FIBK 10-Q Quarterly Report Sept. 30, 2012 | Alphaminr
FIRST INTERSTATE BANCSYSTEM INC
ALPHAMINR

FIBK 10-Q Quarter ended Sept. 30, 2012

Balance Sheet
Cash Flow
Income Statement
FIRST INTERSTATE BANCSYSTEM INC
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10-Q 1 fibk-20120930x10q.htm 10-Q FIBK-2012.09.30-10Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
________________________________________________________________________________________________________
FORM 10-Q
________________________________________________________________________________________________________
ý
Quarterly report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended September 30, 2012
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
81-0331430
(State or other jurisdiction of
incorporation or organization)
(IRS Employer
Identification No.)
401 North 31st Street, Billings, MT
59116-0918
(Address of principal executive offices)
(Zip Code)
Registrant’s telephone number, including area code: 406/255-5390
______________________________________________________________
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes ý No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files.)     Yes ý No ¨
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 definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
¨
Accelerated filer
ý
Non-accelerated filer
¨
Smaller reporting company
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes ¨ No ý
Indicate the number of shares outstanding of each of the Registrant’s classes of common stock:
September 30, 2012 – Class A common stock
17,019,375

September 30, 2012 – Class B common stock
26,233,008




FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
Quarterly Report on Form 10-Q
Index
Page
Part I.
Financial Information
Item 1.
Financial Statements (unaudited)
Consolidated Balance Sheets - September 30, 2012 and December 31, 2011
3

Consolidated Statements of Income - Three and Nine Months Ended September 30, 2012 and 2011
4

Consolidated Statements of Comprehensive Income - Three and Nine Months Ended September 30, 2012 and 2011
5

Consolidated Statements of Changes in Stockholders’ Equity -Nine Months Ended September 30, 2012 and 2011
6

Consolidated Statements of Cash Flows - Nine Months Ended September 30, 2012 and 2011
7

9

Item 2.
34

Item 3.
50

Item 4.
50

Part II.
Item 1.
51

Item 1A .
51

Item  2.
51

Item 3.
51

Item 4.
Mine Safety Disclosures
51

Item 5.
51

Item 6.
51

53








2

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
(Unaudited)
September 30,
2012
December 31,
2011
Assets
Cash and due from banks
$
124,275

$
142,502

Federal funds sold
1,215

309

Interest bearing deposits in banks
485,845

329,636

Total cash and cash equivalents
611,335

472,447

Investment securities:
Available-for-sale
1,979,154

2,016,864

Held-to-maturity (estimated fair values of $199,078 and $161,877 at September 30, 2012 and December 31, 2011, respectively)
187,573

152,781

Total investment securities
2,166,727

2,169,645

Loans held for investment
4,107,171

4,133,028

Mortgage loans held for sale
72,880

53,521

Total loans
4,180,051

4,186,549

Less allowance for loan losses
99,006

112,581

Net loans
4,081,045

4,073,968

Premises and equipment, net of accumulated depreciation
188,851

184,771

Goodwill
183,673

183,673

Company-owned life insurance
76,371

74,880

Other real estate owned (“OREO”)
39,971

37,452

Accrued interest receivable
33,416

31,974

Mortgage servicing rights, net of accumulated amortization and impairment reserve
12,334

11,555

Deferred tax asset, net
1,638

9,628

Core deposit intangibles, net of accumulated amortization
6,291

7,357

Other assets
59,500

68,177

Total assets
$
7,461,152

$
7,325,527

Liabilities and Stockholders’ Equity
Deposits:
Non-interest bearing
$
1,443,773

$
1,271,709

Interest bearing
4,591,959

4,555,262

Total deposits
6,035,732

5,826,971

Securities sold under repurchase agreements
460,805

516,243

Accounts payable and accrued expenses
40,386

42,248

Accrued interest payable
6,706

8,123

Long-term debt
37,170

37,200

Other borrowed funds
6

7

Subordinated debentures held by subsidiary trusts
82,477

123,715

Total liabilities
6,663,282

6,554,507

Stockholders’ equity:
Nonvoting noncumulative preferred stock without par value;
authorized 100,000 shares; issued and outstanding 5,000 shares as of September 30, 2012 and December 31, 2011
50,000

50,000

Common stock
270,553

266,842

Retained earnings
458,506

435,144

Accumulated other comprehensive income, net
18,811

19,034

Total stockholders’ equity
797,870

771,020

Total liabilities and stockholders’ equity
$
7,461,152

$
7,325,527

See accompanying notes to unaudited consolidated financial statements.

3

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
(Unaudited)
Three Months Ended
September 30,
Nine Months Ended
September 30,
2012
2011
2012
2011
Interest income:
Interest and fees on loans
$
57,418

$
61,372

$
173,412

$
185,238

Interest and dividends on investment securities:
Taxable
9,194

10,721

28,357

31,281

Exempt from federal taxes
1,223

1,188

3,667

3,553

Interest on deposits in banks
336

200

852

794

Interest on federal funds sold
4

2

11

11

Total interest income
68,175

73,483

206,299

220,877

Interest expense:
Interest on deposits
5,414

7,905

17,455

26,679

Interest on securities sold under repurchase agreements
144

137

452

545

Interest on long-term debt
502

498

1,495

1,482

Interest on subordinated debentures held by subsidiary trusts
1,110

1,451

4,084

4,354

Total interest expense
7,170

9,991

23,486

33,060

Net interest income
61,005

63,492

182,813

187,817

Provision for loan losses
9,500

14,000

32,750

44,400

Net interest income after provision for loan losses
51,505

49,492

150,063

143,417

Non-interest income:
Income from the origination and sale of loans
11,665

5,512

29,469

13,066

Other service charges, commissions and fees
8,774

8,479

25,452

23,627

Service charges on deposit accounts
4,395

4,609

13,011

13,104

Wealth management revenues
3,557

3,202

10,655

9,980

Investment securities gains, net
66

38

295

56

Other income
1,725

1,285

5,344

5,042

Total non-interest income
30,182

23,125

84,226

64,875

Non-interest expense:
Salaries and wages
23,341

20,801

66,545

61,557

Employee benefits
7,447

6,087

23,232

20,922

Occupancy, net
3,793

4,180

11,818

12,408

Furniture and equipment
3,231

3,018

9,558

9,367

Outsourced technology services
2,182

2,235

6,627

6,688

OREO expense, net of income
2,612

2,878

5,523

6,631

FDIC insurance premiums
1,622

1,631

4,818

5,726

Professional fees
1,050

995

2,985

2,500

Mortgage servicing rights amortization
879

807

2,591

2,285

Mortgage servicing rights impairment (recovery)
55

1,168

(761
)
848

Core deposit intangibles amortization
355

362

1,066

1,085

Other expenses
10,497

10,879

37,801

32,174

Total non-interest expense
57,064

55,041

171,803

162,191

Income before income tax expense
24,623

17,576

62,486

46,101

Income tax expense
8,468

5,655

21,107

14,820

Net income
16,155

11,921

41,379

31,281

Preferred stock dividends
863

862

2,569

2,559

Net income available to common shareholders
$
15,292

$
11,059

$
38,810

$
28,722

Basic earnings per common share
$
0.36

$
0.26

$
0.90

$
0.67

Diluted earnings per common share
$
0.35

$
0.26

$
0.90

$
0.67

See accompanying notes to unaudited consolidated financial statements.

4

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
(Unaudited)

Three Months Ended
September 30,
Nine Months Ended
September 30,
2012
2011
2012
2011
Net income
$
16,155

$
11,921

$
41,379

$
31,281

Other comprehensive income (loss), before tax:
Investment securities available-for sale:
Change in net unrealized gains (losses) during period
931

2,781

(175
)
24,200

Reclassification adjustment for net gains included in income
(66
)
(38
)
(295
)
(56
)
Defined benefit post-retirement benefits plans:
Change in net actuarial loss
35

35

102

104

Other comprehensive income (loss), before tax
900

2,778

(368
)
24,248

Deferred tax benefit (expense) related to other comprehensive
income
(354
)
(1,093
)
145

(9,541
)
Other comprehensive income (loss), net of tax
546

1,685

(223
)
14,707

Comprehensive income, net of tax
$
16,701

$
13,606

$
41,156

$
45,988

See accompanying notes to unaudited consolidated financial statements.


5

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(In thousands, except share and per share data)
(Unaudited)
Preferred
stock
Common
stock
Retained
earnings
Accumulated
other
comprehensive
income
Total
stockholders’
equity
Balance at December 31, 2011
$
50,000

$
266,842

$
435,144

$
19,034

$
771,020

Comprehensive income:
Net income
—

—

41,379

—

41,379

Other comprehensive income, net of tax
—

—

—

(223
)
(223
)
Common stock transactions:
18,333 common shares purchased and retired
—

(262
)
—

—

(262
)
23,973 common shares issued
—

—

—

—

—

122,912 non-vested common shares issued
—

—

—

—

—

4,689 non-vested common shares forfeited
—

—

—

—

—

144,346 stock options exercised, net of 102,213 shares tendered in payment of option price and income tax withholding amounts
—

1,326

—

—

1,326

Tax benefit of stock-based compensation
—

296

—

—

296

Stock-based compensation expense
—

2,351

—

—

2,351

Cash dividends declared:
Common ($0.36 per share)
—

—

(15,448
)
—

(15,448
)
Preferred (6.75% per share)
—

—

(2,569
)
—

(2,569
)
Balance at September 30, 2012
$
50,000

$
270,553

$
458,506

$
18,811

$
797,870

Balance at December 31, 2010
$
50,000

$
264,174

$
413,253

$
9,375

$
736,802

Comprehensive income:
Net income
—

—

31,281

—

31,281

Other comprehensive income, net of tax
—

—

—

14,707

14,707

Common stock transactions:
14,464 common shares purchased and retired
—

(197
)
—

—

(197
)
15,440 common shares issued
—

—

—

—

—

130,904 non-vested common shares issued
—

—

—

—

—

20,039 non-vested common shares forfeited
—

(101
)
—

—

(101
)
Non-vested liability awards vesting during period
—

195

—

—

195

67,197 stock options exercised, net of 114,211 shares tendered in payment of option price and income tax withholding amounts
—

272

—

—

272

Tax benefit of stock-based compensation
—

204

—

—

204

Stock-based compensation expense
—

1,770

—

—

1,770

Cash dividends declared:
Common ($0.3375 per share)
—

—

(14,419
)
—

(14,419
)
Preferred (6.75% per share)
—

—

(2,559
)
—

(2,559
)
Balance at September 30, 2011
$
50,000

$
266,317

$
427,556

$
24,082

$
767,955

See accompanying notes to unaudited consolidated financial statements.

