Overview

Management's discussion of financial condition and results of operations of Intervest Bancshares Corporation and Subsidiaries that follows should be read in conjunction with the accompanying consolidated financial statements in this report on Form 10-K.

Intervest Bancshares Corporation has two wholly owned consolidated subsidiaries, Intervest National Bank and Intervest Mortgage Corporation (together with Intervest Bancshares Corporation are referred to collectively as the "Company" on a consolidated basis in this report). Intervest Bancshares Corporation, Intervest National Bank and Intervest Mortgage Corporation may be referred to individually as "IBC," "INB" and "IMC," respectively, in this report. IBC also has four wholly owned unconsolidated subsidiaries, Intervest Statutory Trust II, III, IV and V, all of which were formed at various times in connection with the issuance of trust preferred securities. For a more detailed discussion of the Company's business, see note 1 to the consolidated financial statements in this report and Item 1 of Part I of this report on Form 10-K.

Critical Accounting Policies

The preparation of the Company's consolidated financial statements and the information included in Management's Discussion and Analysis herein is governed by policies that are based on accounting principles generally accepted in the United States (GAAP) and general practices within the banking industry. The financial information contained in the Company's financial statements is, to a significant extent, based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained either when earning income, recognizing an expense, recovering an asset or relieving a liability. In addition, GAAP itself may change from one previously acceptable method to another method. Among the more significant policies of the Company are those that govern accounting for loans and the allowance for loan losses. For a summary of all of the Company's significant accounting policies, see note 1 to the consolidated financial statements included in this report on Form 10-K.

An accounting policy is deemed to be "critical" if it is important to a company's results of operations and financial condition, and requires significant judgment and estimates on the part of management in its application. The preparation of financial statements and related disclosures in conformity with GAAP requires management to make estimates and assumptions that affect certain amounts reported in the financial statements and related disclosures. Actual results could differ from these estimates and assumptions. The Company believes that the estimates and assumptions used in connection with the amounts reported in its financial statements and related disclosures are reasonable and made in good faith.

The Company believes that currently its only significant critical accounting policy relates to the determination of the allowance for loan losses. The allowance for loan losses is a critical accounting estimate because it is highly susceptible to change from period to period requiring management to make assumptions about future loan chargeoffs. The impact of a large chargeoff could deplete the allowance and potentially require increased provisions to replenish the allowance, which could negatively affect the Company's earnings and financial position.

The allowance for loan losses reflects management's judgment as to the estimated losses that may result from defaults in the loan portfolio. The allowance for loan losses is established through a provision charged to expense. Loans are charged off against the allowance when management believes that the collection of principal is unlikely. Subsequent recoveries of previous chargeoffs are added back to the allowance.

The Company evaluates the adequacy of its allowance for loan losses at least monthly or more frequently when necessary with consideration given to the following factors:

(i) Size of the loans in the portfolio. The loan portfolio has many individual loans with large principal balances, which increases the portfolio's risk profile. At December 31, 2008, the average real estate loan was $2.7 million, with the largest loan being $20.5 million. In addition, loans with principal balances of $5 million or more represented 47% of the portfolio.

(ii) Nature (concentration) of the loans in the portfolio. The loan portfolio is concentrated in loans secured by commercial and multifamily real estate, including some vacant properties and vacant land, all of which are generally considered to have more credit risk than traditional 1-4 family residential lending because these loans tend to involve larger loan balances to single borrowers and their repayment is typically dependent upon the successful operation of the underlying real estate for income-producing properties. Loans on vacant properties and vacant land typically do not have income streams and depend upon other sources of cash flow from the borrower for repayment. The number of vacant land loans in the portfolio has decreased substantially over the last several years. The properties collateralizing the loans are also concentrated by location, and this concentration also increases the risk associated with the portfolio. The properties are concentrated in two states, New York and Florida. Economic conditions and real estate values in Florida are currently depressed and New York is also experiencing weakening economic conditions and lower real estate values. A large number of the properties in New York are located in Manhattan, Brooklyn, Queens, Long Island, Staten Island and the Bronx. A large number of the properties in Florida are located in Clearwater, Tampa, St. Petersburg, Orlando, Fort Lauderdale, Hollywood and Miami. Many of the multifamily properties located in New York City and surrounding boroughs are also subject to rent control and rent stabilization laws, which limit the ability of the property owners to increase rents, which may in turn limit the borrower's ability to repay those mortgage loans. Many of the properties are also located in sections of the cities noted above that are being revitalized or redeveloped. All of these factors increase the risk profile of the portfolio.

