Guaranty Bancorp 10-K 2007
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the fiscal year ended: December 31, 2006
For the transition period from to
Commission file number: 000-51556
CENTENNIAL BANK HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
(Registrants telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No þ
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No þ
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 þ No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of Accelerated Filer and Large Accelerated Filer in Rule 12b-2 of the Act (Check one).
Large Accelerated Filer ¨ Accelerated Filer þ Non-accelerated Filer ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act.) Yes ¨ No þ
The aggregate market value of the voting common stock held by non-affiliates of the registrant, computed by reference to the closing price per share of the registrants common stock as of the close of business on June 30, 2006, was approximately $465 million. For purposes of this computation, all executive officers, directors and 10% beneficial owners of the registrant are assumed to be affiliates. Such determination should not be deemed an admission that such officers, directors and beneficial owners are, in fact, affiliates of the registrant. Registrant does not have any nonvoting common equities.
As of March 16, 2007, there were 55,414,556 shares of the registrants common stock outstanding, including 1,699,925 shares of unvested restricted stock and performance stock.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the 2007 Annual Meeting of Shareholders of Centennial Bank Holdings, Inc. to be held on May 8, 2007 are incorporated by reference in this Form 10-K in response to Part III, Items 10, 11, 12, 13 and 14.
CENTENNIAL BANK HOLDINGS, INC.
ANNUAL REPORT ON FORM 10-K
Table of Contents
As previously reported in the Current Report on Form 8-K filed by the Company on March 16, 2007 (as amended by the Form 8-K/A filed by the Company on March 20, 2007), the Company is restating its previously issued consolidated statements of cash flows for the year ended December 31, 2005 that was set forth in the Companys Annual Report on Form 10-K for the year ended December 31, 2005, the nine-month periods ended September 30, 2006 and 2005, the six-month periods ended June 30, 2006 and 2005, and the three-month periods ended March 31, 2006 and 2005 that were set forth in the Companys Quarterly Reports on Form 10-Q for the periods ended September 30, 2006, June 30, 2006 and March 31, 2006, respectively. Such restatements, which are disclosed in Note 2(a) to our consolidated financial statements included in Part II, Item 8 of this Annual Report on Form 10-K, do not affect the Companys consolidated statements of income, consolidated balance sheets or consolidated statements of stockholders equity and comprehensive income (loss) for any of the affected periods. Accordingly, the Companys historical revenues, net income, earnings per share, total assets and regulatory capital will remain unchanged. For a further discussion of the restatements, including a reevaluation of the effectiveness of our disclosure controls and procedures for the affected periods, see Part II, Item 9A of this Annual Report on Form 10-K.
Forward-Looking Statements and Factors that Could Affect Future Results
Certain statements contained in this Annual Report on Form 10-K that are not statements of historical fact constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 (the Act), notwithstanding that such statements are not specifically identified. In addition, certain statements may be contained in our future filings with the SEC, in press releases, and in oral and written statements made by or with our approval that are not statements of historical fact and constitute forward-looking statements within the meaning of the Act. Examples of forward-looking statements include, but are not limited to: (i) projections of revenues, expenses, income or loss, earnings or loss per share, the payment or nonpayment of dividends, capital structure and other financial items; (ii) statements of plans, objectives and expectations of the Company or its management or board of directors, including those relating to products or services; (iii) statements of future economic performance; and (iv) statements of assumptions underlying such statements. Words such as believes, anticipates, expects, intends, targeted, continue, remain, will, should, may and other similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements.
Forward-looking statements involve risks and uncertainties that may cause actual results to differ materially from those in such statements. Factors that could cause actual results to differ from those discussed in the forward-looking statements include, but are not limited to:
Forward-looking statements speak only as of the date on which such statements are made. We do not intend to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made, or to reflect the occurrence of unanticipated events.
Centennial Bank Holdings, Inc.
We are a financial holding company and a bank holding company registered under the Bank Holding Company Act of 1956, as amended. Our principal business is to serve as a holding company for our subsidiaries. As of December 31, 2006, those subsidiaries were Centennial Bank of the West and Guaranty Bank and Trust Company, or Guaranty Bank. On November 1, 2006, we completed the sale of Collegiate Peaks Bank, which had been classified as held for sale since December 31, 2004. On March 1, 2006, we sold substantially all of the assets of First MainStreet Insurance, Ltd., an independent insurance agency. We refer to Centennial Bank of the West and Guaranty Bank herein as the Banks, and when we say we, us, our or the Company, we mean the Company on a consolidated basis with the Banks. When we refer to Centennial or to the holding company, we are referring to the parent company on a standalone basis.
On March 3, 2004, Centennial was incorporated in Delaware under the name Centennial C Corp. On July 16, 2004, in an acquisition financed by a group of investors led by John M. Eggemeyer, we acquired Centennial Bank of the West and changed our name to Centennial Bank Holdings, Inc. At the time of the acquisition, Centennial Bank of the West, which traced its origins to Eaton Bank founded in 1937, operated 12 branches in Colorado. On December 31, 2004, we acquired Guaranty Corporation, a bank holding company and a Colorado corporation, which operated 18 branches in Colorado through its three banks, Guaranty Bank, Collegiate Peaks and First National Bank of Strasburg. On April 14, 2005, we merged First National Bank of Strasburg into Guaranty Bank. On October 1, 2005, we completed our acquisition of First MainStreet Financial, Ltd., pursuant to which First MainStreet Bank, N.A. was merged into Centennial Bank of the West. On November 1, 2005, we completed the acquisition of Foothills Bank, which was merged into Guaranty Bank.
At December 31, 2006, we had total assets of $2.7 billion, net loans of $1.9 billion, deposits of $2.0 billion and stockholders equity of $0.6 billion, and we operated 36 branches in Colorado through our two banking subsidiaries.
Our Banks are full-service community banks offering an array of banking products and services to the communities we serve, including accepting time and demand deposits and originating commercial loans (including energy loans), real estate loans (including construction loans and mortgage loans), Small Business Administration guaranteed loans and consumer loans. Centennial Bank of the West also provides trust services, including personal trust administration, estate settlement, investment management accounts and self-directed IRAs.
We concentrate our lending activities in the following principal areas:
Construction Loans: Our construction loan portfolio is comprised of single-family residential development, investor developer and owner-occupied properties. The majority of the loans are for pre-sold
homes. In addition, this category includes loans for the construction of commercial buildings, which are primarily owner occupied. The repayment of construction loans is dependent upon the successful and timely completion of the construction of the subject property, as well as the sale of the property to third parties or the availability of permanent financing upon completion of all improvements. Construction loans expose us to the risk that improvements will not be completed on time in accordance with specifications and projected costs. Construction delays, the financial impairment of the builder, interest rate increases or economic downturn may further impair the borrowers ability to repay the loan. In addition, the ultimate sale or rental of the property may not occur as anticipated.
Commercial Real Estate Loans: This portfolio is comprised of loans secured by commercial real estate. The portfolio is not concentrated in one area and ranges from owner occupied to motel properties. In addition, multi-family properties are included in this category. Commercial real estate and multi-family loans typically involve large balances to single borrowers or groups of related borrowers. Since payments on these loans are often dependent on the successful operation or management of the properties, as well as the business and financial condition of the borrower, repayment of such loans may be subject to adverse conditions in the real estate market, adverse economic conditions or changes in applicable government regulations. If the cash flow from the project decreases, or if leases are not obtained or renewed, the borrowers ability to repay the loan may be impaired.
Commercial and Industrial Loans: Our commercial and industrial loan portfolio is comprised of operating loans secured by inventory and receivables. The portfolio is not concentrated in any particular industry. In 2006, the Company started an energy banking group, with a focus on exploration and production, midstream and gas storage sectors. Repayment of secured commercial and industrial loans depends substantially on the borrowers underlying business, financial condition and cash flows, as well as the sufficiency of the collateral. Compared to real estate, the collateral may be more difficult to monitor, valuate and sell. It may also depreciate more rapidly than real estate. Such risks can be significantly affected by economic conditions. In addition, commercial business and industrial lending generally requires substantially greater oversight efforts compared to residential real estate lending.
Consumer and Other Loans: This category includes miscellaneous consumer loans including overdraft, line-of-credit and indirect auto paper. Our auto paper is originated through established dealers in our market. Consumer loans may be unsecured or secured by rapidly depreciable assets. Repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment for the outstanding loan, and the remaining deficiency may not warrant further substantial collection efforts against the borrower. In addition, consumer loan collections are dependent on the borrowers continued financial stability, which can be adversely affected by job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans.