6

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Nine Months Ended September 30,
2012
2011
Cash flows from operating activities:
Net income
$
41,379

$
31,281

Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses
32,750

44,400

Net (gain) loss on disposal of property and equipment
(490
)
28

Depreciation and amortization
12,770

12,997

Net premium amortization on investment securities
7,913

7,373

Net gains on investment securities transactions
(295
)
(56
)
Net gains on sales of mortgage loans held for sale
(20,648
)
(8,730
)
Net gain on sale of OREO
(768
)
(533
)
OREO valuation adjustments
3,457

5,972

Net impairment (reversal of impairment) of mortgage servicing rights
(761
)
848

Net gain on sale of mortgage servicing rights
(19
)
—

Deferred income tax expense
8,013

400

Net increase in cash surrender value of company-owned life insurance policies
(1,491
)
(1,306
)
Stock-based compensation expense
2,351

1,648

Tax benefits from stock-based compensation expense
296

204

Excess tax benefits from stock-based compensation
(187
)
(129
)
Originations of mortgage loans held for sale, net of sales
(2,055
)
799

Changes in operating assets and liabilities:
Increase in interest receivable
(1,442
)
(1,366
)
Decrease in other assets
7,381

11,373

Decrease in accrued interest payable
(1,417
)
(4,392
)
Decrease in accounts payable and accrued expenses
(1,800
)
(1,404
)
Net cash provided by operating activities
84,937

99,407

Cash flows from investing activities:
Purchases of investment securities:
Held-to-maturity
(44,283
)
(11,626
)
Available-for-sale
(787,697
)
(704,619
)
Proceeds from maturities and pay-downs of investment securities:
Held-to-maturity
9,069

8,940

Available-for-sale
817,903

611,918

Capital distribution by unconsolidated subsidiary trust
1,238

—

Proceeds from sales of mortgage servicing rights
907

596

Extensions of credit to customers, net of repayments
(61,721
)
40,278

Recoveries of loans charged-off
4,320

4,269

Proceeds from sales of OREO
31,800

12,247

Capital contribution to unconsolidated equity method investment
(900
)
—

Capital expenditures, net of sales
(11,973
)
(7,099
)
Net cash used in investing activities
$
(41,337
)
$
(45,096
)

7

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(In thousands)
(Unaudited)
Nine Months Ended September 30,
2012
2011
Cash flows from financing activities:
Net increase (decrease) in deposits
$
208,761

$
(74,394
)
Net decrease in repurchase agreements
(55,438
)
(144,632
)
Net increase (decrease) in short-term borrowings
(1
)
131

Repayment of junior subordinated debentures held by subsidiary trusts
(41,238
)
—

Repayments of long-term debt
(30
)
(33
)
Proceeds from issuance of common stock
1,326

272

Excess tax benefits from stock-based compensation
187

129

Purchase and retirement of common stock
(262
)
(197
)
Dividends paid to common stockholders
(15,448
)
(14,419
)
Dividends paid to preferred stockholders
(2,569
)
(2,559
)
Net cash provided by (used in) financing activities
95,288

(235,702
)
Net increase (decrease) in cash and cash equivalents
138,888

(181,391
)
Cash and cash equivalents at beginning of period
472,447

685,618

Cash and cash equivalents at end of period
$
611,335

$
504,227

Supplemental disclosures of cash flow information:
Cash paid during the period for income taxes
$
12,740

$
12,420

Cash paid during the period for interest expense
$
24,903

$
37,452

See accompanying notes to unaudited consolidated financial statements.


8

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share data)


(1)
Basis of Presentation

In the opinion of management, the accompanying unaudited consolidated financial statements of First Interstate BancSystem, Inc. and subsidiaries (the “Company”) contain all adjustments (all of which are of a normal recurring nature) necessary to present fairly the financial position of the Company at September 30, 2012 and December 31, 2011 , the results of operations for each of the three and nine month periods ended September 30, 2012 and 2011 and cash flows for the nine months ended September 30, 2012 and 2011 , in conformity with U.S. generally accepted accounting principles. The balance sheet information at December 31, 2011 is derived from audited consolidated financial statements. Certain reclassifications, none of which were material, have been made to conform prior year financial statements to the September 30, 2012 presentation. These reclassifications did not change previously reported net income or stockholders’ equity.

These unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011 . Operating results for the three and nine months ended September 30, 2012 are not necessarily indicative of the results that may be expected for the year ending December 31, 2012 .

(2)
Investment Securities

The amortized cost and approximate fair values of investment securities are summarized as follows:
September 30, 2012
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Estimated
Fair
Value
Available-for-Sale:
Obligations of U.S. government agencies
$
914,676

$
4,648

$
(39
)
$
919,285

U.S. agency residential mortgage-backed securities & collateralized mortgage obligations
1,030,703

29,824

(1,266
)
1,059,261

Private mortgage-backed securities
598

11

(1
)
608

Total
$
1,945,977

$
34,483

$
(1,306
)
$
1,979,154

September 30, 2012
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Estimated
Fair
Value
Held-to Maturity:
State, county and municipal securities
$
181,792

$
11,489

$
(47
)
$
193,234

Corporate securities
5,658

63

—

5,721

Other securities
123

—

—

123

Total
$
187,573

$
11,552

$
(47
)
$
199,078


9

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share data)



December 31, 2011
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Estimated
Fair
Value
Available-for-Sale:
Obligations of U.S. government agencies
$
1,134,427

$
4,353

$
(662
)
$
1,138,118

U.S. agency residential mortgage-backed securities & collateralized mortgage obligations
848,444

29,567

(14
)
877,997

Private mortgage-backed securities
758

7

(16
)
749

Total
$
1,983,629

$
33,927

$
(692
)
$
2,016,864

December 31, 2011
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Estimated
Fair
Value
Held-to Maturity:
State, county and municipal securities
$
152,619

$
9,113

$
(17
)
$
161,715

Other securities
162

—

—

162

Total
$
152,781

$
9,113

$
(17
)
$
161,877


Gross realized gains and losses from the disposition of investment securities are summarized in the following table:
Three Months Ended September 30,
Nine Months Ended September 30,
2012
2011
2012
2011
Gross realized gains
$
66

$
38

$
298

$
56

Gross realized losses
—

—

(3
)
—

The following tables show 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 September 30, 2012 and December 31, 2011
Less than 12 Months
12 Months or More
Total
September 30, 2012
Fair
Value
Gross
Unrealized
Losses
Fair
Value
Gross
Unrealized
Losses
Fair
Value
Gross
Unrealized
Losses
Available-for-Sale:
Obligations of U.S. government agencies
$
31,855

$
(39
)
$
—

$
—

$
31,855

$
(39
)
U.S. agency residential mortgage-backed securities & collateralized mortgage obligations
124,136

(1,266
)
—

—

124,136

(1,266
)
Private mortgage-backed securities
—

—

154

(1
)
154

(1
)
Total
$
155,991

$
(1,305
)
$
154

$
(1
)
$
156,145

$
(1,306
)
Less than 12 Months
12 Months or More
Total
September 30, 2012
Fair
Value
Gross
Unrealized
Losses
Fair
Value
Gross
Unrealized
Losses
Fair
Value
Gross
Unrealized
Losses
Held-to-Maturity:
State, county and municipal securities
$
4,961

$
(39
)
$
696

$
(8
)
$
5,657

$
(47
)


10

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share data)


Less than 12 Months
12 Months or More
Total
December 31, 2011
Fair
Value
Gross
Unrealized
Losses
Fair
Value
Gross
Unrealized
Losses
Fair
Value
Gross
Unrealized
Losses
Available-for-Sale:
Obligations of U.S. government agencies
$
287,404

$
(662
)
$
—

$
—

$
287,404

$
(662
)
U.S. agency residential mortgage-backed securities & collateralized mortgage obligations
45,694

(14
)
—

—

45,694

(14
)
Private mortgage-backed securities
246

(10
)
177

(6
)
423

(16
)
Total
$
333,344

$
(686
)
$
177

$
(6
)
$
333,521

$
(692
)
Less than 12 Months
12 Months or More
Total
December 31, 2011
Fair
Value
Gross
Unrealized
Losses
Fair
Value
Gross
Unrealized
Losses
Fair
Value
Gross
Unrealized
Losses
Held-to-Maturity:
State, county and municipal securities
$
—

$
—

$
773

$
(17
)
$
773

$
(17
)
The investment portfolio is evaluated quarterly for other-than-temporary declines in the market value of each individual investment security. The Company had 30 and 24 individual investment securities that were in an unrealized loss position as of September 30, 2012 and December 31, 2011 , respectively. Unrealized losses as of September 30, 2012 and December 31, 2011 related primarily to fluctuations in the current interest rates. The Company does not have the intent to sell any of the available-for-sale securities in the above table and it is not likely that the Company will have to sell any such securities before a recovery in cost. No impairment losses were recorded during the three or nine months ended September 30, 2012 and 2011 .

Maturities of investment securities at September 30, 2012 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.
Available-for-Sale
Held-to-Maturity
September 30, 2012
Amortized
Cost
Estimated
Fair Value
Amortized
Cost
Estimated
Fair Value
Within one year
$
432,052

$
440,039

$
5,891

$
5,822

After one year but within five years
1,131,727

1,147,641

33,837

34,853

After five years but within ten years
227,503

232,493

79,891

84,811

After ten years
154,695

158,981

67,831

73,469

Total
1,945,977

1,979,154

187,450

198,955

Investments with no stated maturity
—

—

123

123

Total
$
1,945,977

$
1,979,154

$
187,573

$
199,078


As of September 30, 2012 , the Company had investment securities callable within one year with amortized costs and estimated fair values of $ 490,246 and $ 491,469 , respectively, including callable structured notes with amortized costs and estimated fair values of $ 120,273 and $ 120,519 , 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.


11

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED 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:
September 30,
2012
December 31,
2011
Real estate loans:
Commercial
$
1,513,784

$
1,553,155

Construction:
Land acquisition & development
233,082

278,613

Residential
50,895

61,106

Commercial
56,097

61,054

Total construction loans
340,074

400,773

Residential
639,235

571,943

Agricultural
175,395

175,302

Total real estate loans
2,668,488

2,701,173

Consumer:
Indirect consumer
431,449

407,651

Other consumer
139,984

147,487

Credit card
58,324

60,933

Total consumer loans
629,757

616,071

Commercial
672,100

693,261

Agricultural
135,467

119,710

Other, including overdrafts
1,359

2,813

Loans held for investment
4,107,171

4,133,028

Mortgage loans held for sale
72,880

53,521

Total loans
$
4,180,051

$
4,186,549


12

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share data)



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:
Total Loans
30 - 59
60 - 89
> 90
30 or More
Days
Days
Days
Days
Current
Non-accrual
Total
As of September 30, 2012
Past Due
Past Due
Past Due
Past Due
Loans
Loans
Loans
Real estate
Commercial
$
15,120

$
3,061

$
643

$
18,824

$
1,443,893

$
51,067

$
1,513,784

Construction:


Land acquisition & development
3,518

326

—

3,844

199,991

29,247

233,082

Residential
1,049

—

—

1,049

47,077

2,769

50,895

Commercial
1,875

—

—

1,875

43,703

10,519

56,097

Total construction loans
6,442

326

—

6,768

290,771

42,535

340,074

Residential
3,674

1,064

2,382

7,120

621,601

10,514

639,235

Agricultural
6,419

22

217

6,658

163,943

4,794

175,395

Total real estate loans
31,655

4,473

3,242

39,370

2,520,208

108,910

2,668,488

Consumer:



Indirect consumer
2,792

385

47

3,224

427,774

451

431,449

Other consumer
822

129

24

975

137,904

1,105

139,984

Credit card
368

280

528

1,176

57,125

23

58,324

Total consumer loans
3,982

794

599

5,375

622,803

1,579

629,757

Commercial
5,185

1,808

823

7,816

652,420

11,864

672,100

Agricultural
234

146

—

380

134,509

578

135,467

Other, including overdrafts






—

1,359

—

1,359

Loans held for investment
41,056

7,221

4,664

52,941

3,931,299

122,931

4,107,171

Mortgage loans originated for sale
—

—

—

—

72,880

—

72,880

Total loans
$
41,056

$
7,221

$
4,664

$
52,941

$
4,004,179

$
122,931

$
4,180,051




13

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share data)


Total Loans
30 - 59
60 - 89
> 90
30 or More
Days
Days
Days
Days
Current
Non-accrual
Total
As of December 31, 2011
Past Due
Past Due
Past Due
Past Due
Loans
Loans
Loans
Real estate
Commercial
$
22,124

$
7,871

$
630

$
30,625

$
1,455,139

$
67,391

$
1,553,155

Construction:


Land acquisition & development
5,251

2,448

867

8,566

208,134

61,913

278,613

Residential
415

—

—

415

56,219

4,472

61,106

Commercial
1,698

—

—

1,698

34,820

24,536

61,054

Total construction loans
7,364

2,448

867

10,679

299,173

90,921

400,773

Residential
4,669

973

1,798

7,440

546,278

18,225

571,943

Agricultural
4,103

1,831

—

5,934

166,119

3,249

175,302

Total real estate loans
38,260

13,123

3,295

54,678

2,466,709

179,786

2,701,173

Consumer:



Indirect consumer
3,078

370

45

3,493

403,695

463

407,651

Other consumer
1,479

436

60

1,975

144,625

887

147,487

Credit card
604

375

585

1,564

59,343

26

60,933

Total consumer loans
5,161

1,181

690

7,032

607,663

1,376

616,071

Commercial
13,721

3,464

405

17,590

657,609

18,062

693,261

Agricultural
476

215

110

801

118,150

759

119,710

Other, including overdrafts
—

2

—

2

2,811

—

2,813

Loans held for investment
57,618

17,985

4,500

80,103

3,852,942

199,983

4,133,028

Mortgage loans originated for sale
—

—

—

—

53,521

—

53,521

Total loans
$
57,618

$
17,985

$
4,500

$
80,103

$
3,906,463

$
199,983

$
4,186,549


If interest on non-accrual loans had been accrued, such income would have approximated $ 456 and $ 819 for the three months ended September 30, 2012 and 2011 , respectively, and approximated $ 1,701 and $ 2,283 for the nine months ended September 30, 2012 and 2011 , respectively.