(iii) Specific problem loans, including loans on nonaccrual status, and estimates of fair value of the underlying properties. Whenever a loan experiences payment problems, an internal review of that loan is performed by either or both of the Company's two senior lending officers (the Chairman and the President of INB) to re-evaluate the internal credit rating that is assigned to the loan. This credit rating directly affects the computation of the allowance for loan losses. The estimated loss factors that the Company applies to its loans to calculate the allowance for loan losses increase as a loan's credit rating decreases. Nonaccrual and/or problem loans are normally downgraded based on known facts and circumstances at the time of review, which in turn impacts the level of the allowance for loan losses. The review includes the physical inspection of such properties and the monitoring of impositions and insurance premiums to preserve the Company's security interest in the properties. Additionally, the Company engages independent third parties to perform quarterly loan portfolio reviews, which include all loans on nonaccrual status. The Company takes into consideration the nature and extent of the collateralization of nonaccrual loans, loans past due 90 days and still accruing and any other problem loans in its determination of the allowance for loan losses. Estimates of fair value of the collateral properties is determined based on a variety of information, including available appraisals and the knowledge and experience of the two senior lending officers related to values of properties in the Company's market areas. Determination of the need for updated appraisals is made on a loan-by-loan basis. In addition to appraisals, consideration is also given to the type, location and occupancy of the property and current economic conditions in the area the property is located in assessing estimates of fair value.

(iv) Historical chargeoffs and recoveries. The Company has experienced a limited number of loan charge offs to date. In computing the allowance, the Company currently does not place much reliance on its historical losses. A greater weight is placed on the current level of nonaccrual loans and the specific circumstances for which potential losses may exist in the portfolio. Although the Company has never originated or acquired subprime loans nor invested in securities collateralized by subprime loans, the subprime loan crisis and resulting impact on the credit markets in 2008 has affected the Company indirectly through reductions in overall real estate values and a weakening of the overall economy, both in Florida and New York. The Company has also experienced the effects of misconduct committed by certain of its borrowers, which required the Company to place certain loans that are collateralized by income producing properties on nonaccrual status, in some instances due to involuntary bankruptcy filings filed against the borrowers by third party creditors. Such filings resulted in the cessation of monthly loan payments and have delayed the Company's ability to move forward with foreclosure or other proceedings to acquire and sell the collateral property.

(v) Adverse situations which may affect the borrowers' ability to repay. All nonaccrual and problem loans are reviewed individually based on the facts and circumstances known to the Company at the time of the review. Based on these reviews, the Company's two senior lending officers make an assessment as to whether there are specific issues unique to each problem loan or whether such issues identified are generic to the portfolio, which may in turn necessitate a change to the overall estimated loss factors that are used to calculate the allowance.

(vi) The perception of the Company's two senior lending officers of current and anticipated economic conditions in the Company's primary lending areas, which are concentrated in New York and Florida, and national economic conditions. The real estate market is in a general slowdown that began in 2006, with the magnitude thereof being more pronounced in certain areas of the country than others and in certain types of properties. In addition, the recent crisis in the credit markets and resulting turmoil on Wall Street has also negatively impacted the economy and real estate values by reducing the amount of funds available for lending in general. These factors have increased the level of risk in the portfolio and will likely continue to negatively impact the portfolio in 2009.

(vii) Trends in loan volume and loan terms, changes in risk selection, underwriting standards and lending policies and procedures.The Company has not relaxed its underwriting standards or its lending policies/procedures, and believes it has become more risk averse by being more selective in the current economic environment. Loan-to-value ratios (the ratio that the original principal amount of the loan bears to the lower of the purchase price or appraised value of the property securing the loan at the time of origination) on new loans typically do not exceed 80%. Debt service coverage ratios (the ratio of the net operating income generated by the property securing the loan to the required debt service) on new real estate loans typically are not less than 1.2 times.