Home Equity Lines: Our home equity line portfolio is comprised of home equity lines to customers in our markets. Home equity lines of credit are underwritten in a manner such that they result in credit risk that is substantially similar to that of residential mortgage loans. Nevertheless, home equity lines of credit have greater credit risk than residential mortgage loans because they are often secured by mortgages that are subordinated to the existing first mortgage on the property, which we may or may not hold, and they are not covered by private mortgage insurance coverage.
Agriculture Loans: Our agriculture land secured portfolio is comprised primarily of real estate loans to working farms in Adams, Arapahoe, Elbert, Larimer, Morgan and Weld counties. Our agriculture operating loan portfolio is comprised of operating loans to working farms in the same counties. Repayments on agricultural mortgage loans are substantially dependent on the successful operation or management of the farm property collateralizing the loan, which is affected by many factors, including weather and changing market prices, which are outside of the control of the borrower. Payments on agricultural operating loans are dependent on the successful operation or management of the farm property for which the operating loan is generally utilized. Such loans are similarly subject to farming-related risks, including weather and changing market prices.
In addition, we provide traditional deposit accounts such as demand, NOW, Money Market, IRA, time deposits and savings accounts. Our certificate of deposit customers, excluding brokered deposits, represent local relationships. Our branch network enables us to offer a full range of deposits, loans and personalized services to our targeted commercial and consumer customers.
Through our holding company structure, Centennial creates operating efficiencies for the Banks by consolidating core administrative, operational and financial functions that serve both Banks. These centralized functions include finance and accounting, legal and compliance, human resources, operations and systems, and credit administration. The most senior level oversight of these functions is performed at the holding company level for the benefit of the Banks, though each function may have a limited number of Bank employees performing such functions. By consolidating these activities at the holding company and negotiating with vendors for services on behalf of the Company as a whole, we believe the Company is better able to integrate systems and manage consistently across the organization as well as provide such services for lower cost than if the Banks were to obtain or perform such services directly. The Banks reimburse the holding company for the cost of the services performed on their behalf, pursuant to an expense allocation agreement.
Our Philosophy and Strategy
We have established a philosophy of relationship banking: providing highly personalized and responsive services based on exceptional customer service. That philosophy, combined with flexible banking services, is the driving force behind our growth, financial strength and recognition as a strong competitive business within the communities we serve.
Our strategy is to build a profitable, community-banking franchise along the Colorado Front Range spanning from Castle Rock to Fort Collins and capitalize on the economic growth in our markets. We strive to be a premier community and business bank with an emphasis on high quality customer service, commercial banking and low-cost demand deposits, serving the needs of small to medium-sized businesses, the owners and employees of those businesses, as well as other executives and professionals. The strategy for serving our target markets is the delivery of a finely-focused set of value-added products and services that satisfy the primary needs of our customers, emphasizing superior service and relationships as opposed to transaction volume or low pricing. As a locally managed banking institution, we believe we are able to provide a superior level of customer service compared to larger regional and super-regional banks.
In addition to building growth through our existing branches, we expect to continue to seek opportunities to acquire small to medium-sized banks that will allow us to expand our franchise in a manner consistent with our deposit strategy and community-banking focus. Ideally, the banks we will seek to acquire will be in or contiguous to the existing footprint of the current branch networks of our Banks, which would allow us to consolidate duplicative costs and administrative functions and to rationalize operating expenses. We believe that by streamlining the administrative and operational functions of an acquired bank, we are able to substantially lower operating costs, improve performance and quickly integrate the acquired bank while maintaining the stability of our franchise as well as that of the bank we acquire.
Our Principal Markets
We currently have two banking subsidiaries: Centennial Bank of the West and Guaranty Bank. We currently operate 15 Centennial Bank of the West branches located throughout Colorados Northern Front Range. Guaranty Bank operates 21 branches located in the seven-counties included in the Denver metropolitan area.
The Denver metropolitan area is composed of seven counties: Adams, Arapahoe, Boulder, Broomfield, Denver, Douglas and Jefferson. The metropolitan area stretches from the south in Castle Rock through downtown Denver northward to Boulder and Longmont. The area serves as a major hub of commerce passing from the east coast to the west coast. Denver is the largest city within a 600-mile radius.
Colorados Northern Front Range region begins just 30 miles north of central Denver in southern Boulder County. The I-25 corridor north from Denver to Fort Collins is a contiguous stream of small communities/housing developments, open space, farm properties, and both small and large businesses. The region includes the cities of Fort Collins, Loveland, Greeley and Longmont, all located in Boulder, Larimer and Weld counties. Colorados Northern Front Range has a regional economy that is a diverse mix of agriculture, advanced technology, manufacturing, service firms, government, education, retail, small business and construction. The region is also the gateway to Rocky Mountain National Park, a year-round tourist destination.
No individual or single group of related accounts is considered material in relation to our total assets, or in relation to the overall business of the Company. Approximately 60% of our loan portfolio held for investment at December 31, 2006 consisted of real estate-related loans, including construction loans, miniperm loans and real estate mortgage loans. Our business activities are currently focused in the Colorado Front Range. Consequently, our financial condition, results of operations and cash flows depend upon the general trends in the economy of the Colorado Front Range and, in particular, the residential and commercial real estate markets.
The banking business in Colorado is highly competitive. The market is characterized by a relatively small number of large financial institutions with a large number of offices and numerous small to moderate-sized community banks, including de novo banks. Other entities in both the public and private sectors seeking to raise capital through the issuance and sale of debt or equity securities also provide competition for us in the acquisition of deposits. We also compete with money market funds and issuers of other money market instruments. In recent years, increased competition has also developed from specialized finance and non-finance companies that offer wholesale finance, credit card and other consumer finance services, including on-line banking services and personal finance software. Competition for deposit and loan products remains strong from both banking and non-banking firms and this competition directly affects the rates of those products and the terms on which they are offered to consumers.
Technological innovation continues to contribute to greater competition in domestic and international financial services markets. Technological innovation has, for example, made it possible for non-depository institutions to offer customers automated transfer payment services previously limited to traditional banking products. In addition, customers now expect a choice of several delivery systems and channels, including telephone, mail, home computer, automated teller machines (ATMs), automated clearing house transactions (ACH), and self-service branches.
Mergers between financial institutions have placed additional pressure on banks to consolidate their operations, reduce expenses and increase revenues to remain competitive. In addition, competition has intensified due to federal and state interstate banking laws, which permit banking organizations to expand geographically with fewer restrictions than in the past. These laws allow banks to merge with other banks across state lines, thereby enabling banks to establish or expand banking operations in our market. The competitive environment is also significantly impacted by federal and state legislation that makes it easier for non-bank financial institutions to compete with us.
Economic factors, along with legislative and technological changes, will have an ongoing impact on the competitive environment within the financial services industry. As an active participant in financial markets, we strive to anticipate and adapt to dynamic competitive conditions, but we cannot assure you as to their impact on our future business, financial condition, results of operations or cash flows or as to our continued ability to anticipate and adapt to changing conditions. In order to compete with other competitors in our primary service area, we attempt to use to the fullest extent possible the flexibility that our independent status permits, including an emphasis on specialized services, local promotional activity and personal contacts.
Supervision and Regulation
Set forth below is a description of the significant elements of the laws and regulations applicable to the Company. The description is qualified in its entirety by reference to the full text of the statutes, regulations and policies that are described. Also, such statutes, regulations and policies are continually under review by the U.S. Congress and state legislatures and federal and state regulatory agencies. A change in statutes, regulations or regulatory policies applicable to Centennial or our subsidiaries could have a material effect on our business.
Centennial is a legal entity separate and distinct from its subsidiaries. As a financial holding company and a bank holding company, Centennial is regulated under the Bank Holding Company Act of 1956, as amended, or the BHC Act, and is subject to inspection, examination and supervision by the Board of Governors of the Federal Reserve System, or the Federal Reserve Board. Centennial is also under the jurisdiction of the SEC and is subject to the disclosure and regulatory requirements of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended, as administered by the SEC. Centennial is listed on The NASDAQ Stock Market LLC (Nasdaq) under the trading symbol CBHI, and is subject to the rules of Nasdaq for listed companies.
As Colorado-chartered banks, Centennial Bank of the West and Guaranty Bank are subject to supervision, periodic examination, and regulation by the Colorado Division of Banking, or CDB. As members of the Federal Reserve System, Centennial Bank of the West and Guaranty Bank are also subject to regulation, supervision and periodic examination by the Federal Reserve Bank of Kansas City. If, as a result of an examination of the banks, the Federal Reserve Board or the CDB should determine that the financial condition, capital resources, asset quality, earnings prospects, management, liquidity, or other aspects of its operations are unsatisfactory or that it or its management is violating or has violated any law or regulation, various remedies are available to the Federal Reserve Board and the CDB. Such remedies include the power to enjoin unsafe or unsound practices, to require affirmative action to correct any conditions resulting from any violation or practice, to issue an administrative order that can be judicially enforced, to direct an increase in capital, to restrict its growth, to assess civil monetary penalties, to remove officers and directors, and ultimately to terminate its deposit insurance, which for a Colorado-chartered bank would result in the revocation of its charter.