14

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED 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 September 30, 2012
Unpaid
Total
Principal
Balance
Recorded
Investment
With No
Allowance
Recorded
Investment
With
Allowance
Total
Recorded
Investment
Related
Allowance
Real estate:
Commercial
$
88,185

$
61,509

$
17,143

$
78,652

$
4,453

Construction:
Land acquisition & development
43,595

19,660

12,558

32,218

4,137

Residential
3,333

1,257

1,744

3,001

276

Commercial
13,071

1,379

9,140

10,519

588

Total construction loans
59,999

22,296

23,442

45,738

5,001

Residential
12,044

5,570

5,070

10,640

1,736

Agricultural
5,929

3,293

2,137

5,430

158

Total real estate loans
166,157

92,668

47,792

140,460

11,348

Commercial
13,824

8,338

5,070

13,408

2,924

Agricultural
642

178

412

590

412

Total
$
180,623

$
101,184

$
53,274

$
154,458

$
14,684

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
$
97,745

$
62,769

$
23,218

$
85,987

$
6,741

Construction:
Land acquisition & development
73,258

22,300

39,131

61,431

12,084

Residential
13,721

10,427

2,044

12,471

312

Commercial
26,647

3,510

21,026

24,536

5,042

Total construction loans
113,626

36,237

62,201

98,438

17,438

Residential
18,305

2,678

15,626

18,304

3,844

Agricultural
8,018

7,470

—

7,470

—

Total real estate loans
237,694

109,154

101,045

210,199

28,023

Commercial
26,348

7,354

12,284

19,638

4,664

Agricultural
759

496

263

759

151

Total
$
264,801

$
117,004

$
113,592

$
230,596

$
32,838





15

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share data)


The following tables present the average recorded investment in and income recognized on impaired loans for the periods indicated:
Three Months Ended September 30,
2012
2011
Average Recorded Investment
Income Recognized
Average Recorded Investment
Income Recognized
Real estate:
Commercial
$
81,313

$
366

86,347

$
188

Construction:
Land acquisition & development
36,206

30

66,470

3

Residential
3,151

—

17,627

18

Commercial
10,817

—

23,441

—

Total construction loans
50,174

30

107,538

21

Residential
12,416

1

22,972

160

Agricultural
5,173

9

7,694

56

Total real estate loans
149,076

406

224,551

425

Commercial
15,992

21

33,634

31

Agricultural
748

4

885

—

Total
$
165,816

$
431

259,070

$
456

Nine Months Ended September 30,
2012
2011
Average Recorded Investment
Income Recognized
Average Recorded Investment
Income Recognized
Real estate:
Commercial
$
82,689

$
1,037

$
83,479

$
390

Construction:
Land acquisition & development
49,528

76

54,494

90

Residential
8,591

—

17,248

55

Commercial
18,601

—

20,371

—

Total construction loans
76,720

76

92,113

145

Residential
14,667

22

19,101

257

Agricultural
7,090

41

6,392

98

Total real estate loans
181,166

1,176

201,085

890

Commercial
16,129

65

32,634

96

Agricultural
1,039

19

925

—

Total
$
198,334

$
1,260

$
234,644

$
986


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 principal. Interest income is subsequently recognized only to the extent cash payments are received in excess of principal due. If interest on impaired loans had been accrued, interest income on impaired loans would have been approximately $ 452 and $ 812 for the three months ended September 30, 2012 and 2011 , respectively, and approximately $ 1,688 and $ 2,263 for the nine months ended September 30, 2012 and 2011 , respectively.

16

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share data)


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.
The Company had loans renegotiated in troubled debt restructurings of $ 90,410 as of September 30, 2012 , of which $ 54,982 were included in non-accrual loans and $ 35,428 were on accrual status. 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 following tables present information on the Company's troubled debt restructurings that occurred during the three and nine months ended September 30, 2012 :
Type of Concession
Three Months Ended September 30, 2012
Number of Notes
Interest only period
Extension of terms or maturity
Interest rate adjustment
Other (1)
Principal Balance at Restructure Date
Real estate:
Commercial
2

$
—

$
432

$
628

$
—

$
1,060

Construction:
Residential
1

—

—

233

—

233

Total construction loans
1

—

—

233

—

233

Agricultural
1

—

154

—

—

154

Total real estate loans
4

—

586

861

—

1,447

Commercial
1

—

—

—

35

35

Total loans restructured during period
5

$
—

$
586

$
861

$
35

$
1,482


17

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share data)


Number of Notes
Type of Concession
Principal Balance at Restructure Date
Nine Months Ended September 30, 2012
Interest only period
Extension of terms or maturity
Interest rate adjustment
Other (1)
Real estate:
Commercial
14
$
—

$
432

$
4,504

$
8,612

$
13,548

Construction:
Land acquisition & development
3
—

229

—

623

852

Residential
1
—

—

233

—

233

Commercial
1
—

—

—

3,155

3,155

Total construction loans
5
—

229

233

3,778

4,240

Residential
2
568

25

—

—

593

Agricultural
1
—

154

—

—

154

Total real estate loans
22
568

840

4,737

12,390

18,535

Consumer:
Other
1
—

69

—

—

69

Total consumer loans
1
—

69

—

—

69

Commercial
6
13

98

—

115

226

Total loans restructured during period
29

$
581

$
1,007

$
4,737

$
12,505

$
18,830

(1)
Other includes concessions that reduce or defer payments for a specified period of time and/or extend amortization schedules.

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 principal loan forgiveness or other charge-offs directly related to the restructuring. The Company had no charge-offs directly related to modifying troubled debt restructurings during the three and nine months ended September 30, 2012 or 2011 .

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 the periods indicated. 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.
Three Months Ended
September 30, 2012
Nine Months Ended
September 30, 2012
Number of Notes
Balance
Number of Notes
Balance
Real estate:
Commercial
—

$
—

2

$
507

Construction:
Land acquisition & development
—

—

1

468

Total construction loans
—

—

1

468

Residential
2

599

2

599

Total real estate loans
2

599

5

1,574

Total
2

$
599

5

$
1,574


At September 30, 2012 , there were no material commitments to lend additional funds to borrowers whose existing loans have been renegotiated or are classified as non-accrual.

18

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share data)



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.

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 September 30, 2012
Other Assets
Especially
Mentioned
Substandard
Doubtful
Total
Criticized
Loans
Real estate:
Commercial
$
115,540

$
143,023

$
19,401

$
277,964

Construction:
Land acquisition & development
33,362

25,369

16,198

74,929

Residential
1,444

3,148

1,392

5,984

Commercial
—

799

9,757

10,556

Total construction loans
34,806

29,316

27,347

91,469

Residential
6,901

11,246

8,295

26,442

Agricultural
16,824

11,220

2,532

30,576

Total real estate loans
174,071

194,805

57,575

426,451

Consumer:
Indirect consumer
964

1,682

96

2,742

Other consumer
853

1,583

552

2,988

Credit card
—

358

2,319

2,677

Total consumer loans
1,817

3,623

2,967

8,407

Commercial
43,282

29,318

5,225

77,825

Agricultural
4,136

2,080

412

6,628

Total
$
223,306

$
229,826

$
66,179

$
519,311



19

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share data)


As of December 31, 2011
Other Assets
Especially
Mentioned
Substandard
Doubtful
Total
Criticized
Loans
Real estate:
Commercial
$
129,046

$
153,320

$
25,087

$
307,453

Construction:
Land acquisition & development
37,294

31,873

38,761

107,928

Residential
9,448

5,528

2,044

17,020

Commercial
—

2,620

21,916

24,536

Total construction loans
46,742

40,021

62,721

149,484

Residential
8,149

15,706

15,140

38,995

Agricultural
16,037

18,498

395

34,930

Total real estate loans
199,974

227,545

103,343

530,862

Consumer:
Indirect consumer
1,141

1,729

247

3,117

Other consumer
745

1,361

674

2,780

Credit card
—

486

2,789

3,275

Total consumer loans
1,886

3,576

3,710

9,172

Commercial
34,698

33,478

12,849

81,025

Agricultural
4,345

5,195

263

9,803

Total
$
240,903

$
269,794

$
120,165

$
630,862


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.

20

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share data)



(4)
Allowance For Loan Losses
The following tables present a summary of changes in the allowance for loan losses by portfolio segment for the periods indicated.
Three Months Ended September 30, 2012
Real Estate
Consumer
Commercial
Agriculture
Other
Total
Allowance for loan losses:
Beginning balance
$
77,723

$
7,274

$
16,675

$
1,122

$
—

$
102,794

Provision charged to operating expense
5,371

192

4,222

(285
)
—

9,500

Less loans charged-off
(9,138
)
(1,340
)
(4,335
)
—

—

(14,813
)
Add back recoveries of loans previously
charged-off
387

465

666

7

—

1,525

Ending balance
$
74,343

$
6,591

$
17,228

$
844

$
—

$
99,006

Nine Months Ended September 30, 2012
Real Estate
Consumer
Commercial
Agriculture
Other
Total
Allowance for loan losses:
Beginning balance
$
87,396

$
8,594

$
15,325

$
1,266

$
—

$
112,581

Provision charged to operating expense
22,172

385

10,530

(337
)
—

32,750

Less loans charged-off
(36,645
)
(3,862
)
(10,028
)
(110
)
—

(50,645
)
Add back recoveries of loans previously
charged-off
1,420

1,474

1,401

25

—

4,320

Ending balance
$
74,343

$
6,591

$
17,228

$
844

$
—

$
99,006

As of September 30, 2012
Real Estate
Consumer
Commercial
Agriculture
Other
Total
Allowance for loan losses:
Loans individually evaluated for impairment
$
11,348

$
—

$
2,924

$
412

$
—

$
14,684

Loans collectively evaluated for impairment
62,995

6,591

14,304

432

—

84,322

Allowance for loan losses
$
74,343

$
6,591

$
17,228

$
844

$
—

$
99,006

As of September 30, 2012
Real Estate
Consumer
Commercial
Agriculture
Other
Total
Total loans:
Individually evaluated for impairment
$
140,460

$
—

$
13,408

$
590

$
—

$
154,458

Collectively evaluated for impairment
2,600,908

629,757

658,692

134,877

1,359

4,025,593

Total loans
$
2,741,368

$
629,757

$
672,100

$
135,467

$
1,359

$
4,180,051

Three Months Ended September 30, 2011
Real Estate
Consumer
Commercial
Agriculture
Other
Total
Allowance for loan losses:
Beginning balance
$
90,243

$
8,526

$
24,434

$
1,376

$
—

$
124,579

Provision charged to operating expense
9,984

1,676

2,206

134

—

14,000

Less loans charged-off
(12,210
)
(1,682
)
(6,498
)
(15
)
—

(20,405
)
Add back recoveries of loans previously
charged-off
1,386

453

287

3

—

2,129

Ending balance
$
89,403

$
8,973

$
20,429

$
1,498

$
—

$
120,303


21

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share data)


Nine Months Ended September 30, 2011
Real Estate
Consumer
Commercial
Agriculture
Other
Total
Allowance for loan losses:
Beginning balance
$
84,181

$
9,332

$
25,354

$
1,613

$
—

$
120,480

Provision charged to operating expense
33,080

2,927

8,461

(68
)
—

44,400

Less loans charged-off
(29,598
)
(4,641
)
(14,547
)
(60
)
—

(48,846
)
Add back recoveries of loans previously
charged-off
1,740

1,355

1,161

13

—

4,269

Ending balance
$
89,403

$
8,973

$
20,429

$
1,498

$
—

$
120,303

As of September 30, 2011
Real Estate
Consumer
Commercial
Agriculture
Other
Total
Allowance for loan losses:
Loans individually evaluated for impairment
$
27,344

$
—

$
9,422

$
239

$
—

$
37,005

Loans collectively evaluated for impairment
62,059

8,973

11,007

1,259

—

83,298

Allowance for loan losses
$
89,403

$
8,973

$
20,429

$
1,498

$
—

$
120,303

As of September 30, 2011
Real Estate
Consumer
Commercial
Agriculture
Other
Total
Total loans:
Individually evaluated for impairment
$
223,386

$
—

$
31,470

$
880

$
—

$
255,736

Collectively evaluated for impairment
2,582,202

627,139

671,540

135,848

3,252

4,019,981

Total loans
$
2,805,588

$
627,139

$
703,010

$
136,728

$
3,252

$
4,275,717

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 economic 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 conditions and the estimated impact of these factors on historical loss rates.