(viii) Experience, ability and depth of lending officers and other underwriting staff. All potential new loans are referred to one of the Company's two senior lending officers, both of whom have substantial experience in commercial and multifamily real estate lending. Generally, all loans originated must be first reviewed and approved by a Loan Committee and undergoes extensive underwriting procedures. The Company believes that there is substantial experience on its lending staff.

Based on the management's assessment of all the factors discussed above, the Company maintains an allowance for loan losses that is comprised of an unallocated portion (which is derived from estimated loss factors currently ranging from 0.30% to 1.35% multiplied by the principal amount of loans rated acceptable, and higher percentages for loans that are assigned a lower credit grade) and an allocated (or specific) portion on loans that have been identified as being impaired under Statement of Financial Accounting Standards (SFAS) 114.

SFAS 114 specifies the manner in which the portion of the allowance for loan losses related to impaired loans is computed. A loan is normally deemed impaired under SFAS 114 when, based upon current information and events, it is probable that the Company will be unable to collect both principal and interest due according to the contractual terms of the loan agreement. Impairment for larger balance loans such as the Company's commercial real estate and multifamily loans are measured based on one of the following methods: the present value of expected future cash flows, discounted at the loan's effective interest rate; the observable market price of the loan; or the estimated fair value of the loan's collateral, if payment of the principal and interest is dependent upon the collateral. When the fair value of the property is less than the recorded investment in the loan, this deficiency is recognized as a specific valuation allowance (recorded as part of the overall allowance for loan losses) with a charge to expense through the provision for loan losses. The Company considers a variety of factors in determining whether a loan is impaired, including (i) any notice from the borrower that the borrower will be unable to repay all principal and interest amounts contractually due under the loan agreement, (ii) any delinquency in the principal and/or interest payments other than minimum delays or shortfalls in payments, and (iii) other information known by management that would indicate the full repayment of principal and interest is not probable. In evaluating loans for impairment, management generally considers delinquencies of 60 days or less to be minimum delays, and accordingly does not consider such delinquent loans to be impaired in the absence of other indications. Impaired loans normally consist of loans on nonaccrual status. Generally, all of the Company's loans are evaluated for impairment on a loan-by-loan basis using the estimated fair value of the loan's collateral.

The Company believes, based on information known to it at December 31, 2008, that its allowance for loan losses was adequate to cover estimated credit losses in the loan portfolio as of December 31, 2008. Although the Company believes it uses the best information available to make determinations with respect to the allowance for loan losses, future adjustments to the allowance may be necessary if facts and circumstances differ from those previously assumed in the determination of the allowance. For example, a prolonged downturn in real estate values and economic conditions could have an adverse impact on the Company's asset quality and may result in an increase in future loan charge-offs and loan loss provisions, and may also result in the decrease in the estimated value of real estate acquired through foreclosure.

Finally, the Company's regulators, as an integral part of their examination process, periodically review the allowance for loan losses and the estimated values of real estate acquire through foreclosure. Accordingly, the Company may be required to take certain chargeoffs and/or recognize additions to the allowance for loan losses, or record write downs on the carrying values of foreclosed real estate based on the regulators' judgment concerning information available to them during their examination.

Comparison of Financial Condition at December 31, 2008 and 2007.

Overview

Selected balance sheet information by entity as of December 31, 2008 follows:



($ in thousands)                         IBC            INB           IMC         Eliminations (1)       Consolidated
Cash and cash equivalents             $   2,875     $    45,215     $ 19,949     $          (13,136 )   $       54,903
Security investments                          -         484,482            -                      -            484,482
Loans receivable, net of deferred
fees                                      2,589       1,652,184       50,938                      -          1,705,711
Allowance for loan losses                   (30 )       (27,506 )       (988 )                    -            (28,524 )
Foreclosed real estate                        -           6,754        2,327                      -              9,081
Investment in consolidated
subsidiaries                            260,179               -            -               (260,179 )                -
All other assets                          3,359          39,766        3,241                   (186 )           46,180
Total assets                          $ 268,972     $ 2,200,895     $ 75,467     $         (273,501 )   $    2,271,833
Deposits                              $       -     $ 1,877,273     $      -     $          (13,138 )   $    1,864,135
Borrowed funds and related interest
payable                                  56,824          50,782       41,960                      -            149,566
All other liabilities                       174          44,405        1,763                   (184 )           46,158
Total liabilities                        56,998       1,972,460       43,723                (13,322 )        2,059,859
Total stockholders' equity              211,974         228,435       31,744               (260,179 )          211,974
Total liabilities and stockholders'
equity                                $ 268,972     $ 2,200,895     $ 75,467     $         (273,501 )   $    2,271,833