Bank Holding Company Regulation
In general, the BHC Act limits the business of bank holding companies to banking, managing or controlling banks and other activities that the Federal Reserve Board has determined to be so closely related to banking as to be a proper incident thereto. As a result of the Gramm-Leach-Bliley Financial Modernization Act of 1999, or the GLB Act, which amended the BHC Act, bank holding companies that are financial holding companies may engage in any activity, or acquire and retain the shares of a company engaged in any activity that is either (i) financial in nature or incidental to such financial activity or (ii) complementary to a financial activity and that does not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally (as solely determined by the Federal Reserve Board). Activities that are financial in nature include securities underwriting and dealing, insurance underwriting and making merchant banking investments.
If a bank holding company seeks to engage in the broader range of activities that are permitted under the BHC Act for financial holding companies, (i) all of its depository institution subsidiaries must be well capitalized and well managed and (ii) it must file a declaration with the Federal Reserve Board that it elects to be a financial holding company. A depository institution subsidiary is considered to be well capitalized if it satisfies the requirements for this status discussed in the section captioned Capital Adequacy and Prompt Corrective Action, included elsewhere in this item. A depository institution subsidiary is considered well managed if it received a composite rating and management rating of at least satisfactory in its most recent examination.
In order for a financial holding company to commence any new activity permitted by the BHC Act, or to acquire a company engaged in any new activity permitted by the BHC Act, each insured depository institution subsidiary of the financial holding company must have received a rating of at least satisfactory in its most recent examination under the Community Reinvestment Act. See the section captioned Community Reinvestment Act included elsewhere in this item.
The BHC Act generally limits acquisitions by bank holding companies that are not qualified as financial holding companies to commercial banks and companies engaged in activities that the Federal Reserve Board has determined to be so closely related to banking as to be a proper incident thereto. Financial holding companies like us are also permitted to acquire companies engaged in activities that are financial in nature and in activities that are incidental and complementary to financial activities without prior Federal Reserve Board approval.
The BHC Act, the Bank Merger Act, the Colorado Banking Code and other federal and state statutes regulate acquisitions of commercial banks. The BHC Act requires the prior approval of the Federal Reserve Board for the direct or indirect acquisition of more than 5.0% of the voting shares of a commercial bank or its parent holding company. In reviewing applications seeking approval of merger and acquisition transactions, the bank regulatory authorities will consider, among other things, the competitive effect and public benefits of the transactions, the capital position of the combined organization, the applicants performance record under the Community Reinvestment Act (see the section captioned Community Reinvestment Act included elsewhere in this item) and fair housing laws and the effectiveness of the subject organizations in combating money laundering activities.
The principal source of Centennials cash revenues is from dividends from its subsidiary banks. Our earnings and activities are affected by legislation, by regulations and by local legislative and administrative bodies and decisions of courts in the jurisdictions in which we and our bank subsidiaries conduct business. For example, these include limitations on the ability of our bank subsidiaries to pay dividends to us and our ability to pay dividends to our stockholders. It is the policy of the Federal Reserve Board that bank holding companies should pay cash dividends on common stock only out of income available over the past year and only if prospective earnings retention is consistent with the organizations expected future needs and financial condition. The policy provides that bank holding companies should not maintain a level of cash dividends that undermines the bank holding companys ability to serve as a source of strength to its banking subsidiaries.
As members of the Federal Reserve System, each of Centennial Bank of the West and Guaranty Bank is subject to Regulation H, which, among other things, provides that a member bank may not declare or pay a dividend if the total of all dividends declared during the calendar year, including the proposed dividend, exceeds the sum of the banks net income (as reportable in its Reports of Condition and Income) during the current calendar year and its retained net income for the prior two calendar years, unless the Federal Reserve has approved the dividend. Regulation H also provides that a member bank may not declare or pay a dividend if the dividend would exceed the banks undivided profits as reportable on its Reports of Condition and Income, unless the Federal Reserve and holders of at least two-thirds of the outstanding shares of each class of the banks outstanding stock have approved the dividend. Additionally, there are potential additional restrictions and prohibitions if a bank were to be less than well-capitalized.
Additionally, as Colorado state-chartered banks, the banks are subject to limitations under Colorado law on the payment of dividends. The Colorado Financial Institutions Code provides that a bank may declare dividends from retained earnings and other components of capital specifically approved by the Banking Board so long as the declaration is made in compliance with rules established by the Banking Board.
In addition to these explicit limitations, the federal regulatory agencies have general authority to prohibit a banking subsidiary or bank holding company from engaging in an unsafe or unsound banking practice.
Depending upon the circumstances, the agencies could take the position that paying a dividend would constitute an unsafe or unsound banking practice.
As part of our capital and cash management practices at the holding company, we will utilize our bank subsidiaries excess capital above the well-capitalized requirement through the payment of dividends to the holding company.
There are various restrictions on the ability of Centennial to borrow from, and engage in certain other transactions with, Centennials subsidiary banks. In general, these restrictions require that any extensions of credit must be secured by designated amounts of specified collateral and are limited, as to transactions with any one of Centennials subsidiary banks, to 10% of Centennials subsidiary banks capital stock and surplus, and, as to Centennial, to 20% of Centennials subsidiary banks capital stock and surplus.
Federal law also provides that extensions of credit and other transactions between our subsidiary banks and Centennial must be on terms and conditions, including credit standards, that are substantially the same or at least as favorable to our subsidiary banks as those prevailing at the time for comparable transactions involving other non-affiliated companies or, in the absence of comparable transactions, on terms and conditions, including credit standards, that in good faith would be offered to, or would apply to, non-affiliated companies.
Source of Strength Doctrine
Federal Reserve Board policy requires bank holding companies to act as a source of financial and managerial strength to their subsidiary banks. Under this policy, Centennial is expected to commit resources to support its subsidiary banks, including at times when Centennial may not be in a financial position to provide it. Any capital loans by a bank holding company to any of its subsidiary banks are subordinate in right of payment to deposits and to certain other indebtedness of such subsidiary banks. The BHC Act provides that, in the event of a bank holding companys bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and entitled to priority of payment.
Capital Adequacy and Prompt Corrective Action
Banks and bank holding companies are subject to various regulatory capital requirements administered by state and federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations, involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weighting and other factors.
The Federal Reserve Board has risk-based capital ratio and leverage ratio guidelines for banking organizations, which are intended to ensure that banking organizations have adequate capital given the risk levels of assets and off-balance sheet financial instruments. Under the guidelines, banking organizations are required to maintain minimum ratios for Tier 1 capital and total capital to total risk-weighted assets (including certain off-balance sheet items, such as letters of credit). For purposes of calculating the ratios, a banking organizations assets and some of its specified off-balance sheet commitments and obligations are assigned to various risk categories. A depository institution or holding companys capital, in turn, is classified in one of three tiers, depending on type:
Centennial, like other bank holding companies, currently is required to maintain Tier 1 capital and total capital (the sum of Tier 1, Tier 2 and Tier 3 capital) equal to at least 4.0% and 8.0%, respectively, of its total risk-weighted assets (including various off-balance-sheet items, such as standby letters of credit). Our subsidiary banks, like other depository institutions, are required to maintain similar capital levels under capital adequacy guidelines.
Bank holding companies and banks subject to the market risk capital guidelines are required to incorporate market and interest rate risk components into their risk-based capital standards. Under the market risk capital guidelines, capital is allocated to support the amount of market risk related to a financial institutions ongoing trading activities.
Bank holding companies and banks are also required to comply with minimum leverage ratio requirements. The leverage ratio is the ratio of a banking organizations Tier 1 capital to its total adjusted quarterly average assets (as defined for regulatory purposes). The requirements necessitate a minimum leverage ratio of 3.0% for financial holding companies and banks that either have the highest supervisory rating or have implemented the appropriate federal regulatory authoritys risk-adjusted measure for market risk. All other financial holding companies and banks are required to maintain a minimum leverage ratio of 4.0%, unless a different minimum is specified by an appropriate regulatory authority. For a depository institution to be considered well capitalized under the regulatory framework for prompt corrective action, its leverage ratio must be at least 5.0%.
The Federal Deposit Insurance Act, as amended (FDIA), requires, among other things, the federal banking agencies to take prompt corrective action in respect of depository institutions that do not meet minimum capital requirements. The FDIA sets forth the following five capital tiers: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. A depository institutions capital tier will depend upon how its capital levels compare with various relevant capital measures and certain other factors, as established by regulation. The relevant capital measures are the total capital ratio, the Tier 1 capital ratio and the leverage ratio.
