Summary of INTEGRA BANK CORP

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
INTRODUCTION
The discussion and analysis which follows is presented to assist in the understanding and evaluation of our financial condition and results of operations as presented in the following consolidated financial statements and related notes. The text of this review is supplemented with various financial data and statistics. All amounts presented are in thousands, except for share and per share data and ratios.
Certain statements made in this report may constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. When used in this report, the words "may," "will," "should," "would," "anticipate," "estimate," "expect," "plan," "believe," "intend," and similar expressions identify forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements to be materially different from the results, performance or achievements expressed or implied by such forward-looking statements. Such factors include the risks and uncertainties described in Item 1A "Risk Factors" and other risks and uncertainties disclosed in future periodic reports. We undertake no obligation to release revisions to these forward-looking statements or to reflect events or conditions occurring after the date of this report, except as required to do so in future periodic reports.
OVERVIEW
The impact of deteriorating economic conditions during 2008 significantly impacted the banking industry in terms of lower levels of earnings and stock prices, and declining credit quality. During 2008, we experienced significant increases in non-performing assets and loan loss provisions. Our decline in credit quality impacted our operations during 2008 in the areas of net interest income, provision for loan losses, non-interest expense and a reversal of a state tax benefit. Our focus shifted during 2008 towards managing our credit, liquidity and capital positions.
The net loss for 2008 was $110,875, or $5.39 per share, compared to net income of $30,710 or $1.55 per share in 2007. The 2008 results include goodwill impairment (primarily related to the April 2007 acquisition of Prairie Financial Corporation, of Chicago, Illinois) of $122,824, a provision for loan losses of $65,784, other than temporary securities impairment of $10,612 and a state income tax valuation allowance of $3,205. Results for 2007 included a provision for loan losses of $4,193, an other-than-temporary impairment charge of $2,726 and no goodwill impairment or state tax valuation allowance. The net interest margin for 2008 was 3.18% for 2008, compared to 3.46% in 2007.
The increased provision for loan losses was primarily attributed to commercial real estate and construction land and development loans which represented 81% of total non-performing loans at December 31, 2008. The provision for loan losses exceeded net charge-offs by $37,176 in 2008.
The allowance to total loans was 2.59% at December 31, 2008, while net charge-offs totaled 119 basis points for 2008, compared to 19 basis points for 2007. Non-performing loans were $150,899, or 6.06% of total loans at December 31, 2008 compared to $22,667 or 0.98% of total loans at December 31, 2007, while the allowance to non-performing loans decreased from 120.3% to 42.7% for the same dates. Non-performing assets increased to $170,295, compared to $25,590 at December 31, 2007.
Net interest income was $93,981 for 2008, compared to $93,249 for 2007, while the net interest margin was 3.18% for 2008, compared to 3.46% in 2007. The net interest margin was negatively impacted by a higher level of non-accrual loans throughout 2008. Non-interest income decreased $7,382 to $29,689, primarily driven by higher securities losses of $8,294, partially offset by increases in deposit service charges, debit card interchange and annuity income. Non-interest expense increased $132,403 to $220,053, primarily due to goodwill impairment of $122,824, higher personnel expenses and loan collection costs and the impact of a full year of expense related to the Prairie acquisition.
Low cost deposit average balances, which include non-interest checking, NOW and savings deposits, were $858,521 during the fourth quarter of 2008, an increase of $77,990, or 9.9% from the fourth quarter of 2007. Commercial loan average balances were $1,836,979 in the fourth quarter of 2008, an increase of $260,139, or 16.5% from the fourth quarter of 2007. This included growth in commercial real estate of $202,108, or 18.4% and commercial and industrial of $58,031, or 12.1%. Direct consumer balances increased $8,912, or 5.3%, while home equity loans increased $22,373, or 15.1%.
At December 31, 2008, Integra Bank's ratios were above the regulatory minimum for well capitalized status. Integra Bank Corporation's capital ratios were within the regulatory requirements for being adequately capitalized.

