federal statutes under the Dodd-Frank Act, banks are also permitted to establish new branches in a state if a bank located in that state could establish a new branch at the proposed location without regard to state laws limiting interstate de novo branching. Banks may also merge across state lines. A state can prohibit interstate mergers entirely or prohibit them if the continuing bank would control insured bank deposits in excess of a specified percentage of total insured bank deposits in the state, provided such prohibition does not discriminate against out-of-state banks. Under Montana law, banks, bank holding companies and their respective subsidiaries cannot acquire control of a bank located in Montana if, after the acquisition, the acquiring institution and its affiliates would directly or indirectly control, in the aggregate, more than 22% of the total deposits of insured depository institutions located in Montana. We have voluntarily registered with the Federal Reserve as a financial holding company. As a financial holding company, 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 for 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. In order to assess the financial strength of the bank holding company, the Federal Reserve and the State of Montana also conducts throughout the year periodic onsite and offsite inspections and credit reviews of us. The federal banking agencies, including the Federal Reserve, may also require additional information and reports from us. In addition, the Federal Reserve may examine, and require reports and information regarding, any entity that we control, including entities other than banks or entities engaged in financial activities. In certain circumstances, the Federal Reserve may require us to divest of non- bank entities or limit the activities of those entities even if the activities are otherwise permitted to bank holding companies under governing law. With limited exceptions, as of July 21, 2011, banks and their affiliates are not permitted to engage in proprietary trading, or invest in, or serve as an advisor to, hedge funds or private equity funds. We have not historically engaged in any of those activities. 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. Under both state and federal law, the amount of dividends that may be paid by the Bank from time to time is limited. In general, the Bank is limited to paying dividends that do not exceed the current year net profits together with retained earnings from the two preceding calendar years unless the prior consents of the Montana and federal banking regulators are obtained. 4 Table of Contents 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 currently subject to a specific regulatory dividend limitation other than generally applicable limitations. In general, banks are also prohibited from making capital distributions, including dividends and are prohibited from paying management fees to control persons if it would be “undercapitalized” under the regulatory framework for corrective action after making such payments. See “Capital Standards and Prompt Corrective Action.” Certain restrictive covenants that may exist in future debt instruments may also limit the Bank's ability to make dividend payments to us. Also, under Montana corporate law, a dividend may not be paid if, after giving effect to the dividend: (1) the company would not be able to pay its debts as they become due in the usual course of business; or (2) the company's total assets would be less than the sum of its total liabilities plus the amount that would be needed, if the company were to be dissolved at the time of the dividend, to satisfy the preferential rights upon dissolution of shareholders whose preferential rights are superior to those receiving the dividend. Furthermore, because we are a legal entity separate and distinct from the Bank, our right to participate in the distribution of assets of the Bank upon its liquidation or reorganization will be subject to the prior claims of the Bank's creditors. In the event of such a liquidation or other resolution, the claims of depositors and other general or subordinated creditors of the Bank are entitled to a priority of payment of the claims of holders of any obligation of the Bank to its shareholders, including us, or our shareholders or creditors. Restrictions on Transactions with Affiliates, Directors and Officers Under the Federal Reserve Act, 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 limitation on lending may limit our ability to obtain funds from the Bank for our cash needs, including funds for payment of dividends, interest and operational expenses. The Federal Reserve also has authority to define and limit the transactions between banks and their affiliates. The Federal Reserve's Regulation W and relevant federal statutes, among other things, impose significant additional limitations on transactions in which the Bank may engage with us, with each other, or with other affiliates. Federal Reserve Regulation O restricts loans to the Bank and Company insiders, which includes directors, officers and principal stockholders and their respective related interests. All extensions of credit to the insiders and their related interests must be on the same terms as, and subject to the same loan underwriting requirements as, loans to persons who are not insiders. In addition, Regulation O imposes lending limits on loans to insiders and their related interests and imposes, in certain circumstances, requirements for prior approval of the loans by the Bank board of directors. 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. Under the Dodd-Frank Act, the federal banking agencies are required to establish, by regulation or order, minimum capital requirements for insured depository organizations and the Federal Reserve is permitted to establish capital requirements, by regulation or order, for bank holding companies. The minimum capital requirements to be established cannot be less than the minimum capital guidelines in effect when the Dodd-Frank Act was enacted. The Federal Reserve is required to seek to make capital requirements countercyclical by increasing the amount of required capital during times of economic expansion and decreasing the amount of required capital during times of economic contraction. The provisions of the Dodd-Frank Act, together with actions taken by the Basel Committee for the Basel III accords, may result in future regulatory minimum capital requirements that will exceed the regulatory minimum capital guidelines to which we are currently subject. 5 Table of Contents In 2011, the Federal Reserve issued several requests for comments on proposed rules that, if adopted, would implement, among other things, the capital guideline requirements under the Dodd-Frank Act. In most circumstances the proposed rules would apply only to bank holding companies or banks with consolidated assets in excess of $50 billion. Some proposed rules would apply to bank holding companies or banks with consolidated assets in excess of $10 billion. Because the Company has consolidated assets of less than $10 billion, none of the proposed rules, if adopted, would apply to the Company or the Bank. The Federal Reserve has indicated its intent to issue additional proposed rules in 2012 addressing minimum capital and leverage requirements. Currently, the Federal Reserve Board and the FDIC have substantially similar risk-based capital ratio and leverage ratio guidelines for banks similar in asset size to the Bank. The guidelines are intended to ensure that banks 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, noncumulative perpetual preferred stock (excluding auction rate issues) and minority interests in equity accounts of consolidated subsidiaries, less both goodwill (adjusted for associated deferred tax liability) 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. The Dodd-Frank Act provisions relating to required minimum capital also limit, in certain circumstances, the use of hybrid capital instruments in meeting regulatory capital requirements, including instruments similar to those which we currently have issued and outstanding. However, because our total consolidated assets are substantially less than $15 billion, the limitations on use of hybrid capital instruments are not expected to apply to us for the foreseeable future. We, like other bank holding companies, are required under current guidelines 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 current guidelines require 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 capital 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 capital guidelines also provide that banking organizations experiencing significant internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels, without significant reliance on intangible assets. In addition, the regulations of the bank regulators provide that concentration of credit risks, as well as an institution's ability to manage these risks, are important factors to be taken into account by regulatory agencies in assessing an organization's overall capital adequacy. The Federal Reserve has not advised us of any specific minimum leverage ratio applicable to us or the Bank. 6 Table of Contents 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: (1) “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; (2) “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”; (3) “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); (4) “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 (5) “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. Our regulatory capital ratios and those of the Bank are 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 (1) an amount equal to 5.0% of the depository institution's total assets at the time it became undercapitalized and (2) 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 mandated capital raising activities such as orders to sell sufficient voting stock to become “adequately capitalized,” requirements to reduce total assets, restrictions for interest rates paid, removal of management and cessation of receipt of deposits from correspondent banks. “Critically undercapitalized” institutions are subject to the appointment of a receiver or conservator. A bank that is not “well-capitalized” as defined by applicable regulations may, among other regulatory requirements or limitations, be prohibited under federal law and regulation from accepting or renewing brokered deposits. The capital stock of banks organized under Montana law, such as the Bank, may be subject to assessment upon the direction of the Montana Department of Administration under the Montana Bank Act. Under the Montana Bank Act, if the Department of Administration determines an impairment of a bank's capital exists, it may notify the bank's board of directors of the impairment and require the impairment be made good by an assessment on the bank stock. If the bank fails to make good the impairment, the Department of Administration may, among other things, take charge of the bank and proceed to liquidate the bank. Under FDIA, the appropriate federal banking agency may take certain actions with respect to significantly or critically undercapitalized institutions. The actions may include requiring the sale of additional shares of the institution's stock or other actions deemed appropriate by the federal banking agency, which could include assessment on the institution's stock. 7 Table of Contents 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, internal controls and audit systems, among others, as required by the Federal Deposit Insurance Corporation Improvement Act, or FDICIA. 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, or DIF. 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 The FDIC is an independent federal agency that insures deposits, up to prescribed statutory limits, of federally insured banks and savings institutions and safeguards the safety and soundness of the banking and savings industries. The FDIC insures our customer deposits through the DIF up to prescribed limits for each depositor. The maximum deposit insurance amount is $250,000 per depositor. In addition, certain non-interest bearing deposit accounts are accorded unlimited insurance until December 31, 2013. The amount of FDIC assessments paid by each DIF member institution is based on its relative risk of default as measured by regulatory capital ratios and other supervisory factors. All FDIC-insured institutions are required to pay assessments to the FDIC to fund interest payments on bonds issued by the Financing Corporation, or FICO, an agency of the Federal government established to recapitalize the predecessor to the DIF. The FICO assessment rates, which are determined quarterly, averaged 0.01% of insured deposits in fiscal 2011. These assessments will continue until the FICO bonds mature in 2017. On November 17, 2009, the FDIC imposed a prepayment requirement on most insured depository organizations, requiring that the organizations prepay estimated quarterly risk-based assessments for the fourth quarter of 2009 and for each calendar quarter for calendar years 2010, 2011 and 2012. The FDIC has stated that the prepayment requirement was imposed in response to a negative balance in the DIF. As required by the Dodd-Frank Act the FDIC changed its method of assessment of insurance premiums effective as of April 1, 2011 to an assessment based on the average total consolidated assets of the insured depository institution less the institutions average tangible equity for the assessment period and made other adjustments to the assessment calculation methods. The changes reduced the deposit insurance premium paid by the Bank from the amounts paid under the prior assessment method based on total deposits. The FDIC is also required to set its designated reserve ratio for each year at 1.35% of estimated insured deposits and take actions necessary to reach a reserve ratio of 1.35% of total estimated insured deposits by September 30, 2020. The FDIC may be required to increase deposit insurance premium assessments to meet the reserve ratio requirements. However, under the Dodd-Frank Act, the effects of any increases in deposit insurance premium assessments are to be offset for the benefit of depository institutions with total consolidated assets of less than $10 billion. The Bank currently has total consolidated assets of less than $10 billion. Insolvency of an Insured Depository Institution If the FDIC is appointed the conservator or receiver of an insured depository institution upon its insolvency or in certain other events, the FDIC has the power, among other things: (1) to transfer any of the depository institution's assets and liabilities to a new obligor without the approval of the depository institution's creditors; (2) to enforce the terms of the depository institution's contracts pursuant to their terms; or (3) to repudiate or disaffirm any contract or lease to which the depository institution is a party, the performance of which is determined by the FDIC to be burdensome and the disaffirmation or repudiation of which is determined by the FDIC to promote the orderly administration of the depository institution. 8 Table of Contents 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. Customer Privacy and Other Consumer Protections Federal law imposes customer privacy requirements on any company engaged in financial activities, including the Bank and us. Under these requirements, a financial 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 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, regulations and reporting obligations aimed at protecting consumers and Bank customers. Failure to comply with these laws and regulations may, among other things, impair the collection of loans made in violation of the laws and regulations, provide borrowers or other customers certain rights and remedies or result in the imposition of penalties on the Bank. The Equal Credit Opportunity Act generally prohibits discrimination in credit transactions on, among other things, the basis of race, color, religion, national origin, sex, marital status or age and, in certain circumstances, limits the Bank's ability to require co-obligors or guarantors as a condition to the extension of credit to an individual. The Real Estate Settlement Procedures Act, or RESPA, requires certain disclosures be provided to borrowers in real estate loan closings or other real estate settlements. In addition, RESPA limits or prohibits certain settlement practices, fee sharing, kickbacks and similar practices that are considered to be abusive. The Truth in Lending Act, or TILA, and Regulation Z require disclosures to borrowers and other parties in consumer loans including, among other things, disclosures relating to interest rates and other finance charges, payments and payment schedules and annual percentage rates. TILA provides remedies to borrowers upon certain failures in compliance by a lender. The Fair Housing Act regulates, among other things, lending practices in residential lending and prohibits discrimination in housing related lending activities on the basis of race, color, religion, national origin, sex, handicap, disability or familial status. The Home Mortgage Disclosure Act requires certain lenders and other firms engaged in the home mortgage industry to collect and report information relating to applicants, borrowers and home mortgage lending activities in which they engage in their market areas or communities. The information is used for, among other purposes, evaluation of discrimination or other impermissible acts in home mortgage lending. The Home Ownership and Equity Protection Act regulates terms and disclosures of certain closed end home mortgage loans that are not purchase money loans and includes loans classified as “high cost loans.” The Fair Credit Reporting Act, as amended by the Fair and Accurate Credit Transactions Act, generally limits lenders and other financial firms in their collection, use or dissemination of customer credit information, gives customers some access to, and control over, their credit information and requires financial firms to establish policies and procedures intended to deter identity theft and related frauds. The Fair Debt Collection Practices Act regulates actions that may be taken in the collection of consumer debts and provides consumers with certain rights of access to information related to collection actions. 9 Table of Contents The Electronic Fund Transfer Act regulates fees and other terms on electronic funds transactions. On November 17, 2009, the Federal Reserve Board published a final rule amending Regulation E, which implements the Electronic Fund Transfer Act. Effective July 1, 2010 for new accounts and August 15, 2010 for existing accounts, this rule generally prohibits financial institutions from charging an overdraft fee for automated teller machine and one-time debit card transactions that overdraw a consumer deposit account, unless the customer opts in to having the overdrafts authorized and paid. The Federal Reserve issued regulations relating to fees and charges in debit card transactions intended to implement provisions of the Dodd-Frank Act. Card issuers with consolidated assets of less than $10 billion are exempt from the interchange fee standards but are subject to other rules addressing exclusivity and other requirements. The Bank is not subject to the interchange fee standards as its consolidated assets, together with affiliates, are less than $10 billion. Federal consumer protection laws have been expanded by the Dodd-Frank Act, pursuant to which a Bureau of Consumer Protection has been created with authority to regulate consumer financial products and services and to implement and enforce federal consumer financial laws. Although the Bureau is accorded examination and enforcement authority, the Bureau's authority does not generally extend to depository institutions with total assets of less than $10 billion. The Bank currently has total assets of less than $10 billion. The Community Reinvestment Act, or 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 the CRA into account when regulating and supervising our other activities or in authorizing new 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 an “outstanding” 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 requirements, instances of non-compliance are occasionally identified through normal operational activities. Management responds proactively to correct all instances of non-compliance and implement procedures to prevent further violations from occurring. USA PATRIOT Act The USA PATRIOT Act of 2001 amended the Bank Secrecy Act of 1970 and the Money Laundering Control Act of 1986 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. The USA PATRIOT Act includes the International Money Laundering Abatement and Financial Anti-Terrorism Act of 2001 and also amends laws relating to currency control and regulation. The laws and related 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. Failure of a financial institution to maintain and implement adequate programs to combat money laundering and terrorist financing could have serious legal and reputational consequences for the institution. 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. Office of Foreign Asset Control The United States Treasury Office of Foreign Asset Control enforces economic and trade sanctions imposed by the United States on foreign persons and governments. Among other authorities, the Office of Foreign Asset Control may require United States financial institutions to block or “freeze” assets of identified foreign persons or governments which come within the control of the financial institution. Financial institutions are required to adopt procedures for identification of new and existing deposit accounts and other relationships with persons or governments identified by the Office of Foreign Asset Control and to timely report the accounts or relationships to the Office of Foreign Asset Control. 10 Table of Contents Website Access to SEC Filings All of our reports and statements filed or furnished electronically with the SEC, including Annual Reports 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.FIBK.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, many of which are outside of our control. If any of the events or circumstances described in the following risk factors actually occurs, our business, financial condition, results of operations and prospects could be harmed. These risks are not the only ones that we may face. Other risks of which we are not aware, including those which relate to the banking and financial services industry in general and us in particular, or those which we do not currently believe are material, may harm our future business, financial condition, results of operations and prospects. Readers should consider carefully the following important factors in evaluating us, our business and an investment in our securities. Risks Relating to the Market and Our Business We may incur significant credit losses, particularly in light of recent and existing market conditions. We take on credit risk by virtue of making loans and extending loan commitments and letters of credit. Our credit standards, procedures and policies may not prevent us from incurring substantial credit losses, particularly in light of market developments in recent years. During 2010 and 2011, we experienced deterioration in credit quality, particularly in certain real estate development loans, due, in part, to the impact resulting from the downturn in the prevailing economic, real estate and credit markets. This deterioration resulted in higher levels of non-performing assets, including other real estate owned, or OREO, and internally risk classified loans, thereby increasing our provisions for loan losses and decreasing our operating income in 2010 and 2011. As of December 31, 2011, we had total non-performing assets of approximately $279 million, compared with approximately $244 million as of December 31, 2010 and approximately $163 million as of December 31, 2009. In the first two months of 2012, levels of non- performing assets and provisions for loan losses have remained elevated, which will continue to affect our earnings. Although current economic conditions appear to be trending upwards, management believes we will continue to experience credit impairments and elevated levels of non-performing loans in the near term, which will likely have an adverse impact on our business, financial condition, results of operations and prospects. Our concentration of real estate loans subjects us to increased risks in the event real estate values continue to decline due to the economic recession, a further deterioration in the real estate markets or other causes. At December 31, 2011, we had approximately $2.7 billion of commercial, agricultural, construction, residential and other real estate loans, representing approximately 65% of our total loan portfolio. The recent economic recession, deterioration in the real estate markets and increasing delinquencies and foreclosures have had an adverse effect on the collateral value for many of our loans and on the repayment ability of many of our borrowers. The continuation or further deterioration of these factors, including increasing foreclosures and unemployment, will continue to have the same or similar adverse effects. In addition, these factors could reduce the amount of loans we make to businesses in the construction and real estate industry, which could negatively impact our interest income and results of operations. A continued decline in real estate values could also lead to higher charge-offs in the event of defaults in our real estate loan portfolio. Similarly, the occurrence of a natural or manmade disaster in our market areas could impair the value of the collateral we hold for real estate secured loans. Any one or a combination of the factors identified above could negatively impact our business, financial condition, results of operations and prospects. 11 Table of Contents Economic and market developments, including the potential for inflation, may have an adverse effect on our business, possibly in ways that are not predictable or that we may fail to anticipate. Recent economic and market developments and the potential for continued economic disruptions and inflation represent considerable risks and challenges to us. Dramatic declines in the housing market, with decreased home prices and increased delinquencies and foreclosures throughout most of the nation, have negatively impacted the credit performance of mortgage and construction loans and resulted in significant write-downs of assets by many financial institutions. General downward economic trends, reduced availability of commercial credit and high levels of unemployment have also negatively impacted the credit performance of commercial and consumer credit, resulting in additional write-downs. These risks and challenges have significantly diminished overall confidence in the national economy, the financial markets and many financial institutions. This reduced confidence could further compound the overall market disruptions and risks to banks and bank holding companies, including us. Many of our loans are to commercial borrowers, which have a higher degree of risk than other types of loans. Commercial loans, including commercial real estate loans, are often larger and involve greater risks than other types of lending. Because payments on such loans are often dependent on the successful operation or development of the property or business involved, repayment of such loans is more sensitive than other types of loans to adverse conditions in the real estate market or the general economy. Accordingly, the downturn in the real estate market and economy has heightened our risk related to commercial loans, particularly commercial real estate loans. Unlike residential mortgage loans, which generally are made on the basis of the borrowers' ability to make repayment from their employment and other income and which are secured by real property whose value tends to be more easily ascertainable, commercial loans typically are made on the basis of the borrowers' ability to make repayment from the cash flow of the commercial venture. If the cash flow from business operations is reduced, the borrower's ability to repay the loan may be impaired. Due to the larger average size of each commercial loan as compared with other loans such as residential loans, as well as the collateral which is generally less readily-marketable, losses incurred on a small number of commercial loans could have a material adverse impact on our financial condition and results of operations. At December 31, 2011, we had $2.2 billion of commercial loans, including $1.6 billion of commercial real estate loans, representing approximately 54% of our total loan portfolio. If we experience loan losses in excess of estimated amounts, our earnings will be adversely affected. The risk of credit losses on loans varies with, among other things, general economic conditions, the type of loan being made, the creditworthiness of the borrower over the term of the loan and, in the case of a collateralized loan, the value and marketability of the collateral for the loan. We maintain an allowance for loan losses based upon, among other things, historical experience, an evaluation of economic conditions and regular reviews of loan portfolio quality. Based upon such factors, our management makes various assumptions and judgments about the ultimate collectability of our loan portfolio and provides an allowance for loan losses. These assumptions and judgments are complex and difficult to determine given the significant uncertainty surrounding future conditions in the general economy and banking industry. If management's assumptions and judgments prove to be incorrect and the allowance for loan losses is inadequate, or if the banking authorities or regulations require us to increase the allowance for loan losses, our earnings, financial condition, results of operations and prospects could be significantly and adversely affected. Our goodwill may become impaired, which may adversely impact our results of operations and financial condition and may limit our Bank's ability to pay dividends to us, thereby causing liquidity issues. The excess purchase price over the fair value of net assets from acquisitions, or goodwill, is evaluated for impairment at least annually and on an interim basis if an event or circumstance indicates that it is likely impairment has occurred. In testing for impairment, the fair value of net assets is estimated based on analyses of our market value, discounted cash flows and peer values. Consequently, the determination of the fair value of goodwill is sensitive to market-based economics and other key assumptions. Variability in market conditions or in key assumptions could result in impairment of goodwill, which is recorded as a noncash adjustment to income. An impairment of goodwill could have a material adverse effect on our business, financial condition and results of operations. As of December 31, 2011, we had goodwill of approximately $184 million, or 24% of our total stockholders' equity. Furthermore, an impairment of goodwill could cause our Bank to be unable to pay dividends to us. If our Bank is unable to pay dividends to us, our cash flow and liquidity would be reduced. See below “— Our Bank's ability to pay dividends to us is subject to regulatory limitations, which, to the extent we are not able to receive such dividends, may impair our ability to grow, pay dividends, cover operating expenses and meet debt service requirements.” 12 Table of Contents Changes in interest rates could negatively impact our net interest income, may weaken demand for our products and services or harm our results of operations and cash flows. Our earnings and cash flows are largely dependent upon net interest income, which is the difference between interest income earned on interest-earning assets such as loans and securities and interest expense paid on interest-bearing liabilities such as deposits and borrowed funds. Interest rates are highly sensitive to many factors that are beyond our control, including general economic conditions and policies of various governmental and regulatory agencies, particularly the Federal Reserve. Changes in monetary policy, including changes in interest rates, could influence not only the interest we receive on loans and securities and the amount of interest we pay on deposits and borrowings, but such changes could also adversely affect (1) our ability to originate loans and obtain deposits, (2) the fair value of our financial assets and liabilities, including mortgage servicing rights, (3) our ability to realize gains on the sale of assets and (4) the average duration of our mortgage-backed investment securities portfolio. An increase in interest rates may reduce customers' desire to borrow money from us as it increases their borrowing costs and may adversely affect the ability of borrowers to pay the principal or interest on loans which 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. Further, because many of our variable rate loans contain interest rate floors, as market interest rates begin to rise, the interest rates on these loans may not increase correspondingly. 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 assets faster, which would accelerate expense and lower our earnings. Any substantial, unexpected or prolonged change in market interest rates could have a material adverse effect on our cash flows, financial condition, results of operations and prospects. If the current low interest rate environment were to continue for a prolonged period, our interest income could decrease, adversely impacting our financial condition, results of operations and cash flows. We may not continue to have access to low-cost funding sources. We depend on checking and savings, negotiable order of withdrawal, or NOW, and money market deposit account balances and other forms of customer deposits as our primary source of funding. Such account and deposit balances can decrease when customers perceive alternative investments, such as the stock market, as providing a better risk/return tradeoff. If customers move money out of bank deposits and into other investments, we could lose a relatively low cost source of funds, increasing our funding costs and reducing our net interest income and net income. Our deposit insurance premiums could be substantially higher in the future, which could have a material adverse effect on our future earnings. The FDIC insures deposits at FDIC insured depository institutions, including the Bank. Under current FDIC regulations, each insured depository institution is subject to a risk-based assessment system and, depending on its assigned risk category, is assessed insurance premiums based on average total assets less average tangible equity, with adjustments for brokered deposits, unsecured debt and for custodial banks and banks that primarily provide services to other banks. The FDIC charges insured financial institutions premiums to maintain the Depositors Insurance Fund or DIF at a certain level. Bank failures have substantially reduced the DIF's reserves. The FDIC has published and amended a restoration plan designed to replenish the DIF and to increase the deposit insurance reserve ratio through 2015. To implement the restoration plan, the FDIC has adopted a series of initiatives that have changed its risk-based assessment system, increased its base assessment rates and imposed special assessments. A change in the risk category assigned to our Bank, further adjustments to base assessment rates and additional special assessments could have a material adverse effect on our earnings, financial condition and results of operation. We may not be able to continue growing our business. Our total assets have grown from $5.2 billion as of December 31, 2007 to $7.3 billion as of December 31, 2011. Our ability to grow depends, in part, upon our ability to successfully attract deposits, identify favorable loan and investment opportunities, open new branch banking offices and expand into new and complementary markets when appropriate opportunities arise. In the event we do not continue to grow, our results of operations could be adversely impacted. Our ability to grow successfully depends on our capital resources and whether we can continue to fund growth while maintaining cost controls and asset quality, as well as on other factors beyond our control, such as national and regional economic conditions and interest rate trends. If we are not able to make loans, attract deposits and maintain asset quality due to constrained capital resources or other reasons, we may not be able to continue growing our business, which could adversely impact our earnings, financial condition, results of operations, and prospects. 13 Table of Contents Adverse economic conditions affecting Montana, Wyoming and western South Dakota could harm our business. Our customers with loan and/or deposit balances are located predominantly in Montana, Wyoming and western South Dakota. Because of the concentration of loans and deposits in these states, existing or future adverse economic conditions in Montana, Wyoming or western South Dakota could cause us to experience higher rates of loss and delinquency on our loans than if the loans were more geographically diversified. The recent economic recession has adversely affected the real estate and business environment in certain areas in Montana and Wyoming, especially in markets dependent upon resort communities and second homes such as Bozeman, Montana, Kalispell, Montana, and Jackson, Wyoming. In the future, adverse economic conditions, including inflation, recession and unemployment and other factors, such as regulatory 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 business, financial condition, results of operations and prospects. We are subject to significant governmental regulation and new or changes in existing regulatory, tax and accounting 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 stockholders. These regulations may impose significant limitations on operations. The significant federal and state banking regulations that affect us are described in this report under the heading “Regulation and Supervision.” These regulations, along with the currently existing tax, accounting, securities, insurance, employment, monetary and other 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 undergoing significant review and changes, particularly given the recent market developments in the banking and financial services industries and the recent enactment of the Dodd-Frank Act. Recent events have resulted in legislators, regulators and authoritative bodies, such as the Financial Accounting Standards Board, the Securities and Exchange Commission, or 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 can significantly affect credit conditions in our markets. The nature, extent and timing of the adoption of significant new laws, regulations, rules, standards, policies and interpretations, or changes in or repeal of these items or specific actions of regulators, may increase our costs of compliance and harm our business. For example, potential increases in or other modifications affecting regulatory capital thresholds could impact our status as “well capitalized.” We may not be able to predict accurately the extent of any impact from changes in existing laws, regulations, rules, standards, policies and interpretations. The Dodd-Frank Act will result in sweeping changes in the regulation of financial institutions and could significantly harm our business. On July 21, 2010, the Dodd-Frank Act was signed into law. The Dodd-Frank Act will result in sweeping changes in the regulation of financial institutions. The Dodd-Frank Act contains numerous provisions that will affect all banks and bank holding companies. Many of these and other provisions in the Dodd-Frank Act remain subject to regulatory rule-making and implementation, the effects of which are not yet known including provisions that, among other things: • centralize responsibility for promulgating regulations under and enforcing federal consumer financial protection laws in a new bureau of consumer financial protection that will have direct supervision and examination authority over banks with more than $10 billion in assets; require the FDIC to seek to make its capital requirements for banks countercyclical; impose comprehensive regulation of the over-the-counter derivatives market, which would include certain provisions that would effectively prohibit insured depository institutions from • • conducting certain derivatives businesses in the institution itself; implement corporate governance revisions, including with regard to executive compensation and proxy access by shareholders; • • establish new rules and restrictions regarding the origination of mortgages; and • permit the Federal Reserve to prescribe regulations regarding interchange transaction fees, and limit them to an amount reasonable and proportional to the cost incurred by the issuer for the transaction in question. 14 Table of Contents Although we cannot predict the specific impact and long-term effects that the Dodd-Frank Act will have on us and the financial industry in general, we believe the Dodd-Frank Act and the regulations promulgated thereunder will result in additional administrative burdens that will obligate us to incur additional costs and expenses. Provisions of the Act that affect deposit insurance assessments, payment of interest on demand deposits and interchange fees could increase the costs associated with deposits as well as place limitations on certain revenues those deposits may generate. Although the treatment of our existing trust preferred securities as Tier 1 capital will be grandfathered under the Act, provisions of the Act that revoke Tier 1 capital treatments of trust preferred securities and otherwise require revisions to capital requirements may cause us to seek other sources of capital in the future. Furthermore, the Dodd-Frank Act could limit the types of financial services and products we may offer, increase the ability of non-banks to offer competing financial services and products, reduce interchange fees, require us to renegotiate payment network agreements or enter into multiple payment network agreements, require a significant amount of management's time and attention, and otherwise adversely impact our business, financial condition, results of operations and prospects. Non-compliance with laws and regulations could result in fines, sanctions and other enforcement actions and the loss of our financial holding company status. 