Under the regulations adopted by the federal regulatory authorities, a bank will be: (i) well capitalized if the institution has a total risk-based capital ratio of 10.0% or greater, a Tier 1 risk-based capital ratio of 6.0% or greater, and a leverage ratio of 5.0% or greater, and is not subject to any order or written directive by any such regulatory authority to meet and maintain a specific capital level for any capital measure; (ii) adequately capitalized if the institution has a total risk-based capital ratio of 8.0% or greater, a Tier 1 risk-based capital ratio of 4.0% or greater, and a leverage ratio of 4.0% or greater (3.0% in certain circumstances) and is not well capitalized; (iii) undercapitalized if the institution has a total risk-based capital ratio that is less than 8.0%, a Tier 1 risk-based capital ratio of less than 4.0% or a leverage ratio of less than 4.0% (3.0% in certain circumstances); (iv) significantly undercapitalized if the institution has a total risk-based capital ratio of less than 6.0%, a Tier 1 risk-based capital ratio of less than 3.0% or a leverage ratio of less than 3.0%; and (v) critically undercapitalized if the institutions tangible equity is equal to or less than 2.0% of average quarterly tangible assets. An institution may be downgraded to, or deemed to be in, a capital category that is lower than indicated by its capital ratios if it is determined to be in an unsafe or unsound condition or if it receives an unsatisfactory examination rating with respect to certain matters. A banks capital category is determined solely for the purpose of applying prompt corrective action regulations, and the capital category may not constitute an accurate representation of the banks overall financial condition or prospects for other purposes.
The FDIA generally prohibits a depository institution from making any capital distributions (including payment of a dividend) or paying any management fee to its parent holding company if the depository institution would thereafter be undercapitalized. Undercapitalized institutions are subject to growth limitations and are required to submit a capital restoration plan. The agencies may not accept such a plan without determining, among other things, that the plan is based on realistic assumptions and is likely to succeed in restoring the depository institutions capital. In addition, for a capital restoration plan to be acceptable, the depository institutions parent holding company must guarantee that the institution will comply with such capital restoration plan. The aggregate liability of the parent holding company is limited to the lesser of (i) an amount equal to 5.0% of the depository institutions total assets at the time it became undercapitalized and (ii) the amount which is necessary (or would have been necessary) to bring the institution into compliance with all capital standards applicable with respect to such institution as of the time it fails to comply with the plan. If a depository institution fails to submit an acceptable plan, it is treated as if it is significantly undercapitalized.
Significantly undercapitalized depository institutions may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become adequately capitalized, requirements to reduce total assets, and cessation of receipt of deposits from correspondent banks. Critically undercapitalized institutions are subject to the appointment of a receiver or conservator.
For information regarding the capital ratios and leverage ratio of Centennial and our bank subsidiaries see the discussion under the section captioned Capital included in Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations and Note 21Regulatory Requirements in the notes to consolidated financial statements included in Item 8. Financial Statements and Supplementary Data elsewhere in this report.
The federal bank regulatory authorities risk-based capital guidelines are based upon the 1988 capital accord of the Basel Committee on Banking Supervision, or the BIS. The BIS is a committee of central banks and bank supervisors/regulators from the major industrialized countries that develops broad policy guidelines for use by each countrys supervisors in determining the supervisory policies they apply. In 2004, the BIS published a new capital accord to replace its 1988 capital accord, with an update in November 2005 (BIS II).
BIS II provides two approaches for setting capital standards for credit riskan internal ratings-based approach tailored to individual institutions circumstances (which for many asset classes is itself broken into a foundation approach and an advanced or A-IRB approach, the availability of which is subject to additional restrictions) and a standardized approach that bases risk weightings on external credit assessments to a much greater extent than permitted in existing risk-based capital guidelines. BIS II also would set capital requirements for operational risk and refine the existing capital requirements for market risk exposures.
The U.S. banking and thrift agencies are developing proposed revisions to their existing capital adequacy regulations and standards based on BIS II. In September 2006, the agencies issued a notice of proposed rulemaking setting forth a definitive proposal for implementing BIS II in the United States that would apply only to internationally active banking organizationsdefined as those with consolidated total assets of $250 billion or more or consolidated on-balance sheet foreign exposures of $10 billion or morebut that other U.S. banking organizations could elect but would not be required to apply. In December 2006, the agencies issued a notice of proposed rulemaking describing proposed amendments to their existing risk-based capital guidelines to make them more risk-sensitive, generally following aspects of the standardized approach of BIS II. These latter proposed amendments, often referred to as BIS I-A, would apply to banking organizations that are not internationally active banking organizations subject to the A-IRB approach for internationally active banking organizations and do not opt in to that approach. The agencies previously had issued advance notices of proposed rulemaking on both proposals (in August 2003 regarding the A-IRB approach of BIS II for internationally active banking organizations and in October 2005 regarding BIS II).
The comment periods for both of the agencies notices of proposed rulemakings expire on March 26, 2007. The agencies have indicated their intent to have the A-IRB provisions for internationally active U.S. banking
organizations first become effective in March 2009 and that those provisions and the BIS I-A provisions for others will be implemented on similar timeframes.
We are not an internationally active banking organization and have not made a determination as to whether we would opt to apply the A-IRB provisions applicable to internationally active U.S. banking organizations once they become effective.
The deposits of our bank subsidiaries are insured up to applicable limits by the Deposit Insurance Fund, or the DIF, of the FDIC and are subject to deposit insurance assessments to maintain the DIF. The FDIC utilizes a risk-based assessment system that imposes insurance premiums based upon a risk matrix that takes into account a banks capital level and supervisory rating. Our bank subsidiaries were not required to pay any deposit insurance premiums in 2006; however, it is possible that the FDIC could impose assessment rates in the future in connection with declines in the insurance funds or increases in the amount of insurance coverage. An increase in the assessment rate could have a material adverse effect on our earnings, depending on the amount of the increase.
Because of favorable loss experience and a healthy reserve ratio in the Bank Insurance Fund, or the BIF, of the FDIC, well-capitalized and well-managed banks, including the Banks, have in recent years paid minimal premiums for FDIC insurance. The FDIC notified banks that beginning in 2007, it will increase the premiums for deposit insurance. Concurrently, a deposit premium refund, in the form of credit offsets, was granted to banks that were in existence on December 31, 1996 and paid deposit insurance premiums prior to that date. The amount of any future premiums will depend on the BIF loss experience, legislation or regulatory initiatives and other factors, none of which we are in position to predict at this time.
The FDIA provides that, in the event of the liquidation or other resolution of an insured depository institution, the claims of depositors of the institution, including the claims of the FDIC as subrogee of insured depositors, and certain claims for administrative expenses of the FDIC as a receiver, will have priority over other general unsecured claims against the institution. If an insured depository institution fails, insured and uninsured depositors, along with the FDIC, will have priority in payment ahead of unsecured, non-deposit creditors, including the parent bank holding company, with respect to any extensions of credit they have made to such insured depository institution.
Liability of Commonly Controlled Institutions
FDIC-insured depository institutions can be held liable for any loss incurred, or reasonably expected to be incurred, by the FDIC due to the default of an FDIC-insured depository institution controlled by the same bank holding company, or for any assistance provided by the FDIC to an FDIC-insured depository institution controlled by the same bank holding company that is in danger of default. This means that Guaranty Bank could be held liable for such losses due to a default by Centennial Bank of the West and vice versa because both such depositary institutions are controlled by the holding company. Default means generally the appointment of a conservator or receiver. In danger of default means generally the existence of certain conditions indicating that default is likely to occur in the absence of regulatory assistance.
Community Reinvestment Act
The Community Reinvestment Act of 1977, or the CRA, requires depository institutions to assist in meeting the credit needs of their market areas consistent with safe and sound banking practice. Under the CRA, each
depository institution is required to help meet the credit needs of its market areas by, among other things, providing credit to low- and moderate-income individuals and communities. Depository institutions are periodically examined for compliance with the CRA and are assigned ratings. In order for a financial holding company to commence any new activity permitted by the BHC Act, or to acquire any company engaged in any new activity permitted by the BHC Act, each insured depository institution subsidiary of the financial holding company must have received a rating of at least satisfactory in its most recent examination under the CRA. Furthermore, banking regulators take into account CRA ratings when considering approval of a proposed transaction.
In accordance with the GLB Act, federal banking regulators adopted rules that limit the ability of banks and other financial institutions to disclose non-public information about consumers to nonaffiliated third parties. These limitations require disclosure of privacy policies to consumers and, in some circumstances, allow consumers to prevent disclosure of certain personal information to a nonaffiliated third party. The privacy provisions of the GLB Act affect how consumer information is transmitted through diversified financial companies and conveyed to outside vendors.