22

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share data)



(5)
Other Real Estate Owned
Information with respect to the Company's other real estate owned follows:
Three Months Ended September 30,
Nine Months Ended September 30,
2012
2011
2012
2011
Beginning balance
$
53,817

$
28,323

$
37,452

$
33,632

Additions
3,816

3,385

36,933

9,148

Capitalized improvements
—

—

75

15

Valuation adjustments
(2,310
)
(2,457
)
(3,457
)
(5,972
)
Dispositions
(15,352
)
(4,171
)
(31,032
)
(11,743
)
Ending balance
$
39,971

$
25,080

$
39,971

$
25,080


(6)
Subordinated Debentures Held by Subsidiary Trusts
On June 26, 2012 , the Company redeemed 30-year junior subordinated deferrable interest debentures ("Subordinated Debentures") issued by the Company to First Interstate Statutory Trust I ("FIST"). The redemption price of $41,238 was equal to the $1 liquidation amount of each security plus all accrued and unpaid distributions up to the date of redemption. Unamortized issuance costs of $428 were charged to other expense on the date of redemption.
The redemption of the Subordinated Debentures caused a mandatory redemption of $40,000 of 30-year floating rate mandatorily redeemable capital trust preferred securities issued by FIST to third-party investors and $1,238 of common equity securities issued by FIST to the Company.

(7)
Common Stock

The Company had 17,019,375 and 16,443,429 shares of Class A common stock outstanding as of September 30, 2012 and December 31, 2011 , respectively.

The Company had 26,233,008 and 26,540,745 shares of Class B common stock outstanding as of September 30, 2012 and December 31, 2011 , respectively.

(8)
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.


23

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share data)


The following table sets forth the computation of basic and diluted earnings per share for the three and nine month periods ended September 30, 2012 and 2011 .
Three Months Ended September 30,
Nine Months Ended September 30,
2012
2011
2012
2011
Net income
$
16,155

$
11,921

$
41,379

$
31,281

Less preferred stock dividends
863

862

2,569

2,559

Net income available to common shareholders, basic and diluted
$
15,292

$
11,059

$
38,810

$
28,722

Weighted average common shares outstanding for basic earnings per share computation
42,989,564

42,774,259

42,943,588

42,737,986

Dilutive effects of stock-based compensation
130,513

67,404

102,968

111,368

Weighted average common shares outstanding for diluted earnings per common share computation
43,120,077

42,841,663

43,046,556

42,849,354

Basic earnings per common share
$
0.36

$
0.26

$
0.90

$
0.67

Diluted earnings per common share
$
0.35

$
0.26

$
0.90

$
0.67


The Company had 2,814,277 and 2,888,192 stock options outstanding as of September 30, 2012 and 2011 , respectively, that were not included in the computation of diluted earnings per common share because their effect would be anti-dilutive. The Company had 48,196 and 33,068 shares of unvested restricted stock as of September 30, 2012 and 2011 , respectively, that were not included in the computation of diluted earnings per common share because performance conditions for vesting had not been met.
(9)
Regulatory Capital

The Company is subject to the regulatory capital requirements administered by federal banking regulators and the Federal Reserve. 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. 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 September 30, 2012 and December 31, 2011 , the Company exceeded all capital adequacy requirements to which it is subject.


24

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share data)


Actual capital amounts and ratios and selected minimum regulatory thresholds for the Company and its bank subsidiary, First Interstate Bank (“FIB”), as of September 30, 2012 and December 31, 2011 are presented in the following table:
Actual
Adequately Capitalized
Well Capitalized
Amount
Ratio
Amount
Ratio
Amount
Ratio
September 30, 2012
Total risk-based capital:
Consolidated
$
790,896

16.5
%
$
382,980

8.0
%
NA
NA
FIB
687,085

14.4

381,297

8.0

$
476,621

10.0
%
Tier 1 risk-based capital:
Consolidated
695,572

14.5

191,490

4.0

NA
NA
FIB
612,021

12.8

190,648

4.0

$
285,973

6.0

Leverage capital ratio:
Consolidated
695,572

9.6

291,093

4.0

NA
NA
FIB
612,021

8.4

290,214

4.0

$
362,768

5.0

Actual
Adequately Capitalized
Well Capitalized
Amount
Ratio
Amount
Ratio
Amount
Ratio
December 31, 2011
Total risk-based capital:
Consolidated
$
800,354

16.5
%
$
387,082

8.0
%
NA
NA
FIB
663,860

13.8

384,987

8.0

$
481,234

10.0
%
Tier 1 risk-based capital:
Consolidated
704,229

14.6

193,541

4.0

NA
NA
FIB
588,059

12.2

192,494

4.0

$
288,740

6.0

Leverage capital ratio:
Consolidated
704,229

9.8

286,303

4.0

NA
NA
FIB
588,059

8.2

285,358

4.0

$
356,698

5.0


(10)
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 $867 as of September 30, 2012 .

The Company had commitments to purchase held-to-maturity municipal securities of $988 as of September 30, 2012 .

(11)
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. 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. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. At September 30, 2012 , commitments to extend credit to existing and new borrowers approximated $ 1,120,190 which included $ 301,647 on unused credit card lines and $ 290,844 with commitment maturities beyond one year.

25

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share data)


Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. At September 30, 2012 , the Company had outstanding standby letters of credit of $ 68,895 . The estimated fair value of the obligation undertaken by the Company in issuing the standby letters of credit is included in other liabilities in the Company’s consolidated balance sheet.
(12)
Supplemental Disclosures to Consolidated Statement of Cash Flows
The Company transferred loans of $ 36,933 and $ 9,148 to OREO during the nine months ended September 30, 2012 and 2011 , respectively.
The Company transferred internally originated mortgage servicing rights of $ 3,344 and $ 1,850 from loans to mortgage servicing assets during the nine months ended September 30, 2012 and 2011 , respectively.
The Company transferred land pending disposal with a book value of $ 566 to other assets during the nine months ended September 30, 2012 .

The Company transferred premises and equipment pending disposal with a book value of $ 1,513 to other assets during the nine months ended September 30, 2011 .

The Company transferred accrued liabilities of $ 195 to common stock in conjunction with the vesting of liability-classified non-vested stock awards during the nine months ended September 30, 2011 .

(13)
Other Comprehensive Income

The gross amounts of each component of other comprehensive income and the related tax effects are as follows:
Pre-tax
Tax Expense (Benefit)
Net of Tax
Three Months Ended September 30,
2012
2011
2012
2011
2012
2011
Investment securities available-for sale:
Change in net unrealized gain during period
$
931

$
2,781

$
366

$
1,094

$
565

$
1,687

Reclassification adjustment for net gains included in net income
(66
)
(38
)
(26
)
(15
)
(40
)
(23
)
Defined benefits post-retirement benefit plan:
Change in net actuarial loss
35

35

14

14

21

21

Total other comprehensive income
$
900

$
2,778

$
354

$
1,093

$
546

$
1,685

Pre-tax
Tax Expense (Benefit)
Net of Tax
Nine Months Ended September 30,
2012
2011
2012
2011
2012
2011
Investment securities available-for sale:
Change in net unrealized gain during period
$
(175
)
$
24,200

$
(69
)
$
9,522

$
(106
)
$
14,678

Reclassification adjustment for net gains included in net income
(295
)
(56
)
(116
)
(22
)
(179
)
(34
)
Defined benefits post-retirement benefit plan:
Change in net actuarial loss
102

104

40

41

62

63

Total other comprehensive income
$
(368
)
$
24,248

$
(145
)
$
9,541

$
(223
)
$
14,707


26

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share data)


The components of accumulated other comprehensive income, net of income taxes, are as follows:
September 30,
2012
December 31,
2011
Net unrealized gain on investment securities available-for-sale
$
20,248

$
20,533

Net actuarial loss on defined benefit post-retirement benefit plans
(1,437
)
(1,499
)
Net accumulated other comprehensive income
$
18,811

$
19,034


(14)
Fair Value Measurements
Financial assets and financial liabilities measured at fair value on a recurring basis are as follows:
Fair Value Measurements at Reporting Date Using
Balance
as of
September 30, 2012
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
Significant Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Investment securities available-for-sale:
Obligations of U.S. government agencies
$
919,285

$
—

$
919,285

$
—

U.S. agencies mortgage-backed securities & collateralized mortgage obligations
1,059,261

—

1,059,261

—

Private mortgage-backed securities
608

—

608

—

Mortgage servicing rights
14,082

—

14,082

—

Fair Value Measurements at Reporting Date Using
Balance
as of
December 31, 2011
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
Significant Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Investment securities available-for-sale:
Obligations of U.S. government agencies
$
1,138,118

$
—

$
1,138,118

$
—

U.S. agencies mortgage-backed securities & collateralized mortgage obligations
877,997

—

877,997

—

Private mortgage-backed securities
749

—

749

—

Mortgage servicing rights
11,910

—

11,910

—

Derivative liability contract
383

—

—

383

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 nine months ended September 30, 2012 and 2011 :
Nine Months Ended September 30,
2012
2011
Balance, beginning of period
$
383

$
86

Accruals during the period
—

164

Cash payments during the period
(383
)
(128
)
Balance, end of period
$
—

$
122

There were no transfers between levels of the fair value hierarchy during the nine months ended September 30, 2012 or 2011 .

27

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share data)


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 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 fair value of the derivative liability contract is estimated utilizing an internal valuation model with significant unobservable inputs including the Company's expectations regarding the ultimate resolution of the Visa litigation and loss severity in the event of unfavorable litigation outcomes. The probability of unfavorable litigation outcomes and the estimation of loss severity is determined through review of Visa's press releases and public filings made with the Securities and Exchange Commission and management's estimation of the effect of changes in litigation status on the value of the derivative liability contract. On July 13, 2012, Visa entered into a memorandum of understanding to enter into a proposed settlement of certain litigation. If approved, the proposed settlement will not result in additional material liability to the Company.
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.


28

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share data)


The following table presents information about the Company’s assets and liabilities measured at fair value on a non-recurring basis.
Fair Value Measurements at Reporting Date Using
Balance
as of
September 30, 2012
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
Significant Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Impaired loans
$
66,555

$
—

$
—

$
66,555

Other real estate owned
17,089

—

—

17,089

Long-lived assets to be disposed of by sale
496

—

496

—

Fair Value Measurements at Reporting Date Using
Balance
as of
December 31, 2011
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
Significant Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Impaired loans
$
100,035

$
—

$
—

$
100,035

Other real estate owned
17,000

—

—

17,000


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 September 30, 2012 , certain impaired loans with a carrying value of $ 106,388 were reduced by specific valuation allowance allocations of $ 13,671 and partial loan charge-offs of $ 26,162 resulting in a reported fair value of $ 66,555 . 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 .
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. Write-downs of $ 3,457 during the nine months ended September 30, 2012 included adjustments of $ 625 directly related to receipt of updated appraisals and $ 2,832 based on management estimates of the current fair value of properties. Write-downs of $ 5,972 during the nine months ended September 30, 2011 included adjustments of $ 3,521 directly related to receipt of updated appraisals and $ 2,451 based on management estimates of the current fair value of properties.
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 September 30, 2012 , a long-lived asset to be disposed of by sale with a carrying value of $ 566 was reduced by write-downs of $ 70 charged to other expense resulting in a reported fair value of $ 496 . As of December 31, 2011 , 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 September 30, 2012 and December 31, 2011 , all mortgage loans held for sale were recorded at cost.

