El control interno

The information in this item does not purport to be complete and should be read in conjunction with, and is qualified in its entirety by, reference to Management’s Discussion and Analysis of Financial Condition and Results of Operations and the Financial Statements and Notes thereto included in this report.

The following table sets forth certain information concerning the Bank’s consolidated financial condition, operating results, and key operating ratios at the dates and for the periods indicated.

Year Ended December 31

2008 2007 2006 2005 2004

Income Statement Data:

Interest and dividend income $ 39,715 $ 51,222 $ 45,608 $ 30,932 $ 20,523

Interest expense 9,736 15,864 10,379 4,892 1,946

Net interest income 29,979 35,358 35,229 26,040 18,577

Provision for loan losses 12,015 605 2,079 2,163 725 Net interest income after provision

for loan losses 17,964 34,753 33,150 23,877 17,852

Noninterest income 4,887 4,709 4,498 4,525 4,494

Noninterest expense 21,464 21,451 19,202 16,705 14,383

Income before provision for income taxes 1,387 18,011 18,446 11,697 7,963 Provision for income taxes 378 6,939 7,424 4,288 2,951

Net income $ 1,009 $ 11,072 $ 11,022 $ 7,409 $ 5,012

Dividends and Share Data:

Cash dividends $ - $ - $ - $ - $ -

Share dividends and splits 4,911 11,617 14,852 8,027 5,462

Total dividends 4,911 11,617 14,852 8,027 5,462

Ratio of dividends declared to net income 486.72% 104.92% 134.75% 108.34% 108.98%

Basic earnings per common share $ 0.16 $ 1.78 $ 1.79 $ 1.21 $ 0.82 Diluted earnings per common share 0.16 1.65 1.64 1.11 0.77 Share dividends and splits per

common share 0.74 2.09 2.71 1.47 1.01

Book value per share 10.88 10.78 9.30 7.53 6.39

Weighted-average diluted shares

outstanding 6,488,991 6,719,645 6,720,222 6,666,714 6,528,357

2008 2007 2006 2005 2004

Balance Sheet Data:

Investment securities $ 4,624 $ 21,027 $ 21,502 $ 21,693 $ 25,774

Loans receivable, net 459,081 515,135 517,967 412,149 285,088

Total assets 588,449 625,693 615,062 510,270 394,691

Total deposits and repurchase agreements 457,560 503,241 516,265 448,957 351,177 Notes payable and other borrowed funds 56,700 45,313 31,814 9,000 -

Total stockholders' equity 67,386 67,184 57,269 46,301 39,314

(Dollars in thousands except share data) Year Ended December 31,

At December 31, (Dollars in thousands)

2008 2007 2006 2005 2004 Selected Ratios:

Return on average assets 0.17% 1.78% 2.00% 1.63% 1.35%

Return on average stockholders' equity 1.44% 17.71% 21.35% 17.47% 13.62%

Net interest margin 5.39% 6.07% 6.90% 6.27% 5.59%

Efficiency ratio (1) 61.56% 53.54% 48.34% 54.65% 62.34%

Asset Quality Ratios:

Allowance for loan and lease losses to:

Ending total loans 2.68% 1.92% 1.87% 1.87% 1.93%

Nonperforming assets 86% 1,068% 355% N/A 1,640%

Nonperforming assets to ending

total loans (2) 3.10% 0.18% 0.53% 0.00% 0.12%

Net charge-offs (recoveries) to

average loans 1.82% 0.08% 0.00% -0.02% -0.13%

Capital Ratios:

Tier 1 capital (to risk-weighted assets) 12.50% 11.28% 9.65% 9.57% 10.66%

Total risk-based capital 13.76% 12.54% 10.90% 10.82% 11.92%

Tier 1 capital (to average assets) 11.22% 10.63% 9.69% 9.22% 10.08%

At or For the Year Ended December 31,

______

(1)

Efficiency Ratio is defined as noninterest expense divided by the sum of net interest income and noninterest income. (2) _{Nonperforming assets consist of nonaccrual loans, loans contractually past due 90 days or more, and other real estate owned.}

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

Overview. The Bank’s net income is derived primarily from net interest income of the Bank, which is the difference between interest earned on its loan and investment portfolios and its cost of funds, primarily interest paid on deposits and borrowings. The volume of and yields earned on loans and investments and the volume of and rates paid on deposits and other liabilities determine net interest income. The Bank has historically enjoyed an above average net interest spread (the percentage interest rate on earning assets less the percentage interest paid on liabilities), primarily because of its loan and deposit pricing and its mix of assets and liabilities. At December 31, 2008, 25.6% of the Bank’s total deposits were noninterest-bearing. For the years ended December 31, 2008, 2007, and 2006, the Bank’s net interest spread was 4.78%, 4.98%, and 5.76%, respectively.