(1) All significant intercompany balances and transactions are eliminated in consolidation. Such amounts arise largely from intercompany deposit accounts and investments in subsidiaries.

A comparison of selected consolidated balance sheet information follows:

                                             At December 31, 2008               At December 31, 2007
                                           Carrying         % of              Carrying         % of
($ in thousands)                             Value      Total Assets            Value      Total Assets
Cash and cash equivalents                 $    54,903            2.4 %       $    33,086            1.6 %
Security investments                          484,482           21.4             350,456           17.3
Loans receivable, net of deferred fees
and allowance for loan losses               1,677,187           73.8           1,592,439           78.8
Foreclosed real estate                          9,081            0.4                   -              -
All other assets                               46,180            2.0              45,411            2.3
Total assets                              $ 2,271,833          100.0 %       $ 2,021,392          100.0 %
Deposits                                  $ 1,864,135           82.1 %       $ 1,659,174           82.1 %
Borrowed funds and related interest
payable                                       149,566            6.6             136,434            6.7
All other liabilities                          46,158            2.0              46,223            2.3
Total liabilities                           2,059,859           90.7           1,841,831           91.1
Total stockholders' equity                    211,974            9.3             179,561            8.9
Total liabilities and stockholders'
equity                                    $ 2,271,833          100.0 %       $ 2,021,392          100.0 %

Cash and Cash Equivalents

Cash and cash equivalents include interest-bearing and noninterest-bearing cash balances with banks, and other short-term investments that have original maturities of three months or less. Cash and cash equivalents increased to $55 million at December 31, 2008, from $33 million at December 31, 2007. The level of cash and cash equivalents fluctuates based on various factors, including liquidity needs, loan demand, deposit flows, calls of securities, repayments of borrowed funds and alternative investment opportunities.

Security Investments

Securities are classified as held to maturity and are carried at amortized cost when management has the intent and ability to hold them to maturity. Such investments, all of which are held by INB, increased to $476 million at December 31, 2008, from $344 million at December 31, 2007. The increase reflected new purchases with lower yields exceeding maturities and calls of securities with higher yields during the period. INB invests in U.S. government agency debt obligations to emphasize safety and liquidity. The Company does not own or invest in any collateralized debt obligations, collateralized mortgage obligations, or any preferred or common stock of the Federal National Mortgage Association or Federal Home Loan Mortgage Corporation.

At December 31, 2008, securities held to maturity consisted of investment grade rated debt obligations of the Federal Home Loan Bank, Federal Farm Credit Bank, Federal National Mortgage Association and Federal Home Loan Mortgage Corporation totaling $468 million and corporate securities (consisting of variable-rate pooled trust preferred securities backed by obligations of companies in the banking industry) of $8 million. At December 31, 2008, the entire portfolio had a weighted-average yield of 3.80% and a weighted-average remaining maturity of 4.2 years, compared to 5.01% and 4.0 years, respectively, at December 31, 2007. Nearly all of the securities in the portfolio have fixed rates of interest or have predetermined rate increases, and many have call features that allow the issuer to call the security before its stated maturity without penalty. The sharp decline in market interest rates during 2008 resulted in a large number of securities being called by the issuers with the resulting proceeds being invested in new lower yielding securities.

At December 31, 2008 and 2007, the held-to-maturity portfolio's estimated fair value was $475 million and $346 million, respectively. At December 31, 2008, the portfolio had a net unrealized loss of $0.5 million, compared to a net unrealized gain of $1.4 million at December 31, 2007. See note 2 to the consolidated financial statements in this report for a discussion regarding unrealized losses, which management has deemed to be temporary.