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The weakened housing market has stressed our loan portfolio, resulting in a higher provision for loan losses. We executed adjustments to our strategic plan to take into account the current economic downturn, severe housing correction, and weak credit conditions. We are focused on making sure we have adequate capital, liquidity and loan loss reserves to weather the current credit cycle. To maximize capital, we adjusted our loan targets downward, especially in the area of commercial real estate. The growth in our commercial real estate portfolio is attributable, in part, to the difficulties experienced in the permanent financing market. As a result of the worsening credit markets, many of our borrowers have not been able to refinance their completed and stabilized projects on a permanent basis as expected. Accordingly, given the current environment and the continued difficulties in the permanent market, we determined that pursuing additional growth in our commercial real estate portfolio would not be prudent at this time. Starting in the third quarter of 2008, we discontinued pursuing new commercial real estate opportunities, regardless of property type. As expected our commercial real estate balances continued to grow in the short-term as we worked through our remaining pipeline of pending loans and as we funded committed credit facilities. That pipeline declined significantly during the fourth quarter of 2008. As this credit cycle continues, we will continue to evaluate the size of this portfolio. On February 27, 2009, we entered into a Letter Agreement with the United States Department of Treasury, or Treasury Department, as part of the Treasury Department's Capital Purchase Program established under the Emergency Economic Stabilization Act of 2008, or EESA. Pursuant to the Securities Purchase Agreement-Standard Terms, or Securities Purchase Agreement, attached to the Letter Agreement, we issued to the Treasury Department 83,586 shares of Fixed Rate Cumulative Perpetual Preferred Stock, Series B, or Treasury Preferred Stock, having a liquidation amount per share of $1,000 and a warrant, or Warrant, to purchase up to 7,418,876 shares, or Warrant Shares, of our common stock, at an initial per share exercise price of $1.69, for an aggregate purchase price of $83,586.
The Treasury Preferred Stock pays cumulative dividends at a rate of 5% per year for the first five years and 9% per year thereafter. Pursuant to the terms of the recently enacted American Recovery and Reinvestment Act of 2009, or ARRA, we may, upon prior consultation with the Federal Reserve, redeem the Treasury Preferred Stock at any time. Upon full redemption of the Treasury Preferred Stock, the Treasury Department will also liquidate the associated Warrant in accordance with the ARRA and any rules and regulations thereunder. The Treasury Preferred Stock is generally non-voting.
Our plan for 2009 includes the following key priorities:
• pursue opportunities to raise additional capital to maintain "well capitalized" status, and then begin the process of rebuilding capital levels to "fortress" levels;

• stabilize and then improve our credit profile (as measured by non performing assets);

• return to profitability, then to future acceptable and sustainable profitability;

• grow core deposits faster than loans; and

• generate positive operating leverage (revenue growth that exceeds expense growth).

CRITICAL ACCOUNTING POLICIES
Our accounting and reporting policies conform with accounting principles generally accepted in the United States and general practices within the financial services industry. The preparation of financial statements in conformity with generally accepted accounting principles requires us to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions, and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates, assumptions, and judgments. Certain policies inherently have a greater reliance on the use of estimates, assumptions, and judgments and as such have a greater possibility of producing results that could be materially different than originally reported. We consider our critical accounting policies to include the following:
Allowance for Loan Losses: The allowance for loan losses represents our best estimate of probable losses inherent in the existing loan portfolio. The allowance for loan losses is increased by the provision for losses, and reduced by loans charged off, net of recoveries. The provision for loan losses is determined based on our assessment of several factors: actual loss experience, changes in composition of the loan portfolio, evaluation of specific borrowers and collateral, current economic conditions, trends in past-due and non-accrual loan balances, and the results of recent regulatory examinations. The section labeled "Credit Management" below provides additional information on this subject.
We consider loans impaired when, based on current information and events, it is probable we will not be able to collect all amounts due in accordance with the contractual terms. The measurement of impaired loans is generally based on the present value of expected future cash flows discounted at the historical effective interest rate stipulated in the loan agreement, except that all collateral-dependent loans are measured for impairment based on the market value of the collateral, less estimated cost to liquidate. In measuring the market value of the collateral, we use assumptions and methodologies consistent with those that would be utilized by unrelated third parties.