For each of the three years ended December 31, 2008, 2007, and 2006, the provision for loan losses was $12.0 million, $605,000, and $2.1 million, respectively. The Bank had net charge-offs of $9.5 million during 2008. By comparison, the Bank experienced net charge offs for the year ending December 31, 2007, of $412,000, and a net recovery of $9,000 during the year ending December 31, 2006. See “Liquidity, Capital Resources, and Cash Flow.”

Net income is also affected by noninterest income (primarily service charges on deposits, fees on real estate loans sold, and other operating income), noninterest expenses (primarily salaries and benefits, occupancy expenses, data processing costs, and other operating expenses), and income tax expense. For the years ended December 31, 2008, 2007, and 2006, noninterest income was $4.9 million, $4.7 million, and $4.5 million, respectively. For the years ended December 31, 2008, 2007, and 2006, noninterest expense was $21.5 million, $21.5 million, and $19.2 million, respectively. Income tax expense was $378,000, $6.9 million, and $7.4 million for the years ended December 31, 2008, 2007, and 2006, respectively.

The Bank depends primarily upon customer deposits and repurchase agreements for funds with which to conduct its business. Total deposits and repurchase agreements decreased $45.6 million, or 9.1%, to $457.6 million at December 31, 2008, from $503.2 million at December 31, 2007.

See Part I, Item 1. “Business” for additional management discussion and analysis of financial condition.

Trends and Developments Impacting Our Recent Results

Certain trends emerged and developments have occurred that are important in understanding our recent results and that are potentially significant in assessing future performance.

Growth in our market areas. Much of our past performance has been fueled by population and economic growth in the Coeur d’Alene and Boise areas. This brought about considerable activity in residential and commercial development projects; the construction of residential communities, shopping centers, and office buildings; and the expansion of the businesses and professions that provide goods and services to the growing population. Recent trends in our local markets, however, have been adversely influenced by weakening markets nationwide. Specifically, real estate and related activities slowed significantly during this past year and unemployment rates have increased substantially. Likewise, stressed local housing markets, reduced economic activity, and lower interest rates have adversely impacted our credit quality and operating results.

Asset sensitivity. Management uses various strategies to manage the repricing characteristics of our assets and liabilities. At December 31, 2008, the Bank’s model indicated that, largely due to loans that have interest rate floors, the Bank is liability sensitive in the very short term (0 to 3 months). Further, the model suggests the Bank is slightly liability sensitive within one year. Over all periods, the Bank is asset sensitive. A bank is considered to be asset sensitive if the amount of its interest-earning assets maturing or repricing within a certain time period exceed the amount of its interest- bearing liabilities also maturing or repricing within the same period. Being asset sensitive in times of rising interest rates may result in an increase in the Bank’s net interest income over time. Conversely, in times of falling interest rates, a decrease in net interest income would be expected. As a result, further decreases in short-term interest rates would be expected to reduce the Bank’s net interest margin and adversely impact future financial performance. See “Asset/Liability Management.”

Impact of expansion on non-interest expense. The Bank opened a new branch in Eagle, Idaho in May 2007 and a new branch and administrative offices in downtown Boise, Idaho in July 2007. This resulted in increases in salary, occupancy, and equipment expenses during the latter half of 2007. The full impact of these increases in operating expenses is reflected in 2008 operating results.

Impact of asset quality deterioration on provision for loan loss expense, interest income, and non-interest expense.

The Bank has experienced deterioration in asset quality over previous periods. This resulted in increased provisions for loan losses, reduced interest income as a result of loans being placed on non-accrual status, and increased operating expense related to collection activities, costs of disposing of collateral, and additional collateral valuation allowances. The full impact of these adverse impacts is reflected in current operating results. However, if the economic slowdown accelerates and/or continues for an extended period of time, we can expect further increases in non-performing assets and loan charge-offs, increased provision for loan loss expense, declines in the Bank’s net interest margin, and absolute and relative increases in operating costs during future periods.