Anti-Money Laundering Initiatives and the USA Patriot Act
A major focus of governmental policy on financial institutions in recent years has been aimed at combating money laundering and terrorist financing. The USA PATRIOT Act of 2001, or the USA Patriot Act, substantially broadened the scope of United States anti-money laundering laws and regulations by imposing significant new compliance and due diligence obligations, creating new crimes and penalties and expanding the extra-territorial jurisdiction of the United States. The United States Treasury Department has issued a number of regulations that apply various requirements of the USA Patriot Act to financial institutions such as our bank subsidiaries. These regulations impose obligations on financial institutions to maintain appropriate policies, procedures and controls to detect, prevent and report money laundering and terrorist financing and to verify the identity of their customers. Failure of a financial institution to maintain and implement adequate programs to combat money laundering and terrorist financing, or to comply with all of the relevant laws or regulations, could have serious legal and reputational consequences for the institution.
Office of Foreign Assets Control Regulation
The United States has imposed economic sanctions that affect transactions with designated foreign countries, nationals and others. These are typically known as the OFAC rules based on their administration by the U.S. Treasury Department Office of Foreign Assets Control (OFAC). The OFAC-administered sanctions targeting countries take many different forms. Generally, however, they contain one or more of the following elements: (i) restrictions on trade with or investment in a sanctioned country, including prohibitions against direct or indirect imports from and exports to a sanctioned country and prohibitions on U.S. persons engaging in financial transactions relating to making investments in, or providing investment-related advice or assistance to, a sanctioned country; and (ii) a blocking of assets in which the government or specially designated nationals of the sanctioned country have an interest, by prohibiting transfers of property subject to U.S. jurisdiction (including property in the possession or control of U.S. persons). Blocked assets (e.g., property and bank deposits) cannot be paid out, withdrawn, set off or transferred in any manner without a license from OFAC. Failure to comply with these sanctions could have serious legal and reputational consequences.
As a publicly traded company, we are subject to the Sarbanes-Oxley Act of 2002 (Sarbanes-Oxley Act). NASDAQ has adopted corporate governance rules intended to allow stockholders to more easily and effectively monitor the performance of companies and directors. The principal provisions of the Sarbanes-Oxley Act, many
of which have been implemented or interpreted through regulations, provide for and include, among other things: (i) the creation of an independent accounting oversight board; (ii) auditor independence provisions that restrict non-audit services that accountants may provide to their audit clients; (iii) additional corporate governance and responsibility measures, including the requirement that the chief executive officer and chief financial officer of a public company certify financial statements; (iv) the forfeiture of bonuses or other incentive-based compensation and profits from the sale of an issuers securities by directors and senior officers in the twelve month period following initial publication of any financial statements that later require restatement; (v) an increase in the oversight of, and enhancement of certain requirements relating to, audit committees of public companies and how they interact with the Companys independent auditors; (vi) requirements that audit committee members must be independent and are barred from accepting consulting, advisory or other compensatory fees from the issuer; (vii) requirements that companies disclose whether at least one member of the audit committee is a financial expert (as such term is defined by the SEC) and if not discussed, why the audit committee does not have a financial expert; (viii) expanded disclosure requirements for corporate insiders, including accelerated reporting of stock transactions by insiders and a prohibition on insider trading during pension blackout periods; (ix) a prohibition on personal loans to directors and officers, except certain loans made by insured financial institutions on nonpreferential terms and in compliance with other bank regulatory requirements; (x) disclosure of a code of ethics and filing a Form 8-K for a change or waiver of such code; (xi) a range of enhanced penalties for fraud and other violations; and (xii) expanded disclosure and certification relating to an issuers disclosure controls and procedures and internal controls over financial reporting.
As a result of the Sarbanes-Oxley Act, and its implementing regulations, we have incurred substantial costs to interpret and ensure compliance with the law and its regulations. Future changes in the laws, regulations, or policies that impact us cannot necessarily be predicted and may have a material effect on our business and earnings.
Legislative and Regulatory Initiatives
From time to time, various legislative and regulatory initiatives are introduced in the U.S. Congress and state legislatures, as well as by regulatory agencies. Such initiatives may include proposals to expand or contract the powers of bank holding companies and depository institutions or proposals to substantially change the financial institution regulatory system. Such legislation could change banking statutes and our operating environment in substantial and unpredictable ways. If enacted, such legislation could increase or decrease the cost of doing business, limit or expand permissible activities or affect the competitive balance among banks, savings associations, credit unions, and other financial institutions. We cannot predict whether any such legislation will be enacted, and, if enacted, the effect that it, or any implementing regulations, would have on our financial condition or results of operations. A change in statutes, regulations or regulatory policies applicable to Centennial or any of its subsidiaries could have a material effect on our business.
At December 31, 2006, we employed 518 full-time equivalent employees. None of our employees are represented by collective bargaining agreements. We believe our employee relations to be good.
Centennial maintains an Internet website at www.cbhi.com. At this website, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and proxy statements on Schedule 14A and amendments to such reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act are available, free of charge, as soon as reasonably practicable after such forms are electronically filed with, or furnished to, the SEC. The public may read and copy any materials we file with the SEC at the SECs Public Reference Room, located at 100 F Street, NE, Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains an
Internet site at www.sec.gov that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. You may obtain copies of the Companys filings on the SEC site. These documents may also be obtained in print upon request by our stockholders to our Investor Relations Department.
We have adopted a written code of ethics that applies to all directors, officers and employees of the Company, including our principal executive officer and senior financial officers, in accordance with Section 406 of the Sarbanes-Oxley Act of 2002 and the rules of the Securities and Exchange Commission promulgated thereunder. The code of ethics, which we call our Code of Business Conduct and Ethics, is available on our corporate website, www.cbhi.com, in the section entitled Corporate Governance. In the event that we make changes in, or provide waivers from, the provisions of this code of ethics that the SEC requires us to disclose, we intend to disclose these events on our corporate website in such section. In the Corporate Governance section of our corporate website, we have also posted the charters for our Audit Committee and our Compensation, Nominating and Governance Committee, as well as our Corporate Governance Guidelines. In addition, information concerning purchases and sales of our equity securities by our executive officers and directors is posted on our website.
Our Investor Relations Department can be contacted at Centennial Bank Holdings, Inc., 1331 Seventeenth Street, Suite 300, Denver, CO 80202, Attention: Investor Relations, telephone 303-296-9600, or via e-mail to firstname.lastname@example.org.
Except for the documents specifically incorporated by reference into this document, information contained on Centennials website or information that can be accessed through its website is not incorporated by reference into this document.
An investment in our common stock is subject to risks inherent to our business. The material risks and uncertainties that management believes affect us are described below. Before making an investment decision, you should carefully consider the risks and uncertainties described below together with all of the other information included or incorporated by reference in this report. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties that management is not aware of or focused on or that management currently deems immaterial may also impair our business operations. This report is qualified in its entirety by these risk factors.
If any of the following risks actually occurs, our financial condition and results of operations could be materially and adversely affected. If this were to happen, the value of our common stock could decline significantly, and you could lose all or part of your investment.
We Are Subject to Interest Rate Risk
Our earnings and cash flows are largely dependent upon our net interest income. Net interest income is the difference between interest income earned on interest-earning assets such as loans and securities and interest expense paid on interest-bearing liabilities such as deposits and borrowed funds. Interest rates are highly sensitive to many factors that are beyond our control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the Board of Governors of the Federal Reserve System. Changes in monetary policy, including changes in interest rates, could influence not only the interest we receive on loans and securities and the amount of interest we pay on deposits and borrowings, but such changes could also affect (i) our ability to originate loans and obtain deposits, (ii) the fair value of our financial assets and liabilities, and (iii) the average duration of our loans and securities which are collateralized by mortgages. If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments, our net interest income, and therefore earnings, could be adversely affected.
Earnings could also be adversely affected if the interest rates received on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings.
Any substantial, unexpected, prolonged change in market interest rates could have a material adverse effect on our financial condition and results of operations. See Item 7A. Quantitative and Qualitative Disclosures about Market Risk located elsewhere in this report for further discussion related to our management of interest rate risk.
We are Subject to Credit Risk
There are inherent risks associated with our lending activities. These risks include, among other things, the impact of changes in interest rates and changes in the economic conditions in the markets where we operate as well as those across the United States and abroad. Increases in interest rates and/or weakening economic conditions could adversely impact the ability of borrowers to repay outstanding loans or the value of the collateral securing these loans. We are also subject to various laws and regulations that affect our lending activities. Failure to comply with applicable laws and regulations could subject us to regulatory enforcement action that could result in the assessment of significant civil money penalties against us.