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 various sanctions and 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 fines and 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 The imposition of any such sanctions or other enforcement actions could adversely impact our earnings, financial condition, results of operations and prospects. Furthermore, as a financial holding company, we may engage in authorized financial activities provided we are in compliance with applicable regulatory standards and guidelines. If we fail to meet such standards and guidelines, we may be required to cease certain financial holding company activities and, in certain circumstances, to divest the Bank. The effects of recent legislative and regulatory efforts are uncertain. In response to market disruptions, legislators and financial regulators implemented a number of initiatives designed to stabilize and improve the financial markets, including: • • • • • • • • direct and indirect assistance to distressed financial institutions and the provision of assistance by the banking authorities in arranging acquisitions of weakened banks and broker-dealers; legislation that provided economic stimulus funding and liquidity to the financial markets, including the Troubled Asset Relief Program Capital Purchase Program; programs by the Federal Reserve to provide liquidity to the commercial paper markets, stimulus to increase commercial and consumer based lending, and successive rounds of quantitative easing; proposed guidance by the Federal Reserve on incentive compensation policies at banking organizations; proposals and recent judicial decisions limiting a lender's ability to foreclose on mortgages or make such foreclosures less economically viable, including by allowing Chapter 13 bankruptcy plans to “cram down” the value of certain mortgages on a consumer's principal residence to its market value and/or reset interest rates and monthly payments to permit defaulting debtors to remain in their home; acceleration of the effective date of various provisions of the Credit Card Accountability Responsibility and Disclosure Act of 2009, which restrict certain credit and charge card practices, require expanded disclosures to consumers and provide consumers with the right to opt out of interest rate increases (with limited exceptions); adoption of new rules by the Federal Reserve under Regulation E, effective July 1, 2010 for new accounts and August 15, 2010 for existing accounts, generally prohibiting financial institutions from charging overdraft fees for ATM and one-time debit card transactions that overdraw consumer deposit accounts, unless the consumer “opts in” to having such overdrafts authorized and paid; and enactment of the Dodd-Frank Act. 15 Table of Contents These initiatives may increase our expenses or decrease our income by, among other things, making it harder for us to foreclose on mortgages and impacting the amount of overdraft fees we will be able to charge. Further, the overall effects of these and other legislative and regulatory efforts on the financial markets remain uncertain and they may not have the intended results. These efforts may even have unintended harmful consequences on the U.S. financial system and our business. Should these or other legislative or regulatory initiatives have unintended effects, our business, financial condition, results of operations and prospects could be materially and adversely affected. In addition, we may need to modify our strategies and business operations in response to these changes. We may also incur increased capital requirements and constraints or additional costs in order to satisfy new regulatory requirements. Given the volatile nature of the current market and the uncertainties underlying efforts to mitigate or reverse disruptions, we may not timely anticipate or manage existing, new or additional risks, contingencies or developments in the current or future environment. Our failure to do so could materially and adversely affect our business, financial condition, results of operations and prospects. We are dependent upon the services of our management team and directors. Our future success and profitability is substantially dependent upon the management skills of our executive officers and directors, many of whom have held officer and director positions with us for many years. We do not currently have employment agreements or non-competition agreements with any of our key executives. The unanticipated loss or unavailability of key employees could harm our ability to operate our business or execute our business strategy. We cannot assure you that we will be successful in retaining these key employees or finding and integrating suitable successors in the event of their loss or unavailability. We may not be able to attract and retain qualified employees to operate our business effectively. There is substantial competition for qualified personnel in our markets. Although unemployment rates have been declining in Montana and Wyoming, and the surrounding region, it may still be difficult to attract and retain qualified employees at all management and staffing levels. Failure to attract and retain employees and maintain adequate staffing of qualified personnel could adversely impact our operations and our ability to execute our business strategy. Furthermore, relatively low unemployment rates in certain of our markets, compared with national unemployment rates, may lead to significant increases in salaries, wages and employee benefits expenses as we compete for qualified, skilled employees, which could negatively impact our results of operations and prospects. A failure of the technology we use could harm our business and our information systems may experience a breach in security. We rely heavily on communications and information systems to conduct our business and we depend heavily upon data processing, software, communication and information exchange from a number of vendors on a variety of computing platforms and networks and over the internet. We cannot be certain that all of our systems are entirely free from vulnerability to breaches of security or other technological difficulties or failures. A breach in the security of these systems could result in failures or disruptions in our customer relationship management, general ledger, deposit, loan, investment, credit card 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. Furthermore, the computer systems and network infrastructure we use could be vulnerable to other unforeseen problems, such as damage from fire, privacy loss, telecommunications failure or other similar events which would also have an adverse impact on our financial condition and results of operations. Our operations rely on certain external vendors. We are reliant upon certain external vendors to provide products and services necessary to maintain our day-to-day operations. In addition, we are subject to certain long-term vendor contracts that limit our flexibility and increase our dependence on third party vendors. Failure of certain external vendors to perform in accordance with contractual arrangements could be disruptive to our operations and limit our ability to provide certain products and services demanded by our customers, which could have material adverse impact on our financial condition or results of operations 16 Table of Contents We are subject to liquidity risks. 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. 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. Other potential sources of liquidity include the sale of loans, the utilization of available government and regulatory assistance programs, 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, issuance of equity securities and borrowings through the Federal Reserve's discount window. Without sufficient liquidity from these potential sources, we may not be able to meet the cash flow requirements of our depositors and borrowers. Additionally, our access to funding sources in amounts adequate to finance our activities or on terms that are acceptable to us could be impaired by factors specific to us, the financial services industry or the economy in general. Factors that could reduce our access to liquidity sources include a downturn in our local or national economies, difficult or illiquid credit markets or adverse regulatory actions against us. A failure to maintain adequate liquidity could have a material adverse effect on our business, financial condition or results of operations We may not be able to find suitable acquisition candidates. Although our growth strategy is to primarily focus and promote organic growth, we also have in the past and intend in the future to complement and expand our business by pursuing strategic acquisitions of banks and other financial institutions. We believe, however, there are a limited number of banks that will meet our acquisition criteria and, consequently, we cannot assure you that we will be able to identify suitable candidates for acquisitions. In addition, even if suitable candidates are identified, we expect to compete with other potential bidders for such businesses, many of which may have greater financial resources than we have. Our failure to find suitable acquisition candidates, or successfully bid against other competitors for acquisitions, could adversely affect our ability to successfully implement our business strategy. We may be unable to manage our growth due to acquisitions, which could have an adverse effect on our financial condition or results of operations. Acquisitions of other banks and financial institutions involve risks of changes in results of operations or cash flows, unforeseen liabilities relating to the acquired institution or arising out of the acquisition, asset quality problems of the acquired entity and other conditions not within our control, such as adverse personnel relations, loss of customers because of change of identity, deterioration in local economic conditions and other risks affecting the acquired institution. In addition, the process of integrating acquired entities will divert significant management time and resources. We may not be able to integrate successfully or operate profitably any financial institutions we may acquire. We may experience disruption and incur unexpected expenses in integrating acquisitions. There can be no assurance that any such acquisitions will enhance our cash flows, business, financial condition, results of operations or prospects and such acquisitions may have an adverse effect on our results of operations, particularly during periods in which the acquisitions are being integrated into our operations. We face significant competition from other financial institutions and financial services providers. We face substantial competition in all areas of our operations from a variety of different competitors, many of which are larger and may have more financial resources, higher lending limits and large branch networks. Such competitors primarily include national, regional and community banks within the various markets we serve. We also face competition from many other types of financial institutions, including, without limitation, savings and loans, credit unions, finance companies, brokerage firms, insurance companies, factoring companies and other financial intermediaries. The financial services industry could become even more competitive as a result of legislative, regulatory and technological changes and continued consolidation. Banks, securities firms and insurance companies can merge under the umbrella of a financial holding company, which can offer virtually any type of financial service, including banking, securities underwriting, insurance (both agency and underwriting) and merchant banking. Increased competition among financial services companies due to the recent consolidation of certain competing financial institutions and the conversion of certain investment banks to bank holding companies may adversely affect our ability to market our products and services. Also, technology has lowered barriers to entry and made it possible for nonbanks to offer products and services traditionally provided by banks, such as automatic funds transfer and automatic payment systems. Many of our competitors have fewer regulatory constraints and may have lower cost structures. Additionally, due to their size, many competitors may offer a broader range of products and services as well as better pricing for those products and services than we can. 17 Table of Contents Our ability to compete successfully depends on a number of factors, including, among other things: • • • • • • the ability to develop, maintain and build upon long-term customer relationships based on quality service, high ethical standards and safe, sound assets; the ability to expand our market position; the scope, relevance and pricing of products and services offered to meet customer needs and demands; the rate at which we introduce new products and services relative to our competitors; customer satisfaction with our level of service; and industry and general economic trends. Failure to perform in any of these areas could significantly weaken our competitive position, which could adversely affect our growth and profitability, which, in turn, could harm our business, financial condition, results of operations and prospects. We may not be able to manage risks inherent in our business, particularly given the recent turbulent and dynamic market conditions. A comprehensive and well-integrated risk management function is essential for our business. We have adopted various policies, procedures and systems to monitor and manage risk and are currently implementing a centralized risk oversight function. These policies, procedures and systems may be inadequate to identify and mitigate all risks inherent in our business. In addition, our business and the markets and industry in which we operate are continuously evolving. We may fail to understand fully the implications of changes in our business or the financial markets and fail to adequately or timely enhance our risk framework to address those changes, particularly given the recent turbulent and dynamic market conditions. If our risk framework is ineffective, either because it fails to keep pace with changes in the financial markets or in our business or for other reasons, we could incur losses and otherwise experience harm to our business. 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 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, 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, control deficiencies and losses from operational malfunctions or fraud have occurred and may occur in the future. Any future deficiencies, weaknesses or losses related to internal operating control systems could have an adverse effect on our business and, in turn, on our financial condition, results of operations and prospects. We may become liable for environmental remediation and other costs on repossessed properties, which could adversely impact our results of operations, cash flows and financial condition. A significant portion of our loan portfolio is secured by real property. During the ordinary course of business, we may foreclose on and take title to properties securing certain loans. If hazardous or toxic substances are found on these properties, we may be liable for remediation costs, as well as for personal injury and property damage. Environmental laws may require us to incur substantial expenses and may materially reduce the affected property's value or limit our ability to use or sell the affected property. In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase our exposure to environmental liability. The remediation costs and any other financial liabilities associated with an environmental hazard could have a material adverse effect on our cash flows, financial condition and results of operations. 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 and, in turn, on our financial condition, results of operations and prospects. 18 Table of Contents We may not effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers. The financial services industry is continually undergoing rapid technological change with frequent introductions of new technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs. Our future success depends, in part, upon our ability to use technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements. We may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers. Failure to successfully keep pace with technological change affecting the financial services industry could have a material adverse impact on our business and, in turn, on our financial condition, results of operations and prospects. The Federal Reserve may require us to commit capital resources to support our bank subsidiary. As a matter of policy, the Federal Reserve, which examines us and our subsidiaries, expects a bank holding company 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 cash flows, financial condition, results of operations and prospects. We may be adversely affected by the soundness of other financial institutions. The financial services industry as a whole, as well as the securities markets generally, have been materially and adversely affected by significant declines in the values of nearly all asset classes and a serious lack of liquidity. If other financial institutions in our markets dispose of real estate collateral at below-market prices to meet liquidity or regulatory requirements, such actions could negatively impact overall real estate values, including properties securing our loans. Our credit risk is exacerbated when the collateral we hold cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the credit exposure due to us. Any such losses could harm our financial condition, results of operations and prospects. Financial institutions in particular have been subject to increased volatility and an overall loss of investor confidence. Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services companies are interrelated as a result of trading, clearing, counterparty or other relationships. We have exposure to many different industries and counterparties. For example, we execute transactions with counterparties in the financial services industry, including brokers and dealers, commercial banks, investment banks and other institutional clients. As a result, defaults by, or even rumors or questions about, one or more financial services companies or the financial services industry generally, have led to market-wide liquidity problems and could lead to losses or defaults by us or by other institutions. Many of these transactions expose us to increased credit risk in the event of default of a counterparty or client. The short-term and long-term impact of the new Basel III capital standards and the forthcoming new capital rules to be proposed for U.S. banks is uncertain. On December 16, 2010, the Basel Committee on Banking Supervision, or Basel Committee, released the final text of its reforms to strengthen global capital and liquidity rules designed to create a more resilient banking industry. These reforms, known as Basel III, are intended to strengthen the regulatory capital framework by, among other things, (1) raising the quality, consistency and transparency of an institution's capital base, (2) reducing procyclicality and promoting counter cyclical buffers, (3) enhancing risk coverage, (4) supplementing the risk-based capital requirement with a leverage ratio, and (5) introducing a global liquidity standard. 19 Table of Contents On January 13, 2011, the Basel Committee issued additional criteria to Basel III. This criteria provides that for instruments issued by a bank to be included in Tier 1 or Tier 2 capital, they must meet or exceed minimum requirements designed to require such instruments to fully absorb losses before taxpayers are exposed to loss. Basel III, as supplemented, has been adopted by the Federal Reserve and implementation will start on January 1, 2013. Regulations will be amended and implemented prior to that date. From January 1, 2013 on, banks will have to meet certain minimum capital requirements for share capital, Tier-1 capital, and total capital. Because the regulations are still to be implemented, the short-term and long-term impact of the Basel III capital standards and the forthcoming new capital rules to be proposed for U.S. banks is uncertain. Our Bank's ability to pay dividends to us is subject to regulatory limitations, which, to the extent we are not able to receive such dividends, may impair our ability to grow, pay dividends, cover operating expenses and meet debt service requirements. We are a legal entity separate and distinct from the Bank, our only bank subsidiary. Since we are a holding company with no significant assets other than the capital stock of our subsidiaries, we depend upon dividends from the Bank for a substantial part of our revenue. Accordingly, our ability to grow, pay dividends, cover operating expenses and meet debt service requirements depends primarily upon the receipt of dividends or other capital distributions from the Bank. The Bank's ability to pay dividends to us is subject to, among other things, its earnings, financial condition and need for funds, as well as federal and state governmental policies and regulations applicable to us and the Bank, which limit the amount that may be paid as dividends without prior approval. For example, in general, the Bank is limited to paying dividends that do not exceed the current year net profits together with retained earnings from the two preceding calendar years unless the prior consents of the Montana and federal banking regulators are obtained. Furthermore, the terms of our Series A preferred stock, of which 5,000 shares were outstanding as of December 31, 2011, prohibit us from declaring or paying dividends or distributions on any class of our common stock, unless all accrued and unpaid dividends for the three prior consecutive dividend periods have been paid. Any reduction or elimination of our common stock dividend in the future could adversely affect the market price of our common stock. New lines of business or new products and services may subject us to additional risks. From time to time, we may implement new lines of business or offer new products and services within existing lines of business. There are substantial risks and uncertainties associated with these efforts, particularly in instances where the markets are not fully developed. In developing and marketing new lines of business and/or new products and services we may invest significant time and resources. Initial timetables for the introduction and development of new lines of business and/or new products or services may not be achieved and price and profitability targets may not prove feasible. External factors, such as compliance with regulations, competitive alternatives, and shifting market preferences, may also impact the successful implementation of a new line of business or a new product or service. Furthermore, any new line of business and/or new product or service could have a significant impact on the effectiveness of the our system of internal controls. Failure to successfully manage these risks in the development and implementation of new lines of business or new products or services could have a material adverse effect on our business, results of operations and financial condition. Concerns regarding the downgrade of the U.S. credit rating could have a material adverse effect on our business, financial condition and liquidity. Standard & Poor's downgrade of the U.S. government's sovereign credit rating and of the credit ratings of instruments issued, insured or guaranteed by certain related institutions, agencies and instrumentalities could result in risks to us and general economic conditions that we are not able to predict. On August 5, 2011, Standard & Poor's downgraded the United States long-term debt rating from AAA to AA+. On August 8, 2011, Standard & Poor's downgraded the credit ratings of certain long-term debt instruments issued by Fannie Mae and Freddie Mac and other U.S. government agencies linked to long-term U.S. debt. These downgrades could adversely affect the market value of certain of instruments that we hold, and could adversely impact our ability to obtain funding that is collateralized by affected instruments, as well as affecting the pricing of that funding when it is available. We cannot predict if, when or how these changes to the credit ratings will affect economic conditions. This ratings downgrade could result in a significant adverse impact to us, and could have a material adverse effect on our business, financial condition and liquidity. Because of the unprecedented nature of negative credit rating actions with respect to U.S. government obligations, the ultimate impact on our business, financial condition and liquidity are unpredictable and may not be immediately apparent. 20 Table of Contents Risks Relating to Our Class A Common Stock Our dividend policy may change. Although we have historically paid dividends to our stockholders, we have no obligation to continue doing so and may change our dividend policy at any time without notice to our stockholders. Holders of our common stock are only entitled to receive such cash dividends as our Board may declare out of funds legally available for such payments. Furthermore, consistent with our strategic plans, growth initiatives, capital availability, projected liquidity needs and other factors, we have made and adopted and will continue to make and adopt, capital management decisions and policies that could adversely impact the amount of dividends paid to our stockholders. The trading volume in our Class A Common Stock has been limited, and an active trading market may not develop. Our Class A common stock is currently traded on The NASDAQ Global Select Market. Our Class A common stock is thinly-traded and has substantially less liquidity than the average trading market for many other publicly-traded financial institutions and other companies. Therefore, investors have limited opportunities to sell their shares of Class A common stock in the open market. Limited trading of our Class A common stock also contributes to more volatile price fluctuations. An active trading market for our Class A common stock may never develop or be sustained, which could affect your ability to sell your shares and could depress the market price of your shares. Approximately 45% of our outstanding common stock is owned by members of the Scott family, our executive officers and our directors. The substantial amount of stock owned by these individuals may adversely affect the development of an active and liquid trading market. Our Class A common stock share price could be volatile and could decline. The market price of our Class A common stock is volatile and could be subject to wide fluctuations in price in response to various factors, some of which are beyond our control. These factors include: • • • • • prevailing market conditions; our historical performance and capital structure; estimates of our business potential and earnings prospects; an overall assessment of our management; and the consideration of these factors in relation to market valuation of companies in related businesses. At times the stock markets, including the NASDAQ Stock Market, on which our Class A common stock is listed, may experience significant price and volume fluctuations. As a result, the market price of our Class A common stock is likely to be similarly volatile and investors in our Class A common stock may experience a decrease in the value of their shares, including decreases unrelated to our operating performance or prospects. In addition, in the past, following periods of volatility in the overall market and the market price of a company's securities, securities class action litigation has often been instituted against these companies. This litigation, if instituted against us, could result in substantial costs and a diversion of our management's attention and resources. Holders of the Class B common stock have voting control of our company and are able to determine virtually all matters submitted to stockholders, including potential change in control transactions. Members of the Scott family control in excess of 80% of the voting power of our outstanding common stock. Due to their holdings of common stock, members of the Scott family are able to determine the outcome of virtually all matters submitted to stockholders for approval, including the election of directors, amendment of our articles of incorporation (except when a class vote is required by law), any merger or consolidation requiring common stockholder approval and the sale of all or substantially all of the company's assets. Accordingly, such holders have the ability to prevent change in control transactions as long as they maintain voting control of the company. In addition, because these holders will have the ability to elect all of our directors they will be able to control our policies and operations, including the appointment of management, future issuances of our common stock or other securities, the payments of dividends on our common stock and entering into extraordinary transactions, and their interests may not in all cases be aligned with your interests. Further, because of our dual class structure, members of the Scott family will continue to be able to control all matters submitted to our stockholder for approval even if they come to own less than 50% of the total outstanding shares of our common stock. The Scott family members have entered into a stockholder agreement giving family 21 Table of Contents members a right of first refusal to purchase shares of Class B common stock that are intended to be sold or transferred, subject to certain exceptions, by other family members. This agreement may have the effect of continuing ownership of the Class B common stock and control within the Scott family. This concentrated control will limit your ability to influence corporate matters. As a result, the market price of our Class A common stock could be adversely affected. Future equity issuances could result in dilution, which could cause our Class A common stock price to decline. We are not restricted from issuing additional Class A common stock, including any securities that are convertible into or exchangeable for, or that represent the right to receive, Class A common stock. We may issue additional Class A common stock in the future pursuant to current or future employee stock option plans or in connection with future acquisitions or financings. Should we choose to raise capital by selling shares of Class A common stock for any reason, the issuance would have a dilutive effect on the holders of our Class A common stock and could have a material negative effect on the market price of our Class A common stock. An investment in our Class A common stock is not an insured deposit. Our Class A common stock is not a bank savings account or deposit and, therefore, is not insured against loss by the FDIC, any other deposit insurance fund or any other public or private entity. As a result, holders of our common stock could lose some or all of their investment. “Anti-takeover” provisions and the regulations to which we are subject also may make it more difficult for a third party to acquire control of us, even if the change in control would be beneficial to stockholders. We are a financial and bank holding company incorporated in the State of Montana. Anti-takeover provisions in Montana law and our articles of incorporation and bylaws, as well as regulatory approvals that would be required under federal law, could make it more difficult for a third party to acquire control of us and may prevent stockholders from receiving a premium for their shares of our Class A common stock. These provisions could adversely affect the market price of our Class A common stock and could reduce the amount that stockholders might receive if we are sold. Our articles of incorporation provide that our board of directors, or Board, may issue up to 95,000 additional shares of preferred stock, in one or more series, without stockholder approval and with such terms, conditions, rights, privileges and preferences as the Board may deem appropriate. In addition, our articles of incorporation provide for staggered terms for our Board and limitations on persons authorized to call a special meeting of stockholders. In addition, certain provisions of Montana law may have the effect of inhibiting a third party from making a proposal to acquire us or of impeding a change of control under circumstances that otherwise could provide the holders of our Class A common stock with the opportunity to realize a premium over the then-prevailing market price of such Class A common stock. Further, the acquisition of specified amounts of our common stock (in some cases, the acquisition or control of more than 5% of our voting stock) may require certain regulatory approvals, including the approval of the Federal Reserve and one or more of our state banking regulatory agencies. The filing of applications with these agencies and the accompanying review process can take several months. Additionally, as discussed above, the holders of the Class B common stock will have voting control of our company. This and the other factors described above may hinder or even prevent a change in control of us, even if a change in control would be beneficial to our stockholders. We qualify as a “controlled company” under the NASDAQ Marketplace Rules and may rely on exemptions from certain corporate governance requirements. As a result of the combined voting power of the members of the Scott family described above, we qualify as a “controlled company” under the NASDAQ Marketplace Rules. As a controlled company, we may rely on exemptions from certain NASDAQ corporate governance standards that are available to controlled companies, including the requirements that: • • • a majority of the board of directors consist of independent directors; the compensation of officers be determined, or recommended to the board of directors for determination, by a majority of the independent directors or a compensation committee comprised solely of independent directors; and director nominees be selected, or recommended for the board of directors' selection, by a majority of the independent directors or a nominating committee comprised solely of independent directors with a written charter or board resolution addressing the nomination process. 22 Table of Contents As a result, in the future, our compensation and governance & nominating committees may not consist entirely of independent directors. As long as we choose to rely on these exemptions from NASDAQ Marketplace Rules in the future, you will not have the same protections afforded to stockholders of companies that are subject to all of the NASDAQ corporate governance requirements. The Class A common stock is equity and is subordinate to our existing and future indebtedness and to our Series A preferred stock. Shares of our Class A common stock are equity interests and do not constitute indebtedness. As such, shares of our Class A common stock rank junior to all our indebtedness, including our subordinated term loans, the subordinated debentures held by trusts that have issued trust preferred securities and other non-equity claims on us with respect to assets available to satisfy claims on us. Additionally, holders of our Class A common stock are subject to the prior dividend and liquidation rights of any holders of our Series A preferred stock then outstanding. In the future, we may attempt to increase our capital resources or, if our Bank's capital ratios fall below the required minimums, we or the Bank could be forced to raise additional capital by making additional offerings of debt or equity securities, including medium-term notes, trust preferred securities, senior or subordinated notes and preferred stock. Or, we may issue additional debt or equity securities as consideration for future mergers and acquisitions. Such additional debt and equity offerings may place restrictions on our ability to pay dividends on or repurchase our common stock, dilute the holdings of our existing stockholders or reduce the market price of our Class A common stock. Furthermore, acquisitions typically involve the payment of a premium over book and market values and therefore, some dilution of our tangible book value and net income per common stock may occur in connection with any future transaction. Holders of our Class A common stock are not entitled to preemptive rights or other protections against dilution. None. Item 1B. Unresolved Staff Comments Item 2. Properties Our principal executive offices and one of our banking offices 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 97,313 square feet of office space in the building. We also own a 65,226 square foot building that houses our operations center in Billings, Montana. We provide banking services at 70 additional locations in Montana, Wyoming and western South Dakota, of which 16 properties are leased from independent third parties and 54 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 one or a combination of these matters to have a material adverse effect on our business. Not applicable. Description of Our Capital Stock Item 4. Mine Safety Disclosures PART II Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Our articles provide for two classes of common stock: Class A common stock, which has one vote per share, and Class B common stock, which has five votes per share. Class B common stock is convertible into Class A common stock as described below. Our common stock is uncertificated. 23 Table of Contents Our authorized capital stock consists of 200,100,000 shares, each with no par value per share, of which: • • • 100,000,000 shares are designated as Class A common stock; 100,000,000 shares are designated as Class B common stock; and 100,000 shares are designated as preferred stock. At December 31, 2011, we had issued and outstanding 16,443,429 shares of Class A common stock, 26,540,745 shares of Class B common stock and 5,000 shares of preferred stock that have been designated as Series A preferred stock. At December 31, 2011, we also had outstanding stock options to purchase an aggregate of 362,879 shares of our Class A common stock and 3,122,049 shares of our Class B common stock. Members of the Scott family control in excess of 80% of the voting power of our outstanding common stock. The Scott family members have entered into a stockholder agreement giving family members a right of first refusal to purchase shares of Class B common stock that are intended to be sold or transferred, subject to certain exceptions, by other family members. This agreement may have the effect of continuing ownership of the Class B common stock and control of our Company within the Scott family. Due to the ownership and control of our Company by members of the Scott family, we are a “controlled company” as that term is used under the NASDAQ Marketplace Rules. As a “controlled company,” we may rely on exemptions from certain NASDAQ corporate governance requirements, including those regarding independent director requirements for the Board and committees of the Board. Preferred Stock Our Board is authorized, without approval of the holders of Class A common stock or Class B 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 may cause us to issue preferred stock with voting, conversion and other rights that could adversely affect the holders of Class A common stock or Class B common stock or make it more difficult to effect a change in control. The Company has outstanding 5,000 shares of 6.75% Series A noncumulative redeemable preferred stock, which ranks senior to our Class A common stock and Class B common stock with respect to dividend and liquidation rights. The Series A preferred stock has no voting rights. Holders of the Series A preferred stock are entitled to receive, when and if declared by the Board, noncumulative cash dividends at an annual rate of $675 per share (based on a 360 day year). In the event full dividends are not paid for three consecutive quarters, the Series A preferred stock holders are entitled to elect two members to our Board. We may, at our option, redeem all or any part of the outstanding Series A preferred stock at any time after January 10, 2013, subject to certain conditions, at a price of $10,000 per share plus accrued but unpaid dividends at the date fixed for redemption. After January 10, 2018, the Series A preferred stock may be converted, at the option of the holder, into shares of our Class B common stock at a ratio of 320 shares of Class B common stock for every one share of Series A preferred stock. Common Stock The holders of our Class A common stock are entitled to one vote per share and the holders of our Class B common stock are entitled to five votes per share on any matter to be voted upon by the stockholders. Holders of Class A common stock and Class B common stock vote together as a single class on all matters (including the election of directors) submitted to a vote of stockholders, unless otherwise required by law. The holders of common stock are not entitled to cumulative voting rights with respect to the election of directors, which means that the holders of a majority of the shares voted can elect all of the directors then standing for election. Directors are elected by a majority of the voting power present in person or represented by proxy at a shareholder meeting rather than by a plurality vote. 24 Table of Contents The holders of our Class A common stock and Class B common stock are entitled to share equally in any dividends that our Board may declare from time to time from legally available funds and assets, subject to limitations under Montana law and the preferential rights of holders of any outstanding shares of preferred stock. If a dividend is paid in the form of shares of common stock or rights to acquire shares of common stock, the holders of Class A common stock will be entitled to receive Class A common stock, or rights to acquire Class A common stock, as the case may be and the holders of Class B common stock will be entitled to receive Class B common stock, or rights to acquire Class B common stock, as the case may be Upon any voluntary or involuntary liquidation, dissolution, distribution of assets or winding up of our company, the holders of our Class A common stock and Class B common stock are entitled to share equally, on a per share basis, in all our assets available for distribution, after payment to creditors and subject to any prior distribution rights granted to holders of any outstanding shares of preferred stock. Our Class A common stock is not convertible into any other shares of our capital stock. Any holder of Class B common stock may at any time convert his or her shares into shares of Class A common stock on a share-for-share basis. The shares of Class B common stock will automatically convert into shares of Class A common stock on a share-for-share basis: • when the aggregate number of shares of our Class B common stock is less than 20% of the aggregate number of shares of our Class A common stock and Class B common stock then outstanding; or • upon any transfer, whether or not for value, except for transfers to the holder’s spouse, certain of the holder’s relatives, the trustees of certain trusts established for their benefit, corporations and partnerships wholly-owned by the holders and their relatives, the holder’s estate and other holders of Class B common stock. Once converted into Class A common stock, the Class B common stock cannot be reissued. No class of common stock may be subdivided or combined unless the other class of common stock concurrently is subdivided or combined in the same proportion and in the same manner. Other than in connection with dividends and distributions, subdivisions or combinations, or certain other circumstances, we are not authorized to issue additional shares of Class B common stock. Class A and Class B common stock do not have any preemptive rights. The Class B common stock is not and will not be listed on the NASDAQ Stock Market or any other exchange. Therefore, no trading market is expected to develop in the Class B common stock. Class A common stock is listed on the NASDAQ Stock Market under the symbol “FIBK.” The table below sets forth, for each quarter in the past two years, the quarterly high and low closing sales prices per share of the Class A common stock, as reported by the NASDAQ Stock Market. Quarter Ended High Low March 31, 2010 June 30, 2010 September 30, 2010 December 31, 2010 March 31, 2011 June 30, 2011 September 30, 2011 December 31, 2011 $16.97 16.80 15.83 15.39 15.90 14.74 14.83 13.41 $15.40 15.05 11.07 12.00 12.99 13.16 10.08 9.88 As of December 31, 2011, we had 564 record shareholders, including the Wealth Management division of First Interstate Bank as trustee for 1,649,833 shares of Class A common stock held on behalf of 1,061 individual participants in the Savings and Profit Sharing Plan for Employees of First Interstate BancSystem, Inc., or the Savings Plan. The Savings Plan Trustee votes the shares based on the instructions of each participant. In the event the participant does not provide the Savings Plan Trustee with instructions, the Savings Plan Trustee votes those shares in accordance with voting instructions received from a majority of the participants in the plan. 25 Table of Contents Dividends It is our policy to pay a dividend to all common shareholders quarterly. We currently intend to continue paying quarterly dividends; however, the Board may change or eliminate the payment of future dividends. Recent quarterly dividends follow: Dividend Payment First quarter 2010 Second quarter 2010 Third quarter 2010 Fourth quarter 2010 First quarter 2011 Second quarter 2011 Third quarter 2011 Fourth quarter 2011 First quarter 2012 Dividend Restrictions Amount Per Share Total Cash Dividends $0.1125 0.1125 0.1125 0.1125 0.1125 0.1125 0.1125 0.1125 0.1200 $3,519,163 4,792,655 4,796,025 4,796,835 4,797,595 4,809,901 4,811,704 4,813,801 5,136,079 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 Part II, Item 7 herein. Sales of Unregistered Securities There were no issuances of unregistered securities during the three months ended December 31, 2011. Purchases of Equity Securities by the Issuer and Affiliated Purchasers There were no 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, 2011. 