29

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share data)


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.


30

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share data)


The estimated fair values of financial instruments that are reported at amortized cost in the Company's consolidated balance sheets, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value, are as follows:
Fair Value Measurements at Reporting Date Using
As of September 30, 2012
Carrying Amount
Estimated
Fair Value
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
Significant Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Financial assets:
Cash and cash equivalents
$
611,335

$
611,335

$
—

$
611,335

$
—

Investment securities available-for-sale
1,979,154

1,979,154

—

1,979,154

—

Investment securities held-to-maturity
187,573

199,078

—

199,078

—

Accrued interest receivable
33,416

33,416

—

33,416

—

Mortgage servicing rights, net
12,334

14,082

—

14,082

—

Net loans
4,081,045

4,067,457

—

4,000,902

66,555

Total financial assets
$
6,904,857

$
6,904,522

$
—

$
6,837,967

$
66,555

Financial liabilities:
Total deposits, excluding time deposits
$
4,612,346

4,612,346

—

4,612,346

—

Time deposits
1,423,386

1,431,066

—

1,431,066

—

Securities sold under repurchase agreements
460,805

460,805

—

460,805

—

Other borrowed funds
6

6

—

6

—

Accrued interest payable
6,706

6,706

—

6,706

—

Long-term debt
37,170

34,003

—

34,003

—

Subordinated debentures held by subsidiary
trusts
82,477

57,656

—

57,656

—

Total financial liabilities
$
6,622,896

$
6,602,588

$
—

$
6,602,588

$
—


31

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share data)


Fair Value Measurements at Reporting Date Using
As of December 31, 2011
Carrying Amount
Estimated
Fair Value
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
Significant Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Financial assets:
Cash and cash equivalents
$
472,447

$
472,447

$
—

$
472,447

$
—

Investment securities available-for-sale
2,016,864

2,016,864

—

2,016,864

—

Investment securities held-to-maturity
152,781

161,877

—

161,877

—

Accrued interest receivable
31,974

31,974

—

31,974

—

Mortgage servicing rights, net
11,555

11,910

—

11,910

—

Net loans
4,073,968

4,064,718

—

3,964,683

100,035

Total financial assets
$
6,759,589

$
6,759,790

$
—

$
6,659,755

$
100,035

Financial liabilities:
Total deposits, excluding time deposits
$
4,269,631

$
4,269,631

$
—

$
4,269,631

$
—

Time deposits
1,557,340

1,565,558

—

1,565,558

—

Securities sold under repurchase agreements
516,243

516,243

—

516,243

—

Other borrowed funds
7

7

—

7

—

Accrued interest payable
8,123

8,123

—

8,123

—

Long-term debt
37,200

34,341

—

34,341

—

Subordinated debentures held by subsidiary
trusts
123,715

102,525

—

102,525

—

Derivative contract liability
383

383

—

—

383

Total financial liabilities
$
6,512,642

$
6,496,811

$
—

$
6,496,428

$
383


(15)
Recent Authoritative Accounting Guidance
ASU No. 2011-03, "Transfers and Servicing (Topic 860) - Reconsideration of Effective Control for Repurchase Agreements." Accounting Standards Update (“ASU”) No. 2011-03 is intended to improve financial reporting for 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 provisions of ASU No. 2011-03 became effective for the Company on January 1, 2012 and did not impact the Company's consolidated financial statements, results of operations or liquidity.
ASU No. 2011-04, "Fair Value Measurements (Topic 820) - Amendments to Achieve Common Fair Value Measurements and Disclosure Requirements in U.S. GAAP and IFRSs." ASU No. 2011-04 amends Topic 820, "Fair Value Measurements and disclosures," to converge the fair value measurements guidance in U.S. generally accepted accounting principles and International Financial Reporting Standards. ASU 2011-04 clarifies the application of existing fair value measurement requirements, changes certain principles in Topic 820 and requires additional fair value disclosures. ASU No. 2011-04 became effective for the Company on January 1, 2012 and did not have a significant impact on the Company's consolidated financial statements, results of operations or liquidity.

ASU 2011-05, “Comprehensive Income (Topic 220) - Presentation of Comprehensive Income.” ASU 2011-05 amends Topic 220, “Comprehensive Income,” to require that all non-owner changes in stockholders’ equity be presented in either a single continuous statement of comprehensive income or in two separate but consecutive statements. Additionally, ASU 2011-05 requires entities to present, on the face of the financial statements, reclassification adjustments for items that are reclassified from other comprehensive income to net income in the statement or statements where the components of net income and the components of other comprehensive income are presented. The option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity was eliminated. ASU 2011-05 became effective for the Company on January 1, 2012; however, certain provisions related to the presentation of reclassification adjustments have been deferred by ASU 2011-12 “Comprehensive Income (Topic

32

FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share data)


220) - Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05,” as further discussed below. Adoption of the provisions of ASU 2011-05 did not have a significant impact on the Company's consolidated financial statements, results of operations or liquidity.

ASU 2011-08, “Intangibles - Goodwill and Other (Topic 350) - Testing Goodwill for Impairment.” ASU 2011-08 amends Topic 350, “Intangibles - Goodwill and Other,” to give entities the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step impairment test is unnecessary. However, if an entity concludes otherwise, then it is required to perform the first step of the two-step impairment test by calculating the fair value of the reporting unit and comparing the fair value with the carrying amount of the reporting unit. ASU 2011-08 is effective for annual and interim impairment tests beginning after December 15, 2011. The adoption of ASU2011-08 did not have a significant impact on the Company's annual impairment test conducted as of July 1, 2012, or on the Company's consolidated financial statements, results of operations or liquidity.

ASU 2011-11, “Balance Sheet (Topic 210) - “Disclosures about Offsetting Assets and Liabilities.” ASU 2011-11 amends Topic 210, “Balance Sheet,” to require an entity to disclose both gross and net information about financial instruments, such as sales and repurchase agreements and reverse sale and repurchase agreements and securities borrowing/lending arrangements, and derivative instruments that are eligible for offset in the statement of financial position and/or subject to a master netting arrangement or similar agreement. ASU 2011-11 is effective for annual and interim periods beginning on January 1, 2013, and is not expected to have a significant impact on the Company's consolidated financial statements, results of operations or liquidity.

ASU 2011-12 “Comprehensive Income (Topic 220) - Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05.” ASU 2011-12 defers changes in ASU No. 2011-05 that relate to the presentation of reclassification adjustments to allow the FASB time to redeliberate whether to require presentation of such adjustments on the face of the financial statements to show the effects of reclassifications out of accumulated other comprehensive income on the components of net income and other comprehensive income. ASU 2011-12 allows entities to continue to report reclassifications out of accumulated other comprehensive income consistent with the presentation requirements in effect before ASU No. 2011-05. ASU 2011-12 became effective for the Company on January 1, 2012 and did not have a significant impact on the Company's consolidated financial statements, results of operations or liquidity.

ASU 2012-02 "Intangibles - Goodwill and Other Topics (Topic 350)." ASU 2012-02 amends Topic 350, “Intangibles - Goodwill and Other,” to reduce the cost and complexity of performing an impairment test for indefinite-lived assets by simplifying how an entity tests those assets for impairment and to improve consistency in impairment testing guidance among long-lived asset categories. The amendments in ASU 2012-02 permit an entity to first assess the qualitative factors to determine whether it is more likely than not that an indefinite-lived intangible asset is impaired as a basis for determining whether it is necessary to perform the quantitative impairment test. In addition, ASU 2012-02 provides an entity with an option not to calculate annually the fair value of in indefinite-lived intangible asset if the entity determines that it is not more likely than not that the asset is impaired. ASU 2012-02 is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. Early adoption is permitted including for annual and interim impairment test performed as of a date before July 27, 2012, if a public entity's financial statements for the most recent annual or interim period have not yet been issued. Adoption of the amendments in ASU 2012-02 will not have a significant impact on the Company's consolidated financial statements, results of operations or liquidity.

(16)
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.

33

Item 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2011, including the audited financial statements contained therein, filed with the Securities and Exchange Commission, or SEC.

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

Cautionary Note Regarding Forward-Looking Statements and Factors that Could Affect Future Results

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; 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.

A more detailed discussion of each of the foregoing risks is included in the Company's Annual Report on Form 10-K for the year ended December 31, 2011, filed February 28, 2012. These factors and the other risk factors described in the Company's periodic and current reports filed with the SEC from time to time, however, are not necessarily all of the important factors that could cause the Company's actual results, performance or achievements to differ materially from those expressed in or implied by any of the Company's forward-looking statements. Other unknown or unpredictable factors also could harm the Company's results. Investors and others are encouraged to read the more detailed discussion of the Company's risks contained in the Company's Annual Report on Form 10-K for the year ended December 31, 2011.

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.

34

Executive Overview
We are a financial and bank holding company headquartered in Billings, Montana. As of September 30, 2012 , we had consolidated assets of $7,461 million , deposits of $6,036 million , loans of $4,180 million and total stockholders’ equity of $798 million . We currently operate 72 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.

Recent Trends and Developments

Asset Quality

Non-performing assets decreased to $203 million, or 4.80% of total loans and OREO, as of September 30, 2012 , from $279 million, or 6.60% of total loans and OREO as of December 31, 2011, primarily due to the movement of non-accrual loans out of the loan portfolio through charge-offs or foreclosure.

Provisions for loan losses decreased $4.5 million, or 32.1%, to $9.5 million for the three months ended September 30, 2012 , as compared to $14.0 million for the same period in 2011, and $11.7 million, or 26.2%, to $32.8 million for the nine months ended September 30, 2012 , as compared to $44.4 million for the same period in 2011. These decreases are reflective of continued improvement in and stabilization of credit quality as evidenced by continuing declining levels of non-performing and criticized loans.

Net Interest Margin
Our net interest margin ratio, on a fully taxable-equivalent, or FTE, basis, decreased 21 basis points to 3.63% for the three months ended September 30, 2012 , as compared to 3.84% for the same period in 2011, and 10 basis points to 3.70% for the nine months ended September 30, 2012 , from 3.80% during the same period in 2011. These decreases were attributable to lower outstanding loan balances and lower yields earned on our loan and investment portfolios, which were partially offset by reductions in the cost of interest bearing liabilities combined with a continued shift away from higher-costing savings and time deposits to lower-costing demand deposits. During these times of very low interest rates and low loan growth, management expects further compression in the net FTE interest margin ratio in future quarters.