Our Allowance for Loan Losses May Be Insufficient
We maintain an allowance for loan losses, which is a reserve established through a provision for loan losses charged to expense, that represents managements best estimate of probable losses that may be incurred within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio. The level of the allowance reflects managements continuing evaluation of industry concentrations; specific credit risks; loan loss experience; current loan portfolio quality; present economic, political and regulatory conditions and unidentified losses inherent in the current loan portfolio. The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and judgment and requires us to make significant estimates of current credit risks and future trends, all of which may undergo material changes. Changes in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of our control, may require an increase in the allowance for loan losses. In addition, bank regulatory agencies periodically review our allowance for loan losses and may require an increase in the provision for loan losses or the recognition of further loan charge-offs, based on judgments different than those of management. In addition, if charge-offs in future periods exceed the allowance for loan losses, we will need additional provisions to increase the allowance for loan losses. Any increases in the allowance for loan losses will result in a decrease in net income and, possibly, capital, and may have a material adverse effect on our financial condition and results of operations. See the section captioned Allowance for Loan Losses in Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations located elsewhere in this report for further discussion related to our process for determining the appropriate level of the allowance for loan losses.
A Downturn in Our Real Estate Markets Could Hurt Our Business
A downturn in our real estate markets could hurt our business because many of our loans are secured by real estate. Real estate values and real estate markets are generally affected by changes in national, regional or local economic conditions, fluctuations in interest rates and the availability of loans to potential purchasers, changes in tax laws and other governmental statutes, regulations and policies and acts of nature. If real estate prices decline, the value of real estate collateral securing our loans could be reduced. Our ability to recover on defaulted loans by foreclosing and selling the real estate collateral would then be diminished and we would be more likely to suffer losses on defaulted loans. As of December 31, 2006, approximately 60% of the book value of our loan portfolio consisted of loans collateralized by various types of real estate. Substantially all of our real property collateral is located in Colorado. Any such downturn could have a material adverse effect on our business, financial condition and results of operations.
We are Exposed to Risk of Environmental Liabilities with Respect to Properties to Which We Take Title
In the course of our business, we may own or foreclose and take title to real estate, and could be subject to environmental liabilities with respect to these properties. We may be held liable to a governmental entity or to third parties for property damage, personal injury, investigation and clean-up costs incurred by these parties in connection with environmental contamination, or may be required to investigate or clean up hazardous or toxic substances, or chemical releases at a property. The costs associated with investigation or remediation activities could be substantial. In addition, as the owner or former owner of a contaminated site, we may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from the property. If we ever become subject to significant environmental liabilities, our business, financial condition, liquidity and results of operations could be materially and adversely affected.
Our Profitability Depends Significantly on Economic Conditions in the Colorado Front Range
Our success depends primarily on the general economic conditions in the counties in which we conduct business. Unlike larger banks that are more geographically diversified, we provide banking and financial services to customers primarily in the Colorado Front Range, which includes the Denver metropolitan area. The local economic conditions in our market area have a significant impact on our loans, the ability of the borrowers to repay these loans and the value of the collateral securing these loans. A significant decline in general economic conditions caused by inflation, natural disasters, recession, unemployment or other factors beyond our control would affect these local economic conditions and could adversely affect our financial condition and results of operations. In view of the concentration of our operations and the collateral securing our loan portfolio in Colorados Front Range, we may be particularly susceptible to the adverse effects of any of these consequences, any of which could have a material adverse effect on our business, financial condition, results of operations and cash flows.
We are Subject To Liquidity Risk
Market conditions or other events could negatively affect the level or cost of liquidity, affecting our ongoing ability to accommodate liability maturities and deposit withdrawals, meet contractual obligations, and fund asset growth and new business transactions at a reasonable cost, in a timely manner and without adverse consequences. Although management has implemented strategies to maintain sufficient and diverse sources of funding to accommodate planned as well as unanticipated changes in assets and liabilities under both normal and adverse conditions, any substantial, unexpected and/or prolonged change in the level or cost of liquidity could have a material adverse effect on our financial condition and results of operations.
We Operate in a Highly Competitive Industry and Market Area
We face substantial competition in all areas of our operations from a variety of different competitors, many of which are larger and may have more financial resources. Such competitors primarily include national, regional, and community banks within the various markets we serve. We also face competition from many other types of financial institutions, including, without limitation, savings and loans, credit unions, finance companies, brokerage firms, insurance companies, factoring companies and other financial intermediaries. The financial services industry could become even more competitive as a result of legislative, regulatory and technological changes and continued consolidation. Banks, securities firms and insurance companies can merge under the umbrella of a financial holding company, which can offer virtually any type of financial service, including banking, securities underwriting, insurance (both agency and underwriting) and merchant banking. Also, technology has lowered barriers to entry and made it possible for non-banks to offer products and services traditionally provided by banks, such as automatic funds transfer and automatic payment systems. Many of our competitors have fewer regulatory constraints and may have lower cost structures. Additionally, due to their size, many competitors may be able to achieve economies of scale and, as a result, may offer a broader range of products and services as well as better pricing for those products and services than we can.
Our ability to compete successfully depends on a number of factors, including, among other things:
Failure to perform in any of these areas could significantly weaken our competitive position, which could adversely affect our growth and profitability, which, in turn, could have a material adverse effect on our financial condition and results of operations.
We Are Subject to Extensive Government Regulation and Supervision
We are subject to extensive regulation, supervision and examination. Any change in the laws or regulations applicable to us, or in banking regulators supervisory policies or examination procedures, whether by the Colorado Division of Banking, the FDIC, the Federal Reserve Board, other state or federal regulators, the U.S. Congress or the Colorado legislature could have a material adverse effect on our business, financial condition, results of operations and cash flows.
Our banks are subject to regulations promulgated by the Colorado Division of Banking, as their chartering authority, and by the FDIC as the insurer of their deposits up to certain limits. Our banks also belong to the Federal Home Loan Bank System and, as members of such system, they are subject to certain limited regulations promulgated by the Federal Home Loan Bank of Topeka. In addition, the Federal Reserve Board regulates and oversees Centennial Bank Holdings, Inc. as a bank holding company, and Centennial Bank of the West and Guaranty Bank as members of the Federal Reserve System.
This regulation and supervision limits the activities in which we may engage. The purpose of regulation and supervision is primarily to protect the FDICs insurance fund and our depositors and borrowers, rather than our stockholders. Regulatory authorities have extensive discretion in the exercise of their supervisory and enforcement powers. They may, among other things, impose restrictions on the operation of a banking institution, the classification of assets by such institution and such institutions allowance for loan losses. Regulatory and law enforcement authorities also have wide discretion and extensive enforcement powers under various consumer protection and civil rights laws, including the Truth-in-Lending Act, the Equal Credit Opportunity Act, the Fair Housing Act, the Real Estate Settlement Procedures Act and Colorados deceptive acts and practices law. These laws also permit private individual and class action lawsuits and provide for the recovery of attorneys fees in certain instances. No assurance can be given that the foregoing regulations and supervision will not change so as to affect us adversely.
Our Controls and Procedures May Fail or Be Circumvented
Management regularly reviews and updates our internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of our controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on our business, results of operations and financial condition.
We Face Risks Associated With Acquisitions
We may pursue acquisition opportunities in the future. Risks commonly encountered in acquisitions include, among other things:
We may not be successful in overcoming these risks or any other problems encountered in connection with acquisitions. Our integration of operations of banks or branches that we acquire may not be successfully accomplished and may take a significant amount of time. Our inability to improve the operating performance of acquired banks and branches or to integrate successfully their operations could have a material adverse effect on our business, financial condition, results of operations and cash flows. We expect to hire additional employees and retain consultants to assist with integrating our operations, and we cannot assure you that those individuals or firms will perform as expected or be successful in addressing these issues.
We Rely on Dividends from Our Subsidiaries for Most of Our Revenue
Because we are a holding company with no significant assets other than our banks, we currently depend upon dividends from our banks for a substantial portion of our revenues. Our ability to pay dividends will therefore continue to depend in large part upon our receipt of dividends or other capital distributions from our banks. Our ability to pay dividends is subject to the restrictions of the Delaware General Corporation Law.
The ability of the banks to pay dividends or make other capital distributions to us is also subject to the regulatory authority of the Federal Reserve Board and the Colorado Division of Banking, or the CDB, as further described in the Supervision and Regulation section of Item 1 of this report.
From time to time, we may become a party to financing agreements or other contractual arrangements that have the effect of limiting or prohibiting us or our banks from declaring or paying dividends. Our holding company expenses and obligations with respect to our line of credit with U.S. Bank National Association as well as our trust preferred securities and corresponding subordinated debt securities issued by us may limit or impair our ability to declare or pay dividends. See Item 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity SecuritiesDividends for more information on these restrictions.