26 Table of Contents Performance Graph The performance graph below compares the cumulative total shareholder return on our Class A common stock since our Class A common stock began trading on the Nasdaq Global Select Market on March 23, 2010, as compared with the cumulative total return on equity securities of companies included in the Nasdaq Composite Index and the Nasdaq Bank Index over the same period. The Nasdaq Bank Index is a comparative peer index comprised of financial companies, including banks, savings institutions and related holding companies that perform banking-related functions, listed on the Nasdaq Stock Market. The Nasdaq Composite Index is a comparative broad market index comprised of all domestic and international common stocks listed on the Nasdaq Stock Market. This graph assumes a $100.00 investment in our common stock on the first day of trading, 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. The performance graph represents past performance, which may not be indicative of the future performance of our common stock. Index First Interstate BancSystem, Inc. NASDAQ Composite NASDAQ Bank 3/23/10 3/31/10 6/30/10 9/30/10 12/31/10 3/31/11 6/30/11 9/30/11 12/31/11 $ 100.00 100.00 100.00 112.84 99.30 98.48 110.02 87.56 89.04 94.93 98.62 87.90 108.27 110.78 98.86 97.42 116.38 98.32 106.40 116.35 95.03 78.10 101.57 75.44 95.89 109.92 88.48 Period Ending 27 Table of Contents Item 6. Selected Consolidated Financial Data The following selected consolidated financial data with respect to our consolidated financial position as of December 31, 2011 and 2010, and the results of our operations for the fiscal years ended December 31, 2011, 2010 and 2009, 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, 2009, 2008 and 2007, and the results of our operations for the fiscal years ended December 31, 2008 and 2007, has been derived from our audited consolidated financial statements not included herein. Five Year Summary (Dollars in thousands except share and per share data) As of or for the year ended December 31, Selected Balance Sheet Data: Net loans Investment securities Total assets Deposits Securities sold under repurchase agreements Long-term debt Subordinated debentures held by subsidiary trusts Preferred stockholders’ equity Common stockholders’ equity Selected Income Statement Data: Interest income Interest expense Net interest income Provision for loan losses Net interest income after provision for loan losses Non-interest income Non-interest expense Income before income taxes Income tax expense Net income Preferred stock dividends Net income available to common shareholders Common Share Data: Earnings per share: Basic Diluted Dividends per share Book value per share (2) Tangible book value per share (3) Weighted average shares outstanding: Basic Diluted $ $ $ $ $ 2011 2010 2009 2008 (1) 2007 4,073,968 $ 2,169,645 7,325,527 5,826,971 516,243 37,200 123,715 50,000 721,020 $ 292,883 $ 42,031 250,852 58,151 192,701 91,872 218,412 66,161 21,615 44,546 3,422 41,124 $ 0.96 $ 0.96 0.45 16.77 12.33 4,247,429 $ 1,933,403 7,500,970 5,925,713 620,154 37,502 123,715 50,000 686,802 $ 314,546 $ 63,107 251,439 66,900 184,539 90,911 221,004 54,446 17,090 37,356 3,422 33,934 $ 0.85 $ 0.85 0.45 16.05 11.55 4,424,974 $ 1,446,280 7,137,653 5,824,056 474,141 73,353 123,715 50,000 524,434 $ 328,034 $ 84,898 243,136 45,300 197,836 100,690 217,710 80,816 26,953 53,863 3,422 50,441 $ 1.61 $ 1.59 0.50 16.73 10.53 4,685,497 $ 1,072,276 6,628,347 5,174,259 525,501 84,148 123,715 50,000 489,062 $ 355,919 $ 120,542 235,377 33,356 202,021 128,597 222,541 108,077 37,429 70,648 3,347 67,301 $ 2.14 $ 2.10 0.65 15.50 9.27 3,506,625 1,128,657 5,216,797 3,999,401 604,762 5,145 103,095 — 444,443 325,557 125,954 199,603 7,750 191,853 92,367 178,786 105,434 36,793 68,641 — 68,641 2.11 2.06 0.74 13.88 12.70 42,749,526 42,847,196 39,907,640 40,127,365 31,335,668 31,678,500 31,484,136 32,112,672 32,507,216 33,289,920 28 Table of Contents Five Year Summary (continued) (Dollars in thousands except share and per share data) As of or for the year ended December 31, Financial Ratios: Return on average assets Return on average common stockholders’ equity Average stockholders’ equity to average assets Yield on average earning assets Cost of average interest bearing liabilities Interest rate spread Net interest margin (4) Efficiency ratio (5) Common stock dividend payout ratio (6) Loan to deposit ratio Asset Quality Ratios Non-performing loans to total loans (7) Non-performing assets to total loans and other real estate owned (OREO) (8) Non-performing assets to total assets Allowance for loan losses to total loans Allowance for loan losses to non-performing loans Net charge-offs to average loans Capital Ratios: Tangible common stockholders equity to tangible assets (9) Net tangible common stockholders equity to tangible assets (10) Tier 1 common capital to total risk weighted assets (11) Leverage ratio Tier 1 risk-based capital Total risk-based capital 2011 2010 2009 2008 (1) 2007 0.61 % 5.86 10.25 4.43 0.78 3.65 3.80 63.73 46.88 71.85 5.77 % 6.60 3.81 2.69 46.62 1.54 0.52 % 5.22 9.67 4.85 1.15 3.70 3.89 64.55 52.94 73.71 4.82 % 5.55 3.26 2.76 57.19 1.10 0.79 % 9.98 8.16 5.44 1.63 3.81 4.05 63.32 31.06 77.75 2.75 % 3.57 2.28 2.28 82.64 0.63 1.12 % 14.73 7.98 6.37 2.50 3.87 4.25 61.14 30.37 92.24 1.90 % 2.03 1.46 1.83 96.03 0.28 1.37 % 16.14 8.52 7.21 3.43 3.78 4.46 61.23 35.07 88.99 0.98 % 1.00 0.68 1.47 150.66 0.08 7.43 % 6.76 % 4.76 % 4.55 % 7.85 % 8.28 11.04 9.84 14.55 16.54 7.59 10.12 9.27 13.53 15.50 5.63 6.43 7.30 9.74 11.68 5.49 5.35 7.13 8.57 10.49 7.95 9.95 9.92 12.39 13.64 (1) (2) (3) (4) (5) (6) (7) (8) (9) Significant changes in 2008, as compared to 2007, are primarily attributable to bank acquisitions in 2008. For purposes of computing book value per share, book value equals common stockholders’ equity. Tangible book value per share is a non-GAAP financial measure that management uses to evaluate our capital adequacy. For purposes of computing tangible book value per share, tangible book value equals common stockholders’ equity less goodwill, core deposit intangibles and other intangible assets (except mortgage servicing rights). Tangible book value per share is calculated as tangible common stockholders’ equity divided by common shares outstanding, and its most directly comparable GAAP financial measure is book value per share. See below our reconciliation of non-GAAP financial measures to their most directly comparable GAAP financial measures under the caption “ —Non-GAAP Financial Measures” in this Part II, Item 6. Net interest margin ratio is presented on a fully taxable equivalent, or FTE, basis. Efficiency ratio represents non-interest expense, excluding loan loss provision, divided by the aggregate of net interest income and non-interest income. Common stock dividend payout ratio represents dividends per common share divided by basic earnings per common share. Non-performing loans include non-accrual loans, loans past due 90 days or more and still accruing interest and troubled debt restructurings. Non-performing assets include non-accrual loans, loans past due 90 days or more and still accruing interest, troubled debt restructurings and OREO. Tangible common equity to tangible assets is a non-GAAP financial measure that management uses to evaluate our capital adequacy. For purposes of computing tangible common equity to tangible assets, tangible common equity is calculated as common stockholders’ equity less goodwill and other intangible assets (except mortgage servicing assets), and tangible assets is calculated as total assets less goodwill and other intangible assets (except mortgage servicing rights). See below our reconciliation of non-GAAP financial measures to their most directly comparable GAAP financial measures under the caption “ —Non-GAAP Financial Measures” in this Part II, Item 6. (10) Net tangible common equity to tangible assets is a non-GAAP financial measure that management uses to evaluate our capital adequacy. For purposes of computing net tangible common equity to tangible assets, net tangible common equity is calculated as common stockholders’ equity less goodwill (adjusted for associated deferred tax liability) and other intangible assets (except mortgage servicing assets), and tangible assets is calculated as total assets less goodwill and other intangible assets (except mortgage servicing rights). See below our reconciliation of non-GAAP financial measures to their most directly comparable GAAP financial measures under the caption “ —Non- GAAP Financial Measures” in this Part II, Item 6. (11) For purposes of computing tier 1 common capital to total risk-weighted assets, tier 1 common capital excludes preferred stock and trust preferred securities. 29 Table of Contents Non-GAAP Financial Measures In addition to results presented in accordance with generally accepted accounting principals in the United States of America, or GAAP, this annual report contains the following non-GAAP financial measures that management uses to evaluate our capital adequacy: tangible book value per share, tangible common equity to tangible assets and net tangible common equity to tangible assets. Tangible book value per share is calculated as tangible common stockholders’ equity divided by common shares outstanding. Tangible assets is calculated as total assets less goodwill and other intangible assets (excluding mortgage servicing assets). Tangible common equity to tangible assets is calculated as tangible common stockholders’ equity divided by tangible assets. Net tangible common equity to tangible assets is calculated as net tangible common stockholders’ equity divided by tangible assets. These non-GAAP financial measures may not be comparable to similarly titled measures reported by other companies because other companies may not calculate these non-GAAP measures in the same manner. They also should not be considered in isolation or as a substitute for measures prepared in accordance with GAAP. The following table shows a reconciliation from ending stockholders’ equity (GAAP) to ending tangible common stockholders’ equity (non-GAAP) and ending net tangible common stockholders’ equity (non-GAAP) and ending assets (GAAP) to ending tangible assets (non-GAAP), their most directly comparable GAAP financial measures, in each instance as of the periods presented. Non-GAAP Financial Measures - Five Year Summary (Dollars in thousands except share and per share data) As of December 31, Preferred stockholders’ equity Common stockholders’ equity Total stockholders’ equity Less goodwill and other intangible assets Less preferred stock Tangible common stockholders’ equity Add deferred tax liability for deductible goodwill Net tangible common stockholders’ equity Total assets Less goodwill and other intangible assets (excluding mortgage servicing rights) Tangible assets Number of common shares outstanding Book value per common share Tangible book value per common share Net tangible book value per common share Tangible common stockholders’ equity to tangible assets Net tangible common stockholders’ equity to tangible assets 2011 2010 2009 2008 2007 $ $ $ $ $ 50,000 $ 721,020 771,020 191,065 50,000 529,955 60,499 590,454 $ 7,325,527 $ 191,065 7,134,462 $ 42,984,174 16.77 $ 12.33 13.74 7.43 % 8.28 % 30 50,000 $ 686,802 736,802 192,518 50,000 494,284 60,499 554,783 $ 7,500,970 $ 192,518 7,308,452 $ 42,800,694 16.05 $ 11.55 12.96 6.76 % 7.59 % 50,000 $ 524,434 574,434 194,273 50,000 330,161 60,499 390,660 $ 7,137,653 $ 194,273 6,943,380 $ 31,349,588 16.73 $ 10.53 12.46 4.76 % 5.63 % 50,000 $ 489,062 539,062 196,667 50,000 292,395 60,499 352,894 $ 6,628,347 $ 196,667 6,431,680 $ 31,550,076 15.50 $ 9.27 11.19 4.55 % 5.49 % — 444,443 444,443 37,637 — 406,806 4,907 411,713 5,216,797 37,637 5,179,160 32,024,164 13.88 12.70 12.86 7.85 % 7.95 % Table of Contents Cautionary Note Regarding Forward-Looking Statements and Factors that Could Affect Future Results Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations 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. The following factors, among others, may cause actual results to differ materially from current expectations in the forward-looking statements, including those set forth in this report: • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • credit losses; concentrations of real estate loans; economic and market developments, including inflation; commercial loan risk; adequacy of the allowance for loan losses; impairment of goodwill; changes in interest rates; access to low-cost funding sources; increases in deposit insurance premiums; inability to grow business; adverse economic conditions affecting Montana, Wyoming and western South Dakota; governmental regulation and changes in regulatory, tax and accounting rules and interpretations; sweeping changes in regulation of financial institutions due to passage of the Dodd-Frank Act; changes in or noncompliance with governmental regulations; effects of recent legislative and regulatory efforts to stabilize financial markets; dependence on the Company’s management team; ability to attract and retain qualified employees; failure of technology; reliance on external vendors; disruption of vital infrastructure and other business interruptions; illiquidity in the credit markets; inability to meet liquidity requirements; lack of acquisition candidates; failure to manage growth; competition; inability to manage risks in turbulent and dynamic market conditions; ineffective internal operational controls; environmental remediation and other costs; failure to effectively implement technology-driven products and services; litigation pertaining to fiduciary responsibilities; capital required to support the Company’s bank subsidiary; soundness of other financial institutions; impact of Basel III capital standards and forthcoming new capital rules proposed for U.S. banks; inability of our bank subsidiary to pay dividends; 31 Table of Contents • • • • • • • • • • • • change in dividend policy; lack of public market for our Class A common stock; volatility of Class A common stock; voting control of Class B stockholders; decline in market price of Class A common stock; dilution as a result of future equity issuances; uninsured nature of any investment in Class A common stock; anti-takeover provisions; controlled company status; subordination of common stock to Company debt: uncertainties associated with introducing new products or lines of business; and, downgrade of the U.S. credit rating These factors are not necessarily all of the factors that could cause our actual results, performance or achievements to differ materially from those expressed in or implied by any of our forward-looking statements. Other unknown or unpredictable factors also could harm our results. All forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements set forth above. Forward-looking statements speak only as of the date they are made and we do not undertake or assume any obligation to update publicly any of these statements to reflect actual results, new information or future events, changes in assumptions or changes in other factors affecting forward-looking statements, except to the extent required by applicable laws. If we update one or more forward-looking statements, no inference should be drawn that we will make additional updates with respect to those or other forward-looking statements. Executive Overview We are a financial and bank holding company headquartered in Billings, Montana. As of December 31, 2011, we had consolidated assets of $7.3 billion, deposits of $5.8 billion, loans of $4.2 billion and total stockholders’ equity of $771 million. We currently operate 71 banking offices in 42 communities located in Montana, Wyoming and western South Dakota. Through the Bank, we deliver a comprehensive range of banking products and services to individuals, businesses, municipalities and other entities throughout our market areas. Our customers participate in a wide variety of industries, including energy, tourism, agriculture, healthcare, professional services, education, governmental services, construction, mining, retail and wholesale trade. Our Business 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 non-interest 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; 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 loan portfolio consists of a mix of real estate, consumer, commercial, agricultural and other loans, including fixed and variable rate loans. Our real estate loans comprise commercial real estate, construction (including residential, commercial and land development loans), residential, agricultural and other real estate 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 discretion within pre-approved limits in approving and pricing loans to assure that the banking offices are responsive to competitive issues and community needs in each market area. We fund our loan portfolio primarily with the core deposits from our customers, generally without utilizing brokered deposits and with minimal reliance on wholesale funding sources. For additional information about our underwriting standards and loan approval process, see Business—Lending Activities, included in Part I, Item 1 of this report. 32 Table of Contents Recent Developments On July 15, 2011, the Board of Governors of the Federal Reserve System, or FRB, and the Federal Deposit Insurance Corporation, or FDIC, issued separate final rules to implement the Dodd-Frank Wall Street Reform and Consumer Protection Act, or Dodd-Frank Act, which mandated repeal of the prohibition against paying interest on demand deposits, thereby permitting depository institutions to pay interest on business transaction and other accounts beginning July 21, 2011. This change did not have a significant impact on our interest expense, consolidated financial statements, results of operations or liquidity in 2011. On June 29, 2011, the FRB issued a final rule establishing standards for debit card interchange fees and prohibiting network exclusivity arrangements and routing restrictions. This rule, Regulation II - Debit Card Interchange Fees and Routing, implements provisions of the Dodd-Frank Act. The rule, which became effective October 1, 2011, reduces the maximum allowable interchange fee per transaction for issuers with over $10 billion in assets. Issuers with less than $10 billion in assets, like us, are exempt from the debit card interchange fee limitations. Under this exemption, we do not anticipate any immediate, significant impact to interchange revenues. We recorded debit card interchange fees of $11.6 million during 2011. In February 2011, the FDIC issued a final rule that, among other things, modified the definition of an institution's deposit insurance assessment base and revised assessment rate schedules. The final rule changes the deposit insurance assessment base to an institution's average total assets less its average tangible equity, with adjustments for brokered deposits, unsecured debt and for custodial banks and banks that primarily provide services to other banks. These changes, which became effective April 1, 2011, resulted in a reduction in our FDIC insurance premiums. Asset Quality Non-performing assets peaked during second quarter 2011 at $292 million, and ended the year at $279 million, or 6.60% of total loans and OREO, as compared to $244 million, or 5.55% of total loans and OREO, as of December 31, 2010. Approximately 42% of our non-performing loans were construction loans and 36% were commercial real estates loans as of December 31, 2011. Additionally, as of December 31, 2011, approximately 39% of our non-performing loans and 67% of our OREO properties were located in markets dependent upon second home sales and resort communities, including the Flathead area around Kalispell, Montana, the Gallatin Valley area around Bozeman, Montana and the Jackson, Wyoming market area. Loan charge-offs, net of recoveries, totaled $66 million during 2011, as compared to $49 million during 2010. During fourth quarter 2011, net charge-offs peaked at $21 million for the three month period. Net charge-offs are expected to remain high in future quarters as problem loans continue to work through the credit cycle, but not at the elevated level experienced during fourth quarter 2011. Although economic conditions remained challenging during 2011, there were some tangible signs that economic recovery is underway in many of our market areas. Unemployment rates in Montana, Wyoming and South Dakota continue to compare favorably to national averages and decreased in 2011, as compared to 2010. The table below presents average seasonally-adjusted unemployment rates in the three states in which we operate and nationally for the periods indicated. Montana Wyoming South Dakota National December 2011 December 2010 December 2009 6.8% 5.8% 4.2% 8.5% 7.4% 6.4% 4.7% 9.4% 7.0% 7.7% 5.2% 9.9% Additionally, during the first nine months of 2011, there was a combined 10.9% decrease in individual bankruptcy filings in Montana, Wyoming and South Dakota, as compared to the same period in 2010, while nationally, individual bankruptcy filings decreased 10.3% during the same period. Our criticized loans decreased during 2011, ending the year at $631 million, a $112 million, or 15.1%, decrease from $743 million as of December 31, 2010. Based on our assessment of the adequacy of our allowance for loan losses, we recorded provisions for loan losses of $58.2 million during 2011, compared to $66.9 million during 2010. Management expects provisions for loan losses to continue to decline as credit quality improves. 33 Table of Contents Goodwill Our annual goodwill impairment test is performed each year as of July 1st. Upon completion of this year's test, the estimated fair value of net assets was greater than carrying value of the Company. During the last half of 2011, there was a significant and prolonged decrease in market prices for bank stocks, including our common stock. As a result, we determined that an interim impairment test was warranted. We engaged a third party valuation consultant to assist us in our determination of the fair value of goodwill as of December 31, 2011. Based upon this valuation, we determined that the fair value of our net assets was greater than the carrying value of the Company as of December 31, 2011 and no impairment existed. We will continue to monitor our performance and evaluate our goodwill for impairment annually or more frequently as needed. Primary Factors Used in Evaluating Our Business As a banking institution, we manage and evaluate various aspects of both our financial condition and our results of operations. We monitor our financial condition and performance on a monthly basis, at our holding company, at the Bank and at each banking office. We evaluate the levels and trends of the line items included in our balance sheet and statements of income, as well as various financial ratios that are commonly used in our industry. We analyze these ratios and financial trends against both our own historical levels and the financial condition and performance of comparable banking institutions in our region and nationally. Results of Operations Principal factors used in managing and evaluating our results of operations include return on average assets, net interest income, non-interest income, non-interest expense and net income. 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 rates earned or paid on interest earning assets and interest bearing liabilities, which we refer to as interest rate spread. The volume of loans, investment securities and other interest earning assets, compared to the volume of interest bearing deposits and indebtedness, combined with the interest rate spread, produces changes in our net interest income between periods. Non-interest bearing sources of funds, such as demand deposits and stockholders’ equity, also support earning assets. The impact of free funding sources is captured in the net interest margin, which is calculated as net interest income divided by average earning assets. Given the interest free nature of free funding sources, the net interest margin is generally higher than the interest rate spread. We seek to increase our net interest income over time and evaluate our net interest income on factors that include the yields on our loans and other earning assets, the costs of our deposits and other funding sources, the levels of our net interest spread and net interest margin and the provisions for loan losses required to maintain our allowance for loan losses at an adequate level. We seek to increase our non-interest income over time and we evaluate our non-interest income relative to the trends of the individual types of non-interest income in view of prevailing market conditions. We seek to manage our non-interest expenses in consideration of the growth of our business and our community banking model that emphasizes customer service and responsiveness. We evaluate our non-interest expense on factors that include our non-interest expense relative to our average assets, our efficiency ratio and the trends of the individual categories of non-interest expense. Finally, we seek to increase our net income and provide favorable shareholder returns over time, and we evaluate our net income relative to the performance of other banks and bank holding companies on factors that include return on average assets, return on average equity, and consistency and rates of growth in our earnings. Financial Condition Principal areas of focus in managing and evaluating our financial condition include liquidity, the diversification and quality of our loans, the adequacy of our allowance for loan losses, the diversification and terms of our deposits and other funding sources, the re-pricing characteristics and maturities of our assets and liabilities, including potential interest rate exposure and the adequacy of our capital levels. We seek to maintain sufficient levels of cash and investment securities to meet potential payment and funding obligations, and we evaluate our liquidity on factors that include the levels of cash and highly liquid assets relative to our liabilities, the quality and maturities of our investment securities, the ratio of loans to deposits and any reliance on brokered certificates of deposit or other wholesale funding sources. 34 Table of Contents We seek to maintain a diverse and high quality loan portfolio and evaluate our asset quality on factors that include the allocation of our loans among loan types, credit exposure to any single borrower or industry type, non-performing assets as a percentage of total loans and OREO, and loan charge-offs as a percentage of average loans. We seek to maintain our allowance for loan losses at a level adequate to absorb probable losses inherent in our loan portfolio at each balance sheet date, and we evaluate the level of our allowance for loan losses relative to our overall loan portfolio and the level of non- performing loans and potential charge-offs. We seek to fund our assets primarily using core customer deposits spread among various deposit categories, and we evaluate our deposit and funding mix on factors that include the allocation of our deposits among deposit types, the level of our non-interest bearing deposits, the ratio of our core deposits (i.e. excluding time deposits above $100,000) to our total deposits and our reliance on brokered deposits or other wholesale funding sources, such as borrowings from other banks or agencies. We seek to manage the mix, maturities and re-pricing characteristics of our assets and liabilities to maintain relative stability of our net interest rate margin in a changing interest rate environment, and we evaluate our asset-liability management using complex models to evaluate the changes to our net interest income under different interest rate scenarios. Finally, we seek to maintain adequate capital levels to absorb unforeseen operating losses and to help support the growth of our balance sheet. We evaluate our capital adequacy using the regulatory and financial capital ratios including leverage capital ratio, tier 1 risk-based capital ratio, total risk-based capital ratio, tangible common equity to tangible assets and tier 1 common capital to total risk- weighted assets. 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 financial statements included Part IV, Item 15 of this report. 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 provision for loan losses creates an allowance for loan losses known and inherent in the loan portfolio at each balance sheet date. The allowance for loan losses represents management’s estimate of probable credit losses inherent in the loan portfolio. We perform a quarterly assessment of the risks inherent in our loan portfolio, as well as a detailed review of each significant loan 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. 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, historical loan loss rates, changes in the nature of the loan portfolio, overall portfolio quality, industry concentrations, delinquency trends 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 possible and may have a material impact on our allowance, and therefore our consolidated financial statements or results of operations. 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, and fluctuations in the provision for loan losses result from management’s assessment of the adequacy of the allowance for loan losses. Management monitors qualitative and quantitative trends in the loan portfolio, including changes in the levels of past due, internally classified and non-performing loans. See “Notes to Consolidated Financial Statements — Summary of Significant Accounting Policies” for a description of the methodology used to determine the allowance for loan losses. A discussion of the factors driving changes in the amount of the allowance for loan losses is included herein under the heading “—Financial Condition—Allowance for Loan Losses.” See also Part I, Item 1A, “Risk Factors—Risks Relating to the Market and Our Business.” 35 Table of Contents Goodwill The excess purchase price over the fair value of net assets from acquisitions, or goodwill, is evaluated for impairment at least annually and on an interim basis if an event or circumstance indicates that it is likely impairment has occurred. In testing for impairment, the fair value of net assets is estimated based on an analysis of our market value, discounted cash flows and peer values. Determining the fair value of goodwill is considered a critical accounting estimate because of its sensitivity to market-based economics. In addition, any allocation of the fair value of goodwill to assets and liabilities requires significant management judgment and the use of subjective measurements. Variability in market conditions and key assumptions or subjective measurements used to estimate and allocate fair value are reasonably possible and could have a material impact on our consolidated financial statements or results of operations. For additional information regarding goodwill, see "Executive Overview" above. See also “Notes to Consolidated Financial Statements-Summary of Significant Accounting Policies,” included in Part IV, Item 15 of this report and “Risk Factors-Risks Relating to the Market and Our Business,” included in Part I, Item 1A of this report. Our annual goodwill impairment test is performed each year as of July 1st. Upon completion of this year's test, the estimated fair value of net assets was greater than carrying value of the Company. During the last half of 2011, there was a significant and prolonged decrease in market prices for bank stocks, including our common stock. As a result, we determined that an interim impairment test was warranted. We engaged a third party valuation consultant to assist us in our determination of the fair value of goodwill as of December 31, 2011. Based upon this valuation, we determined that the fair value of our net assets was greater than the carrying value of the Company as of December 31, 2011 and no impairment existed. We will continue to monitor our performance and evaluate our goodwill for impairment annually or more frequently as needed. Other Real Estate Owned Real estate acquired in satisfaction of loans is initially carried at current fair value less estimated selling costs. Any excess of loan carrying value over the fair value of the real estate acquired is recorded as a charge to the allowance for loan losses. Subsequent declines in fair value less estimated selling costs are included in OREO expense. Subsequent increases in fair value less estimated selling costs are recorded as a reduction in OREO expense to the extent of recognized losses. Determining the fair value of OREO is considered a critical accounting estimate due to the assets’ sensitivity to changes in estimates and assumptions used. Changes in these estimates and assumptions are reasonably possible and may have a material impact on our consolidated financial statements, liquidity or results of operations. For additional information regarding OREO, see “Notes to Consolidated Financial Statements—Summary of Significant Accounting Policies” and “Notes to Consolidated Financial Statements— Other Real Estate Owned,” included in Part IV, Item 15 of this report. Results of Operations The following discussion of our results of operations compares the years ended December 31, 2011 to December 31, 2010 and the years ended December 31, 2010 to December 31, 2009. 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. 36 Table of Contents 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. Average Balance Sheets, Yields and Rates (Dollars in thousands) Interest earning assets: Loans (1) (2) U.S. government agency and mortgage-backed securities Federal funds sold Other securities Tax exempt securities (2) Interest bearing deposits in banks Total interest earnings assets Non-earning assets Total assets Interest bearing liabilities: Demand deposits Savings deposits Time deposits Repurchase agreements Other borrowed funds (3) Long-term debt $ $ Subordinated debentures held by by subsidiary trusts Total interest bearing liabilities Non-interest bearing deposits Other non-interest bearing liabilities Stockholders’ equity Total liabilities and stockholders’ equity $ Net FTE interest income Less FTE adjustments (2) Net interest income from consolidated statements of income Interest rate spread Net FTE interest margin (4) Average Balance 2011 Interest Average Rate Average Balance Year Ended December 31, 2010 Interest Average Rate Average Balance 2009 Interest Average Rate $ 4,275,128 $ 247,492 5.79 % $ 4,482,219 $ 268,279 5.99 % $ 4,660,189 $ 281,799 6.05 % 39,911 13 — 8,884 1,050 297,350 3,057 6,448 24,028 695 — 1,975 5,828 42,031 1,878,442 2,231 191 147,559 414,375 6,717,926 618,454 7,336,380 1,269,676 $ 1,714,294 1,737,401 500,882 5,582 37,442 123,715 5,388,992 1,146,535 48,532 752,321 7,336,380 $ $ 255,319 (4,467 ) 250,852 41,824 22 — 7,802 1,093 319,020 3,430 8,934 41,585 879 3 2,433 5,843 63,107 1,529,628 6,238 376 133,207 429,657 6,581,325 665,012 7,246,337 1,135,208 $ 1,530,844 2,143,899 480,276 5,779 46,024 123,715 5,465,745 1,021,409 58,778 700,405 7,246,337 $ $ 255,913 (4,474 ) 251,439 2.12 0.58 — 6.02 0.25 4.43 $ 0.24 % $ 0.38 1.38 0.14 — 5.27 4.71 0.78 $ 3.65 % 3.80 % 41,887 253 50 8,398 520 332,907 4,068 10,033 59,125 776 1,367 3,249 6,280 84,898 1,016,632 105,423 1,556 134,373 199,316 6,117,489 687,110 6,804,599 1,083,054 $ 1,321,625 2,129,313 422,713 57,016 79,812 123,715 5,217,248 965,226 66,862 555,263 6,804,599 $ $ 248,009 (4,873 ) 243,136 2.73 0.35 — 5.86 0.25 4.85 $ 0.30 % $ 0.58 1.94 0.18 0.05 5.29 4.72 1.15 $ 3.70 % 3.89 % 4.12 0.24 3.21 6.25 0.26 5.44 0.38 % 0.76 2.78 0.18 2.40 4.07 5.08 1.63 3.81 % 4.05 % (1) (2) (3) (4) Average loan balances include non-accrual loans. Interest income on loans includes amortization of deferred loan fees net of deferred loan costs, which is not material. Interest income and average rates for tax exempt loans and securities are presented on a FTE basis. Includes interest on federal funds purchased and other borrowed funds. Excludes long-term debt. Net FTE interest margin during the period equals (i) the difference between interest income on interest earning assets and the interest expense on interest bearing liabilities, divided by (ii) average interest earning assets for the period. 37 Table of Contents Our net interest income on a fully taxable equivalent, or FTE, basis decreased $594 thousand, or less than 1.0%, to $255.3 million in 2011, compared to $255.9 million in 2010, and our net FTE interest margin ratio decreased 9 basis points to 3.80% in 2011, compared to 3.89% in 2010. Decrease in net FTE interest income and compression in our net FTE interest margin ratio were attributable to lower yields earned on our investment and loan portfolios and lower outstanding loan balances, the effects of which were substantially offset by a 37 basis point reduction in the cost of interest bearing liabilities. Deposit growth combined with corresponding increases in interest earning assets resulted in an increase in net interest income, on a fully taxable equivalent, or FTE, basis in 2010. Our FTE net interest income increased $7.9 million, or 3.2%, to $255.9 million in 2010, compared to $248.0 million in 2009. Despite growth in net FTE interest income, our net FTE interest margin decreased 16 basis points to 3.89% in 2010, compared to 4.05% in 2009. Deposit growth coupled with low demand for loans resulted in a shift in the mix of interest earning assets from higher-yielding loans to lower-yielding investment securities and interest bearing deposits in banks, which compressed our FTE net interest margin ratio. The remaining compression in net interest margin ratio was attributable to lower yields earned on our investment security and loan portfolios, and was partially offset by a 48 basis point reduction in funding costs during 2010. IPO proceeds of $119 million, net of IPO costs and after the repayment of our variable rate term notes, received during the second quarter of 2010 were initially invested in interest bearing deposits in banks, which yielded 25 basis points during 2010. 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. Analysis of Interest Changes Due To Volume and Rates (Dollars in thousands) Year Ended December 31, 2011 compared with December 31, 2010 Year Ended December 31, 2010 compared with December 31, 2009 Year Ended December 31, 2009 compared with December 31, 2008 Volume Rate Net Volume Rate Net Volume Rate Net Interest earning assets: Loans (1) U.S. government agency and mortgage-backed securities Federal funds sold Other securities Tax exempt securities (1) Interest bearing deposits in banks Total change Interest bearing liabilities: Demand deposits Savings deposits Time deposits Repurchase agreements Borrowings (2) Long-term debt Subordinated debentures held by subsidiary trusts Total change $ (12,395 ) $ (8,392 ) $ (20,787 ) $ (10,762 ) $ (2,758 ) $ (13,520 ) $ 9,537 (14 ) — 841 (39 ) (11,450 ) (1,913 ) 5 — 241 (4 ) (9 ) — 1,082 (43 ) (2,070 ) (19,600 ) (21,670 ) 406 1,071 (7,885 ) 38 — (454 ) — (6,824 ) (779 ) (3,557 ) (9,672 ) (222 ) (3 ) (4 ) (15 ) (373 ) (2,486 ) (17,557 ) (184 ) (3 ) (458 ) (15 ) (14,252 ) (21,076 ) 21,136 (238 ) (38 ) (73 ) 601 10,626 196 1,588 405 106 (1,228 ) (1,375 ) — (308 ) (21,199 ) 7 (12 ) (523 ) (28 ) (24,513 ) (834 ) (2,687 ) (63 ) (231 ) (50 ) (596 ) 573 (13,887 ) (638 ) (1,099 ) (17,945 ) (17,540 ) (3 ) (136 ) 559 (437 ) 103 (1,364 ) (816 ) (437 ) (21,483 ) (21,791 ) Increase (decrease) in FTE net interest income (1) $ 4,754 $ (5,348 ) $ (594 ) $ 10,934 $ (3,030 ) $ 7,904 $ 8,963 $ 4,349 982 (148 ) (853 ) 6,212 19,505 (437 ) 2,855 17,068 (1,640 ) (1,724 ) (374 ) 26 15,774 3,731 $ (34,140 ) $ (25,177 ) (5,798 ) (1,809 ) (16 ) (131 ) (5,883 ) (47,777 ) (8,461 ) (11,276 ) (23,386 ) (5,278 ) (39 ) (955 ) (2,023 ) (51,418 ) (1,449 ) (827 ) (164 ) (984 ) 329 (28,272 ) (8,898 ) (8,421 ) (6,318 ) (6,918 ) (1,763 ) (1,329 ) (1,997 ) (35,644 ) 3,641 $ 7,372 (1) (2) Interest income and average rates for tax exempt loans and securities are presented on a FTE basis. Includes interest on federal funds purchased and other borrowed funds. 38 Table of Contents 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 loan 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” included herein. Our provision for loan losses decreased $8.7 million, or 13.1%, to $58.2 million in 2011, as compared to $66.9 million in 2010, and increased $21.6 million, or 47.7%, to $66.9 million in 2010, as compared to $45.3 million in 2009. Fluctuations in the provision for loan losses reflect management's estimate of possible loan loss based upon evaluation of the borrowers' ability to repay, collateral underlying loans, loan loss trends and estimated effects of current economic conditions on our loan portfolio. The level of provision for loan losses in 2011 is reflective of decreases in the level of criticized loans and overall loan volume in 2011, as compared to 2010. The increase in provision for loan losses in 2010, as compared to 2009, was reflective of increases in criticized loans and weakening economic conditions both nationally and in our market areas. Weak economic conditions particularly affected the performance of many of our land development credit relationships, especially in market areas with economies dependent upon resort and second home communities. For additional information concerning non-performing assets, see “—Financial Condition—Non-Performing Assets” herein. Non-interest Income Our principal sources of non-interest income include other service charges, commissions and fees; income from the origination and sale of loans; service charges on deposit accounts; and wealth management revenues. Non-interest income increased $961 thousand, or 1.1%, to $91.9 million in 2011, from $90.9 million in 2010. Non-interest income decreased $9.8 million, or 9.7%, to $90.9 million in 2010, from $100.7 million in 2009. Significant components of these fluctuations are discussed below. Other service charges, commissions and fees primarily include debit and credit card interchange income, mortgage servicing fees, insurance and other commissions and ATM service charge revenues. Other service charges, commissions and fees increased $2.2 million, or 7.4%, to $31.7 million in 2011, from $29.5 million in 2010, primarily due to increases in debit and credit card interchange income resulting from higher transaction volumes. Other service charges, commission and fees increased $747 thousand, or 2.6%, to $29.5 million in 2010, from $28.7 million in 2009, primarily due to higher debit card interchange income resulting from increased volumes of debit card transactions. On June 29, 2011, the FRB issued a final rule that, among other things, reduces the maximum allowable interchange fee per transaction for issuers with over $10 billion in assets. Issuers with less than $10 billion in assets, like us, are exempt from the debit card interchange fee limitations. As such, the Company does not anticipate any immediate, significant impact to its interchange income. For additional information regarding this final rule, see "—Recent Developments” herein. 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 revenues generated from the origination and sale of loans. Higher interest rates can reduce the demand for home loans and loans to refinance existing mortgages. Conversely, lower interest rates generally stimulate refinancing and home loan origination. Income from the origination and sale of loans decreased $1.7 million, or 7.5%, to $21.2 million in 2011, from $22.9 million in 2010, primarily due to declines in refinancing activity. Although mortgage rates were generally stable in 2011, as compared to 2010, and decreased in the latter part of 2011, refinancing activity declined as many homeowners who qualified for refinancing did so in 2010. Refinancing activity accounted for approximately 56% of the Company’s residential real estate loan originations during 2011, as compared to 60% during 2010. 39 Table of Contents Income from the origination and sale of loans decreased $8.1 million, or 26.1%, to $22.9 million in 2010, from $30.9 million in 2009, due to a substantial decline in refinancing activity from early 2009. Refinancing activity accounted for approximately 60% of the Company’s residential real estate loan originations during 2010, as compared to 71% during 2009. Decreases in refinancing activity were partially offset by increases in originations of new loans to purchase homes, which increased 1.6% during 2010, as compared to 2009. Service charges on deposit accounts decreased $534 thousand, or 2.9%, to $17.6 million in 2011, from $18.2 million in 2010 and $2.1 million, or 10.5%, to $18.2 million in 2010, from $20.3 million in 2009. These decreases are primarily due a reduction in overdraft fees due to changes in customer utilization. Wealth management revenues are principally comprised of fees earned for management of trust assets and investment services revenues. Wealth management revenues increased $770 thousand, or 6.2% to $13.2 million in 2011, from $12.4 million in 2010, and $1.6 million, or 14.5% to $12.4 million in 2010, from $10.8 million in 2009. These increases are primarily due to the addition of new trust customers combined with increases in the market values of new and existing assets under trust management. Also contributing to the increase in 2010, as compared to 2009, was the introduction of revised fee schedules in April 2009. During 2011, we recorded net gains on the disposal of investment securities of $1.5 million, as compared to net gains of $170 thousand in 2010. Net gains on disposal of investment securities in 2011 were primarily due to recognition of unamortized discounts on investment securities called by the issuing agencies during fourth quarter. Other income primarily includes company-owned life insurance revenues, net gains or losses on securities held under deferred compensation plans, check printing income, agency stock dividends and gains on sales of miscellaneous assets. Other income decreased $1.1 million, or 14.5%, to $6.7 million in 2011, from $7.8 million in 2010, primarily due to fluctuations of values of securities held under deferred compensation plans. During 2011, market value adjustments for securities held under deferred compensation plans resulted in reductions in other income of $161 thousand, as compared to increases in other income of $545 thousand in 2010. Other income decreased $1.9 million, or 19.8%, to $7.8 million in 2010, from $9.7 million in 2009, primarily due to the recognition of a $2.1 million one-time gain on the sale of Visa Class B common shares during third quarter 2009. Decreases in other income were partially offset by a $249 thousand one-time gain on the sale of our student loan portfolio recognized during third quarter 2010. Non-interest Expense Non-interest expense decreased $2.6 million, or 1.2%, to $218.4 million in 2011, from $221.0 million in 2010. Non-interest expense increased $3.3 million, or 1.5%, to $221.0 million in 2010, from $217.7 million in 2009. Significant components of these fluctuations are discussed below. Salaries, wages and employee benefits expense decreased $1.3 million, or 1.2%, to $111.4 million in 2011 compared to $112.7 million in 2010 primarily due to lower group health insurance costs, reductions in the market values of securities held under deferred compensation plans and reductions in full-time equivalent employees. These decreases were partially offset by normal inflationary wage increases and higher incentive bonus accruals reflective of our improved performance in 2011. Salaries, wages and employee benefits expense decreased $902 thousand, or less than 1.0%, to $112.7 million in 2010 compared to $113.6 million for the same period in 2009. Normal inflationary wage increases and increases in group health insurance and stock-based compensation expenses were more than offset by reductions in sales commissions and bonus accruals in 2010. OREO expense is recorded net of OREO income. Net OREO expense increased $982 thousand, or 12.8%, to $8.7 million in 2011, as compared to $7.7 million in 2010, and increased $1.3 million, or 19.9%, to $7.7 million in 2010, as compared to $6.4 million in 2009. Increases in net OREO expense between periods was primarily due to write-downs of the estimated fair value of OREO properties. Net OREO expense during 2011 included $1.8 million of net operating expenses, $7.5 million of fair value write-downs and net gains on the sale of OREO properties of $567 thousand, as compared to $1.7 million of net operating expenses, $6.7 million of fair value write-downs and net gains on the sale of OREO properties of $708 thousand in 2010. Approximately 72% of the fair value write-downs recorded during 2011 related to properties in the Flathead, Gallatin Valley and Jackson market areas, as compared to 79% in 2010 and 78% in 2009. 