35

Origination and Sale of Residential Mortgage Loans
With market interest rates dipping to record lows, we experienced a 93% increase in residential mortgage loan origination activity during the first nine months of 2012, as compared to the same period in 2011, resulting in significantly higher income from the origination and sale of loans during the three and nine months ended September 30, 2012 , as compared to the same periods in the prior year. Income from the origination and sale of loans increased $6.2 million, or 111.6%, to $11.7 million during the three months ended September 30, 2012 , compared to $5.5 million during the same period in 2011, and $16.4 million, or 125.5%, to $29.5 million during the nine months ended September 30, 2012 , as compared to $13.1 million during the same period in 2011. Loans for new home purchases accounted for 36% of our residential mortgage loan origination dollars during the first nine months of 2012, an increase of 38.3% from the same period in the prior year. While refinancing activity accounted for 64% of our residential mortgage loan origination dollars during the first nine months of 2012, as compared to 49% during the same period in 2011, management does not expect this level of refinancing activity to continue in future quarters.
Regulatory Capital Proposals
On June 4, 2012, the Board of Governors of the Federal Reserve System, or the Board, issued three notices of proposed rulemaking, or NPRs. Taken together, the NPRs would restructure the Board's current regulatory capital rules and revise current regulatory capital requirements to make them consistent with the Basel III capital standards established by the Basel Committee on Banking Supervision and certain provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act.
The first NPR is primarily focused on quality and quantity of banking organizations' capital. The NPR introduces a new common equity tier 1 minimum capital requirement of 4.5% of risk-weighted assets and increases the minimum tier 1 capital requirement from 4.0% to 6.0% of risk-weighted assets. The minimum total risk-based capital requirement would remain unchanged at 8.0%. In addition to the minimum common equity tier 1, tier 1 and total risk-based capital requirements, banking organizations would be required to hold a buffer of common equity tier 1 capital in an amount above 2.5% of total risk-weighted assets to avoid restrictions on capital distributions and discretionary bonus payments to executive officers. The NPR also proposes changes to the definition of capital that would prohibit the inclusion in tier 1 capital of instruments that are not perpetual or that permit the accumulation of unpaid dividends or interest, such as trust preferred securities. Additionally, banking organizations would be subject to generally stricter regulatory capital deductions (the majority of which would be taken from common equity tier 1 capital) for mortgage servicing rights, deferred tax assets and certain investments in the capital of unconsolidated financial institutions than under current rules.
The second NPR increases the risk-sensitivity of the Board's general risk-based capital requirements for determining risk-weighted assets by expanding the number of risk-weight categories and increasing the capital required for certain high-risk residential mortgages, higher-risk construction and commercial real estate lending, and certain securitization exposures.
These two NPRs would apply to banks, saving associations and bank holding companies with consolidated assets of $500 million or more, like us, and to savings and loan holding companies. While these rules would be effective as of January 1, 2013, full compliance with most aspects of the rules would phase-in over a seven-year period. The new minimum regulatory capital ratios and changes to the calculation of risk-weighted assets would be required to be fully implemented effective January 1, 2014. The capital conservation buffer framework would phase-in between 2016 and 2018, with full implementation effective January 1, 2019. These NPRs are subject to final rulemaking by the Board and their provisions may change before their implementation. Management believes, as of September 30, 2012, we would meet all capital adequacy requirements under the proposed rules on a fully phased-in basis if such requirements were currently effective.
The third NPR would enhance the risk-sensitivity of the advanced approaches risk-based capital rule, including, among other revisions, revisions to better address counterparty credit risk and interconnectedness among financial institutions and incorporation of the Board's market risk rule into the integrated capital framework that would be established by all three proposed rules. This NPR would generally apply only to large, internationally active banking organizations or banking organizations with significant trading activity and would not impact us as currently proposed.

36

Proposed Settlement of Visa Interchange Litigation
On July 13, 2012,Visa, MasterCard and U.S. financial institution defendants signed a memorandum of understanding to enter into a settlement agreement to resolve a class-action lawsuit alleging collusion between the defendant banks and the credit card companies to maintain higher credit card interchange fees. Under the terms of the proposed settlement, class merchants may receive a distribution equal to 10 basis points of default interchange for a period of eight months, which would effectively reduce interchange fees received by credit card issuers, like us, during that time. Based on current transaction volumes, a 10 basis point reduction in credit interchange fees would not have a material impact on our consolidated financial statements, results of operations or liquidity. The proposed settlement agreement was submitted for preliminary federal court approval on October 19, 2012. Assuming the proposed settlement agreement is approved, the eight-month reduction in interchange fees could begin in late 2013.

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.

37

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 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. The most significant accounting policies we follow are summarized in Notes 1 of the Notes to Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2011.
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. Note 1 of the Notes to Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended December 31, 2011 describes 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 “Asset Quality."

38

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. Note 1 of the Notes to the Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended December 31, 2011 describes our accounting policy with regard to goodwill.

Our annual impairment test is performed each year as of July 1st. Upon completion of this year's annual impairment test, we determined that it is not more likely than not that the fair value of our net assets is less than our carrying value and; therefore, a Step 1 impairment test was not warranted. 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. Note 1 of the Notes to the Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended December 31, 2011 describes our accounting policy with regard to OREO.
Results of Operations
The following discussion and analysis is intended to provide greater details of the results of our operations and financial condition.
Net Interest Income. During third quarter 2012, our net interest income on a fully-taxable equivalent, or FTE, basis decreased $2.4 million, or 3.8%, to $62.2 million, as compared to $64.6 million during the same period in 2011, and our net FTE interest margin ratio decreased 21 basis points to 3.63%, as compared to 3.84% during the same period in 2011. For the nine months ended September 30, 2012 , our net FTE interest income decreased $5.0 million, or 2.6%, to $186.3 million, as compared to $191.2 million during the same period in 2011, and our net FTE interest margin ratio decreased 10 basis points to 3.70%, as compared to 3.80% during the same period in 2011. Decreases in net FTE interest income and net FTE interest margin ratio were attributable to lower outstanding loan balances and lower yields earned on our loan and investment portfolios, which were partially offset by reductions in the cost of interest bearing liabilities combined with a continued shift away from higher-costing savings and time deposits to lower-costing demand deposits. During these times of very low interest rates and low loan growth, management expects further compression in the net FTE interest margin ratio in future quarters.


39

The following tables present, 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)
Three Months Ended September 30,
2012
2011
Average
Balance
Interest
Average
Rate
Average
Balance
Interest
Average
Rate
Interest earning assets:
Loans (1) (2)
$
4,183,016

$
57,872

5.50
%
$
4,291,632

$
61,801

5.71
%
Investment securities (2)
2,098,576

11,123

2.11

2,064,019

12,594

2.42

Interest bearing deposits in banks
525,149

336

0.25

311,768

200

0.25

Federal funds sold
3,006

4

0.53

1,858

2

0.43

Total interest earnings assets
6,809,747

69,335

4.05

6,669,277

74,597

4.44

Non-earning assets
633,551

615,472

Total assets
$
7,443,298

$
7,284,749

Interest bearing liabilities:
Demand deposits
$
1,613,136

$
589

0.15
%
$
1,265,339

$
775

0.24
%
Savings deposits
1,523,347

873

0.23

1,712,739

1,478

0.34

Time deposits
1,452,688

3,952

1.08

1,699,633

5,652

1.32

Repurchase agreements
501,640

144

0.11

477,612

137

0.11

Other borrowed funds
6

—

—

5,584

—

—

Long-term debt
37,174

502

5.37

37,473

498

5.27

Subordinated debentures held by subsidiary trusts
82,477

1,110

5.35

123,715

1,451

4.65

Total interest bearing liabilities
5,210,468

7,170

0.55

5,322,095

9,991

0.74

Non-interest bearing deposits
1,399,585

1,153,800

Other non-interest bearing liabilities
43,511

47,412

Stockholders’ equity
789,734

761,442

Total liabilities and stockholders’ equity
$
7,443,298

$
7,284,749

Net FTE interest income
$
62,165

$
64,606

Less FTE adjustments (2)
(1,160
)
(1,114
)
Net interest income from consolidated statements of income
$
61,005

$
63,492

Interest rate spread
3.50
%
3.70
%
Net FTE interest margin (3)
3.63
%
3.84
%
Cost of funds, including non-interest bearing demand deposits (4)
0.43
%
0.61
%
(1)
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.
(2)
Interest income and average rates for tax exempt loans and securities are presented on a FTE basis.
(3)
Net FTE interest margin during the period equals (i) the difference between annualized interest income on interest earning assets and the annualized interest expense on interest bearing liabilities, divided by (ii) average interest earning assets for the period.
(4)
Calculated by dividing total annualized interest on interest bearing liabilities by the sum of total interest bearing liabilities plus non-interest bearing deposits.


40

Average Balance Sheets, Yields and Rates
(Dollars in thousands)
Nine Months Ended September 30,
2012
2011
Average
Balance
Interest
Average
Rate
Average
Balance
Interest
Average
Rate
Interest earning assets:
Loans (1) (2)
$
4,169,311

$
174,809

5.60
%
$
4,288,237

$
186,564

5.82
%
Investment securities (2)
2,112,005

34,141

2.16

2,010,966

36,885

2.45

Interest bearing deposits in banks
447,865

852

0.25

418,661

794

0.25

Federal funds sold
2,430

11

0.60

2,656

11

0.55

Total interest earnings assets
6,731,611

209,813

4.16

6,720,520

224,254

4.46

Non-earning assets
628,732

618,367

Total assets
$
7,360,343

$
7,338,887

Interest bearing liabilities:
Demand deposits
$
1,597,397

$
1,842

0.15
%
$
1,259,421

$
2,456

0.26
%
Savings deposits
1,485,330

2,821

0.25

1,722,782

5,231

0.41

Time deposits
1,496,531

12,792

1.14

1,784,256

18,992

1.42

Repurchase agreements
502,828

452

0.12

505,313

545

0.14

Other borrowed funds
24

—

—

5,579

—

—

Long-term debt
37,184

1,495

5.37

37,485

1,482

5.29

Subordinated debentures held by subsidiary trusts
108,966

4,084

5.01

123,715

4,354

4.71

Total interest bearing liabilities
5,228,260

23,486

0.60

5,438,551

33,060

0.81

Non-interest bearing deposits
1,303,535

1,105,122

Other non-interest bearing liabilities
47,108

48,726

Stockholders’ equity
781,440

746,488

Total liabilities and stockholders’ equity
$
7,360,343

$
7,338,887

Net FTE interest income
$
186,327

$
191,194

Less FTE adjustments (2)
(3,514
)
(3,377
)
Net interest income from consolidated statements of income
$
182,813

$
187,817

Interest rate spread
3.56
%
3.65
%
Net FTE interest margin (3)
3.70
%
3.80
%
Cost of funds, including non-interest bearing demand deposits (4)
0.48
%
0.68
%
(1)
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.
(2)
Interest income and average rates for tax exempt loans and securities are presented on a FTE basis.
(3)
Net FTE interest margin during the period equals (i) the difference between annualized interest income on interest earning assets and the annualized interest expense on interest bearing liabilities, divided by (ii) average interest earning assets for the period.
(4)
Calculated by dividing total annualized interest on interest bearing liabilities by the sum of total interest bearing liabilities plus non-interest bearing deposits.



41

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)
Three Months Ended September 30, 2012
compared with
Three Months Ended September 30, 2011
Nine Months Ended September 30, 2012
compared with
Nine Months Ended September 30, 2011
Volume
Rate
Net
Volume
Rate
Net
Interest earning assets:
Loans (1)
$
(1,547
)
$
(2,382
)
$
(3,929
)
$
(3,430
)
$
(8,325
)
$
(11,755
)
Investment securities (1)
209

(1,680
)
(1,471
)
1,229

(3,973
)
(2,744
)
Interest bearing deposits in banks
135

1

136

37

21

58

Federal funds sold
1

1

2

(1
)
1

—

Total change
(1,202
)
(4,060
)
(5,262
)
(2,165
)
(12,276
)
(14,441
)
Interest bearing liabilities:
Demand deposits
211

(397
)
(186
)
437

(1,051
)
(614
)
Savings deposits
(162
)
(443
)
(605
)
(478
)
(1,932
)
(2,410
)
Time deposits
(812
)
(888
)
(1,700
)
(2,031
)
(4,169
)
(6,200
)
Repurchase agreements
7

—

7

(2
)
(91
)
(93
)
Long-term debt
(4
)
8

4

(8
)
21

13

Subordinated debentures
(478
)
137

(341
)
(344
)
74

(270
)
Total change
(1,238
)
(1,583
)
(2,821
)
(2,426
)
(7,148
)
(9,574
)
Increase (decrease) in FTE net interest income
$
36

$
(2,477
)
$
(2,441
)
$
261

$
(5,128
)
$
(4,867
)
(1) Interest income for tax exempt loans and securities are presented on a FTE basis.
Provision for Loan Losses. The provision for loan losses decreased $4.5 million, or 32.1%, to $9.5 million for the three months ended September 30, 2012 , compared to $14.0 million for the same period in 2011, and decreased $11.7 million, or 26.2%, to $32.8 million for the nine months ended September 30, 2012 , compared to $44.4 million during the same period in 2011. Decreases in the provision for loan losses are reflective of improvement in and stabilization of credit quality as evidenced by declining levels of non-performing and criticized loans. For information regarding our non-performing loans, see “Non-Performing Assets” included 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 $7.1 million, or 30.5%, to $30.2 million for the three months ended September 30, 2012 , as compared to $23.1 million for the same period in 2011, and $19.4 million, or 29.8%, to $84.2 million during the nine months ended September 30, 2012 , as compared to $64.9 million during the same period in 2011. Significant components of these increases are discussed below.
Income from the origination and sale of loans increased $6.2 million, or 111.6%, to $11.7 million during the three months ended September 30, 2012 , compared to $5.5 million during the same period in 2011, and $16.4 million, or 125.5%, to $29.5 million during the nine months ended September 30, 2012 , as compared to $13.1 million during the same period in 2011. Record low mortgage interest rates continued to spur residential mortgage loan originations in our market areas during the first nine months of 2012, resulting in higher income from the origination and sale of loans.