We are Dependent on Key Personnel and the Loss of One or More of Those Key Personnel Could Harm Our Business
Competition for qualified employees and personnel in the banking industry is intense and there are a limited number of qualified persons with knowledge of and experience in the Colorado community banking industry. The process of recruiting personnel with the combination of skills and attributes required to carry out our strategies is often lengthy. Our success depends to a significant degree upon our ability to attract and retain qualified management, loan origination, administrative, marketing and technical personnel and upon the continued contributions of our management and personnel. In particular, our success has been and continues to
be highly dependent upon the abilities of our senior executive management, including Daniel M. Quinn, Sherri L. Heronema, Suzanne R. Brennan and Paul W. Taylor. We believe this management team, comprised of individuals who have worked in the banking industry for many years, is integral to implementing our business plan. The loss of the services of any one of them could harm our business.
Our Information Systems May Experience an Interruption or Breach in Security
We rely heavily on communications and information systems to conduct our business. Any failure, interruption or breach in security of these systems could result in failures or disruptions in our customer relationship management, general ledger, deposit, loan and other systems. While we have policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of our information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately addressed. The occurrence of any failures, interruptions or security breaches of our information systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our financial condition and results of operations.
We Continually Encounter Technological Change
The financial services industry is continually undergoing rapid technological change with frequent introductions of new technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs. Our future success depends, in part, upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements. We may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers. Failure to successfully keep pace with technological change affecting the financial services industry could have a material adverse impact on our business and, in turn, our financial condition and results of operations.
We Are Subject to Claims and Litigation Pertaining to Fiduciary Responsibility
From time to time, customers make claims and take legal action pertaining to our performance of our fiduciary responsibilities. Whether customer claims and legal action related to our performance of our fiduciary responsibilities are founded or unfounded, if such claims and legal actions are not resolved in a manner favorable to us they may result in significant financial liability and/or adversely affect the market perception of us and our products and services as well as impact customer demand for our products and services. Any financial liability or reputation damage could have a material adverse effect on our business, which, in turn, could have a material adverse effect on our financial condition and results of operations.
Severe Weather, Natural Disasters, Acts of War or Terrorism and Other External Events Could Significantly Impact Our Business
Severe weather, natural disasters, acts of war or terrorism and other adverse external events could have a significant impact on our ability to conduct business. Such events could affect the stability of our deposit base, impair the ability of borrowers to repay outstanding loans, impair the value of collateral securing loans, cause significant property damage, result in loss of revenue and/or cause us to incur additional expenses. Although management has established disaster recovery policies and procedures, the occurrence of any such event could have a material adverse effect on our business, which, in turn, could have a material adverse effect on our financial condition and results of operations.
As of February 28, 2007, we had a total of 36 branch office properties, 22 of which we owned and 14 of which we leased. All of our properties are located in the Colorado Front Range. Centennial Bank of the West operates through 15 branches, including its principal office located at 4650 Royal Vista Circle, Ft. Collins, Colorado 80528. Guaranty Bank operates through 21 branches, including its principal office located at 1331 Seventeenth Street, Denver, Colorado 80202. Centennials principal office is located at 1331 Seventeenth Street, Suite 300, Denver, Colorado 80202.
We consider our properties to be suitable and adequate for our needs.
On December 31, 2004, an adversary proceeding was filed against Guaranty Bank and Trust Company in the United States Bankruptcy Court for the District of Colorado, by the trustees of the Will Hoover Company, or the Hoover Company, and William Gordon Hoover, Jr., or Hoover, seeking to avoid certain transfers that occurred over a four-year period commencing in 1999 under the United States Bankruptcy Code (i.e., the Trustee action). The trustees allege that certain transfers were made by the Hoover Company and Hoover with actual fraudulent intent, that the transfers were made for less than reasonably equivalent value and occurred at a time when the Hoover Company and Hoover were insolvent, or were rendered insolvent by the transfers, and that certain other transfers were preferential as to other creditors, were made for less than reasonably equivalent value or were made by the Hoover Company or Hoover with actual fraudulent intent. On September 7, 2005, the Bankruptcy Court granted, in part, Guaranty Banks initial response and dismissed $8.5 million of the claims relating to alleged transfers for payment of items credited in the check collection process. On November 10, 2005, the trustees filed a motion in District Court requesting reconsideration of the Bankruptcy Courts order dismissing those claims. The District Court summarily denied the trustees motion on November 21, 2005. The Trustees filed another motion for reconsideration with the Bankruptcy Court on November 9, 2006, which the court denied. On August 29, 2006, Guaranty Bank filed a motion for partial summary judgment on the trustees claims to recover payments on alleged overdrafts in the amount of approximately $1.7 million, which the court denied. On September 1, 2006, the trustees amended the complaint to include a claim, based on similar arguments, to recover interest payments on loans to Hoover and the Hoover Company in the amount of $0.1 million. We continue to vigorously contest the remaining claims, which amount to approximately $2.9 million. We have established a reserve that, after consultation with our counsel, we have determined is appropriate for this litigation.
On July 22, 2005 and August 18, 2005, two separate but similar actions (i.e., the Barnes action and Teper action, respectively) were filed against Guaranty Bank and a former officer in the Denver District Court, Denver, Colorado by investors who provided funds to Hoover, the Hoover Company or related entities. The investors allege that certain activities of Guaranty Bank and its former officer with respect to the customer relationship with Hoover, the Hoover Company and related entities aided and abetted Hoover and the Hoover Company in securities violations and violations of the Colorado Organized Crime Control Act and amounted to a civil conspiracy, causing the investors to incur damages. The court has subsequently dismissed the entire Teper action. The investors in the Barnes action are seeking actual and statutory treble damages, as well as interest and attorneys fees, against Guaranty Bank and its former officer. The alleged actual losses claimed in connection with the Barnes action are approximately $12.2 million. In a series of preliminary rulings in April 2006, the District Court dismissed a number of the claims representing alleged damages in excess of $1.0 million. The Company will continue to vigorously defend the Barnes action.
Although the Company has established a reserve for the Trustee action, we cannot determine whether the outcome of each of the above matters will have a material adverse impact on our consolidated financial position or results of operations. To the extent these suits are not settled or dismissed, the Company will incur ongoing legal costs. If such legal costs will not be covered by insurance, the legal costs incurred could have an adverse impact on our results of operations.
In the ordinary course of our business, we are party to various other legal actions, which we believe are incidental to the operation of our business. Although the ultimate outcome and amount of liability, if any, with respect to these other legal actions to which we are currently a party cannot presently be ascertained with certainty, in the opinion of management, based upon information currently available to us, any resulting liability is not likely to have a material adverse effect on the Companys consolidated financial position, results of operations or cash flows.
No matters were submitted to a vote of the security holders during the fourth quarter 2006.
Common Stock Market Prices
Our common stock became publicly traded on October 3, 2005, and is traded on the Nasdaq Global Select Market (Nasdaq) under the symbol CBHI. The table below sets forth the high and low sales prices per share of our common stock as reported by Nasdaq for each quarter since our common stock became publicly traded. Prior to October 3, 2005, there was no established trading market for our stock.
On March 16, 2007, the closing price of our common stock on Nasdaq was $8.61 per share. As of that date, we believe, based on the records of our transfer agent, that there were approximately 360 record holders of our common stock.
We have never declared or paid cash dividends on our common stock. Our board of directors reviews the appropriateness of declaring or paying cash dividends on an ongoing basis. Any determination to declare or pay dividends in the future will be at the discretion of our board of directors. Our board of directors will take into account such matters as general business conditions, our financial results, capital requirements, contractual, legal and regulatory restrictions on the payment of dividends by us to our stockholders or by our subsidiaries to the holding company, and such other factors as our board of directors may deem relevant. Our board of directors has determined currently to use our excess capital on repurchases of our common stock. See Repurchases of Common Stock below under this Item 5.
Our ability to pay dividends is subject to the restrictions of the Delaware General Corporation Law. Because we are a holding company with no significant assets other than our bank subsidiaries, we currently depend upon dividends from our bank subsidiaries for a substantial portion of our revenues. Our ability to pay dividends will therefore continue to depend in large part upon our receipt of dividends or other capital distributions from our bank subsidiaries. See Supervision and Regulation in Item 1 of this report for a discussion of potential regulatory limitations on the holding companys receipt of funds from its bank subsidiaries.