40 Table of Contents FDIC insurance premiums decreased $2.7 million, or 27.0%, to $7.3 million in 2011, from $10.0 million in 2010. In February 2011, the FDIC issued a final rule that, among other things, modified the definition of an institution's deposit insurance assessment base and revised assessment rate schedules. These changes, which became effective April 1, 2011, reduced the Company's FDIC insurance premiums in 2011. FDIC insurance premiums decreased $2.1 million, or 17.2%, to $10.0 million in 2010, from $12.1 million in 2009, primarily due to a special FDIC insurance assessment levied during second quarter 2009, which was applicable to all insured depository institutions, and resulted in additional FDIC insurance expense of $3.1 million. In addition, effective July 1, 2010, we opted out of participation in the Transaction Account Guarantee component of the Temporary Liquidity Guaranty Program, which further reduced our FDIC insurance premiums beginning in third quarter 2010. Mortgage servicing rights are amortized in proportion to and over the period of estimated net servicing income. Mortgage servicing rights amortization decreased $1.4 million, or 30.1%, to $3.2 million in 2011, from $4.6 million in 2010 and decreased $3.0 million, or 39.0%, to $4.6 million in 2010, from $7.6 million in 2009, primarily due to lower prepayment rates and the December 2010 sale of mortgage servicing rights with a carrying value of $5 million. Mortgage servicing rights are evaluated quarterly for impairment based on the fair value of the mortgage servicing rights. The fair value of mortgage servicing rights is estimated 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. Fluctuations in the fair value of mortgage servicing rights are primarily due to changes in assumptions regarding prepayments of the underlying mortgage loans, which typically correspond with changes in market interest rates. During 2011 we recorded impairment of $1.3 million, as compared to the reversal of previously recorded impairment of $787 thousand during 2010 and $7.2 million in 2009. Other expenses primarily include professional fees; advertising and public relations costs; office supply, postage, freight, telephone and travel expenses; donations expense; debit and credit card expenses; board of director fees; and other losses. Other expense increased $1.5 million, or 3.3%, to $47.4 million in 2011, from $45.9 million in 2010, primarily due to higher legal expenses associated with foreclosure and collection efforts. Other expenses increased $1.6 million, or 3.7%, to $45.9 million in 2010, from $44.3 million in 2009, primarily due to a $1.5 million loss on the sale of mortgage servicing rights recorded during fourth quarter 2010. Income Tax Expense Our effective federal tax rate was 28.1% for the year ended December 31, 2011, 26.8% for the year ended December 31, 2010 and 29.1% for the year ended December 31, 2009. State income tax applies primarily to pretax earnings generated within Montana and South Dakota. Our effective state tax rate was 4.6% for the year ended December 31, 2011 and 2010 and 4.2% for the year ended December 31, 2009. Changes in effective federal and state income tax rates are primarily due to fluctuations in tax exempt interest income on loan and investment securities as a percentage of total income. Net Income Available to Common Shareholders Net income available to common shareholders was $41.1 million, or $0.96 per diluted share, in 2011, as compared to $33.9 million, or $0.85 per diluted share, in 2010 and $50.4 million, or $1.59 per diluted share, in 2009. 41 Table of Contents Summary of Quarterly Results The following table presents unaudited quarterly results of operations for the fiscal years ended December 31, 2011 and 2010. Quarterly Results (Dollars in thousands except per share data) Year Ended December 31, 2011: Interest income Interest expense Net interest income Provision for loan losses Net interest income after provision for loan losses Non-interest income Non-interest expense Income before income taxes Income tax expense Net income Preferred stock dividends Net income available to common shareholders Basic earnings per common share Diluted earnings per common share Dividends paid per common share Year Ended December 31, 2010: Interest income Interest expense Net interest income Provision for loan losses Net interest income after provision for loan losses Non-interest income Non-interest expense Income before income taxes Income tax expense Net income Preferred stock dividends Net income available to common shareholders Basic earnings per common share Diluted earnings per common share Dividends paid per common share First Quarter Second Quarter Third Quarter Fourth Quarter Full Year $ $ $ $ $ $ 73,843 $ 12,045 61,798 15,000 46,798 20,159 52,958 13,999 4,493 9,506 844 8,662 $ 0.20 $ 0.20 0.1125 79,499 $ 17,830 61,669 11,900 49,769 19,508 52,745 16,532 5,402 11,130 844 10,286 $ 0.33 $ 0.32 0.1125 42 73,551 $ 11,024 62,527 15,400 47,127 21,591 54,192 14,526 4,672 9,854 853 9,001 $ 0.21 $ 0.21 0.1125 79,867 $ 16,691 63,176 19,500 43,676 21,037 55,426 9,287 2,628 6,659 853 5,806 $ 0.14 $ 0.14 0.1125 73,483 $ 9,991 63,492 14,000 49,492 23,125 55,041 17,576 5,655 11,921 862 11,059 $ 0.26 $ 0.26 0.1125 78,965 $ 15,221 63,744 18,000 45,744 24,855 58,010 12,589 3,860 8,729 862 7,867 $ 0.18 $ 0.18 0.1125 72,006 $ 8,971 63,035 13,751 49,284 26,997 56,221 20,060 6,795 13,265 863 12,402 $ 0.29 $ 0.29 0.1125 76,215 $ 13,365 62,850 17,500 45,350 25,511 54,823 16,038 5,200 10,838 863 9,975 $ 0.23 $ 0.23 0.1125 292,883 42,031 250,852 58,151 192,701 91,872 218,412 66,161 21,615 44,546 3,422 41,124 0.96 0.96 0.4500 314,546 63,107 251,439 66,900 184,539 90,911 221,004 54,446 17,090 37,356 3,422 33,934 0.85 0.85 0.4500 Table of Contents Financial Condition Total assets decreased $175 million, or 2.3%, to $7,326 million as of December 31, 2011, from $7,501 million as of December 31, 2010, due to lower outstanding funding sources, including deposits and repurchase agreements. Total assets increased $363 million, or 5.1%, to $7,501 million as of December 31, 2010, from $7,138 million as of December 31, 2009, due to organic growth and IPO proceeds of $119 million, net of IPO costs and after the repayment of our variable rate term notes. 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 authority in approving and pricing loans to assure that the banking offices are responsive to competitive issues and community needs in each market area. For additional information regarding our underwriting standards and loan approval policies, see "Community Banking—Lending Activities", included in Part I, Item I of this report. Total loans decreased $181 million, or 4.2%, to $4,187 million as of December 31, 2011, from $4,368 million as of December 31, 2010 and decreased $160 million, or 3.5% to $4,368 million as of December 31, 2010 from $4,528 million as of December 31, 2009, primarily due to weak loan demand in our market areas, the result of economic uncertainty, and to the movement of lower quality loans out of the loan portfolio through charge-off, pay-off or foreclosure. The following table presents the composition of our loan portfolio as of the dates indicated: Loans Outstanding (Dollars in thousands) Loans Real estate: Commercial Construction Residential Agricultural Consumer Commercial Agricultural Other loans $ Mortgage loans held for sale Total loans Less allowance for loan losses Net loans $ 2011 Percent 2010 Percent 2009 Percent 2008 Percent 2007 Percent As of December 31, 1,553,155 400,773 571,943 175,302 616,071 693,261 119,710 2,813 53,521 4,186,549 112,581 4,073,968 37.1 % $ 9.6 13.7 4.2 14.7 16.6 2.8 — 1.3 100.0 % $ 1,565,665 527,458 549,604 182,794 646,580 730,471 116,546 2,383 46,408 4,367,909 120,480 4,247,429 35.8 % $ 12.1 12.6 4.2 14.8 16.7 2.7 0.1 1.0 100.0 % $ 1,556,273 636,892 539,098 195,045 677,548 750,647 134,470 1,601 36,430 4,528,004 103,030 4,424,974 34.4 % $ 14.1 11.9 4.3 14.9 16.6 3.0 — 0.8 100.0 % $ 1,483,967 790,177 587,464 191,831 669,731 853,798 145,876 2,893 47,076 4,772,813 87,316 4,685,497 31.1 % $ 16.5 12.3 4.0 14.0 17.9 3.1 0.1 1.0 100.0 % $ 1,018,831 664,272 419,001 142,256 608,002 593,669 81,890 4,979 26,080 3,558,980 52,355 3,506,625 28.6 % 18.7 11.8 4.0 17.1 16.7 2.3 0.1 0.7 100.0 % Ratio of allowance to total loans 2.69 % 2.76 % 2.28 % 1.83 % 1.47 % 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. Commercial real estate loans. Commercial real estate loans include loans for property and improvements used commercially by the borrower or for lease to others for the production of goods or services. Approximately 57% and 55% of our commercial real estate loans as of December 31, 2011 and 2010, respectively, were owner occupied. Commercial real estate loans decreased less than 1.0% to $1,553 million as of December 31, 2011, from $1,566 million as of December 31, 2010. Commercial real estate loans increased less than 1.0% to $1,566 million as of December 31, 2010, from $1,556 million as of December 31, 2009. 43 Table of Contents Construction loans. Construction loans are primarily to commercial builders for residential lot development and the construction of single-family residences and commercial real estate properties. Construction loans are generally underwritten pursuant to pre-approved permanent financing. During the construction phase the borrower pays interest only. As of December 31, 2011, our construction loan portfolio was divided among the following categories: approximately $61 million, or 15.3%, residential construction; approximately $61 million, or 15.2%, commercial construction; and, approximately $279 million, or 69.5%, land acquisition and development. As of December 31, 2010, our construction loan portfolio was divided among the following categories: approximately $99 million, or 18.8%, residential construction; approximately $98 million, or 18.7%, commercial construction; and, approximately $330 million, or 62.5%, land acquisition and development. Construction loans decreased $127 million, or 24.0%, to $401 million as of December 31, 2011, from $527 million as of December 31, 2010. Construction loans decreased $109 million, or 17.2%, to $527 million as of December 31, 2010, from $637 million as of December 31, 2009. Management attributes these decreases to the continuing impact of general declines in new home construction in our market areas, particularly in markets dependent upon resort and second home communities, and, to a lesser extent, the movement of lower quality loans out of our loan portfolio through charge-off, pay-off or foreclosure. Management expects construction loans to continue to decline in future quarters as existing non-performing construction loans continue to work through the credit cycle. Construction activity in our market areas remains soft, as reflected by decreases in housing permits and new housing starts. Housing permits in Montana, Wyoming and South Dakota showed a combined decrease of 3.2% during the eleven months ended November 30, 2011, as compared to the same period in 2010. Additionally, privately-owned, 1-unit housing starts in Montana, Wyoming and South Dakota showed a combined 7.3% decrease during the eleven months ended November 30, 2011, as compared to the same period in 2010. Residential real estate loans. Residential real estate loans increased $22 million, or 4.1%, to $572 million as of December 31, 2011, from $550 million as of December 31, 2010, and increased $11 million, or 1.9%, to $550 million as of December 31, 2010, from $539 million as of December 31, 2009. Record low mortgage interest rates resulted in increased residential real estate loan production during 2011. In addition, we typically sell a significant portion of our residential real estate loan production in the secondary market; however, during 2010 we began to retain more of our residential real estate loans. Retained residential real estate loans are typically secured by first liens on the financed property and generally mature in less than fifteen 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 the consumer product dealer network within the market areas we serve. Personal loans and indirect dealer loans are generally secured by automobiles, recreational vehicles, boats and other types of personal property and are made on an installment basis. Credit cards are offered to customers in our market areas. Lines of credit are generally floating rate loans that are unsecured or secured by personal property. Approximately 66.2% and 65.5% of our consumer loans as of December 31, 2011 and 2010, respectively, were indirect dealer loans. Consumer loans decreased $30 million, or 4.7%, to $616 million as of December 31, 2011, from $647 million as of December 31, 2010. Approximately 52% of this decrease occurred in indirect dealer loans and was the result of competitive rate pressure. Management attributes the remaining decrease to changes in consumer behavior resulting from continuing economic uncertainty. Consumer loans decreased $31 million, or 4.6%, to $647 million as of December 31, 2010, from $678 million as of December 31, 2009, primarily due to the third quarter 2010 sale of student loans of $25 million. 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, business credit cards 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. Commercial loans decreased $37 million, or 5.1%, to $693 million as of December 31, 2011, from $730 million as of December 31, 2010, and decreased $20 million, or 2.7%, to $730 million as of December 31, 2010, from $751 million as of December 31, 2009. Management attributes these decreases to the continuing effects of economic uncertainty on borrowers in our market areas and the movement of lower quality loans out of our loan portfolio through charge-off, pay-off or foreclosure. 44 Table of Contents 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. Agricultural loans increased $3 million, or 2.7%, to $120 million as of December 31, 2011, from $117 million as of December 31, 2010 and decreased $17 million, or 13.3%, to $117 million as of December 31, 2010, from $134 million as of December 31, 2009. 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, 2011: Maturities and Interest Rate Sensitivities (Dollars in thousands) Real estate Consumer Commercial Agricultural Other Mortgage loans held for sale Total loans Loans at fixed interest rates Loans at variable interest rates Non-accrual loans Total loans Non-Performing Assets Within One Year One Year to Five Years After Five Years Total $ $ $ $ 1,032,121 $ 282,304 416,647 97,431 — 53,521 1,882,024 $ 1,127,598 $ 754,426 — 1,882,024 $ 1,061,514 $ 314,810 213,325 20,955 — 1,610,604 $ 1,083,676 $ 526,928 — 1,610,604 $ 607,538 $ 18,957 63,289 1,324 2,813 693,921 $ 102,828 $ 391,110 199,983 693,921 $ 2,701,173 616,071 693,261 119,710 2,813 53,521 4,186,549 2,314,102 1,672,464 199,983 4,186,549 Non-performing assets include non-performing loans and OREO. The following table sets forth information regarding non-performing assets as of the dates indicated: Non-Performing Assets (Dollars in thousands) As of December 31, Non-performing loans: Nonaccrual loans Accruing loans past due 90 days or more Troubled debt restructurings Total non-performing loans OREO Total non-performing assets Non-performing loans to total loans Non-performing assets to total loans and OREO Non-performing assets to total assets 2011 2010 2009 2008 2007 $ $ 199,983 $ 4,111 37,376 241,470 37,452 278,922 $ 5.77 % 6.60 3.81 195,342 $ 1,852 13,490 210,684 33,632 244,316 $ 4.82 % 5.55 3.26 115,030 $ 4,965 4,683 124,678 38,400 163,078 $ 2.75 % 3.57 2.28 85,632 $ 3,828 1,462 90,922 6,025 96,947 $ 1.90 % 2.03 1.46 31,552 2,171 1,027 34,750 928 35,678 0.98 % 1.00 0.68 Total non-performing assets peaked at $292 million during second quarter 2011, and ended the year at $279 million, an increase of $35 million, or 14.2%, from $244 million as of December 31, 2010. Non- performing assets increased $81 million, or 49.8%, to $244 million as of December 31, 2010, from $163 million as of December 31, 2009. Difficult economic conditions negatively impacted businesses and consumers in our market areas, especially in the Flathead, Gallatin Valley and Jackson market areas, which have economies dependent upon resort and second home communities. Residential and second home subdivisions in these market areas were overbuilt and these markets are now experiencing severely depressed real estate values and limited sales activity, which has negatively impacted commercial real estate values as well. The Flathead, Gallatin Valley and Jackson market areas accounted for approximately 43% of our non-performing assets as of December 31, 2011 and 18% of our total loans as of the same date. 45 Table of Contents Non-performing loans. Non-performing loans include non-accrual loans, loans contractually past due 90 days or more and still accruing interest and loans renegotiated in troubled debt restructurings. Impaired loans are a subset of non-performing loans and include all loans risk rated doubtful, loans placed on non-accrual status and loans renegotiated in troubled debt restructurings with the exception of consumer loans. We monitor and evaluate collateral values on impaired loans quarterly. Appraisals are required on all impaired loans every 18-24 months, or sooner as conditions necessitate. We monitor real estate values by market for our larger market areas. Based on trends in real estate values, adjustments may be made to the appraised value based on time elapsed between the appraisal date and the impairment analysis or a new appraisal may be ordered. Appraised values in our smaller market areas may be adjusted based on trends identified through discussions with local realtors and appraisers. Appraisals are also adjusted for selling costs. The adjusted appraised value is then compared to the loan balance and any resulting shortfall is recorded in the allowance for loan losses as a specific valuation allowance. Overall increases in specific valuation allowances will result in higher provisions for loan losses. Provisions for loan losses are also impacted by changes in the historical or general valuation elements of the allowance for loan losses as well. The following table sets forth the allocation of our non-performing loans among our different types of loans as of the dates indicated. Non-Performing Loans by Loan Type (Dollars in thousands) As of December 31, Real estate Consumer Commercial Agricultural Other Total non-performing loans 2011 2010 2009 2008 2007 $ $ 216,289 $ 3,455 20,857 869 — 241,470 $ 169,961 $ 2,720 36,906 1,093 4 210,684 $ 101,751 $ 2,265 19,774 888 — 124,678 $ 79,167 $ 2,944 8,594 217 — 90,922 $ 27,513 1,202 5,722 313 — 34,750 As of December 31, 2011, our non-performing real estate loans were divided among the following categories: $63 million, or 29.2%, land and land development; $87 million, or 40.2%, commercial; $14 million, or 6.5% residential construction; $20 million, or 9.3%, residential; $25 million, or 11.3% commercial construction; and, $7 million, or 3.5%, agricultural. As of December 31, 2010, our non-performing real estate loans were divided among the following categories: $45 million, or 29.1%, land and land development; $73 million, or 43.2%, commercial; $17 million, or 9.8% residential construction; $16 million, or 9.5%, residential; $17 million, or 9.8% commercial construction; and, $2 million, or 1.5%, agricultural. Total non-performing loans increased $31 million, or 14.6%, to $241 million as of December 31, 2011, from $211 million as of December 31, 2010, and $86 million, or 69.0%, to $211 million as of December 31, 2010, from $125 million as of December 31, 2009. Significant components of these increases are discussed below. Non-accrual loans. We generally place loans on non-accrual when they become 90 days past due, unless they are well secured and in the process of collection. When a loan is placed on non-accrual status, any interest previously accrued but not collected is reversed from income. Approximately $12.4 million, $8.9 million and $6.4 million of gross interest income would have been accrued if all loans on non-accrual had been current in accordance with their original terms for the years ended December 31, 2011, 2010 and 2009, respectively. Non-accrual loans increased $5 million, or 2.4%, to $200 million at December 31, 2011, from $195 million at December 31, 2010. As of December 31, 2011, approximately 39% of our non-accrual loans were to borrowers in the Flathead, Gallatin Valley and Jackson market areas and were comprised primarily of commercial real estate and construction loans. Non-accrual loans increased $80 million, or 69.8%, to $195 million at December 31, 2010, from $115 million at December 31, 2009. Approximately 82% of the increase in non-accrual loans were loans to borrowers in the Flathead, Gallatin Valley and Jackson market areas and were comprised primarily of commercial real estate and construction loans. 46 Table of Contents Troubled Debt Restructuring. Modifications of performing loans are made in the ordinary course of business and are completed on a case-by-case basis as negotiated with the borrower. Loan modifications typically include interest rate concessions, interest-only periods, short-term payment deferrals and extension of amortization periods to provide payment relief. A loan modification is considered a troubled debt restructuring if the borrower is experiencing financial difficulties and we, for economic or legal reasons, grant a concession to the borrower that we would not otherwise consider. Those modifications deemed to be troubled debt restructurings are monitored centrally to ensure proper classification as a troubled debt restructuring and if or when the loan may be placed on accrual status or removed from impaired loan status. Troubled debt restructuring loans increased to $37 million as of December 31, 2011, from $13 million as of December 31, 2010. Approximately 45% of our restructured loans as of December 31, 2011, were located in the Flathead, Gallatin Valley and Jackson market areas. As of December 31, 2011, approximately 72% of our restructured loans were performing in accordance with their modified terms. Troubled debt restructurings in the preceding non-performing assets table includes $389 thousand of accruing loans past due 90 days or more as of December 31, 2011. All other non-performing restructured loans are included in non-accrual loans in the preceding non-performing assets and non-performing loan tables. Troubled debt restructuring loans increased to $13 million as of December 31, 2010, from $5 million as of December 31, 2009, primarily due to the loans of one commercial and five commercial real estate borrowers. Approximately 34% of our restructured loans as of December 31, 2010 were located in the Flathead, Gallatin Valley and Jackson market areas. OREO. OREO consists of real property acquired through foreclosure on the collateral underlying defaulted loans. We initially record OREO at fair value less estimated costs to sell by a charge against the allowance for loan losses. Estimated losses that result from the ongoing periodic valuation of these properties are charged to earnings in the period in which they are identified. The fair values of OREO properties are estimated using appraisals and management estimates of current market conditions. OREO properties are appraised every 18-24 months unless deterioration in local market conditions indicates the need to obtain new appraisals sooner. OREO properties are evaluated by management quarterly to determine if additional write-downs are appropriate or necessary based on current market conditions. Quarterly evaluations include a review of the most recent appraisal of the property and reviews of recent appraisals and comparable sales data for similar properties in the same or adjacent market areas. Commercial and agricultural OREO properties are listed with unrelated third party professional real estate agents or brokers local to the areas where the marketed properties are located. Residential properties are typically listed with local realtors, after any redemption period has expired. We rely on these local real estate agents and/or brokers to list the properties on the local multiple listing system, to provide marketing materials and advertisements for the properties and to conduct open houses. OREO increased $4 million, or 11.4%, to $37 million as of December 31, 2011 from $34 million as of December 31, 2010. During 2011, the Company recorded additions to OREO of $27 million, wrote down the fair value of OREO properties by $7 million and sold OREO with a book value of $16 million. As of December 31, 2011, approximately 67% of our OREO properties were located in the Flathead, Gallatin Valley and Jackson market areas. OREO decreased $5 million, or 12.4%, to $34 million as of December 31, 2010 from $38 million as of December 31, 2009. During 2010, the Company recorded additions to OREO of $22 million, wrote down the fair value of OREO properties by $7 million and sold OREO with a book value of $20 million. Allowance for Loan Losses The Company performs a quarterly assessment of the adequacy of its allowance for loan losses in accordance with generally accepted accounting principles. The methodology used to assess the adequacy is consistently applied to the Company's loan portfolio. The allowance for loan losses is established through a provision for loan losses based on our evaluation of known and inherent risk in our loan portfolio at each balance sheet date. 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. See the discussion under “Critical Accounting Estimates and Significant Accounting Policies — Allowance for Loan Losses” above. The allowance for loan losses is increased by provisions charged against earnings and reduced by net loan charge-offs. Loans, or portions thereof, are charged-off when management believes that the collectibility of the principal is unlikely or, with respect to consumer installment and credit card loans, according to established delinquency schedules. 47 Table of Contents The allowance for loan losses consists of three elements: (1) Specific valuation allowances associated with impaired loans. Specific valuation allowances are determined based on assessment of the fair value of the collateral underlying the loans as determined through independent appraisals, the present value of future cash flows, observable market prices and any relevant qualitative or environmental factors impacting the loan. No specific valuation allowances are recorded for impaired loans that are adequately secured. (2) Historical valuation allowances based on loan loss experience for similar loans with similar characteristics and trends. Historical valuation allowances are determined by applying percentage loss factors to the credit exposures from outstanding loans. For commercial, agricultural and real estate loans, loss factors are applied based on the internal risk classifications of these loans. For consumer loans, loss factors are applied on a portfolio basis. For commercial, agriculture and real estate loans, loss factor percentages are based on a migration analysis of our historical loss experience, designed to account for credit deterioration. For consumer loans, loss factor percentages are based on a one-year loss history. (3) General valuation allowances determined based on changes in the nature of the loan portfolio, overall portfolio quality, industry concentrations, delinquency trends, general economic conditions and other qualitative risk factors both internal and external to us. Based on the assessment of the adequacy of the allowance for loan losses, management records provisions for loan losses to maintain the allowance for loan losses at appropriate levels. Loans, or portions thereof, are charged-off against the allowance for loan losses when management believes that the collectability of the principal is unlikely, or, with respect to consumer installment loans, according to an established delinquency schedule. Generally, loans are charged-off when (1) there has been no material principal reduction within the previous 90 days and there is no pending sale of collateral or other assets, (2) there is no significant or pending event which will result in principal reduction within the upcoming 90 days, (3) it is clear that we will not be able to collect all or a portion of the loan, (4) payments on the loan are sporadic, will result in an excessive amortization or are not consistent with the collateral held and (5) foreclosure or repossession actions are pending. Loan charge-offs do not directly correspond with the receipt of independent appraisals or the use of observable market data if the collateral value is determined to be sufficient to repay the principal balance of the loan. If the impaired loan is adequately collateralized, a specific valuation allowance is not recorded. As such, significant changes in impaired and non-performing loans do not necessarily correspond proportionally with changes in the specific valuation component of the allowance for loan losses. Additionally, management expects the timing of charge-offs will vary between quarters and will not necessarily correspond proportionally to changes in the allowance for loan losses or changes in non-performing or impaired loans due to timing differences among the initial identification of an impaired loan, recording of a specific valuation allowance for the impaired loan and any resulting charge-off of uncollectible principal. Based on declines in national, regional and local economies which began in 2008, we began to record additional general valuation allowances based on management's estimation of the probable impact that the declines would have on our loan portfolio. Accordingly, beginning in 2008, and continuing in 2009 and 2010, we recorded significantly higher provisions for loan losses to maintain the allowance for loan losses at appropriate levels. During 2008, 2009 and 2010, we experienced higher levels of impaired and non-performing loans as anticipated. Impaired and non-performing loans peaked in mid-2011 and our provision for loan losses decreased slightly during the last half of 2011. Management expects that non-performing and impaired loans will continue to decline as they make their way through the credit cycle and we have a decrease in the volume of newly identified non-performing and impaired loans as the economy improves. 48 Table of Contents The following table sets forth information concerning our allowance for loan losses as of the dates and for the periods indicated. Allowance for Loan Losses (Dollars in thousands) As of and for the year ended December 31, Balance at the beginning of period Allowance of acquired banking offices Charge-offs: Real estate Commercial Construction Residential Agricultural Consumer Commercial Agricultural Total charge-offs Recoveries: Real estate Commercial Construction Residential Consumer Commercial Agricultural Total recoveries Net charge-offs Provision for loan losses Balance at end of period Period end loans Average loans Net charge-offs to average loans Allowance to period-end loans 2011 2010 2009 2008 2007 $ 120,480 $ — 103,030 $ — 87,316 $ — 52,355 $ 14,463 13,227 26,125 6,199 213 6,043 19,332 142 71,281 293 1,641 201 1,739 1,344 13 5,231 66,050 58,151 112,581 $ 4,186,549 $ 4,275,128 1.54 % 2.69 % 8,980 19,989 3,511 2,238 7,577 10,023 21 52,339 34 213 132 2,053 436 21 2,889 49,450 66,900 120,480 $ 4,367,909 $ 4,482,219 1.10 % 2.76 % 5,156 14,153 1,086 11 8,134 3,346 92 31,978 108 7 38 1,850 328 61 2,392 29,586 45,300 103,030 $ 4,528,004 $ 4,660,189 0.63 % 2.28 % 995 3,035 325 642 5,527 3,523 648 14,695 88 1 67 1,404 211 66 1,837 12,858 33,356 87,316 $ 4,772,813 $ 4,527,987 0.28 % 1.83 % $ $ 47,452 — 382 — 134 155 3,778 643 116 5,208 52 1 34 1,390 854 30 2,361 2,847 7,750 52,355 3,558,980 3,449,809 0.08 % 1.47 % The allowance for loan losses was $113 million, or 2.69% of period-end loans, at December 31, 2011, compared to $120 million, or 2.76% of period-end loans, at December 31, 2010, and $103 million, or 2.28% of period-end loans, at December 31, 2009. Decreases in the allowance for loan losses as a percentage of total loans as of December 31, 2011, as compared to December 31, 2010, were primarily due to decreases in specific reserves on impaired loans. Increases in the allowance for loan losses as a percentage of total loans as of December 31, 2010, as compared to prior periods, were primarily attributable to additional reserves recorded based on the estimated effects of current economic conditions on our loan portfolio and increases in past due, non-performing and internally risk classified loans. Net charge-offs in 2011 increased $17 million to $66 million, or 1.54% of average loans, from $49 million, or 1.10% of average loans in 2010. Approximately 46% of loans charged-off during 2011 were related to the loans of one consumer real estate, two land development and three commercial borrowers. Net charge-offs in 2010 increased $20 million to $49 million, or 1.10% of average loans, from $30 million, or 0.63% of average loans in 2009. Approximately 66.8% of loans charged-off during 2010 were located in the Flathead, Gallatin Valley and Jackson markets areas. Additionally, approximately 37.5% of loans charged-off during 2010 were related to nine borrowers, consisting of one commercial, one agricultural, four construction and three commercial real estate borrowers. 49 Table of Contents Although we believe that we have established our allowance for loan losses in accordance with accounting principles generally accepted in the United States and that the allowance for loan losses was adequate to provide for known and inherent losses in the portfolio at all times during the five-year period ended December 31, 2011, future provisions will be subject to on-going evaluations of the risks in the loan portfolio. If the economy declines or asset quality deteriorates, material additional provisions could be required. The allowance for loan losses is allocated to loan categories based on the relative risk characteristics, asset classifications and actual loss experience of the loan portfolio. The following table provides a summary of the allocation of the allowance for loan losses for specific loan categories as of the dates indicated. The allocations presented should not be interpreted as an indication that charges to the allowance for loan losses will be incurred in these amounts or proportions, or that the portion of the allowance allocated to each loan category represents the total amount available for future losses that may occur within these categories. The unallocated portion of the allowance for loan losses and the total allowance are applicable to the entire loan portfolio. Allocation of the Allowance for Loan Losses (Dollars in thousands) As of December 31, 2011 Real estate Consumer Commercial Agricultural Other loans Mortgage loans held for sale Unallocated Totals $ $ Allocated Reserves 87,396 8,594 15,325 1,266 — — — 112,581 2010 2009 2008 2007 % of Loan Category to Total Loans 64.6 % $ 14.7 16.6 2.8 — 1.3 N/A 100.0 % $ Allocated Reserves 84,181 9,332 25,354 1,613 — — — 120,480 % of Loan Category to Total Loans 64.7 % $ 14.8 16.7 2.7 0.1 1.0 N/A 100.0 % $ Allocated Reserves 76,357 6,220 18,608 1,845 — — — 103,030 % of Loan Category to Total Loans 64.7 % $ 14.9 16.6 3.0 — 0.8 N/A 100.0 % $ Allocated Reserves 69,280 5,092 11,021 1,923 — — — 87,316 % of Loan Category to Total Loans 63.9 % $ 14.0 17.9 3.1 0.1 1.0 N/A 100.0 % $ Allocated Reserves 39,420 4,838 7,170 779 — — 148 52,355 % of Loan Category to Total Loans 63.1 % 17.1 16.7 2.3 0.1 0.7 N/A 100.0 % The allowance for loan losses allocated to commercial loans decreased 39.6% to $15 million as of December 31, 2011, from $25 million as of December 31, 2010, primarily due to the charge-off of non- performing loans. The allowance for loan losses allocated to commercial loans increased 36.3% to $25 million as of December 31, 2010, from $19 million as of December 31, 2009, primarily due to the application of historical loss factors to higher levels of internally risk classified commercial loans and the effect of increases in net charge-offs on our historical loss factors. 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. As of December 31, 2011, our portfolio was principally comprised of U.S. government agency mortgage-backed securities and collateralized mortgage obligations, U.S. government agency securities and tax exempt securities. Federal funds sold and interest bearing deposits in bank 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 $236 million, or 12.2%, to $2,170 million as of December 31, 2011, from $1,933 million as of December 31, 2010 and increased $487 million, or 33.7%, to $1,933 million as of December 31, 2010, from $1,446 million as of December 31, 2009. During 2011 and 2010, excess liquidity was primarily invested into available-for-sale U.S. government agency securities. The estimated duration of the Company’s investment securities portfolio was 2.1 years as of December 31, 2011 and 2.5 years as of December 31, 2010. The weighted average yield on investment securities decreased 57 basis points to 2.41% in 2011, from 2.98% in 2010, and 139 basis points to 2.98% in 2010, from 4.37% in 2009. 50 Table of Contents As of December 31, 2011, investment securities with amortized costs and fair values of $1,280 million and $1,311 million, respectively, were pledged to secure public deposits and securities sold under repurchase agreements, as compared to $1,607 million and $1,625 million, respectively, as of December 31, 2010. 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 weighted average yields on investment securities as of December 31, 2011. Weighted-average yields have been computed on a fully taxable-equivalent basis using a tax rate of 35%. Securities Maturities and Yield (Dollars in thousands) U.S. Government agency securities Maturing within one year Maturing in one to five years Maturing in five to ten years Mark-to-market adjustments on securities available-for-sale Total Mortgage-backed securities Maturing within one year Maturing in one to five years Maturing in five to ten years Maturing after ten years Mark-to-market adjustments on securities available-for-sale Total Tax exempt securities Maturing within one year Maturing in one to five years Maturing in five to ten years Maturing after ten years Mark-to-market adjustments on securities available-for-sale Total Other securities (1) No stated maturity Mark-to-market adjustments on securities available-for-sale Total Total Book Value % of Total Investment Securities Weighted Average FTE Yield $ $ 131,038 1,003,389 — 3,691 1,138,118 275,352 353,543 108,529 111,778 29,544 878,746 5,892 23,505 59,870 63,352 NA 152,619 162 NA 162 2,169,645 6.04% 46.25 — 0.17 52.46 12.69 16.29 5.00 5.15 1.36 40.50 0.27 1.08 2.76 2.92 NA 7.03 0.01 NA 0.01 100.00% 1.40% 0.85 — NA 0.92 3.43 3.12 2.51 2.74 NA 2.99 5.56 5.78 5.78 5.49 NA 5.65 NA NA NA 2.09% (1) Equity investments in community development entities. Investment income is in the form of credits that reduce income tax expense. Maturities of U.S. government agency securities noted above reflect $697 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 have been adjusted to reflect shorter maturities based upon estimated prepayments of principal. As of December 31, 51 Table of Contents 2011, the carrying value of our investments in non-agency mortgage-backed securities totaled $749 thousand. All other mortgage-backed securities included in the table above were issued by U.S. government agencies and corporations. As of December 31, 2011, there were no significant concentrations of investments (greater than 10% of stockholders’ equity) in any individual security issuer, except for U.S. government or agency-backed securities. As of December 31, 2011, approximately 74% of our tax-exempt securities were general obligation securities, of which 59% were issued by political subdivisions or agencies within the states of Montana, Wyoming and South Dakota. As of December 31, 2010, we had U.S. government agency securities with carrying values of $953 million and a weighted average yield of 0.77%; mortgage-backed securities with carrying values of $833 million and a weighted average yield of 3.52%; tax exempt securities with carrying values of $147 million and a weighted average yield of 5.78%; and other securities with carrying values of $218 thousand with no weighted average yield. As of December 31, 2009, we had U.S. government agency securities with carrying values of $571 million and a weighted average yield of 2.59%; mortgage-backed securities with carrying values of $745 million and a weighted average yield of 4.59%; tax exempt securities with carrying values of $129 million and a weighted average yield of 6.10%; and other securities with carrying values of $470 thousand and a weighted average yield of 3.93%. 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, 2011, we had investment securities with fair values of $950 thousand that had been in a continuous loss position more than twelve months. Gross unrealized losses on these securities totaled $23 as of December 31, 2011, and were primarily attributable to changes in interest rates. No impairment losses were recorded during 2011, 2010 or 2009. For additional information concerning investment securities, see “Notes to Consolidated Financial Statements — Investment Securities” included in Part IV, Item 15. Cash and Cash Equivalents Cash and cash equivalents include cash on hand, amounts due from banks, federal funds sold for one day periods and interest bearing deposits in banks with original maturities of less than three months. Cash and cash equivalents decreased $213 million, or 31.1%, to $472 million as of December 31, 2011, from $686 million as of December 31, 2010. During 2011, excess liquidity was redeployed to purchase investment securities, which provide higher yields. Cash and cash equivalents increased $62 million, or 10.0%, to $686 million as of December 31, 2010, from $623 million as of December 31, 2009, largely due to increasing liquidity from continued weak loan demand. IPO proceeds of $119 million, net of IPO costs and after the repayment of our variable rate term notes, were included in interest bearing deposits in banks as of December 31, 2010. Increases in interest bearing deposits in banks due to IPO proceeds were offset by decreases in cash on hand and federal funds sold, as excess liquidity was invested in higher yielding investment securities. Mortgage Servicing Rights Mortgage servicing rights decreased $2 million, or 12.4%, to $12 million as of December 31, 2011, from $13 million as of December 31, 2010, primarily due to higher valuation reserves. Valuation reserves were $2 million as of December 31, 2011, as compared to $620 thousand as of December 31, 2010. Mortgage servicing rights decreased $4 million, or 23.9%, to $13 million as of December 31, 2010, from $17 million as of December 31, 2009. On December 1, 2010, we sold mortgage servicing rights with a book value of $5 million. A loss of $1.5 million on the sale was included in other expenses. In conjunction with the sale, we entered into an agreement with the purchaser whereby we continue to sub-service the loans underlying the sold mortgage servicing rights. The sub-servicing agreement may by terminated by the purchaser upon written notice, subject to termination fees during the first three years of the agreement. Subsequent to the third anniversary of the sub-servicing agreement, either party may terminate the agreement with written notice. 