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Changes in the financial condition of individual borrowers, economic conditions, historical loss experience and the conditions of the various markets in which the collateral may be liquidated may all affect the required level of the allowance for loan losses and the associated provision for loan losses. Estimation of Fair Value: The estimation of fair value is significant to several of our assets, including loans held for sale, investment securities available for sale and other real estate owned, as well as fair values associated with derivative financial instruments, intangible assets and the value of loan collateral when valuing loans. These are all recorded at either market value or the lower of cost or fair value. Fair values are determined based on third party sources, when available. Furthermore, accounting principles generally accepted in the United States require disclosure of the fair value of financial instruments as a part of the notes to the consolidated financial statements. Fair values may be influenced by a number of factors, including market interest rates, prepayment speeds, discount rates and the shape of yield curves. Fair values for securities available for sale are typically based on quoted market prices. If a quoted market price is not available, fair values are estimated using quoted market prices for similar securities or level 3 values. Note 17 to the consolidated financial statements provides additional information on how we determine level 3 values. The fair values for loans held for sale are based upon quoted prices. The fair values of other real estate owned are typically determined based on appraisals by third parties, less estimated costs to sell. If necessary, appraisals are updated to reflect changes in market conditions. The fair values of derivative financial instruments are estimated based on current market quotes.
Goodwill represents the excess of the cost of an acquisition over the fair value of the net assets acquired. We assessed goodwill for impairment quarterly during 2008 by applying a series of fair-value-based tests. During the third and fourth quarters of 2008, we recorded goodwill impairment of $48,000 and $74,824, respectively. Impairment exists when the net book value of our one reporting unit exceeds its fair value and the carrying amount of the goodwill exceeds its implied fair value. Other intangible assets represent purchased assets that also lack physical substance but can be distinguished from goodwill because of contractual or other legal rights or because the asset is capable of being sold or exchanged either on its own or in combination with an asset or liability. Core deposit intangibles are recorded at fair value based on a discounted cash model valuation at the time of acquisition and are evaluated periodically for impairment. Customer relationship intangibles utilize a method that discounts the cash flows related to future loan relationships that are expected to result from referrals from existing customers. Estimated cash flows are determined based on estimated future net interest income resulting from these relationships, less a provision for loan losses, non-interest expense, income taxes and contributory asset charges.
Other-than-temporary securities impairment: Declines in the fair value of securities below their cost that are other than temporary are reflected as realized losses. In estimating other-than-temporary losses, we consider: 1) the length of time and extent that fair value has been less than cost; 2) the financial condition and near term prospects of the issuer; and 3) our ability and intent to hold the security for a period sufficient to allow for any anticipated recovery in fair value.
For securities falling under EITF 99-20, "Recognition of Interest Income and Impairment on Purchased Beneficial Interests and Beneficial Interests That Continue to be Held by a Transferor in Securitized Financial Assets", such as collateralized mortgage obligations, or CMOs, and collateralized debt obligations, or CDOs, an other-than-temporary impairment is deemed to have occurred when there is an adverse change in the expected cash flows (principal or interest) to be received and the fair value of the beneficial interest is less than its carrying amount. In determining whether an adverse change in cash flows occurred during the first three quarters of 2008, the present value of the remaining cash flows, as estimated at the initial transaction date (or the last date previously revised), was compared to the present value of the expected cash flows at the current reporting date. The estimated cash flows reflect those a "market participant" would use and were discounted at a rate equal to the current effective yield. If an other-than-temporary impairment was recognized as a result of this analysis, the yield was changed to the market rate. The last revised estimated cash flows were then used for future impairment analysis purposes.
In January, 2009, the Financial Accounting Standards Board, or FASB, issued FASB Staff Position No 99-20-1 ("EITF 99-20-1"). This FSP substantially aligns the basis for determining impairment under EITF 99-20 for determining impairment with the guidance found in paragraph 16 of SFAS No. 115, which requires entities to assess whether it is probable that the holder will be unable to collect all amounts due according to contractual terms. SFAS No. 115 does not require exclusive reliance on market participant assumptions regarding future cash flows, permitting the use of reasonable management judgment of the probability that the holder will be unable to collect all amounts due.