Summary of Critical Accounting Policies. The SEC defined “critical accounting policies” as those that require application of Management’s most difficult, subjective, or complex judgment, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and may change in future periods. Our significant accounting policies are described in Note 1 in the “Notes to Consolidated Financial Statements” in Item 8 of this report. Not all of these critical accounting policies require Management to make difficult, subjective, or complex judgments or estimates.

Management believes that the following policies would be considered critical under the SEC definition.

Allowance for Loan and Lease Losses and Reserve for Unfunded Commitments. The Bank performs regular credit reviews of the loan and lease portfolio to determine the credit quality of the portfolio and the adherence to underwriting

standards. When loans and leases are originated, they are assigned a risk rating that is assessed periodically during the term of the loan through the credit review process. Each risk rating is assessed an inherent credit loss factor that determines the amount of the allowance for loan losses (“ALLL”) provided for that group of loans with similar risk ratings. The risk rating categories are a primary factor in determining an appropriate amount for the ALLL. Bank Management reviews the ALLL methodology, including loss factors, ensuring that it is designed and applied in accordance with generally accepted accounting principles. Management also reviews loans that have been placed on non- accrual status and approves placing loans on impaired status, as well as approves removing loans that are no longer impaired from the impairment and/or non-accrual status. The Bank’s Board of Directors reviews and approves the ALLL on at least a quarterly basis.

Regular credit reviews of the portfolio also identify loans that are considered potentially impaired. Potentially impaired loans are referred to Management, who review and approve designated loans as impaired. A loan is considered impaired when, based on current information and events, the Bank determines that it will probably not be able to collect all amounts due according to its contractual terms, including scheduled interest payments. When the Bank identifies a loan as impaired, Management measures the impairment using current fair value of the collateral, less selling costs, discounted cash flows, or the loan’s obtainable market price. If Management determines that the value of the impaired loan is less than the recorded investment in the loan, the Bank recognizes this impairment in the reserve as a specific component to be provided for in the allowance for loan and lease losses or charges the amount of the impairment against the ALLL. The reserve for unfunded commitments (“RUC”) is established to absorb inherent losses associated with our commitments to lend funds, such as with a letter of credit or lines of credit, contingent liabilities associated with the sale of real estate loans, or other off-balance sheet risks. The adequacy of the ALLL and RUC are monitored on a regular basis and are based on Management’s evaluation of numerous factors. These factors include the quality of the current loan portfolio, the trend in the loan portfolio’s risk ratings, current economic conditions, loan concentrations, loan growth rates, past-due and non-performing trends, volume of contingent liabilities, evaluation of specific loss estimates for all significant problem loans, historical charge-off and recovery experience, and other pertinent information.

Management believes that the ALLL and the RUC were adequate and represents the best estimate of the probable credit losses inherent in the loan portfolio as of December 31, 2008. There is, however, no assurance that future loan and other losses will not exceed the levels provided for in the ALLL and RUC and could possibly result in additional charges to the provision for loan losses or other operating expenses. In addition, bank regulatory authorities, as part of their periodic examination of the Bank, may require additional charges to the provision for loan losses or other operating expenses in future periods. Approximately 77.9% of our loan portfolio is secured by real estate, and further declines in real estate market values may require an increase in the ALLL.

Stock-Based Compensation. Effective January 1, 2006, the Bank adopted the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123R, Share Based Payment, a revision to the previously issued guidance on accounting for stock options and other forms of equity-based compensation. SFAS No. 123R requires companies to recognize in the income statement the grant-date fair value of stock options and other equity-based forms of compensation issued to employees and Directors over the employee or Directors’ requisite service period (generally the vesting period). The fair value of each option grant is estimated by the Bank as of the grant date using the Black-Scholes option-pricing model. This involves assumptions calculated using Management’s best estimates at the time of the grant, which impacts the fair value of the option calculated under the Black-Scholes methodology and, ultimately, the expense that will be recognized over the life of the option. Additional information is included in Notes 1 and 12 of the “Notes to Consolidated Financial Statements.”