52 Table of Contents Deferred Tax Asset/Liability Our net deferred tax asset decreased $9 million, or 47.9%, to $10 million as of December 31, 2011, from $18 million as of December 31, 2010. This decrease was primarily due to increases in net unrealized gains on available-for-sale investment securities and tax amortization of goodwill and core deposits intangibles. As of December 31, 2010, we had a net deferred tax asset of $18 million, as compared to a net deferred tax liability of $2 million included in accounts payable and other accrued expenses as of December 31, 2009. Changes in net deferred tax asset/liability are primarily related to timing of tax deductions for charged-off loans for book versus tax purposes and, to a lesser extent, fluctuations in net unrealized gains on available-for-sale investment securities, tax amortization of goodwill and core deposit intangibles and the write-down of OREO to fair value. Other Assets Other assets decreased $14 million, or 16.8% to $68 million as of December 31, 2011, from $82 million as of December 31, 2010. Approximately 50% of the decrease was due to reductions in prepaid FDIC insurance assessments. In addition, during second quarter 2011 we sold a condominium unit located inside one of our branch bank buildings, which had a carrying value of $3 million. Other assets decreased $6 million, or 7.1% to $82 million as of December 31, 2010, from $88 million as of December 31, 2009, primarily due to reductions in prepaid FDIC insurance assessments and the January 2010 sale of a condominium unit located inside one of our branch bank buildings. 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 non-interest bearing and interest bearing demand, savings, individual retirement and time deposit accounts. The following table summarizes our deposits as of the dates indicated: Deposits (Dollars in thousands) As of December 31, 2011 Percent 2010 Percent 2009 Percent 2008 Percent 2007 Percent Non-interest bearing demand $ 1,271,709 21.8% $ 1,063,869 18.0% $ 1,026,584 17.6% $ 985,155 19.0% $ 836,753 20.9% Interest bearing: Demand Savings Time, $100 or more Time, other Total interest bearing Total deposits 1,306,509 1,691,413 681,047 876,293 4,555,262 5,826,971 $ 22.4 29.0 11.7 15.1 78.2 100.0% $ 1,218,078 1,718,521 908,044 1,017,201 4,861,844 5,925,713 20.5 29.0 15.3 17.2 82.0 100.0% $ 1,197,254 1,362,410 996,839 1,240,969 4,797,472 5,824,056 20.6 23.4 17.1 21.3 82.4 100.0% $ 1,059,818 1,198,783 821,437 1,109,066 4,189,104 5,174,259 20.5 23.2 15.9 21.4 81.0 100.0% $ 1,019,208 992,571 464,560 686,309 3,162,648 3,999,401 25.5 24.8 11.6 17.2 79.1 100.0% Total deposits decreased $99 million, or 1.7%, to $5,827 million as of December 31, 2011, from $5,926 million as of December 31, 2010. During 2011, the mix of deposits continued to shift from higher- costing time deposits to lower-costing interest bearing and non-interest bearing demand deposits. Total deposits increased $102 million, or 1.7%, to $5,926 million as of December 31, 2010, from $5,824 million as of December 31, 2009, with all categories of deposits demonstrating growth. During 2010, there was a shift in the mix of deposits from higher costing time deposits to lower costing savings deposits. Management attributed organic deposit growth in 2010 to ongoing business development in our market areas and increases in consumer savings. Non-Interest Bearing Demand. Non-interest bearing demand deposits increased $208 million, or 19.5%, to $1,272 million as of December 31, 2011 from $1,064 million as of December 31, 2010. Management attributes this increase to customer liquidity combined with the availability of unlimited deposit insurance coverage on these deposits and the current low interest rates offered on alternative interest earning deposit products. Non-interest bearing demand deposits increased $37 million, or 3.6%, to $1,064 million as of December 31, 2010 from $1,027 million as of December 31, 2009. 53 Table of Contents Time deposits of $100,000 or more. Time deposits of $100,000 or more decreased $227 million, or 25.0%, to $681 million as of December 31, 2011, from $908 million as of December 31, 2010. Time deposits of $100,000 or more decreased 8.9% to $908 million as of December 31, 2010, from $997 million as of December 31, 2009. These decreases occurred primarily in time deposits with maturities of less than 12 months and appear related to the lower interest rate environment experienced over the last three years as many customers have become less inclined to invest their funds for extended periods at such low interest rates. As of December 31, 2011 and 2010, we had no certificates of deposit issued in brokered transactions. The following table presents the maturities of time deposits of $100,000 or more as of December 31, 2011. Maturities of Time Deposits of $100,000 or More (Dollars in thousands) Maturing in 3 months or less Maturing in 3-6 months Maturing in 6-12 months Maturing in over 12 months Total time deposits of $100,000 or more $ $ 169,341 144,517 205,692 161,497 681,047 Other time deposits. Other time deposits decreased $141 million, or 13.9%, to $876 million as of December 31, 2011, from $1,017 million as of December 31, 2010, and decreased 18.0% to $1,017 million as of December 31, 2010, from $1,241 million as of December 31, 2009. Approximately 29% of the decreases in other time deposits as of December 31, 2011, as compared to December 31, 2010 occurred in Certificate of Deposit Account Registry Service, or CDARS, deposits, as compared to 51% of the decrease as of December 31, 2010, as compared to December 31, 2009. For additional information concerning customer deposits, including the use of repurchase agreements, see “Business—Community Banking—Deposit Products,” included in Part I, Item 1 and “Notes to Consolidated Financial Statements—Deposits,” included in Part IV, Item 15 of this report. Federal Funds Purchased and Securities Sold Under Repurchase Agreements In addition to deposits, we use federal funds purchased as a source of funds to meet the daily liquidity needs of our customers, maintain required reserves with the Federal Reserve Bank and fund growth in earning assets. As of December 31, 2011 and 2010, we had no federal funds purchased balances outstanding. Under repurchase agreements with commercial and municipal depositors, customer deposit balances are invested in short-term U.S. government agency securities overnight and are then repurchased the following day. All outstanding repurchase agreements are due in one day. Repurchase agreement balances decreased $104 million, or 16.8%, to $516 million as of December 31, 2011, from $620 million as of December 31, 2010. Repurchase agreement balances increased $146 million, or 30.8%, to $620 million as of December 31, 2010, from $474 million as of December 31, 2009. Fluctuations in repurchase agreement balances correspond with fluctuations in the liquidity of our customers. 54 Table of Contents The following table sets forth certain information regarding federal funds purchased and repurchase agreements as of the dates indicated: Federal Funds Purchased and Securities Sold Under Repurchase Agreements (Dollars in thousands) As of and for the year ended December 31, Federal funds purchased: Balance at period end Average balance Maximum amount outstanding at any month-end Average interest rate: During the year At period end Securities sold under repurchase agreements: Balance at period end Average balance Maximum amount outstanding at any month-end Average interest rate: During the year At period end Other Borrowed Funds 2011 2010 2009 $ $ — $ — — —% — 516,243 $ 500,882 560,515 0.14% 0.19 — $ — — —% — 620,154 $ 480,276 620,154 0.18% 0.14 — 9,323 57,230 0.21% — 474,141 422,713 474,141 0.18% 0.38 Other borrowed funds decreased $5 million or 99.9% to $7 thousand as of December 31, 2011, from $5 million as of December 31, 2010, and decreased $432 thousand, or 8.0% to $5 million as of December 31, 2010, from $5 million as of December 31, 2009, primarily due to scheduled repayments and maturities of short-term borrowings from the FHLB. For additional information on other borrowed funds, see “Notes to Consolidated Financial Statements—Long-Term Debt and Other Borrowed Funds,” included in Part IV, Item 15 of this report. Long-Term Debt Long-term debt decreased $302 thousand, or less than 1.0%, to $37 million as of December 31, 2011, from $38 million as of December 31, 2010 due to scheduled debt repayments. Long-term debt decreased $36 million, or 48.9%, to $38 million as of December 31, 2010, from $73 million as of December 31, 2009 primarily due to the early repayment of the term notes under our syndicated credit agreement on March 29, 2010. A loss of $306 thousand on the early extinguishment of the debt, comprised of unamortized debt issuance costs, was included in other expenses in the Company’s consolidated statement of income. For additional information regarding long-term debt, see “Notes to Consolidated Financial Statements—Long- Term Debt and Other Borrowed Funds,” included in Part IV, Item 15 of this report. Subordinated Debentures Held by Subsidiary Trusts Subordinated debentures held by subsidiary trusts were $124 million as of December 31, 2011 and 2010. For additional information regarding the Subordinated Debentures, see “Notes to Consolidated Financial Statements—Subordinated Debentures Held by Subsidiary Trusts,” included in Part IV, Item 15 of this report. Accounts Payable and Accrued Expenses Accounts payable and accrued expenses increased $3 million, or 8.6% to $42 million as of December 31, 2011, from $39 million as of December 31, 2010. Accounts payable and accrued expenses decreased $6 million, or 13.4% to $39 million as of December 31, 2010, from $45 million as of December 31, 2009. Fluctuations in accounts payable and accrued expenses are primarily due to the timing and amounts of corporate tax payments. 55 Table of Contents Contractual Obligations Contractual obligations as of December 31, 2011 are summarized in the following table. Contractual Obligations (Dollars in thousands) Deposits without a stated maturity Time deposits Securities sold under repurchase agreements Other borrowed funds (1) Long-term debt obligations (2) Capital lease obligations Operating lease obligations Purchase obligations (3) Subordinated debentures held by subsidiary trusts (4) Total contractual obligations Within One Year One Year to Three Years Payments Due Three Years to Five Years After Five Years Total $ $ 4,269,631 $ 1,152,712 516,243 7 — 40 3,079 5,922 — 5,947,634 $ — $ 293,101 — — 200 93 5,428 — — 298,822 $ — $ 111,438 — — 225 125 2,756 — — 114,544 $ — $ 89 — — 35,000 1,517 4,572 — 123,715 164,893 $ 4,269,631 1,557,340 516,243 7 35,425 1,775 15,835 5,922 123,715 6,525,893 (1) (2) (3) (4) Included in other borrowed funds are tax deposits made by customers pending subsequent withdrawal by the federal government and borrowings with original maturities of less than one year. For additional information concerning other borrowed funds, see “Notes to Consolidated Financial Statements — Long Term Debt and Other Borrowed Funds” included in Part IV, Item 15. Long-term debt obligations consists of various notes payable to FHLB at various rates with maturities through October 31, 2015; a fixed rate subordinated term loan bearing interest of 6.81% and maturing January 9, 2018; and a variable rate subordinated term loan maturing February 28, 2018. For additional information concerning long-term debt, see “Notes to Consolidated Financial Statements — Long Term Debt and Other Borrowed Funds” included in Part IV, Item 15. Purchase obligations relate to obligations under construction contracts to build or renovate banking offices and obligations to purchase investment securities. The subordinated debentures are unsecured, with various interest rates and maturities from March 26, 2033 through April 1, 2038. Interest distributions are payable quarterly; however, we may defer interest payments at any time for a period not exceeding 20 consecutive quarters. For additional information concerning the subordinated debentures, see “Notes to Consolidated Financial Statements — Subordinated Debentures Held by Subsidiary Trusts” included in Part IV, Item 15. We also have obligations under a postretirement healthcare benefit plan. These obligations represent actuarially determined future benefit payments to eligible plan participants. See “Notes to Consolidated Financial Statements — Employee Benefit Plans” included in Part IV, Item 15. Off-Balance Sheet Arrangements We have entered into various arrangements not reflected on the consolidated balance sheet that have or are reasonably likely to have a current or future effect on our financial condition, results of operations or liquidity. These include guarantees, commitments to extend credit and standby letters of credit. We guarantee the distributions and payments for redemption or liquidation of capital trust preferred securities issued by our wholly-owned subsidiary business trusts to the extent of funds held by the trusts. Although the guarantees are not separately recorded, the obligations underlying the guarantees are fully reflected on our consolidated balance sheets as subordinated debentures held by subsidiary trusts. The subordinated debentures currently qualify as tier 1 capital under the Federal Reserve capital adequacy guidelines. For additional information regarding the subordinated debentures, see “Notes to Consolidated Financial Statements — Subordinated Debentures Held by Subsidiary Trusts” included in Part IV, Item 15. 56 Table of Contents We are a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit and standby letters of credit. For additional information regarding our off-balance sheet arrangements, see “Notes to Consolidated Financial Statements — Financial Instruments with Off- Balance Sheet Risk” included in Part IV, Item 15. Capital Resources and Liquidity Management Capital Resources Stockholders’ equity is influenced primarily by earnings, dividends, sales and redemptions of common stock and, to a lesser extent, changes in the unrealized holding gains or losses, net of taxes, on available-for-sale investment securities. Stockholders’ equity increased $34 million, or 4.6%, to $771 million as of December 31, 2011 from $737 million as of December 31, 2010, due primarily to the retention of earnings and increases in net unrealized gains on available-for-sale investment securities. We paid aggregate cash dividends of $19.2 million to common shareholders and $3.4 million to preferred shareholders during 2011. Stockholders’ equity increased $162 million, or 28.3%, to $737 million as of December 31, 2010 from $574 million as of December 31, 2009, primarily due to the completion of our IPO of Class A common stock discussed below. On March 5, 2010, our shareholders approved proposals to recapitalize our existing common stock. The recapitalization included a redesignation of existing common stock as Class B common stock with five votes per share, convertible into Class A common stock on a share for share basis; a four-for-one stock split of the Class B common stock; an increase in the authorized number of Class B common shares from 20,000,000 to 100,000,000; and, the creation of a new class of common stock designated as Class A common stock, with one vote per share, with 100,000,000 shares authorized. On March 29, 2010, we concluded an IPO of 10,000,000 shares of Class A common stock, and an additional 1,500,000 shares of Class A common stock pursuant to the full exercise of the underwriters’ option to purchase Class A common shares in the offering. We received net proceeds of $153 million from the sale of the shares, after deducting underwriting discounts, commissions and other offering expenses of $14 million Pursuant to the FDICIA, the Federal Reserve and FDIC have adopted regulations setting forth a five-tier system for measuring the capital adequacy of the financial institutions they supervise. At December 31, 2011 and 2010, our Bank had capital levels that, in all cases, exceeded the well capitalized guidelines. For additional information concerning our capital levels, see “Notes to Consolidated Financial Statements—Regulatory Capital” contained in Part IV, Item 15 of this report. Liquidity Liquidity measures our ability to meet current and future cash flow needs on a timely basis and at a reasonable cost. We manage our liquidity position to meet the daily cash flow needs of customers, while maintaining an appropriate balance between assets and liabilities to meet the return on investment objectives of our shareholders. Our liquidity position is supported by management of liquid assets and liabilities and access to alternative sources of funds. Liquid assets include cash, interest bearing deposits in banks, federal funds sold, available-for-sale investment securities and maturing or prepaying balances in our held-to-maturity investment and loan portfolios. Liquid liabilities include core deposits, federal funds purchased, securities sold under repurchase agreements and borrowings. Other sources of liquidity include the sale of loans, the ability to acquire additional national market, non-core deposits, the issuance of additional collateralized borrowings such as FHLB advances, the issuance of debt securities, additional borrowings through the Federal Reserve’s discount window and the issuance of preferred or common securities. We do not engage in derivatives or hedging activities to support our liquidity position. Our short-term and long-term liquidity requirements are primarily to fund on-going operations, including payment of interest on deposits and debt, extensions of credit to borrowers, capital expenditures and shareholder dividends. These liquidity requirements are met primarily through cash flow from operations, redeployment of prepaying and maturing balances in our loan and investment portfolios, debt financing and increases in customer deposits. For additional information regarding our operating, investing and financing cash flows, see “Consolidated Financial Statements—Consolidated Statements of Cash Flows,” included in Part IV, Item 15 of this report. 57 Table of Contents As a holding company, we are a corporation separate and apart from our subsidiary Bank and, therefore, we provide for our own liquidity. Our main sources of funding include management fees and dividends declared and paid by our subsidiaries and access to capital markets. There are statutory, regulatory and debt covenant limitations that affect the ability of our Bank to pay dividends to us. Management believes that such limitations will not impact our ability to meet our ongoing short-term cash obligations. For additional information regarding dividend restrictions, see “—Financial Condition—Long-Term Debt” and “—Capital Resources and Liquidity Management” above and “Business—Regulation and Supervision—Restrictions on Transfers of Funds to Us and the Bank” and “Risk Factors—Our Bank’s ability to pay dividends to us is subject to regulatory limitations, which, to the extent we are not able to receive such dividends, may impair our ability to grow, pay dividends, cover operating expenses and meet debt service requirements.” Item 7A. Quantitative and Qualitative Disclosures About Market Risk Our primary market risk exposure is interest rate risk. Our business and the composition of our balance sheet consists of investments in interest earning assets (principally loans and investment securities) which are primarily funded by interest bearing liabilities (deposits and indebtedness). Such financial instruments have varying levels of sensitivity to changes in market interest rates. Interest rate risk results when, due to different maturity dates and repricing intervals, interest rate indices for interest earning assets decrease relative to interest bearing liabilities, thereby creating a risk of decreased net earnings and cash flow. Although we characterize some of our interest-sensitive assets as securities available-for-sale, such securities are not purchased with a view to sell in the near term. Rather, such securities may be sold in response to or in anticipation of changes in interest rates and resulting prepayment risk. See “Notes to Consolidated Financial Statements—Summary of Significant Accounting Policies” included in Part IV, Item 15 of this report. Asset Liability Management The goal of asset liability management is the prudent control of market risk, liquidity and capital. Asset liability management is governed by policies, goals and objectives adopted and reviewed by the Bank’s board of directors. The Board delegates its responsibility for development of asset liability management strategies to achieve these goals and objectives to the Asset Liability Committee, or ALCO, which is comprised of members of senior management. Interest Rate Risk Interest rate risk is the risk of loss of future earnings or long-term value due to changes in interest rates. Our primary source of earnings is the net interest margin, which is affected by changes in interest rates, the relationship between rates on interest bearing assets and liabilities, the impact of interest rate fluctuations on asset prepayments and the mix of interest bearing assets and liabilities. The ability to optimize the net interest margin is largely dependent upon the achievement of an interest rate spread that can be managed during periods of fluctuating interest rates. Interest sensitivity is a measure of the extent to which net interest income will be affected by market interest rates over a period of time. Interest rate sensitivity is related to the difference between amounts of interest earning assets and interest bearing liabilities which either reprice or mature within a given period of time. The difference is known as interest rate sensitivity gap. 58 Table of Contents The following table shows interest rate sensitivity gaps and the earnings sensitivity ratio for different intervals as of December 31, 2011. The information presented in the table is based on our mix of interest earning assets and interest bearing liabilities and historical experience regarding their interest rate sensitivity. Interest Rate Sensitivity Gaps (Dollars in thousands) Interest earning assets: Loans (1) Investment securities (2) Interest bearing deposits in banks Federal funds sold Total interest earning assets Interest bearing liabilities: Interest bearing demand accounts (3) Savings deposits (3) Time deposits, $100 or more Other time deposits Securities sold under repurchase agreements Other borrowed funds Long-term debt Subordinated debentures held by subsidiary trusts Total interest bearing liabilities Rate gap Cumulative rate gap Cumulative rate gap as a percentage of total interest earning assets $ $ $ $ $ Three Months or Less Three Months to One Year One Year to Five Years After Five Years Total Projected Maturity or Repricing 1,559,901 272,551 329,636 309 2,162,397 $ $ $ 97,988 1,412,711 169,341 263,284 516,243 7 15,010 77,322 2,551,906 (389,509) $ (389,509) $ 868,709 546,425 — — 1,415,134 293,965 67,797 350,209 369,879 — — 30 36,083 1,117,963 297,171 (92,338) $ $ $ $ $ -6.01 % -1.42 % 1,054,217 $ 1,049,933 — — 2,104,150 $ 914,556 $ 210,905 118,365 174,736 — — 643 10,310 1,429,515 $ 674,635 $ 582,297 8.98% 503,739 $ 300,736 — — 804,475 $ — $ — 43,132 68,394 — — 21,517 — 133,043 $ 671,432 $ 1,253,729 19.33% 3,986,566 2,169,645 329,636 309 6,486,156 1,306,509 1,691,413 681,047 876,293 516,243 7 37,200 123,715 5,232,427 1,253,729 19.33% (1) (2) (3) Does not include non-accrual loans of $199,983. Adjusted to reflect: (a) expected shorter maturities based upon our historical experience of early prepayments of principal, and (b) the redemption of callable securities on their next call date. Includes savings deposits paying interest at market rates in the three month or less category. All other deposit categories, while technically subject to immediate withdrawal, actually display sensitivity characteristics that generally fall within one to five years. Their allocation is presented based on that historical analysis. If these deposits were included in the three month or less category, the above table would reflect a negative three month gap of $1,877 million, a negative cumulative one year gap of $1,218 million and a positive cumulative one to five year gap of $582 million. Net Interest Income Sensitivity We believe net interest income sensitivity provides the best perspective of how day-to-day decisions affect our interest rate risk profile. We monitor net interest margin sensitivity by utilizing an income simulation model to subject twelve month net interest income to various rate movements. Simulations modeled quarterly include scenarios where market rates change suddenly up or down in a parallel manner and scenarios where market rates gradually change up or down at nonparallel rates resulting in a change in the slope of the yield curve. Estimates produced by our income simulation model are based on numerous assumptions including, but not limited to, the nature and timing of changes in interest rates, prepayments of loans and investment securities, volume of loans originated, level and composition of deposits, ability of borrowers to repay adjustable or variable rate loans and reinvestment opportunities for cash flows. Given these various assumptions, the actual effect of interest rate changes on our net interest margin may be materially different than estimated. 59 Table of Contents We target a mix of interest earning assets and interest bearing liabilities such that no more than 5% of the net interest margin will be at risk over a one-year period should short-term interest rates shift up or down 2%. As of December 31, 2011, our income simulation model predicted net interest income would decrease $1.7million, or less than 1.0%, assuming a 2% increase in short-term and long-term interest rates over a twelve-month period. This scenario predicts that our funding sources will reprice slightly faster than our interest earning assets. We have not engaged in derivatives or hedging activities to manage our interest rate risk. We did not simulate a decrease in interest rates due to the extremely low rate environment as of December 31, 2011. Prime rate has historically been set at a rate of 300 basis points over the targeted federal funds rate, which is currently set between 0 and 25 basis points. Our income simulation model has an assumption that prime will continue to be set at a rate of 300 basis points over the targeted federal funds rate. Additionally, rates that are currently below 2% are modeled not to fall below 0% with an overall decrease of 2% in interest rates. The preceding interest rate sensitivity analysis does not represent a forecast and should not be relied upon as being indicative of expected operating results. In addition, if the actual prime rate falls below a 300 basis point spread to targeted federal funds rates, we could experience a continued decrease in net interest income as a result of falling yields on earning assets tied to prime rate. Recent Accounting Pronouncements The expected impact of accounting standards recently issued but not yet adopted are discussed in “Notes to Consolidated Financial Statements—Authoritative Accounting Guidance” included in Part IV, Item 15 of this report. The following consolidated financial statements of First Interstate BancSystem, Inc. and subsidiaries are contained in Part IV, Item 15 of this report and are incorporated herein by reference. Item 8. Financial Statements and Supplementary Data Report of McGladrey & Pullen LLP, Independent Registered Public Accounting Firm Consolidated Balance Sheets — December 31, 2011 and 2010 Consolidated Statements of Income — Years Ended December 31, 2011, 2010 and 2009 Consolidated Statements of Stockholders’ Equity — Years Ended December 31, 2011, 2010 and 2009 Consolidated Statements of Cash Flows — Years Ended December 31, 2011, 2010 and 2009 Notes to Consolidated Financial Statements Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure There have been no disagreements with accountants on accounting and financial disclosure. Item 9A. Controls and Procedures Disclosure Controls and Procedures We have established and maintain disclosure controls and procedures, as defined under Rules 13a-15(e) and 15d-15(e) of the Exchange Act. As of December 31, 2011, our management evaluated, under the supervision and with the participation of the Chief Executive Officer and Chief Financial Officer, the effectiveness of the design and operation of our disclosure controls and procedures. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures, as of December 31, 2011, were effective in ensuring that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods required by the SEC’s rules and forms and is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. 60 Table of Contents Management’s Report on Internal Control Over Financial Reporting Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Our system of internal control over financial reporting within the meaning of Rules 13a- 15(f) and 15d-15(f) of the Exchange Act is designed to provide reasonable assurance to our management and board of directors regarding the preparation and fair presentation of our published financial statements in accordance with U.S. generally accepted accounting principles. Our management, including the Chief Executive Officer and the Chief Financial Officer, assessed the effectiveness of our system of internal control over financial reporting as of December 31, 2011. In making this assessment, we used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated Framework. Based on our assessment, we believe that, as of December 31, 2011, our system of internal control over financial reporting was effective to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of our financial statements for external purposes in accordance with U.S. generally accepted accounting principles. McGladrey & Pullen, LLP, the independent registered public accounting firm that audited our consolidated financial statements included in this Annual Report on Form 10-K, has issued an attestation report on the effectiveness of our internal control over financial reporting as of December 31, 2011. The report, which expresses an unqualified opinion on the effectiveness of our internal control over financial reporting as of December 31, 2011, is included below. Report of Independent Registered Public Accounting Firm To the Board of Directors and Shareholders First Interstate BancSystem, Inc. We have audited First Interstate BancSystem Inc. and subsidiaries' internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. First Interstate BancSystem, Inc. and subsidiaries' management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management's Annual Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the company's internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (a) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (b) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (c) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, First Interstate BancSystem, Inc. and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. 61 Table of Contents We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of First Interstate BancSystem, Inc. and subsidiaries as of December 31, 2011 and 2010 and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2011 and our report dated February 27, 2012 expressed an unqualified opinion. /s/ MCGLADREY & PULLEN, LLP Des Moines, Iowa February 27, 2012 There were no items required to be disclosed in a report on Form 8-K during the fourth quarter of 2011 that were not reported. Item 9B. Other Information PART III Item 10. Directors, Executive Officers and Corporate Governance. Information concerning “Directors, Executive Officers and Corporate Governance” is set forth under the heading “Directors and Executive Officers” in our Proxy Statement relating to our 2012 annual meeting of shareholders and is herein incorporated by reference. Information concerning “Compliance With Section 16(a) of the Securities Exchange Act of 1934” is set forth under the heading “Section 16(a) Beneficial Ownership Reporting Compliance” in our Proxy Statement relating to our 2012 annual meeting of shareholders and is herein incorporated by reference. Item 11. Executive Compensation Information concerning “Executive Compensation” is set forth under the headings “Compensation of Executive Officers Compensation Discussion and Analysis” and “Compensation of Executive Officers and Directors” in our Proxy Statement relating to our 2012 annual meeting of shareholders and is herein incorporated by reference. Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters Information concerning “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters” is set forth under the heading “Security Ownership of Certain Beneficial Owners and Management” and “Securities Authorized for Issuance under Equity Compensation Plans” in our Proxy Statement relating to our 2012 annual meeting of shareholders and is herein incorporated by reference. Information concerning “Certain Relationships and Related Transactions and Director Independence” is set forth under the headings “Directors and Executive Officers” and “Certain Relationships and Related Transactions” in our Proxy Statement relating to our 2012 annual meeting of shareholders and is herein incorporated by reference. In addition, see “Notes to Consolidated Financial Statements — Related Party Transactions” included in Part IV, Item 15. Item 13. Certain Relationships and Related Transactions and Director Independence Information concerning “Principal Accountant Fees and Services” is set forth under the heading “Directors and Executive Officers — Principal Accounting Fees and Services” in our Proxy Statement relating to our 2012 annual meeting of shareholders and is herein incorporated by reference. Item 14. Principal Accountant Fees and Services (a) 1. Our audited consolidated financial statements follow. PART IV Item 15. Exhibits and Financial Statement Schedules 62 Table of Contents REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Shareholders First Interstate BancSystem, Inc. We have audited the accompanying consolidated balance sheets of First Interstate BancSystem, Inc. and subsidiaries as of December 31, 2011 and 2010, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2011. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of First Interstate BancSystem, Inc. and subsidiaries as of December 31, 2011 and 2010, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2011, in conformity with U.S. generally accepted accounting principles. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States),First Interstate BancSystem, Inc. and subsidiaries' internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated February 27, 2012 expressed an unqualified opinion on the effectiveness of First Interstate BancSystem Inc. and subsidiaries' internal control over financial reporting. /s/ MCGLADREY & PULLEN, LLP Des Moines, Iowa February 27, 2012 63 Table of Contents FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands, except share data) December 31, Assets Cash and due from banks Federal funds sold Interest bearing deposits in banks Total cash and cash equivalents Investment securities: Available-for-sale Held-to-maturity (estimated fair values of $161,877 and $146,508 at December 31, 2011 and 2010, respectively) Total investment securities Loans held for investment Mortgage loans held for sale Total loans Less allowance for loan losses Net loans Premises and equipment, net of accumulated depreciation Goodwill Company-owned life insurance Other real estate owned (“OREO”) Accrued interest receivable Mortgage servicing rights, net of accumulated amortization and impairment reserve Deferred tax asset, net Core deposit intangibles, net of accumulated amortization Other assets Total assets Liabilities and Stockholders’ Equity Deposits: Non-interest bearing Interest bearing Total deposits Securities sold under repurchase agreements Accounts payable and accrued expenses Accrued interest payable Long-term debt Other borrowed funds Subordinated debentures held by subsidiary trusts Total liabilities Stockholders’ equity: Nonvoting noncumulative preferred stock without par value; authorized 100,000 shares; issued and outstanding 5,000 shares as of December 31, 2011 and 2010 Common stock Retained earnings Accumulated other comprehensive income, net Total stockholders’ equity Total liabilities and stockholders’ equity See accompanying notes to consolidated financial statements. 64 2011 2010 142,502 309 329,636 472,447 2,016,864 152,781 2,169,645 4,133,028 53,521 4,186,549 112,581 4,073,968 184,771 183,673 74,880 37,452 31,974 11,555 9,628 7,357 68,177 7,325,527 1,271,709 4,555,262 5,826,971 516,243 42,248 8,123 37,200 7 123,715 6,554,507 50,000 266,842 435,144 19,034 771,020 7,325,527 $ $ $ $ 107,035 2,114 576,469 685,618 1,786,335 147,068 1,933,403 4,321,501 46,408 4,367,909 120,480 4,247,429 188,138 183,673 73,056 33,632 33,628 13,191 18,472 8,803 81,927 7,500,970 1,063,869 4,861,844 5,925,713 620,154 38,915 13,178 37,502 4,991 123,715 6,764,168 50,000 264,174 413,253 9,375 736,802 7,500,970 $ $ $ $ Table of Contents FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (In thousands, except per share data) Year Ended December 31, Interest income: Interest and fees on loans Interest and dividends on investment securities: Taxable Exempt from federal taxes Interest on deposits in banks Interest on federal funds sold Total interest income Interest expense: Interest on deposits Interest on federal funds purchased Interest on securities sold under repurchase agreements Interest on other borrowed funds Interest on long-term debt Interest on subordinated debentures held by subsidiary trusts Total interest expense Net interest income Provision for loan losses Net interest income after provision for loan losses Non-interest income: Other service charges, commissions and fees Income from the origination and sale of loans Service charges on deposit accounts Wealth management revenues Investment securities gains, net Other income Total non-interest income Non-interest expense: Salaries, wages and employee benefits Occupancy, net Furniture and equipment Outsourced technology services OREO expense, net of income FDIC insurance premiums Mortgage servicing rights amortization Mortgage servicing rights impairment (recovery) Core deposit intangibles amortization Other expenses Total non-interest expense Income before income tax expense Income tax expense Net income Preferred stock dividends Net income available to common shareholders Basic earnings per common share Diluted earnings per common share See accompanying notes to consolidated financial statements. 2011 2010 2009 $ 245,767 $ 266,472 $ 279,985 41,304 4,749 1,050 13 292,883 33,533 — 695 — 1,975 5,828 42,031 250,852 58,151 192,701 31,689 21,153 17,647 13,157 1,544 6,682 91,872 111,352 16,223 12,562 8,933 8,652 7,333 3,225 1,275 1,446 47,411 218,412 66,161 21,615 44,546 3,422 41,124 0.96 0.96 $ $ 42,338 4,621 1,093 22 314,546 53,949 — 879 3 2,433 5,843 63,107 251,439 66,900 184,539 29,494 22,868 18,181 12,387 170 7,811 90,911 112,667 16,251 13,434 9,477 7,670 10,044 4,615 (787) 1,748 45,885 221,004 54,446 17,090 37,356 3,422 33,934 0.85 0.85 $ $ 41,978 5,298 520 253 328,034 73,226 20 776 1,347 3,249 6,280 84,898 243,136 45,300 197,836 28,747 30,928 20,323 10,821 137 9,734 100,690 113,569 15,898 12,405 10,567 6,397 12,130 7,568 (7,224) 2,131 44,269 217,710 80,816 26,953 53,863 3,422 50,441 1.61 1.59 $ $ 65 Table of Contents FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (In thousands, except share and per share data Balance at December 31, 2008 Comprehensive income: Net income Other comprehensive income, net of tax Total comprehensive income Common stock transactions: 642,752 common shares purchased and retired 254,156 common shares issued 64,136 non-vested common shares issued 299,436 stock options exercised, net of 175,464 shares tendered in payment of option price and income tax withholding amounts Tax benefit of stock-based compensation Stock-based compensation expense Cash dividends declared: Common ($0.50 per share) Preferred (6.75% per share) Balance at December 31, 2009 Comprehensive income: Net income Other comprehensive loss, net of tax Total comprehensive income Common stock transactions: 246,596 common shares purchased and retired 11,506,503 common shares issued 117,140 non-vested common shares issued 18,821 non-vested common shares forfeited 92,880 stock options exercised, net of 111,792 shares tendered in payment of option price and income tax withholding amounts Tax benefit of stock-based compensation Non-vested liability awards vesting during period Stock-based compensation expense Cash dividends declared: Common ($0.45 per share) Preferred (6.75% per share) Balance at December 31, 2010 Preferred Stock Common Stock Retained Earnings Accumulated Other Comprehensive Income (Loss) Total Stockholders’ Equity $ 50,000 $ 117,613 $ 362,477 $ 8,972 $ 539,062 — — 53,863 — — — — — — — — — — — 50,000 — — — — — — — — — — $ — — 50,000 66 $ (11,052) 3,813 — 144 742 875 — — 112,135 — — (3,699) 153,257 — — 649 239 59 1,534 — — 264,174 — — — — — — (15,694) (3,422) 397,224 37,356 — — — — — — — — — — 6,103 — — — — — — — — 15,075 — (5,700) — — — — — — — — 53,863 6,103 59,966 (11,052) 3,813 — 144 742 875 (15,694) (3,422) 574,434 37,356 (5,700) 31,656 (3,699) 153,257 — — 649 239 59 1,534 (17,905) (3,422) 736,802 (17,905) (3,422) $ 413,253 $ — — 9,375 $ Table of Contents FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (CONTINUED) (In thousands, except share and per share data Balance at December 31, 2010 Comprehensive income: Net income Other comprehensive income, net of tax Total comprehensive income Common stock transactions: 17,926 common shares purchased and retired 15,440 common shares issued 130,904 non-vested common shares issued 27,963 non-vested common shares forfeited or canceled 83,025 stock options exercised, net of 174,583 shares tendered in payment of option price and income tax withholding amounts Non-vested liability awards vesting during period Tax benefit of stock-based compensation Stock-based compensation expense Cash dividends declared: Common ($0.45 per share) Preferred (6.75% per share) Balance at December 31, 2011 See accompanying notes to consolidated financial statements. Preferred Stock Common Stock Retained Earnings Accumulated Other Comprehensive Income (Loss) Total Stockholders’ Equity $ 50,000 $ 264,174 $ 413,253 $ 9,375 $ 736,802 — — (248) 205 — — 385 216 204 1,906 — — 266,842 — — — — — — — — — — — — 50,000 $ $ 67 44,546 — — — — — — — — — — 9,659 — — — — — — — — (19,233) (3,422) $ 435,144 $ — — 19,034 $ 44,546 9,659 54,205 (248) 205 — — 385 216 204 1,906 (19,233) (3,422) 771,020 Table of Contents FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) Year Ended December 31, Cash flows from operating activities: Net income Adjustments to reconcile net income from operations to net cash provided by operating activities: Provisions for loan losses Net loss on disposal of property and equipment Depreciation and amortization Net premium amortization on investment securities Net gains on investment securities transactions Net gains on sales of mortgage loans held for sale Net gains on sales of student loan portfolio Net loss on sale of mortgage servicing rights Write-down of OREO Write-down of equipment pending disposal Loss on early extinguishment of debt Mortgage servicing rights impairment (recovery) Deferred income tax expense (benefit) Net increase in cash surrender value of company-owned life insurance policies Stock-based compensation expense Tax benefits from stock-based compensation Excess tax benefits from stock-based compensation Originations of loans held for sale Changes in operating assets and liabilities: Decrease in accrued interest receivable Decrease (increase) in other assets Decrease in accrued interest payable Increase (decrease) in accounts payable and accrued expenses Net cash provided by operating activities Cash flows from investing activities: Purchases of investment securities: Held-to-maturity Available-for-sale Proceeds from maturities, paydowns and calls of investment securities: Held-to-maturity Available-for-sale Proceeds from sales of mortgage servicing rights, net of acquisitions Extensions of credit to customers, net of repayments Proceeds from sale of student loan portfolio Recoveries of loans charged-off Proceeds from sales of OREO Capital expenditures, net of sales Net cash used in investing activities 2011 2010 2009 $ 44,546 $ 37,356 $ 53,863 58,151 28 17,368 10,353 (1,544) (14,443) — — 7,464 — — 1,275 2,405 (1,824) 2,111 204 (124) 4,466 1,654 12,487 (5,055) 3,579 143,101 66,900 672 20,136 6,762 (170) (15,321) (374) 1,525 6,724 — 306 (787) (17,257) (1,682) 1,764 239 (225) 1,121 3,495 7,450 (4,407) (4,969) 109,258 (18,846) (1,166,364) (33,118) (1,317,938) 12,682 943,490 596 90,548 — 5,231 15,896 (9,172) 15,134 833,910 2,480 71,762 25,032 2,889 20,336 (7,998) 45,300 306 22,286 1,293 (137) (18,315) — 48 5,545 350 — (7,224) 5,547 (1,859) 1,067 742 (719) 19,280 1,571 (36,120) (2,946) (8,043) 81,835 (9,910) (868,917) 19,785 493,389 2,051 146,943 — 2,392 10,849 (26,393) $ (125,939) $ (387,511) $ (229,811) 68 Table of Contents INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) (In thousands) Year Ended December 31, Cash flows from financing activities: Net (decrease) increase in deposits Net decrease in federal funds purchased Net (decrease) increase in repurchase agreements Net decrease in short-term borrowings Repayments of long-term debt Debt issuance costs Proceeds from issuance of common stock Common stock issuance costs Excess tax benefits from stock-based compensation Purchase and retirement of common stock Dividends paid to common stockholders Dividends paid to preferred stockholders Net cash provided by (used in) financing activities Net increase (decrease) in cash and cash equivalents Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year Supplemental disclosures of cash flow information: Cash paid during the year for income taxes Cash paid during the year for interest expense See accompanying notes to consolidated financial statements. 