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Income Taxes: The provision for income taxes is based on income as reported in the financial statements. Deferred income tax assets and liabilities are computed for differences between the financial statement and tax basis of assets and liabilities that will result in taxable or deductible amounts in the future. The deferred tax assets and liabilities are computed based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. An assessment is made as to whether it is more likely than not that deferred tax assets will be realized. Valuation allowances are established when necessary to reduce deferred tax assets to an amount expected to be realized. Income tax expense is the tax payable or refundable for the period plus or minus the change during the period in deferred tax assets and liabilities. Tax credits are recorded as a reduction to tax provision in the period for which the credits may be utilized.
NET INCOME (LOSS)
Net income (loss) for 2008 was $(110,875) compared to $30,710 in 2007 and $19,547 in 2006. Earnings per share on a diluted basis were $(5.39), $1.55 and $1.11 for 2008, 2007 and 2006, respectively. Return on average assets and return on average equity were (3.28) % and (35.34) % for 2008, 0.99% and 10.22% for 2007, and 0.72% and 8.50% for 2006, respectively.

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NET INTEREST INCOME
Net interest income in the following tables is presented on a tax equivalent basis and is the difference between interest income on earning assets, such as loans and investments, and interest expense paid on liabilities, such as deposits and borrowings. Net interest income is affected by the general level of interest rates, changes in interest rates, and by changes in the amount and composition of interest-earning assets and interest-bearing liabilities. Changes in net interest income for the last two years are presented in the schedule following the three-year average balance sheet analysis. The change in net interest income not solely due to changes in volume or rates has been allocated in proportion to the absolute dollar amounts of the change in each.

AVERAGE BALANCE SHEET AND ANALYSIS OF NET INTEREST INCOME

                                                       2008                                            2007                                            2006
                                       Average         Interest        Yield/          Average         Interest        Yield/          Average         Interest        Yield/
Year Ended December 31,               Balances          & Fees          Cost          Balances          & Fees          Cost          Balances          & Fees          Cost
EARNING ASSETS:

Interest-bearing deposits in
banks                                $     4,511       $      90          2.00 %     $     3,427       $     167          4.87 %     $     1,718       $      81          4.71 %
Federal funds sold & other
short-term investments                       683              14          2.05 %           1,578              58          3.68 %           5,437             252          4.63 %
Loans held for sale                        5,936             366          6.17 %           3,346             235          7.02 %           1,950             140          7.18 %
Securities:
Taxable                                  494,080          23,581          4.77 %         510,129          24,588          4.82 %         567,452          26,525          4.67 %
Tax-exempt                                99,499           7,048          7.08 %         111,070           7,949          7.16 %          91,690           6,853          7.47 %


Total securities                         593,579          30,629          5.16 %         621,199          32,537          5.24 %         659,142          33,378          5.06 %

Regulatory Stock                          29,179           1,273          4.36 %          26,389           1,286          4.87 %          29,368           1,479          5.04 %

Loans                                  2,407,677         143,260          5.95 %       2,128,551         160,630          7.55 %       1,782,918         125,728          7.05 %


Total earning assets                   3,041,565       $ 175,632          5.77 %       2,784,490       $ 194,913          7.00 %       2,480,533       $ 161,058          6.49 %


Fair value adjustment on
securities available for sale            (13,341 )                                        (7,996 )                                       (13,767 )
Allowance for loan loss                  (34,641 )                                       (25,088 )                                       (21,990 )
Other non-earning assets                 385,527                                         353,545                                         274,280


TOTAL ASSETS                         $ 3,379,110                                     $ 3,104,951                                     $ 2,719,056

INTEREST-BEARING LIABILITIES:

Deposits
Savings and interest-bearing
demand                               $   560,420       $   5,056          0.90 %     $   506,144       $   4,903          0.97 %     $   497,237       $   4,197          0.84 %
Money market accounts                    370,099           8,296          2.24 %         370,953          15,114          4.07 %         281,480          10,589          3.76 %
Certificates of deposit and
other time                             1,135,916          42,311          3.72 %       1,144,434          53,725          4.69 %         946,938          39,635          4.19 %


Total interest-bearing deposits        2,066,435          55,663          2.69 %       2,021,531          73,742          3.65 %       1,725,655          54,421          3.15 %