Deferred Income Taxes.Deferred income taxes are reported for temporary differences between items of income or expense reported in the financial statements and those reported for income tax purposes. Deferred taxes are estimated using the asset and liability approach as prescribed in SFAS No. 109, Accounting for Income Taxes. Under this method, a deferred tax asset or liability is determined based on Management’s estimate of the enacted tax rates that will be in effect when the differences between the financial statement carrying amounts and tax basis of existing assets and liabilities are expected to be reported in the Bank’s income tax returns. The deferred tax provision for the year is equal to the net change in the net deferred tax asset from the beginning to the end of the year, less amounts applicable to the change in value related to investments available for sale. The effect on deferred taxes of a change in tax rates is

recognized in income in the period that includes the enactment date. The primary differences between financial statement income and taxable income result from depreciation expense, ALLL, deferred compensation, other real estate owned (“OREO”) valuation allowances, and dividends received from the FHLB of Seattle.

Real estate acquired in settlement of loans. Real estate acquired through foreclosure or deeds in lieu of foreclosure is stated at the lower of cost or estimated net realizable value. When the property is acquired, any excess of the loan balance over the estimated net realizable value is charged to the reserve for loan losses. Holding costs, subsequent write- downs to net realizable value, if any, or any disposition gains or losses are included in noninterest income and expenses. Costs of development and improvement of the property are capitalized.

Recent Accounting Pronouncements. Recently issued accounting pronouncements that could potentially impact the Bank are included in Note 1 of the “Notes to Consolidated Financial Statements” (Item 8).

Average Balances and Average Rates Earned and Paid. The following table shows average balances and interest income or interest expense, with the resulting average yield or rate by category of average earning asset or interest- bearing liability.

Year Ended December 31,

2008 2007 2006 Average Balance Interest Income or Expense Average Yield or Rate Average Balance Interest Income or Expense Average Yield or Rate Average Balance Interest Income or Expense Average Yield or Rate (dollars in thousands) Interest-earning assets: Loans (1) (2) (3) $505,026 $37,586 7.44% $519,670 $48,112 9.26% $472,966 $44,013 9.31% Investment securities: Taxable securities 8,414 242 2.88 25,051 1,122 4.48 12,279 520 4.23 Nontaxable securities (3) 896 53 5.92 1,116 65 5.83 1,660 70 4.22 Certificates of deposit with

other banks 40,824 1,851 4.53 22,502 1,217 5.41 13,685 537 3.92 Fed funds sold 2,223 44 1.98 14,523 755 5.20 10,431 504 4.83 Total interest-earning assets 557,383 $39,776 7.14% 582,862 $51,271 8.80% 511,021 $45,644 8.93% Noninterest-earning assets 45,076 37,727 39,486

Total assets $602,459 $620,589 $550,507

Interest-bearing liabilities: Interest-bearing checking and

savings accounts $233,278 $4,081 1.75% $ 235,328 $7,182 3.05% $ 203,177 $ 5,003 2.46% Time deposits 99,592 3,907 3.92 129,246 6,405 4.96 88,414 3,776 4.27 Other borrowed funds 43,664 1,225 2.81 16,378 841 5.13 15,468 785 5.06 Repurchase agreements 37,227 523 1.40 34,468 1,436 4.17 20,729 815 3.93 Total interest-bearing liabilities 413,761 9,736 2.35 415,421 15,864 3.82 327,788 10,379 3.17 Other liabilities 118,835 142,645 171,098 Total liabilities 532,596 558,066 498,886 Stockholders’ equity 69,863 62,523 51,621 Total liabilities and equity $602,459 $620,589 $550,507

Net interest income $30,040 $35,407 $35,265 Interest rate spread 4.79% 4.98% 5.76% Net interest margin (4) 5.39% 6.07% 6.90% Ratio of average interest-earning

assets to average interest- bearing liabilities

134.71% 140.31% 155.90% Taxable equivalent adjustment

(3) $61 $49 $36

_______

(1) Includes nonaccrual loans.

(2) Interest income includes loan fees of $2.3 million, $3.5 million, and $4.4 million for 2008, 2007, and 2006, respectively. (3) Tax-exempt income has been adjusted to a tax-equivalent basis at a 39.5% tax rate for 2008, 40.0% for 2007, and 38.5% for 2006. (4) Net interest margin is calculated as net interest income divided by average interest-earning assets.