2011 2010 2009 $ $ $ (98,742) — (103,911) (4,984) (302) — 385 — 124 (248) (19,233) (3,422) (230,333) (213,171) 685,618 472,447 16,640 47,086 $ $ $ 101,657 — 146,013 (432) (35,851) — 167,400 (13,597) 225 (3,699) (17,905) (3,422) 340,389 62,136 623,482 685,618 37,325 67,514 $ $ $ 649,797 (30,625) (51,360) (73,793) (10,795) (261) 3,914 — 719 (11,052) (15,694) (3,422) 457,428 309,452 314,030 623,482 25,813 87,844 69 Table of Contents FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share data) (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Business. First Interstate BancSystem, Inc. (the “Parent Company” and collectively with its subsidiaries, the “Company”) is a financial and bank holding company that, through the branch offices of its bank subsidiary, provides a comprehensive range of banking products and services to individuals, businesses, municipalities and other entities throughout Montana, Wyoming and western South Dakota. In addition to its primary emphasis on commercial and consumer banking services, the Company also offers trust, employee benefit and investment and insurance services through its bank subsidiary. The Company is subject to competition from other financial institutions and nonbank financial companies, and is also subject to the regulations of various government agencies and undergoes periodic examinations by those regulatory authorities. Basis of Presentation. The Company’s consolidated financial statements include the accounts of the Parent Company and its operating subsidiaries. As of December 31, 2011, the Company had one significant subsidiary, First Interstate Bank (“FIB”). All significant intercompany balances and transactions have been eliminated in consolidation. Certain reclassifications, none of which were material, have been made in the consolidated financial statements for 2010 and 2009 to conform to the 2011 presentation. These reclassifications did not change previously reported net income or stockholders’ equity. On March 5, 2010, the Company’s shareholders approved proposals to recapitalize the Company’s existing common stock. The recapitalization included, among other things, a redesignation of existing common stock as Class B common stock; a four-for-one stock split of the Class B common stock; and, the creation of a new class of common stock designated as Class A common stock. All share and per share information included in the accompanying consolidated financial statements, including the notes thereto, has been adjusted to give effect to the recapitalization of the common stock, including the four-for-one stock split of Class B common stock, as if the recapitalization had occurred on January 1, 2009, the earliest date presented. For additional information regarding the recapitalization, see Note 13—Capital Stock and Dividend Restrictions. Merger of Bank Subsidiaries. On September 25, 2009, the Company merged First Western Bank (“Wall”) and The First Western Bank Sturgis (“Sturgis”) into FIB. Subsequent to the merger, FIB is the Company’s only bank subsidiary. Equity Method Investments. The Company has an investment in a real estate joint venture that is not consolidated because the Company does not own a majority voting interest, control the operations or receive a majority of the losses or earnings of the joint venture. This joint venture is accounted for using the equity method of accounting whereby the Company initially records its investment at cost and then subsequently adjusts the cost for the Company’s proportionate share of distributions and earnings or losses of the joint venture. Variable Interest Entities. The Company’s wholly-owned business trusts, First Interstate Statutory Trust (“FIST”), FI Statutory Trust I (“Trust I”), FI Capital Trust II (“Trust II”), FI Statutory Trust III (“Trust III”), FI Capital Trust IV (“Trust IV”), FI Statutory Trust V (“Trust V”) and FI Statutory Trust VI (“Trust VI”) are variable interest entities for which the Company is not a primary beneficiary. Accordingly, the accounts of FIST, Trust I, Trust II, Trust III, Trust IV, Trust V and Trust VI are not included in the accompanying consolidated financial statements, and are instead accounted for using the equity method of accounting. Assets Held in Fiduciary or Agency Capacity. The Company holds certain trust assets in a fiduciary or agency capacity. The Company also purchases and sells federal funds as an agent. These and other assets held in an agency or fiduciary capacity are not assets of the Company and, accordingly, are not included in the accompanying consolidated financial statements. Use of Estimates. The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and income and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to change relate to the determination of the allowance for loan losses and the valuation of goodwill and other real estate owned. 70 Table of Contents FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share data) Cash and Cash Equivalents. For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks, federal funds sold for one day periods and interest bearing deposits in banks with original maturities of less than three months. As of December 31, 2011 and 2010, the Company had cash of $329,390 and $576,207, respectively, on deposit with the Federal Reserve Bank. In addition, the Company maintained compensating balances with the Federal Reserve Bank of approximately $5,000 as of December 31, 2011 and 2010 to reduce service charges for check clearing services. Investment Securities. Investments in debt securities that the Company has the positive intent and ability to hold to maturity are classified as held-to-maturity and carried at amortized cost. Investments in debt securities that may be sold in response to or in anticipation of changes in interest rates and resulting prepayment risk, or other factors, and marketable equity securities are classified as available-for-sale and carried at fair value. The unrealized gains and losses on these securities are reported, net of applicable income taxes, as a separate component of stockholders’ equity and comprehensive income. Management determines the appropriate classification of securities at the time of purchase and at each reporting date management reassesses the appropriateness of the classification. The amortized cost of debt securities classified as held-to-maturity or available-for-sale is adjusted for accretion of discounts to maturity and amortization of premiums over the estimated average life of the security, or in the case of callable securities, through the first call date, using the effective yield method. Such amortization and accretion is included in interest income. Realized gains and losses are included in investment securities gains (losses). Declines in the fair value of securities below their cost that are judged to be other-than-temporary are included in other expenses if the decline is related to credit losses. Other-than-temporary impairment losses related to other factors are recognized in other comprehensive income, net of income taxes. In estimating other-than-temporary impairment losses, the Company considers, among other things, the length of time and the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer and the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. The cost of securities sold is based on the specific identification method. The Company invests in securities on behalf of certain officers and directors of the Company who have elected to participate in the Company’s deferred compensation plans. These securities are included in other assets and are carried at their fair value based on quoted market prices. Net realized and unrealized holding gains and losses are included in other non-interest income and salaries, wages and employee benefits expense. Loans. Loans are reported at the principal amount outstanding. Interest income on loans is calculated using the simple interest method on the daily balance of the principal amount outstanding. Loan origination fees and certain direct origination costs are deferred, and the net amount is amortized as an adjustment of the related loan’s yield using a level yield method over the expected lives of the related loans. The accrual of interest on loans is discontinued when, in management’s opinion, the borrower may be unable to meet payment obligations as they become due or when a loan becomes contractually past due ninety days or more with respect to interest or principal, unless such past due loan is well secured and in the process of collection. When interest accrual is discontinued, all unpaid accrued interest is reversed against current period interest income. Interest income is subsequently recognized only to the extent cash payments are received in excess of principal due. Loans are returned to accrual status when all principal and interest amounts contractually due are brought current and when, in the opinion of management, the loans are estimated to be fully collectible as to both principal and interest. A loan is considered impaired when, based upon current information and events, it is probable that the Company will be unable to collect, on a timely basis, all amounts due according to the contractual terms of the loan’s original agreement. The amount of the impairment is measured using cash flows discounted at the loan’s effective interest rate, except when it is determined that the primary source of repayment for the loan is the operation or liquidation of the underlying collateral. In such cases, the current fair value of the collateral, reduced by anticipated selling costs, is used to measure impairment. The Company considers impaired loans to include all loans risk rated doubtful and non-consumer loans on which interest accrual has been discontinued or have been renegotiated in a troubled debt restructuring. Interest payments received on impaired loans are applied based on whether they are on accrual or non-accrual status. Interest income recognized by the Company on impaired loans primarily relate to loans modified in a troubled debt restructuring that remain on accrual status. Interest payments received on non-accrual impaired loans are applied to principle. Interest income is subsequently recognized only to the extent cash payments are received in excess of principle due. 71 Table of Contents FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share data) A loan is considered a troubled debt restructuring when a borrower is experiencing financial difficulties that leads to a restructuring of the loan and the Company grants concessions to the borrower in the restructuring that it would not otherwise consider. These concessions may include rate reductions, principal forgiveness, extension of maturity date and other actions to minimize potential losses. Certain troubled debt restructurings are on non-accrual status at the time of restructuring and are typically returned to accrual status after considering the borrower's sustained repayment performance in accordance with the restructuring agreement for a reasonable period of at least six months and management is reasonably assured of future performance. If the troubled debt restructuring meets these performance criteria and the interest rate granted at the modification is equal to or greater than the rate that the Company was willing to accept at the time of the restructuring for a new loan with comparable risk, then the loan will no longer be deemed impaired. Included in loans are certain residential mortgage loans originated for sale. These loans are carried at the lower of aggregate cost or estimated market value. Market value is estimated based on binding contracts or quotes or bids from third party investors. Residential mortgages held for sale were $53,521 and $46,408 as of December 31, 2011 and 2010, respectively. Gains and losses on sales of mortgage loans are determined using the specific identification method and are included in income from the origination and sale of loans. Allowance for Loan Losses. The allowance for loan losses is established through a provision for loan losses which is charged to expense. Loans, or portions thereof, are charged against the allowance for loan losses when management believes that the collectibility of the principal is unlikely or, with respect to consumer installment and credit card loans, according to established delinquency schedules. The allowance balance is an amount that management believes will be adequate to absorb known and inherent losses in the loan portfolio based upon quarterly analyses of the current risk characteristics of the loan portfolio, an assessment of individual problem loans and actual loss experience, industry concentrations and current economic factors and the estimated impact of current economic and environmental conditions on historical loss rates. Goodwill. The excess purchase price over the fair value of net assets from acquisitions, or goodwill, is evaluated for impairment at least annually and on an interim basis if an event or circumstance indicates that it is likely impairment has occurred. In testing for impairment, the fair value of net assets is estimated based on analyses of our market value, discounted cash flows and peer values. The determination of goodwill is sensitive to market-based economics and other key assumptions used in determining or allocating fair value. Variability in the market and changes in assumptions or subjective measurements used to allocate fair value are reasonably possible and may have a material impact on our consolidated financial statements or results of operations. During 2011, the Company determined that due to a significant and prolonged decrease in market prices for bank stocks, including the Company's common stock, an interim goodwill impairment test was warranted. The interim impairment test indicated that, as of December 31, 2011, the fair value of net assets was greater than the carrying value of the Company and no impairment existed. Core Deposit Intangibles. Core deposit intangibles represent the intangible value of depositor relationships resulting from deposit liabilities assumed and are amortized using an accelerated method based on the estimated weighted average useful lives of the related deposits of 9.5 years. Accumulated core deposit intangibles amortization was $19,563 as of December 31, 2011 and $18,117 as of December 31, 2010. Amortization expense related to core deposit intangibles recorded as of December 31, 2011 is expected to total $1,421, $1,417, $1,417, $1,417 and $1,380 in 2012, 2013, 2014, 2015 and 2016, respectively. Mortgage Servicing Rights. The Company recognizes the rights to service mortgage loans for others, whether acquired or internally originated. Mortgage servicing rights are initially recorded at fair value based on comparable market data and are amortized in proportion to and over the period of estimated net servicing income. 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 including loan type, note rate and loan term. Impairment adjustments, if any, are recorded through a valuation allowance. 72 Table of Contents FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share data) Premises and Equipment. Buildings, furniture and equipment are stated at cost less accumulated depreciation. Depreciation expense is computed using straight-line methods over estimated useful lives of 5 to 45 years for buildings and improvements and 4 to 15 years for furniture and equipment. Leasehold improvements and assets acquired under capital lease are amortized over the shorter of their estimated useful lives or the terms of the related leases. Land is recorded at cost. Company-Owned Life Insurance. Key executive life insurance policies are recorded at their cash surrender value. Group life insurance policies are subject to a stable value contract that offsets the impact of interest rate fluctuations on the market value of the policies. Group life insurance policies are recorded at the stabilized investment value. Increases in the cash surrender or stabilized investment value of insurance policies, as well as insurance proceeds received, are recorded as other non-interest income, and are not subject to income taxes. Impairment of Long-Lived Assets. Long-lived assets, including premises and equipment and certain identifiable intangibles, are reviewed for impairment whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. The amount of the impairment loss, if any, is based on the asset’s fair value. Impairment losses of $350 were recognized in other non- interest expense in 2009. No impairment losses were recognized during 2011 or 2010. Other Real Estate Owned. Real estate acquired in satisfaction of loans is initially carried at current fair value less estimated selling costs. Any excess of loan carrying value over the fair value of the real estate acquired is recorded as a charge to the allowance for loan losses. Subsequent declines in fair value less estimated selling costs are included in OREO expense. Subsequent increases in fair value less estimated selling costs are recorded as a reduction in OREO expense to the extent of recognized losses. Operating expenses, net of related income, and gains or losses on sales are included in OREO expense. Write-downs of $7,464, $6,724 and $5,545 were recorded in 2011, 2010 and 2009 respectively. Restricted Equity Securities. The Company, as a member of the Federal Reserve Bank and the Federal Home Loan Bank (“FHLB”), is required to maintain investments in each of the organization’s capital stock. As of December 31, 2011, restricted equity securities of the Federal Reserve Bank and the Federal Home Loan Bank of $13,357 and $6,807, respectively, were included in other assets at cost. As of December 31, 2010, restricted equity securities of the Federal Reserve Bank and the Federal Home Loan Bank were $13,357 and $6,819, respectively. No ready market exists for these restricted equity securities, and they have no quoted market values. Restricted equity securities are periodically reviewed for impairment based on ultimate recovery of par value. The determination of whether a decline affects the ultimate recovery of par value is influenced by the significance of the decline compared to the cost basis of the restricted equity securities, the length of time a decline has persisted, the impact of legislative and regulatory changes on the issuing organizations and the liquidity positions of the issuing organizations. Based on management’s assessment, no impairment losses were recorded on restricted equity securities during 2011, 2010 or 2009. Income from Fiduciary Activities. Consistent with industry practice, income for trust services is recognized on the basis of cash received. However, use of this method in lieu of accrual basis accounting does not materially affect reported earnings. Income Taxes. The Parent Company and its subsidiaries have elected to be included in a consolidated federal income tax return. For state income tax purposes, the combined taxable income of the Parent Company and its subsidiaries is apportioned among the states in which operations take place. Federal and state income taxes attributable to the subsidiaries, computed on a separate return basis, are paid to or received from the Parent Company. The Company accounts for income taxes using the liability method. Under the liability method, deferred tax assets and liabilities are determined based on enacted income tax rates which will be in effect when the differences between the financial statement carrying values and tax bases of existing assets and liabilities are expected to be reported in taxable income. 73 Table of Contents FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share data) Positions taken in the Company’s tax returns may be subject to challenge by the taxing authorities upon examination. Uncertain tax positions are initially recognized in the financial statements when it is more likely than not the position will be sustained upon examination by the tax authorities. Such tax positions are both initially and subsequently measured as the largest amount of tax benefit that is greater than 50% likely of being realized upon settlement with the tax authority, assuming full knowledge of the position and all relevant facts. The Company provides for interest and, in some cases, penalties on tax positions that may be challenged by the taxing authorities. Interest expense is recognized beginning in the first period that such interest would begin accruing. Penalties are recognized in the period that the Company claims the position in the tax return. Interest and penalties on income tax uncertainties are classified within income tax expense in the income statement. With few exceptions, the Company is no longer subject to U.S. federal and state examinations by tax authorities for years before 2008. The Company had no accrued interest or penalties as of December 31, 2011 or 2010. Earnings Per Common Share. Basic and diluted earnings per common share are calculated using a two-class method. Under the two-class method, basic earnings per common share is calculated by dividing net income available to common shareholders by the weighted average number of common shares outstanding during the period, excluding outstanding participating securities. Participating securities include non-vested restricted stock awards. Diluted earnings per common share is calculated by dividing net income available to common shareholders by the weighted average number of common shares outstanding determined for the basic earnings per share calculation plus the dilutive effect of stock compensation using the treasury stock method. Comprehensive Income. Comprehensive income includes net income, as well as other changes in stockholders’ equity that result from transactions and economic events other than those with shareholders. In addition to net income, the Company’s comprehensive income includes the after tax effect of changes in unrealized gains and losses on available-for-sale investment securities and changes in net actuarial gains and losses on defined benefit post-retirement benefits plans. Segment Reporting. An operating segment is defined as a component of a business for which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and evaluate performance. The Company has one operating segment, community banking, which encompasses commercial and consumer banking services offered to individuals, businesses, municipalities and other entities. Advertising Costs. Advertising costs are expensed as incurred. Advertising expense was $3,048, $3,200, and $3,422 in 2011, 2010 and 2009, respectively. Transfers of Financial Assets. Transfers of financial assets are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when the assets have been isolated from the Company; the transferee obtains the right, free of conditions that constrain it from taking advantage of that right, to pledge or exchange the transferred assets; and, the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity. Stock-Based Compensation. Compensation cost for all stock-based awards is measured at fair value on the date of grant and is recognized over the requisite service period for awards expected to vest. Stock-based compensation expense of $1,906, $1,660 and $1,024 for the years ended December 31, 2011, 2010 and 2009, respectively, is included in salaries, wages and benefits expense in the Company’s consolidated statements of income. Related income tax benefits recognized for the years ended December 31, 2011, 2010 and 2009 were $736, $635 and $392, respectively. All compensation cost for stock-based awards is expensed at the Parent Company. Fair Value Measurements. In general, fair value measurements are based upon quoted market prices, where available. If quoted market prices are not available, fair value measurements are estimated using relevant market information and other assumptions. Fair value estimates involve uncertainties and require some degree of judgment regarding interest rates, credit risk, prepayments and other factors. The use of different assumptions or estimation techniques may have a significant effect on the fair value amounts reported. 74 Table of Contents FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share data) (2) INVESTMENT SECURITIES The amortized cost and approximate fair values of investment securities are summarized as follows: December 31, 2011 Available-for-Sale Obligations of U.S. government agencies U.S. agency mortgage-backed securities & collateralized mortgage obligations Private mortgage-backed securities Total December 31, 2011 Held-to Maturity State, county and municipal securities Other securities Total Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Estimated Fair Value 1,134,427 $ 848,444 758 1,983,629 $ 4,353 $ 29,567 7 33,927 $ (662) $ (14) (16) (692) $ 1,138,118 877,997 749 2,016,864 Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Estimated Fair Value 152,619 $ 162 152,781 $ 9,113 $ — 9,113 $ (17) $ — (17) $ 161,715 162 161,877 $ $ $ $ Gross gains of $1,544 and gross losses of $0 were realized on the disposition of available-for-sale securities in 2011. December 31, 2010 Available-for-Sale Obligations of U.S. government agencies U.S. agency mortgage-backed securities & collateralized mortgage obligations Private mortgage-backed securities Total December 31, 2010 Held-to Maturity State, county and municipal securities Other securities Total Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Estimated Fair Value 956,017 $ 812,372 1,057 1,769,446 $ 3,337 $ 24,107 10 27,454 $ (5,934) $ (4,619) (12) (10,565) $ 953,420 831,860 1,055 1,786,335 Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Estimated Fair Value 146,850 $ 218 147,068 $ 1,375 $ — 1,375 $ (1,935) $ — (1,935) $ 146,290 218 146,508 $ $ $ $ Gross gains of $173 and gross losses of $3 were realized on the disposition of available-for-sale securities in 2010. Gross gains of $138 and gross losses of $1 were realized on the disposition of available-for-sale securities in 2009. As of December 31, 2011, the Company had general obligation securities with amortized costs of $112,215 included in state, county and municipal securities, of which $66,418 were issued by political subdivisions or agencies within the states of Montana, Wyoming and South Dakota. In 2009, the Company transferred available-for-sale state, county and municipal investment securities with amortized costs and fair values of $28,288 and $29,426, respectively, into the held-to-maturity category. Unrealized net gains of $1,138 included in accumulated other comprehensive income at the time of transfer are being amortized to yield over the remaining lives of the transferred securities of 3.4 years. 75 Table of Contents FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share data) The following table shows the gross unrealized losses and fair values of investment securities, aggregated by investment category, and the length of time individual investment securities have been in a continuous unrealized loss position, as of December 31, 2011 and 2010. December 31, 2011 Available-for-Sale Obligations of U.S. government agencies U.S. agency mortgage-backed securities & collateralized mortgage obligations Private mortgage-backed securities Total December 31, 2011 Held-to-Maturity State, county and municipal securities December 31, 2010 Available-for-Sale Obligations of U.S. government agencies U.S. agency mortgage-backed securities & collateralized mortgage obligations Private mortgage-backed securities Total December 31, 2010 Held-to-Maturity Less than 12 Months 12 Months or More Total Fair Value Gross Unrealized Losses Fair Value Gross Unrealized Losses Fair Value Gross Unrealized Losses $ $ $ $ $ 287,404 $ 45,694 246 333,344 $ (662) $ (14) (10) (686) $ — $ — 177 177 $ — $ — (6) (6) $ 287,404 $ 45,694 423 333,521 $ (662) (14) (16) (692) Less than 12 Months 12 Months or More Total Fair Value Gross Unrealized Losses Fair Value Gross Unrealized Losses Fair Value Gross Unrealized Losses — $ — $ 773 $ (17) $ 773 $ (17) Less than 12 Months 12 Months or More Total Fair Value Gross Unrealized Losses Fair Value Gross Unrealized Losses Fair Value Gross Unrealized Losses 498,344 $ (5,934) $ 160,161 — 658,505 $ (4,619) — (10,553) $ — $ — 249 249 $ — $ 498,344 $ (5,934) — (12) (12) $ 160,161 249 658,754 $ (4,619) (12) (10,565) Less than 12 Months 12 Months or More Total Fair Value Gross Unrealized Losses Fair Value Gross Unrealized Losses Fair Value Gross Unrealized Losses State, county and municipal securities $ 42,178 $ (1,814) $ 3,023 $ (121) $ 45,201 $ (1,935) The investment portfolio is evaluated quarterly for other-than-temporary declines in the market value of each individual investment security. Consideration is given to the length of time and the extent to which the fair value has been less than cost; the financial condition and near term prospects of the issuer; and, the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. As of December 31, 2011, the Company had 24 individual investment securities that were in an unrealized loss position. As of December 31, 2010, the Company had 128 individual investment securities that were in an unrealized loss position. Unrealized losses as of December 31, 2011 and 2010 related primarily to fluctuations in the current interest rates. The fair value of these investment securities is expected to recover as the securities approach their maturity or repricing date or if market yields for such investments decline. As of December 31, 2011, the Company had the intent and ability to hold these investment securities for a period of time sufficient to allow for an anticipated recovery. Furthermore, the Company does not have the intent to sell any of the available-for-sale securities in the above table and it is more likely than not that the Company will not have to sell any such securities before a recovery in cost. No impairment losses were recorded during 2011, 2010 or 2009. 76 Table of Contents FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share data) Maturities of investment securities at December 31, 2011 are shown below. Maturities of mortgage-backed securities have been adjusted to reflect shorter maturities based upon estimated prepayments of principal. All other investment securities maturities are shown at contractual maturity dates. December 31, 2011 Within one year After one year but within five years After five years but within ten years After ten years Total Investments with no stated maturity Total Available-for-Sale Held-to-Maturity Amortized Cost Estimated Fair Value Amortized Cost Estimated Fair Value $ 406,390 $ 1,356,932 108,529 111,778 1,983,629 — $ 1,983,629 $ 417,159 1,371,734 112,305 115,666 2,016,864 — 2,016,864 $ $ 5,892 $ 23,505 59,870 63,352 152,619 162 152,781 $ 5,632 24,258 63,965 67,860 161,715 162 161,877 At December 31, 2011, the Company had investment securities callable within one year with amortized costs and estimated fair values of $695,610 and $696,727, respectively. These investment securities are primarily classified as available-for-sale and included in the after one year but within five years category in the table above. At December 31, 2011, the Company had callable structured notes with amortized costs and estimated fair values of $179,961 and $180,473, respectively. These callable structured notes, which are classified as available-for-sale and included in the after one year but within five years category in the table above, have fixed interest rates that increase at various intervals as market rates increase. Maturities of securities do not reflect rate repricing opportunities present in adjustable rate mortgage-backed securities. At December 31, 2011 and 2010, the Company had variable rate mortgage- backed securities with amortized costs of $21,333 and $15,946, respectively, classified as available-for-sale in the table above. There are no significant concentrations of investments at December 31, 2011, (greater than 10 percent of stockholders’ equity) in any individual security issuer, except for U.S. government or agency- backed securities. As of December 31, 2011 and 2010, all mortgage-backed securities were residential in nature. Investment securities with amortized cost of $1,280,317 and $1,606,951 at December 31, 2011 and 2010, respectively, were pledged to secure public deposits and securities sold under repurchase agreements. The approximate fair value of securities pledged at December 31, 2011 and 2010 was $1,310,895 and $1,624,767, respectively. All securities sold under repurchase agreements are with customers and mature on the next banking day. The Company retains possession of the underlying securities sold under repurchase agreements. 77 Table of Contents FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share data) (3) LOANS The following table presents loans by class as of the dates indicated: December 31, Real estate loans: Commercial Construction: Land acquisition & development Residential Commercial Total construction loans Residential Agricultural Total real estate loans Consumer: Indirect consumer Other consumer Credit card Total consumer loans Commercial Agricultural Other, including overdrafts Loans held for investment Mortgage loans held for sale Total loans 2011 2010 $ 1,553,155 $ 1,565,665 278,613 61,106 61,054 400,773 571,943 175,302 2,701,173 407,651 147,487 60,933 616,071 693,261 119,710 2,813 4,133,028 53,521 4,186,549 $ 329,720 99,196 98,542 527,458 549,604 182,794 2,825,521 423,552 162,137 60,891 646,580 730,471 116,546 2,383 4,321,501 46,408 4,367,909 $ The Company has lending policies and procedures in place that are designed to maximize loan income within an acceptable level of risk. Management reviews and approves these policies and procedures on a regular basis. A reporting system supplements the review process by providing management with frequent reports related to loan production, loan quality, concentrations of credit, loan delinquencies and internally risk-classified loans. Real estate loans include construction and permanent financing for both single-family and multi-unit properties, term loans for commercial, agricultural and industrial property and/or buildings and home equity loans and lines of credit secured by real estate. Longer-term residential real estate loans are generally 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 fifteen years. Home equity loans and lines of credit are typically secured by first or second liens on residential real estate and generally do not exceed a loan to value ratio of 80%. The Company had home equity loans and lines of credit of $312,295 and $348,272 as of December 31, 2011 and 2010, respectively. Commercial and agricultural real estate loans are generally secured by first liens on income-producing real estate and generally mature in less than five years. Construction loans are primarily to commercial builders for residential lot development and the construction of single-family residences and commercial real estate properties. Construction loans are generally underwritten pursuant to pre-approved permanent financing. During the construction phase the borrower pays interest only. Consumer loans include direct personal loans, credit card loans and lines of credit; and indirect dealer loans for the purchase of automobiles, recreational vehicles, boats and other consumer goods. 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 individuals in our market areas. Lines of credit are generally floating rate loans that are unsecured or secured by personal property. 78 Table of Contents FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share data) Commercial loans include a mix of variable and fixed rate loans 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, business credit cards 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 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. Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. The following tables present the contractual aging of the Company’s recorded investment in past due loans by class as of the period indicated: As of December 31, 2011 Real estate Commercial Construction: Land acquisition & development Residential Commercial Total construction loans Residential Agricultural Total real estate loans Consumer: Indirect consumer Other consumer Credit card Total consumer loans Commercial Agricultural Other, including overdrafts Loans held for investment Mortgage loans originated for sale Total loans $ 30 - 59 Days Past Due 60 - 89 Days Past Due > 90 Days Past Due Total Loans 30 or More Days Past Due Current Loans Non-accrual Loans Total Loans $ 22,124 $ 7,871 $ 630 $ 30,625 $ 1,455,139 $ 67,391 $ 1,553,155 5,251 415 1,698 7,364 4,669 4,103 38,260 3,078 1,479 604 5,161 13,721 476 — 57,618 — 57,618 $ 2,448 — — 2,448 973 1,831 13,123 370 436 375 1,181 3,464 215 2 17,985 — 17,985 $ 867 — — 867 1,798 — 3,295 45 60 585 690 405 110 — 4,500 — 4,500 $ 79 8,566 415 1,698 10,679 7,440 5,934 54,678 3,493 1,975 1,564 7,032 17,590 801 2 80,103 — 80,103 $ 208,134 56,219 34,820 299,173 546,278 166,119 2,466,709 403,695 144,625 59,343 607,663 657,609 118,150 2,811 3,852,942 53,521 3,906,463 $ 61,913 4,472 24,536 90,921 18,225 3,249 179,786 463 887 26 1,376 18,062 759 — 199,983 — 199,983 $ 278,613 61,106 61,054 400,773 571,943 175,302 2,701,173 407,651 147,487 60,933 616,071 693,261 119,710 2,813 4,133,028 53,521 4,186,549 Table of Contents FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share data) As of December 31, 2010 Real estate Commercial Construction: Land acquisition & development Residential Commercial Total construction loans Residential Agricultural Total real estate loans Consumer: Indirect consumer Other consumer Credit card Total consumer loans Commercial Agricultural Other, including overdrafts Loans held for investment Mortgage loans originated for sale 30 - 59 Days Past Due 60 - 89 Days Past Due > 90 Days Past Due Total Loans 30 or More #CIRCULAR! Days Past Due Current Loans Non-accrual Loans #CIRCULAR! Total Loans $ 12,934 $ 5,025 $ — $ 17,959 $ 1,478,758 $ 68,948 $ 1,565,665 5,666 2,783 2,794 11,243 1,219 3,086 28,482 3,376 1,345 613 5,334 5,220 697 — 39,733 — 39,733 $ 3,942 239 — 4,181 973 1,770 11,949 341 207 392 940 2,849 1,417 123 17,278 — 17,278 $ — — — — — — — — 15 759 774 957 117 4 1,852 — 1,852 $ 9,608 3,022 2,794 15,424 2,192 4,856 40,431 3,717 1,567 1,764 7,048 9,026 2,231 127 58,863 — 58,863 $ 278,565 79,495 79,159 437,219 532,190 175,441 2,623,608 419,271 159,233 59,097 637,601 690,492 113,339 2,256 4,067,296 46,408 4,113,704 $ 41,547 16,679 16,589 74,815 15,222 2,497 161,482 564 1,337 30 1,931 30,953 976 — 195,342 — 195,342 $ 329,720 99,196 98,542 527,458 549,604 182,794 2,825,521 423,552 162,137 60,891 646,580 730,471 116,546 2,383 4,321,501 46,408 4,367,909 Total loans $ If interest on non-accrual loans had been accrued, such income would have approximated $12,378, $8,912 and $6,448 during the years ended December 31, 2011, 2010 and 2009, respectively. 80 Table of Contents FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share data) The Company considers impaired loans to include all loans risk rated doubtful, loans placed on non-accrual status and loans renegotiated in troubled debt restructurings with the exception of consumer loans. The following tables present information on the Company’s recorded investment in impaired loans as of dates indicated: As of December 31, 2011 Unpaid Total Principal Balance Recorded Investment With No Allowance Recorded Investment With Allowance Total Recorded Investment Related Allowance Real estate: Commercial Construction: Land acquisition & development Residential Commercial Total construction loans Residential Agricultural Total real estate loans Commercial Agricultural Total Real estate: Commercial Construction: Land acquisition & development Residential Commercial Total construction loans Residential Agricultural Total real estate loans Commercial Agricultural Total $ 97,745 $ 62,769 $ 23,218 $ 85,987 $ 73,258 13,721 26,647 113,626 18,305 8,018 237,694 26,348 759 264,801 $ 22,300 10,427 3,510 36,237 2,678 7,470 109,154 7,354 496 117,004 $ 39,131 2,044 21,026 62,201 15,626 — 101,045 12,284 263 113,592 $ 61,431 12,471 24,536 98,438 18,304 7,470 210,199 19,638 759 230,596 $ 6,741 12,084 312 5,042 17,438 3,844 — 28,023 4,664 151 32,838 As of December 31, 2010 Unpaid Total Principal Balance Recorded Investment With No Allowance Recorded Investment With Allowance Total Recorded Investment Related Allowance 79,193 $ 31,925 $ 41,703 $ 73,628 $ 24,120 2,993 2,976 30,089 1,741 1,065 64,820 11,354 498 76,672 $ 20,440 13,721 13,578 47,739 7,110 1,432 97,984 24,168 478 122,630 $ 44,560 16,714 16,554 77,828 8,851 2,497 162,804 35,522 976 199,302 $ 48,371 18,632 17,458 84,461 8,951 3,045 175,650 36,251 976 212,877 $ 81 10,315 8,064 3,431 3,877 15,372 1,266 128 27,081 14,892 253 42,226 $ $ $ Table of Contents FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share data) The following table presents the average recorded investment in and income recognized on impaired loans for the periods indicated: Real estate: Commercial Construction: Land acquisition & development Residential Commercial Total construction loans Residential Agricultural Total real estate loans Commercial Agricultural Total December 31, 2011 Average Recorded Investment Income Recognized December 31, 2010 Average Recorded Investment $ 85,702 $ 57,675 19,769 20,676 98,120 15,768 6,188 205,778 31,490 907 238,175 $ $ 633 96 384 — 480 258 167 1,538 121 — 1,659 $ $ 49,713 34,871 15,097 21,086 71,054 10,889 1,737 133,393 22,017 974 156,384 As of December 31, 2009, the Company’s total recorded investment in impaired loans was $113,975, including $61,529 with no specific allowance for loan loss and $52,446 with an allowance for loan losses of $20,182. For the year ended December 31, 2009, the Company’s average recorded investment in impaired loans was $106,048. The amount of interest income recognized by the Company within the period that the loans were impaired was primarily related to loans modified in a troubled debt restructuring that remained on accrual status. Interest payments received on non-accrual impaired loans are applied to principle. Interest income is subsequently recognized only to the extent cash payments are received in excess of principle due. If interest on impaired loans had been accrued, interest income on impaired loans during 2011, 2010 and 2009 would have been approximately $12,231, $8,794 and $6,261, respectively. Collateralized impaired loans are generally recorded at the fair value of the underlying collateral using discounted cash flows, independent appraisals and management estimates based upon current market conditions. For loans measured under the present value of cash flows method, the change in present value attributable to the passage of time, if applicable, is recognized in the provision for loan losses and thus no interest income is recognized. Modifications of performing loans are made in the ordinary course of business and are completed on a case-by-case basis as negotiated with the borrower. Loan modifications typically include interest rate concessions, interest only periods of less than twelve months, short-term payment deferrals and extension of amortization periods to provide payment relief. A loan modification is considered a troubled debt restructuring if the borrower is experiencing financial difficulties and the Company, for economic or legal reasons, grants a concession to the borrower that it would not otherwise consider. Certain troubled debt restructurings are on non-accrual status at the time of restructuring and are typically returned to accrual status after considering the borrower's sustained repayment performance in accordance with the restructuring agreement for a period of at least six months and management is reasonably assured of future performance. If the troubled debt restructuring meets these performance criteria and the interest rate granted at the modification is equal to or greater than the rate that the Company was willing to accept at the time of the restructuring for a new loan with comparable risk, then the loan will return to performing status and the accrual of interest will resume. 82 Table of Contents FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share data) The Company had loans renegotiated in troubled debt restructurings of $94,827 as of December 31, 2011, of which $57,451 were included in non-accrual loans and $37,376 were on accrual status. The Company had loans renegotiated in troubled debt restructurings of $53,700 as of December 31, 2010, of which $40,210 were included in non-accrual loans and $13,490 were on accrual status. The Company had loans renegotiated in troubled debt restructurings of $11,413 as of December 31, 2009, of which $6,730 were included in non-accrual loans and $4,683 were on accrual status. The following table presents information on the Company's troubled debt restructurings that occurred during 2011: Real estate: Commercial Construction: Land acquisition & development Residential Total construction loans Residential Agriculture Total real estate loans Consumer: Indirect consumer Other consumer Total consumer loans Commercial Agriculture Total Number of Notes Interest only period Extension of terms or maturity Interest rate adjustment Other Type of Concession Principle Balance at Restructure Date 60 $ 23,982 $ 4,444 $ 3,131 $ 7,364 $ 9 5 14 6 7 87 2 3 5 40 5 137 995 7,749 8,744 9,771 3,594 46,091 17 17 11,727 $ 57,835 $ 4,124 878 5,002 364 517 10,327 11 11 428 24 10,790 $ 680 234 914 223 189 4,457 — 662 5,119 $ 408 — 408 590 240 8,602 29 50 79 2,555 163 11,399 $ 38,921 6,207 8,861 15,068 10,948 4,540 69,477 29 78 107 15,372 187 85,143 For troubled debt restructurings that were on non-accrual status or otherwise deemed impaired before the modification, a specific reserve may already be recorded. In periods subsequent to modification, the Company continues to evaluate all troubled debt restructurings for possible impairment and recognizes impairment through the allowance. Additionally these loans continue to work their way through the credit cycle through charge-off, pay-off or foreclosure. Financial effects of modifications of troubled debt restructurings may include principle loan forgiveness or other charge- offs directly related to the restructuring. Due to the types of the modifications made during 2011, which largely consisted of interest only period modifications, the Company had no charge-offs directly related to modifying troubled debt restructurings during 2011. 