In order for INB to be a member of the Federal Reserve Bank (FRB) and the Federal Home Loan Bank of New York (FHLB), INB maintains an investment in the capital stock of each entity, which amounted to $3.6 million and $5.3 million, respectively, at December 31, 2008. The FRB stock has historically paid a dividend of 6%, while the FHLB stock dividend fluctuates quarterly and was as follows for four quarters of 2008: 7.80%, 6.50%, 3.50% and 1.09%. The total required investment, which amounted to $8.9 million at December 31, 2008, compared to $6.4 million at December 31, 2007, fluctuates based on INB's capital level for the FRB stock and INB's loans and outstanding FHLB borrowings for the FHLB stock.

Loans Receivable, Net of Deferred Fees

Loans receivable, net of deferred fees, increased to $1.71 billion at December 31, 2008, from $1.61 billion at December 31, 2007. The growth reflected $387 million of originations secured by commercial and multi-family real estate exceeding the aggregate of $267 million of principal repayments, $25 million of loans transferred to foreclosed real estate and $4.3 million of loan chargoffs. Nearly all the new loans have fixed interest rates and collectively have a weighted-average yield and term of 6.33% and 5.2 years, respectively. Commencing in early 2007, as a result of competitive market conditions, the Company began placing greater reliance on fixed-rate loan originations with somewhat longer maturities. To illustrate, fixed-rate loans constituted approximately 72% of the loan portfolio at December 31, 2008, compared to approximately 40% at December 31, 2006. Loans in the portfolio had an average life of approximately 4 years at December 31, 2008, compared with 3 years at December 31, 2006. For additional information on the loan portfolio, see the section entitled "Lending Activities" in Item 1 of Part 1 of this report.

Nonaccrual Loans

Nonaccrual loans increased to $108.6 million at December 31, 2008, from $90.8 million at December 31, 2007. For a discussion of nonaccrual loans, see the section entitled "Asset Quality" in Item 1 of Part 1 of this report.

Allowance for Loan Losses

The allowance for loan losses was $28.5 million at December 31, 2008, compared to $21.6 million at December 31, 2007. The increase was due to $11.2 million of provisions, partially offset by $4.3 million of loan charge offs. The allowance represented 1.67% of total loans (net of deferred fees) at December 31, 2008 and 1.34% at December 31, 2007. The loan loss provision for 2008 was attributable to the following: $10.3 million resulted from downgrades of internal risk ratings on nonaccrual loans as well as lower estimates of real estate values on collateral properties and $0.9 million resulted from net loan growth of $90 million. For a discussion of the criteria used to determine the adequacy of the allowance for loan losses, see the section entitled "Critical Accounting Policies" at the beginning of Item 7 of this report.

Foreclosed Real Estate

Real estate acquired through foreclosure amounted to $9.1 million at December 31, 2008. For a discussion of foreclosed real estate, see the section entitled "Asset Quality" in Item 1 of Part 1 of this report.

All Other Assets

The following table sets forth the composition of the caption "All other assets"
in the tables on page 39:



                                                         At December 31,
           ($ in thousands)                              2008       2007
           Accrued interest receivable                 $ 11,965   $ 10,981
           Loan fees receivable                           8,590      9,781
           Premises and equipment, net                    5,415      5,897
           Deferred income tax asset                     13,503     10,387
           Deferred debenture offering costs, net         2,750      4,098
           Investment in unconsolidated subsidiaries      1,702      1,702
           Prepaid estimated income taxes                   352        586
           Deferred issuance costs from brokered CDs      1,486      1,729
           All other                                        417        250
                                                       $ 46,180   $ 45,411

Accrued interest receivable fluctuates based on the level of interest-earning assets and the timing of interest payments received. Loan fees receivable are fees due in accordance with the terms of mortgage loans. Such amounts are generally due upon the full repayment of the loan. This fee is recorded as deferred income at the time a loan is originated and is then amortized to interest income over the life of the loan as a yield adjustment. The decrease was due to payments exceeding new fees that were charged on new loan originations.

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