Analysis of Changes in Interest Differential. The following table sets forth, on a tax-equivalent basis, a summary of the changes in net interest income resulting from changes in volumes and rates. Information is provided with respect to: (1) effects on interest income attributable to changes in volume (changes in volume multiplied by prior rate); and (2) effects on interest income attributable to changes in rate (changes in rate multiplied by prior volume). The changes attributable to both rate and volume, which cannot be segregated, are allocated proportionately to the changes in rate and volume.

Increase (Decrease) Increase (Decrease) Due to Change in Due to Change in

Volume Rate Net Change Volume Rate Net Change

Interest-earning assets: Loans $ (1,323) $ (9,203) $ (10,526) $ 4,325 $ (226) $ 4,099 Investment securities Taxable (572) (308) (880) 570 32 602 Non-taxable (1) (13) 1 (12) (27) 22 (5) Certificates of deposit 858 (224) 634 429 251 680 Fed funds sold (410) (301) (711) 211 40 251

Total $ (1,460) $ (10,035) $ (11,495) $ 5,508 $ 119 $ 5,627

Interest-bearing liabilities:

Interest-bearing checking

and savings accounts (62) (3,039) (3,101) 867 1,312 2,179 Time deposits (1,309) (1,189) (2,498) 1,951 678 2,629 Repurchase agreements 107 (1,020) (913) 569 52 621 Other borrowed funds 902 (518) 384 45 11 56

Total (362) (5,766) (6,128) 3,432 2,053 5,485

Net increase (decrease) in

net interest income $ (1,098) $ (4,269) $ (5,367) $ 2,076 $ (1,934) $ 142

(in thousands)

2008 Compared to 2007 2007 Compared to 2006

_______

(1) Tax-exempt income has been adjusted to a tax-equivalent basis at a 39.5% tax rate for 2008, a 40.0% tax rate for 2007, and a 38.5% rate for 2006.

Net Interest Income. The Bank’s results of operations are very dependent on its net interest income. Interest income and cost of funds are affected by general economic conditions, regulatory policy, and competition in the marketplace. See “Liquidity and Capital Resources.”

The following table sets forth information with regard to year-end balances of assets and liabilities for the Bank as well as the total dollar amounts of interest income from interest-earning assets and interest expense on interest-bearing liabilities, net interest income, and the net interest spread.

2008 2007 2006

Assets:

Investment securities $ 4,624 $ 21,027 $ 21,502

Certificates of deposit-other banks 55,324 34,737 18,687

Loans, net 459,081 515,135 517,967

Total assets 588,449 625,693 615,062

Liabilities:

Deposits 420,935 471,330 484,611

Securities sold under repurchase agreements 36,625 31,911 31,654

Other borrowed funds 56,700 45,313 31,814

Total liabilities 521,063 558,509 557,793

Interest income and expense:

Interest income 39,715 51,222 45,608

Interest expense 9,736 15,864 10,379

Net interest income 29,979 35,358 35,229

Net interest income after provision for loan losses 17,964 34,753 33,150

Net interest spread (1) 5.22% 4.86% 5.76%

Year Ended December 31, (Dollars in thousands)

(1) Based on monthly averages.

Asset/Liability Management. To a great extent, the Bank’s operating strategies focus on asset/liability management. The Bank has established a Funds Management Policy that is intended to provide stable net interest income growth while both maintaining adequate liquidity and protection from undue interest rate risk. The Funds Management Policy is established by Management and is approved by the Board of Directors. Consistent with the Funds Management Policy, it is Management’s strategy to control risk in a rising interest rate environment by taking action to shorten the average maturity of its investment and loan assets in order to achieve a more asset sensitive position, thereby allowing quicker asset repricing. Conversely, in a declining interest rate environment, Management’s strategy is generally to lengthen the average maturity or otherwise limit the repricing frequency of its assets, thereby making the balance sheet more liability sensitive. In addition, partially due to the size of the Bank’s loan portfolio in relation to levels of customer deposits, the duration of investments have purposely been kept short to help assure liquidity.

The Funds Management Policy is also designed to maintain an appropriate balance between rate-sensitive assets and