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 $295 thousand, or 3.5%, to $8.8 million during the three months ended September 30, 2012, as compared to $8.5 million during the same period in 2011, and $1.8 million, or 7.7%, to $25.5 million during the nine months ended September 30, 2012, as compared to $23.6 million during the same period in 2011. These increases were primarily due to higher credit and debit card interchange fee revenue resulting from higher transaction volumes.



42

Wealth management revenues are comprised principally of fees earned for management of trust assets and investment services revenues. Fees earned for management of trust assets are generally based on the market value of assets managed. Wealth management revenues increased $355 thousand, or 11.1%, to $3.6 million during the three months ended September 30, 2012, as compared to $3.2 million during the same period in 2011, and increased $675 thousand, or 6.8%, to $10.7 million during the nine months ended September 30, 2012, as compared to $10.0 million during the same period in 2011. These increases were primarily due to new business activity combined with increases in the market values of assets under trust management.
Other income increased $440 thousand, or 34.2%, to $1.7 million for the three months ended September 30, 2012, compared to $1.3 million for the same period in 2011. Other income increased $302 thousand, or 6.0% to $5.3 million during the nine months ended September 30, 2012, as compared to $5.0 million during the same period in 2011. Increases in other income during the three and nine months ended September 30, 2012, as compared to the same periods in 2011, were primarily due to increases in earnings on securities held under deferred compensation plans. Also contributing to the increase in other income during the nine months ended September 30, 2012, as compared to the same period in 2011, was a $581 thousand gain on the sale of a bank building recorded during second quarter 2012.

Non-interest Expense. Non-interest expense increased $2.0 million, or 3.7%, to $57.1 million for the three months ended September 30, 2012, as compared to $55.0 million for the same period in 2011, and increased $9.6 million, or 5.9%, to $171.8 million for the nine months ended September 30, 2012, as compared to $162.2 million for the same period in 2011. Significant components of these increases are discussed below.

Salaries and wages increased $2.5 million, or 12.2%, to $23.3 million during the three months ended September 30, 2012, as compared to $20.8 million during the same period in the prior year, and $5.0 million, or 8.1%, to $66.5 million during the nine months ended September 30, 2012, as compared to $61.6 million during the same period in 2011 primarily due to higher incentive bonus accruals, inflationary wage increases and higher commissions and overtime compensation related to the substantial volume of residential real estate loan activity in 2012.

Employee benefits expense increased $1.4 million, or 22.3%, to $7.4 million during the three months ended September 30, 2012, as compared to $6.1 million during same period in 2011, and $2.3 million, or 11.0%, to $23.2 million during the nine months ended September 30, 2012, as compared to $20.9 million during the same period in 2011. These increases were primarily due to increases in the market value of securities held under deferred compensation plans. Also contributing to the increase in employee benefits expense during the nine months ended September 30, 2012, as compared to the same period in 2011, were higher stock-based compensation expense and increases in profit sharing accruals reflective of our improved performance.

OREO expense is recorded net of OREO income. Variations in OREO expense between periods are primarily due to write-downs of the estimated fair values of OREO properties, fluctuations in gains and losses recorded on sales of OREO properties and fluctuations in the carrying costs and/or operating expenses associated with OREO properties. OREO expense, net of income, decreased $266 thousand, or 9.2%, to $2.6 million for the three months ended September 30, 2012, compared to $2.9 million for the same period in 2011, and decreased $1.1 million, or 16.7%, to $5.5 million during the nine months ended September 30, 2012, as compared to $6.6 million for the same period in 2011. Additional carrying costs associated with properties foreclosed during the first nine months of 2012 were more than offset by net gains recorded on the sale of OREO properties during third quarter 2012 and decreases in write-downs of estimated fair value of OREO properties during the three and nine moths ended September, 30, 2012, as compared to the same periods in the prior year.

Professional fees increased $55 thousand, or 5.5%, to $1.1 million during the three months ended September 30, 2012, as compared to $995 thousand during the same period in 2011, and $485 thousand, or 19.4%, to $3.0 million during the nine months ended September 30, 2012, as compared to $2.5 million during the same period in 2011. These increases in professional fees were primarily attributable to additional costs associated with strategic planning initiatives.

Mortgage servicing rights are amortized in proportion to and over the period of estimated servicing income. Changes in estimated servicing period and changes in the serviced loan portfolio cause amortization expense to vary between periods. The period of estimated net servicing income is significantly influenced by market interest rates. Mortgage servicing rights amortization increased $72 thousand, or 8.9%, to $879 thousand during the three months ended September 30, 2012, as compared to $807 thousand during the same period in 2011, and $306 thousand, or 13.4%, to $2.6 million during the nine months ended September 30, 2012, as compared to $2.3 million during the same period in 2011.

43

Mortgage servicing rights are evaluated quarterly for impairment. 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 third quarter 2012, we recorded impairment of $55 thousand, as compared to impairment of $1.2 million during the same period in 2011. During the nine months ended September 30, 2012, we reversed impairment of mortgage servicing rights of $761 thousand, as compared to recording additional impairment of $848 thousand during the same period in 2011.

Other expenses primarily include advertising and public relations costs; office supply, postage, freight and telephone expenses; travel expense; donations expense; debit and credit card expenses; board of director fees; and other losses. Other expenses decreased $382 thousand, or 3.5%, to $10.5 million for the three months ended September 30, 2012, as compared to $10.9 million during the same period in 2011, and increased $5.6 million, or 17.5%, to $37.8 million during the nine months ended September 30, 2012, as compared to $32.2 million during the same period in 2011. During second quarter 2012, we recorded donation expense of $1.5 million in conjunction with the sale of a bank building to a charitable organization. In addition, during second quarter 2012, we expensed unamortized issuance costs of $428 thousand in conjunction with the June 26, 2012 redemption of junior subordinated debentures. Also contributing to the increase in other expenses during the nine months ended September 30, 2012, as compared to the same period in the prior year, were $3.0 million of estimated collection and settlement costs related to one borrower that were recorded as other expense during the first quarter of 2012. For additional information regarding the redemption of junior subordinated debentures, see "Financial Condition – Subordinated Debentures Held by Subsidiary Trusts" included herein and “Note 5 – Subordinated Debentures Held by Subsidiary Trusts” in the accompanying “Notes to Unaudited Consolidated Financial Statements” included in this report.
Income Tax Expense. Our effective federal income tax rate was 29.2% for the nine months ended September 30, 2012 and 27.6% for the nine months ended September 30, 2011. State income tax applies primarily to pretax earnings generated within Montana and South Dakota. Our effective state tax rate was 4.6% for the nine months ended September 30, 2012 and 2011. Changes in the effective federal income tax rates were primarily fluctuations in tax exempt interest income as a percentage of total income.
Financial Condition
Total assets increased $136 million, or 1.9%, to $7,461 million as of September 30, 2012, from $7,326 million as of December 31, 2011.
Loans. Total loans decreased $6 million, or less than 1%, to $4,180 million as of September 30, 2012, from $4,187 million as of December 31, 2011. Modest growth in residential real estate, agricultural and indirect consumer loans was more than offset primarily by decreases in commercial real estate and land acquisition and development loans. Management attributes these decreases to the movement of lower quality loans out of the loan portfolio through charge-off or foreclosure and low loan demand. Growth in residential real estate loans was primarily due to the retention of selected mortgage loan production.
Non-performing Assets. Non-performing assets include non-accrual loans, loans contractually past due 90 days or more and still accruing interest, loans renegotiated in troubled debt restructurings and OREO. The following table sets forth information regarding non-performing assets as of the dates indicated:
Nonperforming Assets
(Dollars in thousands)
September 30,
2012
June 30,
2012
March 31,
2012
December 31,
2011
September 30,
2011

Non-performing loans:
Non-accrual loans
$
122,931

$
129,923

$
180,910

$
199,983

$
223,961

Accruing loans past due 90 days or more
4,339

6,451

5,017

4,111

3,001

Troubled debt restructurings
35,428

35,959

36,838

37,376

35,616

Total non-performing loans
162,698

172,333

222,765

241,470

262,578

OREO
39,971

53,817

44,756

37,452

25,080

Total non-performing assets
$
202,669

$
226,150

$
267,521

$
278,922

$
287,658

Non-performing loans to total loans
3.89
%
4.13
%
5.36
%
5.77
%
6.14
%
Non-performing assets to total loans and OREO
4.80
%
5.35
%
6.36
%
6.60
%
6.69
%
Non-performing assets to total assets
2.72
%
3.10
%
3.60
%
3.81
%
3.94
%

44

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 various loan categories as of the dates indicated:
Non-Performing Loans by Loan Type
(Dollars in thousands)
September 30,
2012
Percent
of Total
December 31,
2011
Percent
of Total
Real estate:
Commercial
$
79,454

48.8
%
$
86,990

36.0
%
Construction:
.
Land acquisition and development
32,218

19.9
%
63,195

26.2
%
Commercial
10,519

6.5
%
14,023

5.8
%
Residential
3,001

1.8
%
24,536

10.2
%
Total construction
45,738

28.1
%
101,754

42.2
%
Residential
12,945

8.0
%
20,075

8.3
%
Agricultural
5,647

3.5
%
7,470

3.1
%
Total real estate
143,784

88.4
%
216,289

89.6
%
Consumer
3,412

2.1
%
3,455

1.4
%
Commercial
14,685

9.0
%
20,857

8.6
%
Agricultural
817

0.5
%
869

0.4
%
Total non-performing loans
$
162,698

100.0
%
$
241,470

100.0
%

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. If all loans on non-accrual had been current in accordance with their original terms, gross income of approximately $451 thousand and $810 thousand would have been accrued for the three months ended September 30, 2012 and 2011, respectively. If all loans on non-accrual had been current in accordance with their original terms, gross income of approximately $1.7 million and $2.3 million would have been accrued for the nine months ended September 30, 2012 and 2011, respectively.
Non-accrual loans, the largest component of non-performing loans, decreased $77 million, or 38.5%, to $123 million at September 30, 2012, from $200 million at December 31, 2011, primarily due to movement of non-accrual loans out of the loan portfolio due to charge-off or foreclosure. As of September 30, 2012, approximately 42% of our non-accrual loans were commercial real estate loans and approximately 24% were land acquisition and development loans.
Troubled Debt Restructuring . Modifications of performing loans are made 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.

45

We had loans renegotiated in troubled debt restructurings of $90 million as of September 30, 2012, of which $55 million were included in non-accrual loans in the non-performing assets table above and $35 million were on accrual status and reported as troubled debt restructurings in the non-performing assets table above. As of September 30, 2012, approximately 85% of our loans restructured in troubled debt restucturings were performing in accordance with their modified terms.
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 $3 million, or 6.7%, to $40 million as of September 30, 2012 from $37 million as of December 31, 2011. During the first nine months of 2012, we recorded additions to OREO of $37 million, wrote down the fair value of OREO properties by $3 million and sold OREO with a book value of $31 million at a gain of $768 thousand. As of September 30, 2012, the composition of our OREO was as follows: 52% land and land development properties, 21% commercial properties, 25% residential properties and 2% agricultural real estate properties.
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.
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.