83 Table of Contents FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share data) The following table presents information on the Company's troubled debt restructurings during the previous 12 months for which there was a payment default during 2011. The Company considers a payment default to occur on troubled debt restructurings when the loan is 90 days or more past due or was placed on non-accrual status after the modification. Eighteen of the twenty troubled debt restructurings with payment defaults in the following table are on non-accrual status. Real estate: Commercial Construction: Land acquisition & development Residential Total construction loans Agriculture Total real estate loans Commercial Agricultural Total As of December 31, 2011 Number of Notes Balance 9 1 1 2 1 12 6 2 20 $ $ 2,747 1,135 170 1,305 33 4,085 213 24 4,322 At December 31, 2011, there were no material commitments to lend additional funds to borrowers whose existing loans have been renegotiated or are classified as non-accrual. As part of the on-going and continuous monitoring of the credit quality of the Company’s loan portfolio, management tracks internally assigned risk classifications of loans. The Company adheres to a Uniform Classification System developed jointly by the various bank regulatory agencies to internally risk rate loans. The Uniform Classification System defines three broad categories of criticized assets, which the Company uses as credit quality indicators: Other Assets Especially Mentioned — includes loans that exhibit weaknesses in financial condition, loan structure or documentation, which if not promptly corrected, may lead to the development of abnormal risk elements. Substandard — includes loans that are inadequately protected by the current sound worth and paying capacity of the borrower. Although the primary source of repayment for a Substandard is not currently sufficient; collateral or other sources of repayment are sufficient to satisfy the debt. Continuance of a Substandard loan is not warranted unless positive steps are taken to improve the worthiness of the credit. Doubtful — includes loans that exhibit pronounced weaknesses to a point where collection or liquidation in full, on the basis of currently existing facts, conditions and values, is highly questionable and improbable. Doubtful loans are required to be placed on non-accrual status and are assigned specific loss exposure. 84 Table of Contents FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share data) The following tables present the Company’s recorded investment in criticized loans by class and credit quality indicator based on the most recent analysis performed as of the dates indicated: As of December 31, 2011 Real estate: Commercial Construction: Land acquisition & development Residential Commercial Total construction loans Residential Agricultural Total real estate loans Consumer: Indirect consumer Other consumer Credit card Total consumer loans Commercial Agricultural Total As of December 31, 2010 Real estate: Commercial Construction: Land acquisition & development Residential Commercial Total construction loans Residential Agricultural Total real estate loans Consumer: Indirect consumer Other consumer Credit card Total consumer loans Commercial Agricultural Total Other Assets Especially Mentioned Substandard Doubtful Total Criticized Loans $ 129,046 $ 153,320 $ 25,087 $ 37,294 9,448 — 46,742 8,149 16,037 199,974 1,141 745 — 1,886 34,698 4,345 240,903 $ 31,873 5,528 2,620 40,021 15,706 18,498 227,545 1,729 1,361 486 3,576 33,478 5,195 269,794 $ 38,761 2,044 21,916 62,721 15,140 395 103,343 247 674 2,789 3,710 12,849 263 120,165 $ $ 307,453 107,928 17,020 24,536 149,484 38,995 34,930 530,862 3,117 2,780 3,275 9,172 81,025 9,803 630,862 Other Assets Especially Mentioned Substandard Doubtful Total Criticized Loans $ 133,700 $ 149,604 $ 41,662 $ 73,151 9,083 9,025 91,259 13,889 12,683 251,531 768 903 — 1,671 47,307 5,416 305,925 $ 36,552 9,842 18,611 65,005 18,725 20,885 254,219 1,964 1,499 571 4,034 39,145 6,255 303,653 $ 21,795 13,721 13,598 49,114 11,474 1,432 103,682 315 1,131 3,467 4,913 24,280 478 133,353 $ $ 85 324,966 131,498 32,646 41,234 205,378 44,088 35,000 609,432 3,047 3,533 4,038 10,618 110,732 12,149 742,931 Table of Contents FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share data) The Company maintains a credit review function, which is independent of the credit approval process, to assess assigned internal risk classifications and monitor compliance with internal lending policies and procedures. Written action plans with firm target dates for resolution of identified problems are maintained and reviewed on a quarterly basis for all categories of criticized loans. (4) ALLOWANCE FOR LOAN LOSSES The following table presents a summary of changes in the allowance for loan losses by portfolio segment: Year ended December 31, 2011 Allowance for loan losses: Beginning balance Provision charged to operating expense Less loans charged-off Add back recoveries of loans previously charged-off Ending balance Individually evaluated for impairment Collectively evaluated for impairment Ending balance Total loans: Individually evaluated for impairment Collectively evaluated for impairment Total loans Year ended December 31, 2010 Allowance for loan losses: Beginning balance Provision charged to operating expense Less loans charged-off Add back recoveries of loans previously charged-off Ending balance Individually evaluated for impairment Collectively evaluated for impairment Ending balance Total loans: Individually evaluated for impairment Collectively evaluated for impairment Total loans $ $ $ $ $ $ $ $ $ $ $ $ Real Estate Consumer Commercial Agriculture Other Total 84,181 $ 46,844 (45,764) 2,135 87,396 $ 28,023 $ 59,373 87,396 $ 9,332 $ 3,566 (6,043) 1,739 8,594 $ — $ 8,594 8,594 $ 25,354 $ 7,959 (19,332) 1,344 15,325 $ 4,664 $ 10,661 15,325 $ 1,613 $ (218) (142) 13 1,266 $ 151 $ 1,115 1,266 $ — $ — — — — $ — $ — — $ 120,480 58,151 (71,281) 5,231 112,581 32,838 79,743 112,581 210,199 $ 2,544,495 2,754,694 $ — $ 616,071 616,071 $ 19,638 $ 673,623 693,261 $ 759 $ 118,951 119,710 $ — $ 2,813 2,813 $ 230,596 3,955,953 4,186,549 Real Estate Consumer Commercial Agriculture Other Total 76,357 $ 42,163 (34,718) 379 84,181 $ 27,081 $ 57,100 84,181 $ 6,220 $ 8,636 (7,577) 2,053 9,332 $ — $ 9,332 9,332 $ 18,608 $ 16,333 (10,023) 436 25,354 $ 14,892 $ 10,462 25,354 $ 1,845 $ (232) (21) 21 1,613 $ 253 $ 1,360 1,613 $ — $ — — — — $ — $ — — $ 103,030 66,900 (52,339) 2,889 120,480 42,226 78,254 120,480 162,804 $ 2,709,125 2,871,929 $ — $ 646,580 646,580 $ 35,522 $ 694,949 730,471 $ 976 $ 115,570 116,546 $ — $ 2,383 2,383 $ 199,302 4,168,607 4,367,909 86 Table of Contents FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share data) The Company performs a quarterly assessment of the adequacy of its allowance for loan losses in accordance with generally accepted accounting principles. The methodology used to assess the adequacy is consistently applied to the Company's loan portfolio and consists of three elements: (1) specific valuation allowances based on probable losses on impaired loans; (2) historical valuation allowances based on loan loss experience for similar loans with similar characteristics and trends; and (3) general valuation allowances determined based on changes in the nature of the loan portfolio, overall portfolio quality, industry concentrations, delinquency trends, general economic conditions and other qualitative risk factors both internal and external to the Company. Specific allowances are established for loans where management has determined that probability of a loss exists by analyzing the borrower’s ability to repay amounts owed, collateral deficiencies and any relevant qualitative or environmental factors impacting the loan. Historical valuation allowances are determined by applying percentage loss factors to the credit exposures from outstanding loans. For commercial, agricultural and real estate loans, loss factors are applied based on the internal risk classifications of these loans. For consumer loans, loss factors are applied on a portfolio basis. For commercial, agriculture and real estate loans, loss factor percentages are based on a migration analysis of our historical loss experience, designed to account for credit deterioration. For consumer loans, loss factor percentages are based on a one-year loss history. General valuation allowances are determined by evaluating, on a quarterly basis, changes in the nature and volume of the loan portfolio, overall portfolio quality, industry concentrations, current economic and regulatory factors and the estimated impact of current economic, environmental and regulatory conditions on historical loss rates. The following table presents a summary of changes in the allowance for loan losses for 2009: Year ended December 31, Balance at beginning of year Provision charged to operating expense Less loans charged-off Add back recoveries of loans previously charged-off Balance at end of year (5) PREMISES AND EQUIPMENT Premises and equipment and related accumulated depreciation are as follows: December 31, Land Buildings and improvements Furniture and equipment Less accumulated depreciation Premises and equipment, net 2009 87,316 45,300 (31,978) 2,392 103,030 $ $ 2011 2010 $ $ 38,743 188,509 63,939 291,191 (106,420) 184,771 $ $ 35,573 185,606 61,689 282,868 (94,730) 188,138 The Parent Company and a FIB branch office lease premises from an affiliated partnership. See Note 16—Commitments and Contingencies. 87 Table of Contents FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share data) (6) COMPANY-OWNED LIFE INSURANCE Company-owned life insurance consists of the following: December 31, Key executive, principal shareholder Key executive split dollar Group life Total 2011 2010 4,800 4,441 65,639 74,880 $ $ 4,680 4,330 64,046 73,056 $ $ The Company maintains key executive life insurance policies on certain principal shareholders. Under these policies, the Company receives benefits payable upon the death of the insured. The net cash surrender value of key executive, principal shareholder insurance policies was $4,800 and $4,680 at December 31, 2011 and 2010, respectively. The Company also has life insurance policies covering selected other key officers. The net cash surrender value of these policies was $4,441 and $4,330 at December 31, 2011 and 2010, respectively. Under these policies, the Company receives benefits payable upon death of the insured. An endorsement split dollar agreement has been executed with the selected key officers whereby a portion of the policy death benefit is payable to their designated beneficiaries. The endorsement split dollar agreement will provide postretirement coverage for those selected key officers meeting specified retirement qualifications. The Company expenses the earned portion of the post-employment benefit through the vesting period. The Company has a group life insurance policy covering selected officers of FIB. The net cash surrender value of the policy was $65,639 and $64,046 at December 31, 2011 and 2010, respectively. Under the policy, the Company receives benefits payable upon death of the insured. An endorsement split dollar agreement has been executed with the insured officers whereby a portion of the policy death benefit is payable to their designated beneficiaries if they are employed by the Company at the time of death. (7) OTHER REAL ESTATE OWNED Information with respect to the Company’s other real estate owned follows: Year Ended December 31, Balance at beginning of year Additions Capitalized improvements Valuation adjustments Dispositions Balance at end of year 2011 2010 2009 $ $ 33,632 26,644 14 (7,464) (15,374) 37,452 $ $ 38,400 21,314 240 (6,724) (19,598) 33,632 $ $ 6,025 42,212 6,515 (5,545) (10,807) 38,400 Write-downs of $7,464 during 2011 included adjustments of $4,197 directly related to receipt of updated appraisals and adjustments of $3,267 based on management estimates of the current fair value of properties. Write-downs of $6,724 during 2010 included adjustments of $2,491 directly related to receipt of updated appraisals and adjustments of $4,233 based on management estimates of the current fair value of properties. 88 Table of Contents FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share data) (8) MORTGAGE SERVICING RIGHTS Information with respect to the Company’s mortgage servicing rights follows: Year Ended December 31, Balance at beginning of year Sales of mortgage servicing rights Purchases of mortgage servicing rights Originations of mortgage servicing rights Amortization expense Write-off of permanent impairment Balance at end of year Less valuation reserve Balance at end of year Principal balance of serviced loans underlying mortgage servicing rights Mortgage servicing rights as a percentage of serviced loans 2011 2010 2009 $ $ $ 13,811 — — 2,864 (3,225) — 13,450 (1,895) 11,555 1,803,303 0.64% $ $ $ 18,732 (4,528) — 4,222 (4,615) — 13,811 (620) 13,191 1,594,697 0.83% $ $ $ 27,788 (3,022) 8 9,681 (7,568) (8,155) 18,732 (1,407) 17,325 2,394,331 0.72% At December 31, 2011, the estimated fair value and weighted average remaining life of the Company’s mortgage servicing rights were $11,910 and 3.6 years, respectively. The fair value of mortgage servicing rights was determined using discount rates ranging from 8.5% to 21.0% and monthly prepayment speeds ranging from 1.0% to 6.2% depending upon the risk characteristics of the underlying loans. The Company recorded additional impairment of $1,275 in 2011 and recorded impairment reversals of $787 and $7,224 in 2010 and 2009, respectively. Permanent impairment of $8,155 was charged against the carrying value of mortgage servicing rights in 2009. No permanent impairment was recorded in 2011 or 2010. The Company sold mortgage servicing rights with a carrying value of $4,528 and $3,022 in 2010 and 2009, respectively. Losses of $1,525 and $48 on the sales were recorded as other expense in 2010 and 2009, respectively. In conjunction with the sales, the Company entered into agreements with the purchaser whereby the Company continues to sub-service the loans underlying the sold mortgage servicing rights. (9) DEPOSITS Deposits are summarized as follows: December 31, Non-interest bearing demand Interest bearing: Demand Savings Time, $100 and over Time, other Total interest bearing Total deposits 2011 2010 $ 1,271,709 $ 1,063,869 1,306,509 1,691,413 681,047 876,293 4,555,262 5,826,971 $ 1,218,078 1,718,521 908,044 1,017,201 4,861,844 5,925,713 $ The Company had no brokered time deposits as of December 31, 2011 and 2010. Other time deposits include deposits obtained through the Company’s participation in the Certificate of Deposit Account Registry Service (“CDARS”). CDARS deposits totaled $98,331 and $139,431 as of December 31, 2011 and 2010, respectively. 89 Table of Contents FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share data) Maturities of time deposits at December 31, 2011 are as follows: 2012 2013 2014 2015 2016 Thereafter Total Time, $100 and Over Total Time 519,550 95,794 22,571 19,140 23,992 — 681,047 $ $ 1,152,712 232,999 60,102 53,898 57,540 89 1,557,340 $ $ Interest expense on time deposits of $100 or more was $10,377, $18,595 and $25,212 for the years ended December 31, 2011, 2010 and 2009, respectively. (10) LONG-TERM DEBT AND OTHER BORROWED FUNDS A summary of long-term debt follows: December 31, Parent Company: 6.81% subordinated term loan maturing January 9, 2018, principal due at maturity, interest payable quarterly Subsidiaries: Variable rate subordinated term loan maturing February 28, 2018, principal due at maturity, interest payable quarterly (rate of 2.52% at December 31, 2011) Various notes payable to FHLB, interest due monthly at various rates and maturities through October 31, 2015 (weighted average rate of 4.83% at December 31, 2011) 8.00% capital lease obligation with term ending October 25, 2029 Total long-term debt Maturities of long-term debt at December 31, 2011 are as follows: 2012 2013 2014 2015 2016 Thereafter Total $ $ 2011 2010 20,000 $ 20,000 15,000 425 1,775 37,200 $ $ $ 15,000 690 1,812 37,502 40 244 49 285 65 36,517 37,200 On January 10, 2008, the Company borrowed $20,000 on a 6.81% unsecured subordinated term loan maturing January 9, 2018, with interest payable quarterly and principal due at maturity. The unsecured subordinated term loan qualifies as tier 2 capital under regulatory capital adequacy guidelines. During February 2008, the Company borrowed $15,000 on a variable rate unsecured subordinated term loan maturing February 28, 2018, with interest payable quarterly and principal due at maturity. The Company may elect at various dates either prime or LIBOR plus 2.00%. The interest rate on the subordinated term loan was 2.52% as of December 31, 2011. The unsecured subordinated term loan qualifies as tier 2 capital under regulatory capital adequacy guidelines. 90 Table of Contents FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share data) The notes payable to FHLB are secured by a blanket assignment of the Company’s qualifying residential and commercial real estate loans. The Company has available lines of credit with the FHLB of approximately $143,069, subject to collateral availability. As of December 31, 2011 and 2010, FHLB advances of $425 and $690, respectively, were included in long-term debt. As of December 31, 2011 and December 31, 2010 there were no short-term advances outstanding with the FHLB. The Company has a capital lease obligation on a banking office. The balance of the obligation was $1,775 and $1,812 as of December 31, 2011 and 2010, respectively. Assets acquired under capital lease, consisting solely of a building and leasehold improvements, are included in premises and equipment and are subject to depreciation. The Company had other borrowed funds of $7 and $4,991 as of December 31, 2011 and 2010, respectively, consisting of demand notes issued to the United States Treasury, secured by investment securities and bearing no interest. The Company has federal funds lines of credit with third parties amounting to $115,000, subject to funds availability. These lines are subject to cancellation without notice. The Company also has a line of credit with the Federal Reserve Bank for borrowings up to $301,948 secured by a blanket pledge of indirect consumer loans. (11) SUBORDINATED DEBENTURES HELD BY SUBSIDIARY TRUSTS The Company sponsors seven wholly-owned business trusts, FIST, Trust I, Trust II, Trust III, Trust IV, Trust V and Trust VI (collectively, the “Trusts”). The Trusts were formed for the exclusive purpose of issuing an aggregate of $120,000 of 30-year floating rate mandatorily redeemable capital trust preferred securities (“Trust Preferred Securities”) to third-party investors. The Trusts also issued, in aggregate, $3,715 of common equity securities to the Parent Company. Proceeds from the issuance of the Trust Preferred Securities and common equity securities were invested in 30-year junior subordinated deferrable interest debentures (“Subordinated Debentures”) issued by the Parent Company. A summary of Subordinated Debenture issuances follows: Issuance Maturity Date March 2003 October 2007 November 2007 December 2007 December 2007 January 2008 January 2008 Total subordinated debentures held by subsidiary trusts March 26, 2033 January 1, 2038 December 15, 2037 December 15, 2037 April 1, 2038 April 1, 2038 April 1, 2038 Principal Amount Outstanding as of December 31, 2011 2010 41,238 10,310 15,464 20,619 15,464 10,310 10,310 123,715 $ $ 41,238 10,310 15,464 20,619 15,464 10,310 10,310 123,715 $ $ In March 2003, the Company issued $41,238 of Subordinated Debentures to FIST. The Subordinated Debentures bear a cumulative floating interest rate equal to LIBOR plus 3.15% per annum. As of December 31, 2011 the interest rate on the Subordinated Debentures was 3.72%. In October 2007, the Company issued $10,310 of Subordinated Debentures to Trust II. The Subordinated Debentures bear a cumulative floating interest rate equal to LIBOR plus 2.25% per annum. As of December 31, 2011 the interest rate on the Subordinated Debentures was 2.62%. In November 2007, the Company issued $15,464 of Subordinated Debentures to Trust I. The Subordinated Debentures bear interest at a fixed rate of 7.50% for five years after issuance, and thereafter at a variable rate equal to LIBOR plus 2.75% per annum. 91 Table of Contents FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share data) In December 2007, the Company issued $20,619 of Subordinated Debentures to Trust III. The Subordinated Debentures bear interest at a fixed rate of 6.88% for five years after issuance, and thereafter at a variable rate equal to LIBOR plus 2.40% per annum. In December 2007, the Company issued $15,464 of Subordinated Debentures to Trust IV. The Subordinated Debentures bear a cumulative floating interest rate equal to LIBOR plus 2.70% per annum. As of December 31, 2011 the interest rate on the Subordinated Debentures was 3.07%. In January 2008, the Company issued $10,310 of Subordinated Debentures to Trust V. The Subordinated Debentures bear interest at a fixed rate of 6.78% for five years after issuance, and thereafter at a variable rate equal to LIBOR plus 2.75% per annum. In January 2008, the Company issued $10,310 of Subordinated Debentures to Trust VI. The Subordinated Debentures bear a cumulative floating interest rate equal to LIBOR plus 2.75% per annum. As of December 31, 2011, the interest rate on the Subordinated Debentures was 3.12%. The Subordinated Debentures are unsecured with interest distributions payable quarterly. The Company may defer the payment of interest at any time provided that the deferral period does not extend past the stated maturity. During any such deferral period, distributions on the Trust Preferred Securities will also be deferred and the Company’s ability to pay dividends on its common and preferred shares is restricted. The Subordinated Debentures may be redeemed, subject to approval by the Federal Reserve Bank, at the Company’s option on or after five years from the date of issue, or at any time in the event of unfavorable changes in laws or regulations. Debt issuance costs consisting primarily of underwriting discounts and professional fees were capitalized and are being amortized through maturity to interest expense using the straight-line method, which approximates level yield. The terms of the Trust Preferred Securities are identical to those of the Subordinated Debentures. The Trust Preferred Securities are subject to mandatory redemption upon repayment of the Subordinated Debentures at their stated maturity dates or earlier redemption in an amount equal to their liquidation amount plus accumulated and unpaid distributions to the date of redemption. The Company guarantees the payment of distributions and payments for redemption or liquidation of the Trust Preferred Securities to the extent of funds held by the Trusts. Subject to certain limitations, the Trust Preferred Securities qualify as tier 1 capital of the Parent Company under the Federal Reserve Board’s capital adequacy guidelines. Proceeds from the issuance of the Trust Preferred Securities were used to fund acquisitions. (12) CAPITAL STOCK AND DIVIDEND RESTRICTIONS The Company has 5,000 shares of 6.75% Series A noncumulative redeemable preferred stock (“Series A Preferred Stock”) issued with an aggregate value of $50,000. The Series A Preferred Stock ranks senior to the Company’s common stock with respect to dividend and liquidation rights and has no voting rights. Holders of the Series A Preferred Stock are entitled to receive, if and when declared, noncumulative dividends at an annual rate of $675 per share, based on a 360 day year. The Company may redeem all or part of the Series A Preferred Stock at any time after January 10, 2013 at a redemption price of $10,000 per share plus all accrued and unpaid dividends. After January 10, 2018, the Series A Preferred Stock may be converted, at the option of the holder, into shares of the Company’s Class B common stock at a ratio of 320 shares of common stock for every one share of Series A Preferred Stock. On March 5, 2010, the Company’s shareholders approved proposals to recapitalize the Company’s existing common stock. The recapitalization included a redesignation of existing common stock as Class B common stock with five votes per share, convertible into Class A common stock on a share for share basis; a four-for-one stock split of the Class B common stock; an increase in the authorized number of Class B common shares from 20,000,000 to 100,000,000; and, the creation of a new class of common stock designated as Class A common stock, with one vote per share, with 100,000,000 shares authorized. 92 Table of Contents FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share data) On March 29, 2010, the Company concluded its initial public offering (“IPO”) of 10,000,000 shares of Class A common stock, and an additional 1,500,000 shares of Class A common stock pursuant to the full exercise of the underwriters’ option to purchase Class A common shares in the offering. The Company received net proceeds of $153,153 from the sale of the shares, after deducting the underwriting discount, commissions and other offering expenses. The Company had 16,443,429 and 15,598,632 shares of Class A common stock outstanding as of December 31, 2011 and 2010, respectively. The Company had 26,540,745 and 27,202,062 shares of Class B common stock outstanding as of December 31, 2011 and 2010, respectively. The payment of dividends by subsidiary banks is subject to various federal and state regulatory limitations. In general, a bank is limited, without the prior consent of its regulators, to paying dividends that do not exceed current year net profits together with retained earnings from the two preceding calendar years. The Company’s debt instruments also include limitations on the payment of dividends. (13) EARNINGS PER COMMON SHARE Basic earnings per common share is calculated by dividing net income by the weighted average number of common shares outstanding during the period presented, excluding unvested restricted stock. Diluted earnings per share is calculated by dividing net income by the weighted average number of common shares determined for the basic earnings per share computation plus the dilutive effects of stock-based compensation using the treasury stock method. The following table sets forth the computation of basic and diluted earnings per common share: Year Ended December 31, Net income Less preferred stock dividends Net income available to common shareholders, basic and diluted Weighted average common shares outstanding for basic earnings per share computation Dilutive effects of stock-based compensation Weighted average common shares outstanding for diluted earnings per common share computation Basic earnings per common share Diluted earnings per common share 2011 2010 2009 $ $ $ $ 44,546 3,422 41,124 42,749,526 97,670 42,847,196 0.96 0.96 $ $ $ $ 37,356 3,422 33,934 39,907,640 219,725 40,127,365 0.85 0.85 $ $ $ $ 53,863 3,422 50,441 31,335,668 342,832 31,678,500 1.61 1.59 The Company had 2,865,832, 2,301,413 and 1,933,532 stock options outstanding as of December 31, 2011, 2010 and 2009, respectively, that were not included in the computation of diluted earnings per common share because their effect would be anti-dilutive. The Company had 9,427, 17,644 and 24,656 shares of unvested restricted stock as of December 31, 2011, 2010 and 2009, respectively, that were not included in the computation of diluted earnings per common share because performance conditions for vesting had not been met. 93 Table of Contents FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share data) (14) REGULATORY CAPITAL The Company is subject to the regulatory capital requirements administered by federal banking regulators and the Federal Reserve. Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company must meet specific capital guidelines that involve quantitative measures of the Company’s assets, liabilities and certain off- balance sheet items as calculated under regulatory accounting practices. The Parent Company, like all bank holding companies, is not subject to the prompt corrective action provisions. Capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Company to maintain minimum amounts and ratios of total and tier 1 capital to risk-weighted assets, and of tier 1 capital to average assets, as defined in the regulations. As of December 31, 2011, the Company exceeded all capital adequacy requirements to which it is subject. The Company’s actual capital amounts and ratios and selected minimum regulatory thresholds and prompt corrective action provisions as of December 31, 2011 and 2010 are presented in the following table: Actual Adequately Capitalized Well Capitalized Amount Ratio Amount Ratio Amount Ratio December 31, 2011 Total risk-based capital: Consolidated FIB Tier 1 risk-based capital: Consolidated FIB Leverage capital ratio: Consolidated FIB December 31, 2010 Total risk-based capital: Consolidated FIB Tier 1 risk-based capital: Consolidated FIB Leverage capital ratio: Consolidated FIB $ $ 800,354 663,860 704,229 588,059 704,229 588,059 16.5% 13.8 $ 14.6 12.2 9.8 8.2 387,082 384,987 193,541 192,494 286,303 285,358 Actual Adequately Capitalized Amount Ratio Amount Ratio 772,337 634,976 674,319 557,261 674,319 557,261 398,720 396,754 199,360 198,377 291,023 290,071 15.5% 12.8 $ 13.5 11.2 9.3 7.7 94 8.0% 8.0 4.0 4.0 4.0 4.0 8.0% 8.0 4.0 4.0 4.0 4.0 $ $ $ $ $ $ NA NA 481,234 10.0% NA NA 288,740 NA NA 356,698 Well Capitalized Amount Ratio 6.0 5.0 NA NA 495,943 10.0% NA NA 297,566 NA NA 362,589 6.0 5.0 Table of Contents FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share data) (15) COMMITMENTS AND CONTINGENCIES In the normal course of business, the Company is involved in various claims and litigation. In the opinion of management, following consultation with legal counsel, the ultimate liability or disposition thereof is not expected to have a material adverse effect on the consolidated financial condition, results of operations or liquidity of the Company. The Company had commitments under construction contracts of $4,006 as of December 31, 2011. The Company had commitments to purchase held-to-maturity municipal investment securities of $1,916 as of December 31, 2011. The Company leases certain premises and equipment from third parties under operating leases. Total rental expense to third parties was $2,030 in 2011, $1,960 in 2010 and $2,425 in 2009. The total future minimum rental commitments, exclusive of maintenance and operating costs, required under operating leases that have initial or remaining noncancelable lease terms in excess of one year at December 31, 2011, are as follows: For the year ending December 31: 2012 2013 2014 2015 2016 Thereafter Total Third Parties Related Partnership Total $ $ 1,008 922 835 812 745 4,572 8,894 $ $ 2,071 1,916 1,755 1,199 — — 6,941 $ $ 3,079 2,838 2,590 2,011 745 4,572 15,835 The Parent Company and the Billings office of FIB are the anchor tenants in a building owned by a partnership in which FIB is one of two partners, and has a 50% partnership interest. In 2008, Visa, Inc. completed a restructuring and issued shares of Class B Visa, Inc. common stock to its financial members, including 60,108 shares to the Company. In September 2009, the Company sold all of its Visa Class B shares for $2,128. In conjunction with the sale, the Company entered into a derivative contract whereby the Company will make or receive payments based on subsequent changes in the conversion rate of Class B Visa common shares in Class A Visa common shares, which is subject to adjustment depending on the outcome of certain specifically defined litigation against Visa, Inc. The value of the derivative liability contract is estimated based on the Company's expectations regarding the ultimate resolution of the Visa, Inc. litigation, which involves a high degree of judgment and subjectivity. This litigation had not been resolved as of December 31, 2011. As of December 31, 2011 and 2010, a liability of $383 and $86, respectively, related to the derivative contract is included in accounts payable and accrued expenses. The derivative contract is collateralized by $1,021 of U.S. government agency investment securities. Residential mortgage loans sold to investors in the secondary market are sold with varying recourse provisions. Essentially all of the loan sales agreements require the repurchase of a mortgage loan by the seller in situations such as breach of representation, warranty or covenant; untimely document delivery; false or misleading statements; failure to obtain certain certificates or insurance; unmarketability; etc. Certain loan sales agreements contain repurchase requirements based on payment-related defects that are defined in terms of the number of days or months since the purchase, the sequence number of the payment, and/or the number of days of payment delinquency. Based on the specific terms stated in the agreements, the Company had $13,839 and $18,122 of sold residential mortgage loans with recourse provisions still in effect as of December 31, 2011 and 2010, respectively. The Company did not repurchase any significant amount of loans from secondary market investors under the terms of loan sales agreements during the years ended December 31, 2011, 2010 and 2009. In the opinion of management, the risk of recourse and the subsequent 95 Table of Contents FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share data) requirement of loan repurchase to the Company is not significant, and accordingly no liabilities have been established related to such. In addition, the Company issues various representations and warranties associated with the sale of loans. The Company has not incurred significant losses resulting from these provisions. (16) FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of amounts recorded in the consolidated balance sheet. The Company evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained is based on management’s credit evaluation of the customer. Collateral held varies but may include accounts receivable, inventory, premises and equipment, and income-producing commercial properties. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the commitment contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Generally, commitments to extend credit are subject to annual renewal. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Commitments to extend credit to borrowers approximated $1,049,796 at December 31, 2011, which included $285,761 on unused credit card lines and $283,861 with commitment maturities beyond one year. Commitments to extend credit to borrowers approximated $1,038,979 at December 31, 2010, which included $270,142 on unused credit card lines and $232,795 with commitment maturities beyond one year. Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Most commitments extend for no more than two years and are generally subject to annual renewal. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. At December 31, 2011 and 2010, the Company had outstanding stand-by letters of credit of $69,934 and $85,543, respectively. The estimated fair value of the obligation undertaken by the Company in issuing standby letters of credit is included in accounts payable and accrued expenses in the Company’s consolidated balance sheets. (17) INCOME TAXES Income tax expense consists of the following: Year ended December 31, Current: Federal State Total current Deferred: Federal State Total deferred Total income tax expense 2011 2010 2009 $ $ 16,451 2,759 19,210 2,131 274 2,405 21,615 $ $ 29,866 4,481 34,347 (15,268) (1,989) (17,257) 17,090 $ $ 18,691 2,715 21,406 4,846 701 5,547 26,953 96 Table of Contents FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share data) Total income tax expense differs from the amount computed by applying the statutory federal income tax rate of 35 percent in 2011, 2010 and 2009 to income before income taxes as a result of the following: Year ended December 31, Tax expense at the statutory tax rate Increase (decrease) in tax resulting from: Tax-exempt income State income tax, net of federal income tax benefit Other, net Tax expense at effective tax rate 2011 2010 2009 23,156 $ 19,056 $ (3,578) 1,972 65 21,615 $ (3,661) 1,619 76 17,090 $ 28,286 (3,784) 2,225 226 26,953 $ $ The tax effects of temporary differences between the financial statement carrying amounts and tax bases of assets and liabilities that give rise to significant portions of the net deferred tax asset (liability) relate to the following: December 31, Deferred tax assets: Loans, principally due to allowance for loan losses Employee benefits Other real estate owned write-downs and carrying costs Deferred gain on sale of subsidiary Other Deferred tax assets Deferred tax liabilities: Fixed assets, principally differences in bases and depreciation Investment securities, unrealized gains Investment in joint venture partnership, principally due to differences in depreciation of partnership assets Prepaid amounts Government agency stock dividends Goodwill and core deposit intangibles Mortgage servicing rights Other Deferred tax liabilities Net deferred tax assets 2011 2010 42,602 7,659 7,444 1,010 428 59,143 (4,284) (13,091) (855) (921) (2,079) (22,736) (4,150) (1,399) (49,515) 9,628 $ $ 46,623 7,182 3,170 1,263 400 58,638 (4,467) (6,652) (735) (789) (2,081) (19,044) (4,761) (1,637) (40,166) 18,472 $ $ As of December 31, 2011, the Company had a net deferred tax asset of $9,628. The Company had a current net income tax payable of $489 and a current net income tax receivable of $1,764 at December 31, 2011 and 2010, respectively, which are included in accounts payable and accrued expenses. (18) STOCK-BASED COMPENSATION The Company has equity awards outstanding under two stock-based compensation plans; the 2006 Equity Compensation Plan (the “2006 Plan”) and the 2001 Stock Option Plan. These plans were primarily established to enhance the Company’s ability to attract, retain and motivate employees. The Company’s Board of Directors or, upon delegation, the Compensation Committee of the Board of Directors (“Compensation Committee”) has exclusive authority to select employees, advisors and others, including directors, to receive awards and to establish the terms and conditions of each award made pursuant to the Company’s stock-based compensation plans. 97 Table of Contents FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share data) The 2006 Plan, approved by the Company’s shareholders in May 2006, was established to consolidate into one plan the benefits available under the 2001 Stock Option Plan and all other then existing share-based award plans (collectively, the “Previous Plans”). The Previous Plans continue with respect to awards made prior to May 2006. All shares of common stock available for future grant under the Previous Plans were transferred into the 2006 Plan. At December 31, 2011, there were 854,739 common shares available for future grant under the 2006 Plan. All awards granted subsequent to completion of the Company’s IPO on March 29, 2010 will be for shares of Class A common stock. All awards granted prior to the Company’s IPO are for shares of Class B common stock. Stock Options. All options granted have an exercise price equal to fair market value, which is currently defined as the closing sales price for the stock as quoted on the NASDAQ Stock Market for the last market trading day preceding the date that the Company’s Board of Directors awards the benefit. Options may be subject to vesting as determined by the Company's Board of Directors or Compensation Committee, and can be exercised for periods of up to ten years from the date of grant. Compensation expense related to stock option awards of $915, $813 and $588 was included in salaries, wages and benefits expense on the Company’s consolidated income statements for the years ended December 31, 2011, 2010 and 2009, respectively. Related income tax benefits recognized for the years ended December 31, 2011, 2010 and 2009 were $349, $311 and $225, respectively. The weighted average grant date fair value of options granted was $4.30, $4.58 and $1.01 during the years ended December 31, 2011, 2010 and 2009, respectively. The fair value of each option award is estimated on the date of grant using the Black-Scholes option pricing model. The following table presents the weighted-average assumptions used in the option pricing model for the periods indicated: Years ended December 31, Expected volatility Expected dividend yield Risk-free interest rate Expected life of options (in years) 2011 2010 2009 36.36% 3.17% 3.05% 8.0 35.66% 2.98% 3.08% 7.7 9.58% 3.28% 2.64% 7.7 Expected dividend yield is based on the Company’s annualized expected dividends per share divided by the average common stock price. Risk-free interest rate is based on the U.S. treasury constant maturity yield for treasury securities with maturities approximating the expected life of the options granted on the date of grant. The 2011 and 2010 expected life of options is based on the Company’s historical exercise and post-vesting termination behaviors. Prior to 2010, the Company elected to use the “simplified” method to estimate expected life. The Company expected the historical volatility of its common stock would not be indicative of future volatility subsequent to the Company’s IPO, which was concluded on March 29, 2010. As such, in 2011 and 2010 the Company estimated expected volatility based on the share price volatility of a peer group of publicly-traded regional banks of similar size and performance as the Company over the expected life of options. Prior to 2010, expected volatility was based on the historical volatility of the Company’s common stock calculated using the quarterly appraised value of a minority interest over the expected life of options. 98 Table of Contents FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share data) The following table summarizes stock option activity under the Company’s active stock option plans for the year ended December 31, 2011: Outstanding options, beginning of year Granted Exercised Forfeited Expired Outstanding options, end of year Outstanding options exercisable, end of year Number of Shares Weighted-Average Exercise Price Weighted-Average Remaining Contract Life 3,584,852 359,729 (257,608) (54,500) (147,545) 3,484,928 2,896,755 $ $ $ 16.15 14.16 10.74 14.91 18.63 16.26 16.60 5.04 years 4.33 years The total intrinsic value of fully-vested stock options outstanding as of December 31, 2011 was $889. The total intrinsic value of options exercised was $764, $757 and $2,035 during the years ended December 31, 2011, 2010 and 2009, respectively. The actual tax benefit realized for the tax deduction from option exercises totaled $285, $250 and $733 for the years ended December 31, 2011, 2010 and 2009, respectively. The Company received cash of $385, $649 and $144 from stock option exercises during the years ended December 31, 2011, 2010 and 2009, respectively. The Company redeemed common stock with aggregate values of $2,381, $1,643 and $3,183 tendered in payment for stock option exercises during the years ended December 31, 2011, 2010 and 2009, respectively. Information with respect to the Company’s nonvested stock options as of and for the year ended December 31, 2011 follows: Nonvested stock options, beginning of year Granted Vested Forfeited Nonvested stock options, end of year Number of Shares 625,354 359,729 (342,347) (54,500) 588,236 Weighted-Average Grant Date Fair Value 2.46 4.30 2.09 3.42 3.71 $ $ As of December 31, 2011, there was $1,410 of unrecognized compensation cost related to nonvested stock options granted under the Company’s active stock option plans. That cost is expected to be recognized over a weighted-average period of 1.53 years. The total fair value of shares vested during 2011 was $713. Restricted Stock Awards. Common stock issued under the Company’s restricted stock plan may not be sold or otherwise transferred until restrictions have lapsed or performance objectives have been obtained. During the vesting periods, participants have voting rights and receive dividends on the restricted shares. Upon termination of employment, common shares upon which restrictions have not lapsed must be returned to the Company. Based on the substantive terms of each award, restricted shares are classified as equity or liability awards. The fair value of equity-classified restricted stock awards is being amortized as compensation expense on a straight-line basis over the period restrictions lapse or performance goals are met. Compensation cost for liability-classified awards is expensed each period from the date of grant to the measurement date based on the fair value of the Company’s common stock at the end of each period. Compensation expense related to restricted stock awards of $991, $847 and $436 was included in salaries, wages and benefits expense on the Company’s consolidated statements of income for the years ended December 31, 2011, 2010 and 2009, respectively. Related income tax benefits recognized for the years ended December 31, 2011, 2010 and 2009 were $379, $324 and $167, respectively. 