Short-term borrowings                    314,212           7,563          2.41 %         194,033           9,431          4.86 %         178,976           8,574          4.79 %
Long-term borrowings                     373,306          15,693          4.20 %         285,925          15,498          5.42 %         305,881          13,092          4.28 %


Total interest-bearing
liabilities                            2,753,953       $  78,919          2.87 %       2,501,489       $  98,671          3.94 %       2,210,512       $  76,087          3.44 %


Non-interest bearing deposits            281,647                                         272,175                                         257,625
Other noninterest-bearing
liabilities and shareholders'
equity                                   343,510                                         331,287                                         250,919


TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY                 $ 3,379,110                                     $ 3,104,951                                     $ 2,719,056


Interest income/earning assets                         $ 175,632          5.77 %                       $ 194,913          7.00 %                       $ 161,058          6.49 %
Interest expense/earning assets                           78,919          2.59 %                          98,671          3.54 %                          76,087          3.06 %


Net interest income/earning
assets                                                 $  96,713          3.18 %                       $  96,242          3.46 %                       $  84,971          3.43 %

Note: Tax exempt
income
presented on
a tax
equivalent
basis based
on a 35%
federal tax
rate.

Loans include
loan fees of
$3,668,
$2,786, and
$1,881 for
2008, 2007,
and 2006,
respectively,
and
nonaccrual
loans.

Securities
yields are
calculated on
an amortized
cost basis.

Federal tax
equivalent
adjustments
on securities
are $2,467,
$2,782, and
$2,441 for
2008, 2007,
and 2006,
respectively.

Federal tax
equivalent
adjustments
on loans are
$265, $211,
and $224 for
2008, 2007,
and 2006,
respectively.

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CHANGES IN NET INTEREST INCOME (INTEREST ON A FEDERAL-TAX-EQUIVALENT BASIS)

                                        2008 Compared to 2007                      2007 Compared to 2006
                                     Change Due to                              Change Due to
                                      a Change in              Total             a Change in             Total
Increase (decrease)              Volume         Rate          Change         Volume         Rate         Change

Interest income

Loans                           $ 19,397      $ (36,767 )    $ (17,370 )    $ 25,553      $  9,349      $ 34,902
Securities                        (1,420 )         (488 )       (1,908 )      (1,986 )       1,145          (841 )
Regulatory Stock                     129           (142 )          (13 )        (145 )         (48 )        (193 )
Loans held for sale                  162            (31 )          131            98            (3 )          95
Other short-term investments           9           (130 )         (121 )         (97 )         (11 )        (108 )


Total interest income             18,277        (37,558 )      (19,281 )      23,423        10,432        33,855

Interest expense

Deposits                           1,615        (19,694 )      (18,079 )      10,033         9,288        19,321
Short-term borrowings              4,212         (6,080 )       (1,868 )         730           127           857
Long-term borrowings               4,130         (3,935 )          195          (899 )       3,305         2,406


Total interest expense             9,957        (29,709 )      (19,752 )       9,864        12,720        22,584


Net interest income             $  8,320      $  (7,849 )    $     471      $ 13,559      $ (2,288 )    $ 11,271

The following discussion of results of operations is on a tax-equivalent basis. Tax-exempt income, such as interest on loans and securities of state and political subdivisions, has been increased to an amount that would have been earned had such income been taxable.
Net interest income for 2008 was $96,713, or 0.5% higher than 2007. An increase in overall earning assets contributed positively to net interest income. A higher level of non-accrual loans offset this increase, as did the impact from reductions in interest rates, coupled with the inability to further reduce certain funding costs that have reached a floor. Earning asset yields decreased 123 basis points in 2008, compared to a 107 basis point decrease in interest bearing liabilities. The net interest margin was 3.18%, compared to 3.46% in 2007.
Major components of the change in net interest income from 2007 to 2008 are as follows:
• Average earning assets increased $257,075, or 9.2%. An increase in commercial loan average balances of $356,730 was slightly offset by lower residential mortgage loan average balances of $81,067, lower securities average balances of $27,620 and lower indirect consumer loan average . . .