46

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.
The following table sets forth information regarding our allowance for loan losses as of and for the periods indicated.
Allowance for Loan Losses
(Dollars in thousands)
Three Months Ended
September 30,
June 30,
March 31,
December 31,
September 30,
2012
2012
2012
2011
2011
Balance at beginning of period
$
102,794

$
115,902

$
112,581

$
120,303

$
124,579

Provision charged to operating expense
9,500

12,000

11,250

13,751

14,000

Charge offs:
Real estate
Commercial
3,058

6,362

681

2,972

4,064

Construction
4,477

15,107

2,571

9,178

7,997

Residential
1,603

861

1,825

3,803

149

Agricultural
1

20

79

213

—

Consumer
1,340

1,210

1,312

1,402

1,682

Commercial
4,334

3,180

2,512

4,785

6,498

Agricultural
—

5

107

82

15

Total charge-offs
14,813

26,745

9,087

22,435

20,405

Recoveries:
Real estate
Commercial
24

483

213

116

41

Construction
260

13

173

227

1,272

Residential
102

30

120

52

73

Agricultural
2

—

—

—

—

Consumer
465

488

521

384

453

Commercial
665

609

126

183

287

Agricultural
7

14

5

—

3

Total recoveries
1,525

1,637

1,158

962

2,129

Net charge-offs
13,288

25,108

7,929

21,473

18,276

Balance at end of period
$
99,006

$
102,794

$
115,902

$
112,581

$
120,303

Period end loans
$
4,180,051

$
4,169,963

$
4,158,616

$
4,186,549

$
4,275,717

Average loans
4,183,016

4,159,565

4,165,203

4,236,228

4,291,632

Net loans charged-off to average loans, annualized
1.26
%
2.42
%
0.76
%
2.01
%
1.69
%
Allowance to period end loans
2.37
%
2.47
%
2.79
%
2.69
%
2.81
%


47

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, 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.
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. Investment securities decreased $3 million, or less than 1%, to $2,167 million, or 29.0% of total assets, as of September 30, 2012, from $2,170 million, or 29.6% of total assets, as of December 31, 2011.
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 September 30, 2012, we had investment securities with fair values of $850 thousand that had been in a continuous loss position more than twelve months. Gross unrealized losses on these securities totaled $9 thousand as of September 30, 2012, and were attributable to changes in interest rates. No impairment losses were recorded during the three and nine months ended September 30, 2012 and 2011.
Deferred Tax Asset. Our net deferred tax asset decreased $8 million, or 83.0%, to $2 million as of September 30, 2012, from $10 million as of December 31, 2011, primarily due to loan charge-offs, which are deductible currently for income tax purposes.
Deposits. Our deposits consist of non-interest bearing and interest bearing demand, savings, individual retirement and time deposit accounts. Total deposits increased $209 million, or 3.6%, to $6,036 million as of September 30, 2012, from $5,827 million as of December 31, 2011, with a shift in the mix of deposits away from higher-costing time deposits to lower-costing savings, interest bearing demand and non-interest bearing demand deposits. As a result of a regulatory change allowing businesses to receive interest on checking accounts, during first quarter 2012 we discontinued our savings sweep product, which resulted in a shift of approximately $300 million from savings deposits into interest-bearing demand deposits.
The following table summarizes our deposits as of the dates indicated:
Deposits
(Dollars in thousands)
September 30,
2012
Percent
of Total
December 31,
2011
Percent
of Total
Non-interest bearing demand
$
1,443,773

23.9
%
$
1,271,709

21.8
%
Interest bearing:
Demand
1,637,214

27.1

1,306,509

22.4

Savings
1,531,359

25.4

1,691,413

29.0

Time, $100 and over
613,586

10.2

681,047

11.7

Time, other (1)
809,800

13.4

876,293

15.1

Total interest bearing
4,591,959

76.1

4,555,262

78.2

Total deposits
$
6,035,732

100.0
%
$
5,826,971

100.0
%
(1)
Included in Time, other are Certificate of Deposit Account Registry Service, or CDAR, deposits of $76 million as of September 30, 2012 and $98 million as of December 31, 2011.
Repurchase Agreements. In addition to deposits, repurchase agreement with commercial depositors, which include municipalities, provide an additional source of funds. Under repurchase agreements, deposits 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 agreements decreased $55 million, or 10.7%, to $461 million as of September 30, 2012, from $516 million as of December 31, 2011 due to fluctuations in the liquidity of our customers.


48

Subordinated Debentures Held by Subsidiary Trusts. Subordinated debentures held by subsidiary trusts decreased $41 million, or 33.3%, to $82 million as of September 30, 2012, from $124 million as of December 31, 2011. During second quarter 2012, we redeemed $41 million of junior subordinated deferrable interest debentures, or subordinated debentures, maturing March 26, 2033 and bearing a cumulative floating interest rate equal to LIBOR plus 3.15% per annum. Redemption of the subordinated debentures caused a mandatory redemption of $40 million of floating rate mandatorily redeemable capital trust preferred securities, or trust preferred securities, and all common securities issued by First Interstate Statutory Trust I, a wholly-owned unconsolidated business trust sponsored by us. See “Note 5 – Subordinated Debentures Held by Subsidiary Trusts” in the accompanying “Notes to Unaudited Consolidated Financial Statements” included in this report for additional information regarding this redemption

Capital Resources and Liquidity Management

Stockholders’ equity is influenced primarily by earnings, dividends, changes in the unrealized holding gains or losses, net of taxes, on available-for-sale investment securities and sales and redemptions of common stock. Stockholders’ equity increased $27 million, or 3.5% to $798 million as of September 30, 2012, from $771 million as of December 31, 2011, primarily due to the retention of earnings.

On September 27, 2012, we declared a quarterly dividend to common stockholders of $0.12 per share paid on October 17, 2012 to shareholders of record as of October 3, 2012. During the first nine months of 2012, we paid aggregate cash dividends of $15.4 million, or $0.36 per share, to common stockholders, as compared to aggregate cash dividends of $14.4 million, or $0.3375 per share, to common shareholders during the same period in 2011. In addition, we paid dividends of $2.6 million to preferred stockholders during the first nine months of 2012 and 2011.

Pursuant to the Federal Deposit Insurance Corporation Improvement Act, 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. As of September 30, 2012 and December 31, 2011, the Bank had capital levels that, in all cases, exceeded the well-capitalized guidelines. As of September 30, 2012, we had consolidated leverage, tier 1 and total risk-based capital ratios of 9.56%, 14.53% and 16.52%, respectively, as compared to 9.84%, 14.55% and 16.54%, respectively, as of December 31, 2011. Decreases in our tier 1 and total risk based capital ratios as of September 30, 2012, compared to December 31, 2011, were due to the redemption of $40 million of trust preferred securities that qualified as tier 1 capital under regulatory capital guidelines. For additional information regarding the redemption, see "Subordinated Debentures Held by Subsidiary Trusts" included herein and “Note 5 – Subordinated Debentures Held by Subsidiary Trusts” in the accompanying “Notes to Unaudited Consolidated Financial Statements” included in 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.
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 the unaudited “Consolidated Statements of Cash Flows,” included in Part I, Item 1.
As a holding company, we are a corporation separate and apart from the Bank and, therefore, we provide for our own liquidity. Our main sources of funding include management fees and dividends declared and paid by the Bank and access to capital markets. There are statutory, regulatory and debt covenant limitations that affect the ability of our subsidiary bank to pay dividends to us. Management believes that such limitations will not impact our ability to meet our ongoing short-term cash obligations.

49

Management continuously monitors our liquidity position and adjustments are made to the balance between sources and uses of funds as deemed appropriate. Our management is not aware of any events that are reasonably likely to have a material adverse effect on our liquidity, capital resources or operations. In addition, our management is not aware of any regulatory recommendations regarding liquidity, which if implemented, would have a material adverse effect on us.
Recent Accounting Pronouncements
See “Note 15 – Recent Authoritative Accounting Guidance” in the accompanying “Notes to Unaudited Consolidated Financial Statements” included in this report for details of recently issued accounting pronouncements and their expected impact on our financial statements.

Item 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
As of September 30, 2012, there have been no material changes in the quantitative and qualitative information about market risk provided pursuant to Item 305 of Regulation S-K as presented in our Annual Report on Form 10-K for the year ended December 31, 2011.

Item 4.
CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
Our management is responsible for establishing and maintaining effective disclosure controls and procedures, as defined under Rules 13a-15(e) and 15d-15(e) of the Exchange Act. As of September 30, 2012, an evaluation was performed, under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officer, of 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 September 30, 2012, were effective in ensuring that information required to be disclosed in our reports filed or submitted 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.
Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting for the quarter ended September 30, 2012, that have materially affected, or are reasonably likely to materially affect, such control.
Limitations on Controls and Procedures
The effectiveness of our disclosure controls and procedures and our internal control over financial reporting is subject to various inherent limitations, including cost limitations, judgments used in decision making, assumptions about the likelihood of future events, the soundness of our systems, the possibility of human error, and the risk of fraud. Moreover, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions and the risk that the degree of compliance with policies or procedures may deteriorate over time. Because of these limitations, any system of disclosure controls and procedures or internal control over financial reporting 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.

50


PART II.
OTHER INFORMATION

Item 1.
Legal Proceedings
There have been no material changes in legal proceedings as described in our Annual Report on Form 10-K for the year ended December 31, 2011.

Item 1A.
Risk Factors
There have been no material changes in risk factors described in our Annual Report on Form 10-K for the year ended December 31, 2011.

Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
(a) There were no unregistered sales of equity securities during the three months ended September 30, 2012.
(b) Not applicable.
(c) The following table provides information with respect to purchases made by or on behalf of us or any “affiliated purchasers” (as defined in Rule 10b-18(a)(3) under the Exchange Act), of our common stock during the three months ended September 30, 2012.
Period
Total Number
of Shares
Purchased (1)
Average
Price Paid
Per Share
Total Number of
Shares Purchased
as Part of Publicly
Announced Plans
or Programs
Maximum Number
of Shares that
May Yet Be
Purchased Under the
Plans or Programs
July 2012
—
$
—

—
Not Applicable
August 2012
—
—

—
Not Applicable
September 2012
352
15.23

—
Not Applicable
Total
352
$
15.23

—
Not Applicable
(1)
Represents shares purchased by the Company in satisfaction of minimum required income tax withholding requirements pursuant to the vesting of restricted stock.

Item 3.
Defaults upon Senior Securities
None.

Item 4.
Mine Safety Disclosures
Not applicable.

Item 5.
Other Information
Not applicable or required.

Item 6.
Exhibits
2.1

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)
2.2

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)
3.1

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)
3.2

Second Amended and Restated Bylaws dated January 27, 2011 (incorporated herein by reference to Exhibit 3.1 of the Company’s Current Report on Form 8-K/A filed on February 3, 2011)




51

4.1

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)
10.1

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)
10.2

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)
10.3†

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)
10.4†

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)
10.5†

2001 Stock Option Plan (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)
10.6†

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)
10.7†

First Interstate BancSystem, Inc. 2006 Equity Compensation Plan (incorporated herein by reference to Appendix A of the Company’s 2006 Definitive Proxy Statement of Schedule 14A)
10.8†

Amendment to 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)
10.9†

Second Amendment to 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

Trademark License Agreements between Wells Fargo & Company and First Interstate BancSystem, Inc. (incorporated herein by reference to Exhibit 10.11 of the Company’s Registration Statement on Form S-1, No. 333-25633 filed on April 22, 1997)
31.1*

Certification of Quarterly Report on Form 10-Q pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 by Chief Executive Officer
31.2*

Certification of Quarterly Report on Form 10-Q pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 by Chief Financial Officer
32*

Certification of Quarterly Report on Form 10-Q pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101**

Interactive data file
________________________
†
Management contract or compensatory 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.



52

SIGNATURES
Pursuant to the requirements 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.
FIRST INTERSTATE BANCSYSTEM, INC.
Date: November 7, 2012
/ S /    ED GARDING
Ed Garding
President and Chief Executive Officer
Date: November 7, 2012
/ S /    TERRILL R. MOORE
Terrill R. Moore
Executive Vice President and
Chief Financial Officer

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