99 Table of Contents FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share data) The following table presents information regarding the Company’s restricted stock as of December 31, 2011: Restricted stock, beginning of year Granted Vested Forfeited Canceled Restricted stock, end of year Number of Shares Weighted-Average Measurement Date Fair Value $ 155,410 130,904 (67,581) (22,527) (5,436) 190,770 $ 15.76 14.20 16.07 15.10 18.63 14.57 During 2011, the Company issued 130,904 restricted common shares as follows: 24,056 shares, of which 12,028 vest in varying percentages upon achievement of defined return on asset performance goals and 12,028 vest in varying percentages upon achievement of defined return on equity performance goals. All are contingent on employment as of December 31, 2013. Additionally, 106,848 shares were issued that vest one-third on each annual anniversary of the grant date through February 15, 2014 contingent on continued employment. As of December 31, 2011, there was $1,718 of unrecognized compensation cost related to nonvested restricted stock awards expected to be recognized over a period of 1.66 years. (19) EMPLOYEE BENEFIT PLANS Profit Sharing Plan. The Company has a noncontributory profit sharing plan. All employees, other than temporary employees, working 20 hours or more per week are eligible to participate in the profit sharing plan. The Company’s Board of Directors authorized quarterly contributions to the profit sharing plan that are not to exceed, on an individual basis, the lesser of 100% of compensation or $40 annually. Participants become 100% vested upon the completion of three years of vesting service. The Company accrued contribution expense for this plan of $1,480, $1,197 and $1,757 in 2011, 2010 and 2009, respectively. Savings Plan. In addition, the Company has a contributory employee savings plan. Eligibility requirements for this plan are the same as those for the profit sharing plan discussed in the preceding paragraph. Employee participation in the plan is at the option of the employee. The Company contributes $1.25 for each $1.00 of employee contributions up to 4% of the participating employee’s compensation. The Company accrued contribution expense for this plan of $3,905, $3,896 and $3,857 in 2011, 2010 and 2009, respectively. Postretirement Healthcare Plan. The Company sponsors a contributory defined benefit healthcare plan (the “Plan”) for active employees and employees and directors retiring from the Company at the age of at least 55 years and with at least 15 years of continuous service. Retired Plan participants contribute the full cost of benefits based on the average per capita cost of benefit coverage for both active employees and retired Plan participants. The Plan’s unfunded benefit obligation of $3,948 and $3,575 as of December 31, 2011 and 2010, respectively, is included in accounts payable and accrued expenses in the Company’s consolidated balance sheets. Net periodic benefit costs of $507, $502 and $194 for the years ended December 31, 2011, 2010 and 2009, respectively, are included in salaries, wages and employee benefits expense in the Company’s consolidated statements of income. Weighted average actuarial assumptions used to determine the postretirement benefit obligation at December 31, 2011 and 2010, and the net periodic benefit costs for the year then ended, included a discount rate of 5.3% and a 5.0% annual increase in the per capita cost of covered healthcare benefits. The estimated effect of a one percent increase or a one percent decrease in the assumed healthcare cost trend rate would not significantly impact the service and interest cost components of the net periodic benefit cost or the accumulated postretirement benefit obligation. Future benefit payments are expected to be $177, $176, $207, $195 $195 and $1,381 for 2012, 2013, 2014, 2015, 2016, and 2017 through 2021, respectively. 100 Table of Contents FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share data) At December 31, 2011, the Company had accumulated other comprehensive loss related to the Plan of $2,400, or $1,499 net of related income tax benefit, comprised of net actuarial losses of $1,932 and unamortized transition asset of $468. The Company estimates $135 will be amortized from accumulated other comprehensive loss into net period benefit costs in 2012. (20) OTHER COMPREHENSIVE INCOME Total comprehensive income is reported in the accompanying statements of changes in stockholders’ equity. Information related to net other comprehensive income is as follows: Year ended December 31, Other comprehensive income (loss): Investment securities available-for-sale: Change in net unrealized (loss) gain during the period Reclassification adjustment for gains included in income Unamortized premium on available-for-sale securities transferred into held-to-maturity Change in the net actuarial loss on defined benefit post-retirement benefit plans Deferred tax expense Net other comprehensive income (loss) The components of accumulated other comprehensive income, net of income taxes, are as follows: Year ended December 31, Net unrealized gain on investment securities available-for-sale Net actuarial loss on defined benefit post-retirement benefit plans Net accumulated other comprehensive income (21) NON-CASH INVESTING AND FINANCING ACTIVITIES 2011 2010 2009 $ $ 17,168 (1,544) 389 135 16,148 6,489 9,659 $ $ $ $ $ (8,438) (170) 722 (940) (8,826) (3,126) (5,700) $ 2011 2010 20,533 (1,499) 19,034 $ $ 10,322 (137) 1,055 (1,179) 10,061 3,958 6,103 10,959 (1,584) 9,375 The Company transferred loans of $26,644, $21,314 and $42,212 to other real estate owned in 2011, 2010 and 2009, respectively. The Company transferred internally originated mortgage servicing assets of $2,864, $4,222 and $9,681 from loans to mortgage servicing assets in 2011, 2010 and 2009, respectively. The Company transferred real property pending disposal of $1,513 to other assets in 2010. The Company transferred equipment pending disposal of $1,519 to other assets in 2009. The Company transferred accrued liabilities of $216 and $59 to common stock in conjunction with the vesting of liability-classified non-vested stock awards during 2011 and 2010, respectively. In conjunction with the sale of mortgage servicing rights, the Company recorded receivables of $1,204 and $938 during 2010 and 2009, respectively. 101 Table of Contents FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share data) (22) CONDENSED FINANCIAL INFORMATION (PARENT COMPANY ONLY) Following is condensed financial information of First Interstate BancSystem, Inc. December 31, Condensed balance sheets: Cash and cash equivalents Investment in subsidiaries, at equity: Bank subsidiaries Nonbank subsidiaries Total investment in subsidiaries Other assets Total assets Other liabilities Advances from subsidiaries, net Long-term debt Subordinated debentures held by subsidiary trusts Total liabilities Stockholders’ equity Total liabilities and stockholders’ equity Years Ended December 31, Condensed statements of income: Dividends from subsidiaries Other interest income Other income, primarily management fees from subsidiaries Total income Salaries and benefits Interest expense Other operating expenses, net Total expenses Earnings before income tax benefit Income tax expense (benefit) Income before undistributed earnings of subsidiaries Undistributed earnings of subsidiaries Net income 2011 2010 131,860 $ 133,277 775,026 1,973 776,999 27,569 936,428 19,552 2,141 20,000 123,715 165,408 771,020 936,428 2010 15,400 105 11,336 26,841 13,435 7,703 6,827 27,965 (1,124) (6,254) 5,130 32,226 37,356 $ $ $ $ $ 740,006 1,975 741,981 27,010 902,268 16,697 5,054 20,000 123,715 165,466 736,802 902,268 2009 41,900 9 11,529 53,438 12,687 8,773 6,270 27,730 25,708 (6,261) 31,969 21,894 53,863 $ $ $ $ $ $ 2011 30,000 118 10,617 40,735 13,975 7,273 6,903 28,151 12,584 (6,518) 19,102 25,444 44,546 $ $ 102 Table of Contents FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share data) Years Ended December 31, Condensed statements of cash flows: Cash flows from operating activities: 2011 2010 2009 Net income Adjustments to reconcile net income to cash provided by operating activities: $ 44,546 $ 37,356 $ 53,863 Undistributed earnings of subsidiaries Depreciation and amortization Write-down of equipment pending sale Deferred income tax expense (benefit) Stock-based compensation expense Tax benefits from stock-based compensation Excess tax benefits from stock-based compensation Other, net Net cash provided by operating activities Cash flows from investing activities: Capitalization of subsidiaries Capital expenditures Net cash used in investing activities Cash flows from financing activities: Net (decrease) increase in advances from nonbank subsidiaries Repayments of long-term debt Debt issuance costs Proceeds from issuance of common stock Common stock issuance costs Excess tax benefits from stock-based compensation Purchase and retirement of common stock Dividends paid to common stockholders Dividends paid to preferred stockholders Net cash provided by (used in) financing activities Net change in cash and cash equivalents Cash and cash equivalents, beginning of year Cash and cash equivalents, end of year (25,444) 85 — 23 2,111 204 (124) 2,492 23,893 — (3) (3) (2,913) — — 385 — 124 (248) (19,233) (3,422) (25,307) (1,417) $ 133,277 131,860 $ (32,226) 217 — (1,455) 1,764 239 (225) (3,087) 2,583 (130) — (130) 5,002 (33,929) — 167,400 (13,597) 225 (3,699) (17,905) (3,422) 100,075 102,528 30,749 133,277 $ (21,894) 241 350 (1,401) 1,067 742 (719) (8,664) 23,585 (535) — (535) (4,718) (8,928) (261) 3,914 — 719 (11,052) (15,694) (3,422) (39,442) (16,392) 47,141 30,749 Noncash Investing and Financing Activities — The Company transferred accrued liabilities of $216 and $59 to common stock in conjunction with the vesting of liability-classified non-vested stock awards during 2011 and 2010, respectively. During 2009, the Company settled an intercompany payable to a nonbank subsidiary through investment in subsidiary. The settlement resulted in a decrease in advances from subsidiary of $581 and a corresponding decrease in investment in subsidiary. During 2009, the Company transferred equipment pending disposal of $1,519 to other assets. 103 Table of Contents FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share data) (23) FAIR VALUE MEASUREMENTS Financial assets and financial liabilities measured at fair value on a recurring basis are as follows: Investment securities available-for-sale: Obligations of U.S. government agencies U.S. agencies mortgage-backed securities & collateralized mortgage obligations Private mortgage-backed securities Mortgage servicing rights Derivative liability contract Investment securities available-for-sale: Obligations of U.S. government agencies U.S. agencies mortgage-backed securities & collateralized mortgage obligations Private mortgage-backed securities Mortgage servicing rights Derivative liability contract Balance as of 12/31/2011 Fair Value Measurements at Reporting Date Using Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) 1,138,118 $ 877,997 749 11,910 383 — $ — — — — 1,138,118 $ 877,997 749 11,910 — Balance as of 12/31/2010 Fair Value Measurements at Reporting Date Using Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) 953,420 $ 831,860 1,055 13,694 86 — $ — — — — 953,420 $ 831,860 1,055 13,694 — — — — — 383 — — — — 86 $ $ The following table reconciles the beginning and ending balances of the derivative liability contract measured at fair value on a recurring basis using significant unobservable (Level 3) inputs during the twelve months ended December 31, 2011 and 2010: For the Twelve Months Ended December 31, Balance, beginning of period Accruals during the period Cash payments during the period Balance, end of period 2011 2010 86 $ 425 (128) 383 $ 245 155 (314) 86 $ $ The methodologies used by the Company in determining the fair values of each class of financial instruments are based primarily on the use of independent, market-based data to reflect a value that would be reasonably expected in an orderly transaction between market participants at the measurement date. The Company obtains fair value measurements for investment securities from an independent pricing service and evaluates mortgage servicing rights for impairment using an independent valuation service. The vendors chosen by the Company are widely recognized vendors whose evaluations support the pricing functions of financial institutions, investment and mutual funds, and 104 Table of Contents FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share data) portfolio managers. The Company has documented and evaluated the pricing methodologies used by the vendors and maintains internal processes that regularly test valuations. These internal processes include obtaining and reviewing available reports on internal controls, evaluating the prices for reasonableness given market changes, obtaining and evaluating the inputs used in the model for a sample of securities, investigating anomalies and confirming determinations through discussions with the vendor. For investment securities, if needed, a broker may be utilized to determine the reported fair value. Further details on the methods used to estimate the fair value of each class of financial instruments above are discussed below: Investment Securities Available-for-Sale. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the investment's terms and conditions, among other things. Mortgage Servicing Rights. Mortgage servicing rights are initially recorded at fair value based on comparable market quotes and are amortized in proportion to and over the period of estimated net servicing income. Mortgage servicing rights are evaluated quarterly for impairment using an independent valuation service. The valuation service utilizes discounted cash flow modeling techniques, which consider observable data that includes market consensus prepayment speeds and the predominant risk characteristics of the underlying loans including loan type, note rate and loan term. Management believes the significant inputs utilized in the valuation model are observable in the market. Derivative Liability Contract. In conjunction with the sale of all of its Class B shares of Visa, Inc. (“Visa”) common stock in 2009, the Company entered into a derivative liability contract with the purchaser whereby the Company will make or receive cash payments based on subsequent changes in the conversion rate of the Class B shares into Class A shares of Visa. The conversion rate is dependent upon the resolution of certain litigation involving Visa U.S.A. Inc. card association or its affiliates. The value of the derivative liability contract is estimated based on the Company's expectations regarding the ultimate resolution of that litigation, which involves a high degree of judgment and subjectivity. On April 6, 2011 and December 29, 2011, Visa disclosed it had provided additional funding to its litigation escrow account thereby reducing the conversion rate of the Class B shares into Class A shares. During 2011, the Company made cash payments to the purchaser of $102 due to changes in conversion rates and $26 to extend the derivative liability contract until all litigation is settled. In addition, during 2011 the Company revised its estimate of Visa's future litigation funding and increased its derivative liability contract by $425. Additionally, from time to time, certain assets are measured at fair value on a non-recurring basis. Adjustments to fair value generally result from the application of lower-of-cost-or-market accounting or write-downs of individual assets due to impairment. The following table presents information about the Company’s assets and liabilities measured at fair value on a non-recurring basis. As of December 31, 2011 Impaired loans Other real estate owned As of December 31, 2010 Impaired loans Other real estate owned Fair Value Measurements at Reporting Date Using Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Total Significant Unobservable Inputs (Level 3) Total Gains (Losses) $ $ 100,035 $ 17,000 97,574 $ 23,727 105 — $ — — $ — — $ — — $ — 100,035 $ 17,000 97,574 $ 23,727 (67,043) (21,282) (55,800) (20,974) Table of Contents FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share data) Impaired Loans. Collateralized impaired loans are reported at the fair value of the underlying collateral if repayment is expected solely from collateral. The impaired loans are reported at fair value through specific valuation allowance allocations. In addition, when it is determined that the fair value of an impaired loan is less than the recorded investment in the loan, the carrying value of the loan is adjusted to fair value through a charge to the allowance for loan losses. Collateral values are estimated using independent appraisals and management estimates of current market conditions. As of December 31, 2011, certain impaired loans with a carrying value of $167,078 were reduced by specific valuation allowance allocations of $32,838 and partial loan charge-offs of $34,205 resulting in a reported fair value of $100,035. As of December 31, 2010, certain impaired loans with a carrying value of $153,374 were reduced by specific valuation allowance allocations of $42,226 and partial loan charge-offs of $13,574 resulting in a reported fair value of $97,574. OREO.The fair values of OREO are estimated using independent appraisals and management estimates of current market conditions. Upon initial recognition, write-downs based on the foreclosed asset's fair value at foreclosure are reported through charges to the allowance for loan losses. Periodically, the fair value of foreclosed assets is remeasured with any subsequent write-downs charged to OREO expense in the period in which they are identified. Long-lived Assets to be Disposed of by Sale. Long-lived assets to be disposed of by sale are carried at the lower of carrying value or fair value less estimated costs to sell. The fair values of long-lived assets to be disposed of by sale are based upon observable market data and management estimates of current market conditions. As of December 31, 2011 and 2010, the Company had a long-lived asset to be disposed of by sale of $1,513 that was carried at cost. In addition, mortgage loans held for sale are required to be measured at the lower of cost or fair value. The fair value of mortgage loans held for sale is based upon binding contracts or quotes or bids from third party investors. As of December 31, 2011 and 2010, all mortgage loans held for sale were recorded at cost. The Company is required to disclose the fair value of financial instruments for which it is practical to estimate fair value. The methodologies for estimating the fair value of financial instruments that are measured at fair value on a recurring or non-recurring basis are discussed above. The methodologies for estimating the fair value of other financial instruments are discussed below. For financial instruments bearing a variable interest rate where no credit risk exists, it is presumed that recorded book values are reasonable estimates of fair value. Financial Assets. Carrying values of cash, cash equivalents and accrued interest receivable approximate fair values due to the liquid and/or short-term nature of these instruments. Fair values for investment securities held-to-maturity are obtained from an independent pricing service, which considers observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the investment’s terms and conditions, among other things. Fair values of fixed rate loans and variable rate loans that reprice on an infrequent basis are estimated by discounting future cash flows using current interest rates at which similar loans with similar terms would be made to borrowers of similar credit quality. Carrying values of variable rate loans that reprice frequently, and with no change in credit risk, approximate the fair values of these instruments. Financial Liabilities. The fair values of demand deposits, savings accounts, securities sold under repurchase agreements and accrued interest payable are the amount payable on demand at the reporting date. The fair values of fixed-maturity certificates of deposit are estimated using external market rates currently offered for deposits with similar remaining maturities. The carrying values of the interest bearing demand notes to the United States Treasury are deemed an approximation of fair values due to the frequent repayment and repricing at market rates. The fair value of the derivative contract was estimated by discounting cash flows using assumptions regarding the expected outcome of related litigation. The floating rate term notes, floating rate subordinated debentures, floating rate subordinated term loan and unsecured demand notes bear interest at floating market rates and, as such, carrying amounts are deemed to approximate fair values. The fair values of notes payable to the FHLB, fixed rate subordinated term debt, fixed rate subordinated debentures and capital lease obligation are estimated by discounting future cash flows using current rates for advances with similar characteristics. Commitments to Extend Credit and Standby Letters of Credit. The fair value of commitments to extend credit and standby letters of credit, based on fees currently charged to enter into similar agreements, is not significant. 106 Table of Contents FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share data) A summary of the estimated fair values of financial instruments follows: As of December 31, Financial assets: Cash and cash equivalents Investment securities available-for-sale Investment securities held-to-maturity Net loans Accrued interest receivable Mortgage servicing rights, net Total financial assets Financial liabilities: Total deposits, excluding time deposits Time deposits Securities sold under repurchase agreements Derivative contract Accrued interest payable Other borrowed funds Long-term debt Subordinated debentures held by subsidiary trusts Total financial liabilities (24) RELATED PARTY TRANSACTIONS 2011 2010 Carrying Amount Estimated Fair Value Carrying Amount Estimated Fair Value $ $ $ $ 472,447 $ 2,016,864 152,781 4,073,968 31,974 11,555 6,759,589 $ 4,269,631 $ 1,557,340 516,243 383 8,123 7 37,200 123,715 6,512,642 $ 472,447 $ 2,016,864 161,877 4,064,718 31,974 11,910 6,759,790 $ 4,269,631 $ 1,565,558 516,243 383 8,123 7 34,341 102,525 6,496,811 $ 685,618 $ 1,786,335 147,068 4,247,429 33,628 13,191 6,913,269 $ 4,000,468 $ 1,925,245 620,154 86 13,178 4,991 37,502 123,715 6,725,339 $ 685,618 1,786,335 146,508 4,222,984 33,628 13,694 6,888,767 4,000,468 1,936,011 620,154 86 13,178 4,991 34,249 101,861 6,710,998 The Company conducts banking transactions in the ordinary course of business with related parties, including directors, executive officers, shareholders and their associates, on the same terms as those prevailing at the same time for comparable transactions with unrelated persons and that do not involve more than a normal risk of collectibility or present other unfavorable features. Certain executive officers, directors and greater than 5% shareholders of the Company and certain entities and individuals related to such persons, incurred indebtedness in the form of loans, as customers, of $44,430 and $40,772 at December 31, 2011 and 2010, respectively. During 2011, new loans and advances on existing loans of $28,134 were funded and loan repayments totaled $23,443. These loans were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable loans with persons not related to the Company and are allowable under the Sarbanes Oxley Act of 2002. Additionally, during 2011, net loans of $1,033 were removed due to changes in related parties from the prior year. The Company leases an aircraft from an entity wholly-owned by the chairman of the Company’s Board of Directors. Under the terms of the lease, the Company pays a fee for each flight hour plus certain third party operating expenses related to the aircraft. During 2011, 2010 and 2009, the Company paid total fees and operating expenses of $311, $305 and $296, respectively, for its use of the aircraft. In addition, the Company leases a portion of its hanger and provides pilot services to the related entity. During 2011, 2010 and 2009, the Company received payments from the related entity of $70, $63 and $129, respectively, for hanger use, pilot fees and reimbursement of certain third party operating expenses related to the chairman’s personal use of the aircraft. 107 Table of Contents FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share data) The Company purchases property, casualty and other insurance through an agency in which a director of the Company has a controlling ownership interest. The Company paid insurance premiums to the agency of $1,328, $879, and $830 in 2011, 2010 and 2009, respectively. The Company purchases services from an entity in which two greater than 5% shareholders and five directors of the Company, including the chairman and vice chairman of the Board of Directors, have an aggregate ownership interest of 12%, and in which the vice chairman is the chairman of such entity. Services provided for the Company’s benefit include shareholder education and communication, strategic enterprise planning and corporate governance consultation. During 2011, 2010 and 2009, the Company paid $250, $337 and $342, respectively, for these services. The Company also reimbursed the related entity for certain costs incurred in the Company’s behalf, primarily office costs for the vice chairman of the Company’s Board of Directors and the Company’s charitable foundation. These reimbursements totaled $88 and $81 in 2010 and 2009, respectively. During 2011, the Company paid these costs directly and thus no reimbursements were made. The related entity reimburses the Company for all salaries, wages and employee benefits expenses incurred by the Company in behalf of the related entity for its personnel. During 2010, the Company entered into an agreement to sell real property to a director of the Company. The sale closed in 2011 at a sales price of $2,695. Prior to entering the agreement, the independent members of the Governance and Nominating Committee of the Company’s Board of Directors approved the transaction after reviewing fully the relationship and proposed terms of the transaction. In conjunction with an acquisition, the Company assumed certain existing deferred compensatory agreements. Under the terms of one such agreement, the Company is required to make cash payments to a director of the Company for the promotion of growth and development of new business through December 31, 2011. The total amount due under the agreement was fixed prior to the acquisition date at $577, with a portion to be paid over four years and the remaining balance of $424 due in January 2012. As additional consideration under the agreement, the director provided, among other things, a covenant not to compete. Under the terms of the agreement, the Company made cash payments of $38 during 2011, 2010 and 2009. As of December 31, 2011, the Company had accrued a liability of $424 related to the final payment due in January 2012. A director of the Company is party to an agreement to guarantee the payment of interest on loans between FIB and an unrelated third party borrower through December 31, 2012. Under the terms of the interest guaranty agreement, the director made interest payments to FIB on behalf of the borrower of $954 in 2011 and $487 in 2010. In addition, the director pledged to FIB collateral for the loans of the unrelated third party borrower. During 2011, the collateral was liquidated and proceeds of $7,998 were applied to the outstanding principal balances of the loans. (25) AUTHORITATIVE ACCOUNTING GUIDANCE FASB ASC Topic 220, “Comprehensive Income.” The Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2011-05 under Accounting Standards Codification (“ASC”) Topic 220, “Comprehensive Income.” ASU No. 2011-05 allows an entity the option to present the total of comprehensive income, the components of net income and the components of other comprehensive income either in a single continuous statement of comprehensive income or in separate but consecutive statements. With the exception of amendments to the presentation of reclassifications of items out of accumulated other comprehensive income under the ASU, ASU No. 2011-05 is effective for the Company on January 1, 2012, and is to be applied retrospectively to all periods presented. ASU 2011-12 under ASC Topic 220, "Comprehensive Income" was subsequently issued and defers the amendments to the presentation of reclassification of items out of accumulated other comprehensive income until such further time that the FASB can redeliberate and finalize this section. Management does not expect the adoption of ASU No. 2011-05 will have a significant impact on the Company's consolidated financial statements, results of operations or liquidity. FASB ASC Topic 820, “Fair Value Measurements and Disclosures.” New authoritative accounting guidance, ASU No. 2011-04, under ASC Topic 820 represents the converged guidance of the FASB and the International Accounting Standards Board (collectively, the “Boards”) on fair value measurement. The collective efforts of the Boards and their staffs have resulted in common requirements for measuring fair value and for disclosing information about fair value measurements, including a consistent meaning of the term “fair value.” ASU No. 2011-04 is effective for the Company on January 1, 2012. Management does not expect the adoption of ASU No. 2011-04 will have a significant impact on the Company's consolidated financial statements, results of operations or liquidity. 108 Table of Contents FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except share and per share data) FASB ASC Topic 860, “Transfers and Servicing.” New authoritative accounting guidance, ASU No. 2011-03, under ASC Topic 860, “Transfers and Servicing,” is intended to improve financial reporting or repurchase agreements and other agreements that both entitle and obligate a transferor to repurchase or redeem financial assets before their maturity. ASU No. 2011-03 removes from the assessment of effective control (1) the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee, and (2) the collateral maintenance implementation guidance related to that criterion. The amendments in ASU No. 2011-03 are effective for the Company on January 1, 2012. Management does not expect the adoption of ASU No. 2011-03 will have a significant impact on the Company's consolidated financial statements, results of operations or liquidity. FASB ASC Topic 310, “Receivables.” New authoritative accounting guidance, ASU No. 2011-02, under ASC Topic 310, “Receivables,” requires significant new disclosures about the nature, extent and financial impact of troubled debt restructurings presented at the level of disaggregation that management uses when assessing and monitoring the portfolio's risk and performance. ASU No. 2011- 02 also provides additional guidance to assist creditors in determining whether a restructuring of a receivable meets the criteria to be considered a troubled debt restructuring. ASU No. 2011-02 was effective for the Company on July 1, 2011, and has been applied retrospectively to restructurings occurring on or after the beginning of the fiscal year of adoption. The adoption of ASU 2011-02 did not have a significant impact on the Company's consolidated financial statements, results of operations or liquidity. FASB ASC Topic 350, “Intangibles - Goodwill and Other.” New authoritative accounting guidance under ASC Topic 350, “Intangibles - Goodwill and Other,” amends prior guidance. Under this amended guidance, an entity is required to perform Step 2 of the goodwill impairment test if the reporting unit has a zero or negative carrying amount and if it is more likely than not that impairment exists. This guidance, which became effective for the Company on January 1, 2011, did not impact the Company's consolidated financial statements, results of operations or liquidity. Additional new authoritative guidance, ASU No. 2011-08, under ASC Topic 350, “Intangibles - Goodwill and Other”, permits an entity to first assess qualitative factors to determine whether it is “more likely than not” that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill test. The “more likely than not” threshold is defined as having a likelihood of more than 50%. This guidance is effective for the Company January 1, 2012, with early adoption permitted. Management does not expect the adoption of ASU No. 2011-08 will have a significant impact on the Company's consolidated financial statements, results of operations or liquidity. (26) SUBSEQUENT EVENTS Subsequent events have been evaluated for potential recognition and disclosure through the date financial statements were filed with the Securities and Exchange Commission. No events requiring recognition or disclosure were identified. 109 Table of Contents (a) 2. Financial statement schedules All other schedules to the consolidated financial statements of the Registrant are omitted since the required information is either not applicable, deemed immaterial, or is shown in the respective financial statements or in notes thereto. (a) 3. Exhibits Exhibit Number Description 2.1 2.2 3.1 3.2 4.1 10.1 10.2 10.3† 10.4† 10.5† 10.6† 10.7† 10.8† 10.9† Stock Purchase Agreement dated as of September 18, 2007, by and between First Interstate BancSystem, Inc. and First Western Bancorp, Inc. (incorporated herein by reference to Exhibit 2.1 of the Company’s Current Report on Form 8-K filed on September 19, 2007) First Amendment to Stock Purchase Agreement dated as of January 10, 2008, between First Interstate BancSystem, Inc. and Christen Group, Inc. formerly known as First Western Bancorp, Inc. (incorporated herein by reference to Exhibit 10.20 of the Company’s Current Report on Form 8-K filed on January 16, 2008) Amended and Restated Articles of Incorporation dated March 5, 2010 (incorporated herein by reference to Exhibit 3.1 of the Company’s Current Report on Form 8-K/A filed on March 10, 2010) Second Amended and Restated Bylaws dated January 27, 2011 (incorporated herein by reference to Exhibit 3.8 of the Company’s Current Report on Form 8-K filed on February 3, 2011) Specimen of Series A preferred stock certificate of First Interstate BancSystem, Inc. (incorporated herein by reference to Exhibit 4.2 of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2007) Credit Agreement Re: Subordinated Term Note dated as of January 10, 2008, between First Interstate BancSystem, Inc. and First Midwest Bank (incorporated herein by reference to Exhibit 10.24 of the Company’s Current Report on Form 8-K filed on January 16, 2008) Lease Agreement between Billings 401 Joint Venture and First Interstate Bank Montana dated September 20, 1985 and addendum thereto (incorporated herein by reference to Exhibit 10.4 of the Company’s Post-Effective Amendment No. 3 to Registration Statement on Form S-1, No. 033-84540, filed on September 29, 1994) First Interstate BancSystem’s Deferred Compensation Plan dated December 1, 2006 (incorporated herein by reference to Exhibit 10.9 of the Company’s Pre-Effective Amendment No. 3 to Registration Statement on Form S-1, No. 333-164380, filed on March 23, 2010) First Amendment to the First Interstate BancSystem’s Deferred Compensation Plan dated October 24, 2008 (incorporated herein by reference to Exhibit 10.10 of the Company’s Pre-Effective Amendment No. 3 to Registration Statement on Form S-1, No. 333-164380, filed on March 23, 2010) 2001 Stock Option Plan, as amended (incorporated herein by reference to Exhibit 4.12 of the Company’s Registration Statement on Form S-8, No. 333-106495, filed on June 25, 2003) Second Amendment to 2001 Stock Option Plan (incorporated herein by reference to Exhibit 10.6 of the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2010) First Interstate BancSystem, Inc. 2006 Equity Compensation Plan (incorporated herein by reference to Appendix A of the Company’s 2006 Definitive Proxy Statement on Schedule 14A) Amendment to the First Interstate BancSystem, Inc. 2006 Equity Compensation Plan (incorporated herein by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K filed on March 22, 2010) Second Amendment to the First Interstate BancSystem, Inc. 2006 Equity Compensation Plan (incorporated herein by reference to Exhibit 10.9 of the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2010) 10.10† Form of First Interstate BancSystem, Inc. 2006 Equity Compensation Plan Restricted Stock Agreement (Time) for Certain Executive Officers (incorporated herein by reference to Exhibit 10.13 of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2008) 110 Table of Contents Exhibit Number 10.11† 10.12† 10.13† 10.14 14.1 Form of First Interstate BancSystem, Inc. 2006 Equity Compensation Plan Restricted Stock Agreement (Performance) for Certain Executive Officers (incorporated herein by reference to Exhibit 10.14 of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2008) Description First Interstate BancSystem, Inc. 2006 Equity Compensation Plan Restricted Stock Agreement (Performance) for Lyle R. Knight (incorporated herein by reference to Exhibit 10.15 of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2008) First Interstate BancSystem, Inc. 2006 Equity Compensation Plan Restricted Stock Agreement (Performance) for Lyle R. Knight (incorporated herein by reference to Exhibit 10.16 of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2008) Trademark License Agreements between Wells Fargo & Company and First Interstate BancSystem, Inc. (incorporated herein by reference to Exhibit 10.11 of the Registration Statement on Form S-1, filed on April 22, 1997) Code of Ethics for Chief Executive Officer and Senior Financial Officers (incorporated herein by reference to Exhibit 14.1 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2010) 21.1* Subsidiaries of First Interstate BancSystem, Inc. 23.1* Consent of McGladrey & Pullen, LLP, Independent Registered Public Accounting Firm 31.1* Certification of Annual Report on Form 10-K pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 by Chief Executive Officer 31.2* Certification of Annual Report on Form 10-K pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 by Chief Financial Officer 32* Certification of Annual Report on Form 10-K pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 101** Interactive data file † Management contract or compensatory plan or arrangement. * Filed herewith. ** As provided in Rule 406T of Regulation S-T, this information is furnished and not filed for purposes of Sections 11 and 12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934. (b) Exhibits See Item 15(a)3 above. (c) Financial Statements Schedules See Item 15(a)2 above. 111 Table of Contents Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates First Interstate BancSystem, Inc. By: /s/ LYLE R. KNIGHT Lyle R. Knight President and Chief Executive Officer February 27, 2012 Date indicated. By: /s/ THOMAS W. SCOTT Thomas W. Scott, Chairman of the Board By: /s/ JAMES R. SCOTT James R. Scott, Vice Chairman of the Board By: /s/ JULIE A. SCOTT Julie A. Scott, Director By: /s/ SANDRA A. SCOTT SUZOR Sandra A. Scott Suzor, Director By: /s/ STEVEN J. CORNING Steven J. Corning, Director By: /s/ DAVID H. CRUM David H. Crum, Director By: /s/ WILLIAM B. EBZERY William B. Ebzery, Director By: /s/ CHARLES E. HART, M.D., M.S. Charles E. Hart, M.D., M.S., Director By: /s/ JAMES W. HAUGH James W. Haugh, Director By: /s/ JOHN M. HEYNEMAN, JR. John M. Heyneman, Jr., Director By: /s/ CHARLES M. HEYENMAN Charles M. Heyneman, Director By: /s/ DAVID L. JAHNKE David L. Jahnke, Director By: /s/ ROSS E. LECKIE Ross E. Leckie, Director By: /s/ TERRY W. PAYNE Terry W. Payne, Director By: /s/ MICHAEL J. SULLIVAN Michael J. Sullivan, Director By: /s/ TERESA A. TAYLOR Teresa A. Taylor, Director February 27, 2012 Date February 27, 2012 Date February 27, 2012 Date February 27, 2012 Date February 27, 2012 Date February 27, 2012 Date February 27, 2012 Date February 27, 2012 Date February 27, 2012 Date February 27, 2012 Date February 27, 2012 Date February 27, 2012 Date February 27, 2012 Date February 27, 2012 Date February 27, 2012 Date February 27, 2012 Date 112 Table of Contents By: /s/ LYLE R. KNIGHT Lyle R. Knight President, Chief Executive Officer and Director (Principal executive officer) By: /s/ TERRILL R. MOORE Terrill R. Moore Executive Vice President and Chief Financial Officer (Principal financial and accounting officer) (Back To Top) Section 2: EX-21.1 February 27, 2012 Date February 27, 2012 Date 113 Subsidiaries of First Interstate BancSystem, Inc. State of Incorporation or Jurisdiction of Organization Montana South Dakota Delaware Connecticut Delaware Delaware Delaware Delaware Delaware Montana Montana Montana Montana Business Name First Interstate Bank First Western Data, Inc. First Interstate Statutory Trust FI Statutory Trust I FI Capital Trust II FI Statutory Trust III FI Capital Trust IV FI Statutory Trust V FI Statutory Trust VI Commerce Financial, Inc. First Interstate Insurance Agency, Inc. Crytech FIB, LLC Subsidiary First Interstate Bank First Western Data, Inc. First Interstate Statutory Trust FI Statutory Trust I FI Capital Trust II FI Statutory Trust III FI Capital Trust IV FI Statutory Trust V FI Statutory Trust VI Commerce Financial, Inc. First Interstate Insurance Agency, Inc. FIBCT, LLC FIB, LLC (Back To Top) Section 3: EX-23.1 Exhibit 21.1 Exhibit 23.1 Consent of Independent Registered Public Accounting Firm We consent to the incorporation by reference in the Registration Statements (Form S-8 No. 333-106495 and Form S-8 No. 333-69490) pertaining to the First Interstate BancSystem, Inc. 2001 Stock Option Plan, as amended; and Registration Statement (Form S-8 No. 333-133837) pertaining to the First Interstate BancSystem, Inc. 2006 Equity Compensation Plan, as amended, of our reports dated February 27, 2012, relating to our audits of the consolidated financial statements and internal control over financial reporting which appear in the Annual Report on Form 10-K of First Interstate BancSystem, Inc. for the year ended December 31, 2011. /s/ MCGLADREY & PULLEN, LLP Des Moines, Iowa February 27, 2012 (Back To Top) Section 4: EX-31.1 Exhibit 31.1 I, Lyle R. Knight, certify that: CERTIFICATION OF ANNUAL REPORT ON FORM 10-K PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 1. 2. 3. 4. I have reviewed this annual report on Form 10-K for the fiscal year ended December 31, 2011 of First Interstate BancSystem, Inc., Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: (a) (b) (c) (d) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes, in accordance with generally accepted accounting principles; Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. DATE: February 27, 2012 (Back To Top) Section 5: EX-31.2 I, Terrill R. Moore, certify that: /s/ LYLE R. KNIGHT Lyle R. Knight President and Chief Executive Officer CERTIFICATION OF ANNUAL REPORT ON FORM 10-K PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 Exhibit 31.2 1. 2. 3. 4. I have reviewed this annual report on Form 10-K for the fiscal year ended December 31, 2011 of First Interstate BancSystem, Inc., Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: (a) (b) (c) (d) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes, in accordance with generally accepted accounting principles; Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. DATE: February 27, 2012 /s/ TERRILL R. MOORE Terrill R. Moore Executive Vice President and Chief Financial Officer (Back To Top) Section 6: EX-32 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 Exhibit 32 The undersigned are the Chief Executive Officer and the Chief Financial Officer of First Interstate BancSystem, Inc. (the “Registrant”). This Certification is made pursuant to Section 906 of the Sarbanes- Oxley Act of 2002. This Certification accompanies the Annual Report on Form 10-K of the Registrant for the year ended December 31, 2011. We certify to the best of our knowledge that such Annual Report on Form 10-K fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that the information contained in the Form 10-K fairly presents, in all material respects, the financial condition and results of operations of the Registrant for the periods presented therein. This Certification is executed as of February 27, 2012. /s/ LYLE R. KNIGHT Lyle R. Knight President and Chief Executive Officer /s/ TERRILL R. MOORE Terrill R. Moore Executive Vice President and Chief Financial Officer The forgoing certification is being furnished solely pursuant to Subsections (a) and (b) of Section 1350, Chapter 63 of Title 18, United States Code in accordance with Section 906 of the Sarbanes- Oxley Act of 2002 and shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, or otherwise subject to the liability of that section, and shall not be deemed to be incorporated by reference into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934. (Back To Top) 

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