The ability of our subsidiary banks to pay dividends or make other capital distributions to us is also subject to the regulatory authority of the Federal Reserve Board and the Colorado Division of Banking, or the CDB. It is possible, depending upon the financial condition of the bank in question, and other factors, that Federal Reserve Board and/or the CDB could assert that payment of dividends or other payments is an unsafe or unsound practice. As part of our capital and cash management practices at the holding company, we will utilize our bank subsidiaries excess capital above the well-capitalized requirement through the payment of dividends to the holding company. See Item 1. BusinessSupervision and RegulationDividends.
In addition, the Companys ability to pay dividends to its stockholders is limited by certain provisions of its pledge agreement with U.S. Bank National Association in connection with our line of credit. The agreement provides that if any default occurs and is continuing, all cash dividends distributed by Guaranty Bank shall be delivered to U.S. Bank and held as collateral under the agreement.
Our ability to pay dividends is also limited by certain covenants contained in the indentures governing trust preferred securities that have been issued, and in the debentures underlying the trust preferred securities. The indentures provide that if an Event of Default (as defined in the indentures) has occurred and is continuing, or if we are in default with respect to any obligations under our guarantee agreement which covers payments of the obligations on the trust preferred securities, or if we give notice of any intention to defer payments of interest on the debentures underlying the trust preferred securities, then we may not, among other restrictions, declare or pay any dividends (other than a dividend payable by the bank subsidiaries to the holding company) with respect to our common stock.
Securities Authorized for Issuance Under Equity Compensation Plans
The following table provides information as of December 31, 2006, regarding securities issued and to be issued under our equity compensation plans that were in effect during the year ended December 31, 2006:
Repurchases of Common Stock
Stock repurchase programs allow us to proactively manage our capital position and return excess capital to stockholders. The following table provides information with respect to purchases made by or on behalf of the Company or any affiliated purchaser (as defined in Rule 10b-18(a)(3) under the Securities Exchange Act of 1934) of our common stock during the fourth quarter of 2006.
On February 13, 2007, we announced the authorization of an additional 924,490 shares to our existing stock repurchase program announced in October 2006, to be purchased from time to time over a one-year period in the open market or through private transactions in accordance with applicable regulations of the Securities and Exchange Commission. Under the increased program, we are authorized to repurchase up to 2,750,000 shares.
Our common stock trades on the NASDAQ Global Select Market under the symbol CBHI. The following graph shows a comparison from October 3, 2005 (the date the Companys common stock commenced trading on NASDAQ) through December 31, 2006 of cumulative total return for the Companys common stock, the NASDAQ Stock Market (U.S.) Index and NASDAQ Bank Stocks Index. Such returns are based on historical results and are not intended to suggest future performance. Data for the NASDAQ Stock Market (U.S.) Index and NASDAQ Bank Stocks Index assumes reinvestment of dividends. The Company has never paid dividends on its common stock. The total return on the Companys common stock is determined based on the change in the price of the Companys common stock and assumes an original investment of $100. The total return on each of the indicated indices also assumes an original investment in the index of $100.
The following table sets forth certain of our financial and statistical information for each of the years in the five-year period ended December 31, 2006. This data should be read in conjunction with our audited consolidated financial statements as of December 31, 2006 and 2005, and for each of the years in the three-year period ended December 31, 2006, and related Notes to Consolidated Financial Statements contained in Item 8. Financial Statements and Supplementary Data. The financial information for Centennial Bank Holdings for the year ended December 31, 2004 separately reflects the activity for the Company for the period July 17, 2004 to December 31, 2004, which we refer to as Successor, and our predecessor for the period January 1, 2004 to July 16, 2004, which we refer to as Predecessor. All financial information relating to the Company prior to July 17, 2004 is for our Predecessor.
This section should be read in conjunction with the disclosure regarding Forward-Looking Statements and Factors that Could Affect Future Results set forth in the beginning of Part I of this report, as well as the discussion set forth in Item 1A. Risk Factors and Item 8. Financial Statements and Supplementary Data.
We are a financial holding company and a bank holding company providing banking and other financial services throughout our targeted Colorado markets to consumers and to small- and medium-sized businesses, including the owners and employees of those businesses. We offer an array of banking products and services to the communities we serve, including accepting time and demand deposits, originating commercial loans including energy loans, real estate loans, including construction and mortgage loans, Small Business Administration guaranteed loans and consumer loans. We derive our income primarily from interest received on real estate related loans, commercial loans and leases and consumer loans and, to a lesser extent, from fees on the sale or referral of loans, interest on investment securities and fees received in connection with servicing loan and deposit accounts. Our major operating expenses are the interest we pay on deposits and borrowings and general operating expenses. We rely primarily on locally generated deposits to provide us with funds for making loans.
We are subject to competition from other financial institutions and our operating results, like those of other financial institutions operating exclusively or primarily in Colorado, are significantly influenced by economic conditions in Colorado, including the strength of the real estate market. In addition, both the fiscal and regulatory policies of the federal government and regulatory authorities that govern financial institutions and market interest rates also impact our financial condition, results of operations and cash flows.
On July 16, 2004, in a cash purchase funded by the proceeds of our sale of 18,500,000 shares of our common stock, we acquired our Predecessor and changed our name to Centennial Bank Holdings, Inc. On December 31, 2004, we acquired Guaranty Corporation, including its bank subsidiaries Guaranty Bank and Trust Company, First National Bank of Strasburg and Collegiate Peaks Bank. On April 14, 2005, we merged First National Bank of Strasburg into Guaranty Bank. We sold Collegiate Peaks Bank on November 1, 2006. We refer to Guaranty Corporation and its subsidiaries as Guaranty and to Guaranty Bank and Trust Company (including the merged First National Bank of Strasburg) as Guaranty Bank.
The Companys financial statements as of and for the year ended December 31, 2004 present the consolidated financial position of Centennial at December 31, 2004, which includes Guaranty, and the results of operations of the Predecessor from January 1, 2004 through July 16, 2004 and the Successor from July 17, 2004 through December 31, 2004. The results of operations for 2004 with respect to either the Successor or Predecessor do not include Guaranty. With respect to the year ended December 31, 2004, we present results for our Predecessor for the period January 1, 2004 through July 16, 2004, for the Company (Successor) for the period July 17, 2004 through December 31, 2004, and for the year ended December 31, 2004, combined results of operations of the Company (Successor) and our Predecessor. We believe that presenting combined results of operations information for the year ended December 31, 2004 is helpful to our investors. In light of the continuity of management from our Predecessor to our Successor, the information for the year ended December 31, 2004 was combined in a manner similar to entities under common control.
On October 1, 2005, we consummated our stock-for-stock acquisition of First MainStreet Financial, Ltd., a financial holding company, pursuant to which its wholly owned subsidiary, First MainStreet Bank, N.A., merged with and into Centennial Bank of the West. First MainStreet Financials other wholly owned subsidiary, First MainStreet Insurance, Ltd., an independent insurance agency, became a wholly owned subsidiary of Centennial. We subsequently sold the insurance agency on March 1, 2006. The acquisition of First MainStreet resulted in the issuance of 9,517,727 shares of our common stock. We acquired $245.2 million of loans and $332.8 million of deposits as a result of the First MainStreet acquisition.
On November 1, 2005, we completed the acquisition of Foothills Bank, which was merged into Guaranty Bank. Foothills had $90.8 million in loans and deposits of $114.2 million at consummation of the transaction.
On November 1, 2006, we consummated the sale of Collegiate Peaks Bank, which had been classified as held for sale since December 31, 2004. The sale of Collegiate Peaks Bank accounted for a decrease in total assets of $98.2 million from December 31, 2005. See Note 22 of the Notes to Consolidated Financial Statements contained in Item 8. Financial Statements and Supplementary Data.
Application of Critical Accounting Policies and Accounting Estimates
Our accounting policies are integral to understanding the financial results reported. Our most complex accounting policies require managements judgment to ascertain the valuation of assets, liabilities, commitments and contingencies. We have established detailed policies and control procedures that are intended to ensure valuation methods are well controlled and consistently applied from period to period. In addition, the policies and procedures are intended to ensure that the process for changing methodologies occurs in an appropriate manner. The following is a brief description of our current accounting policies that we believe are critical or involve significant management judgment.
Allowance for Loan Losses
The loan portfolio is the largest category of assets on our balance sheets. We determine probable losses inherent in our loan portfolio and establish an allowance for those losses by considering factors including characteristics of certain identified classified loans, historical loss rates, expected cash flows and estimated collateral values. In assessing these factors, we use organizational history and experience with credit decisions and related outcomes. The allowance for loan losses represents our best estimate of losses inherent in the existing loan portfolio. The allowance for loan losses is increased by the provision for loan losses charged to expense and reduced by loans charged off, net of recoveries. We evaluate our allowance for loan losses quarterly. If our underlying assumptions later prove to be inaccurate based on subsequent loss evaluations, the allowance for loan losses is adjusted.
We estimate the appropriate level of allowance for loan losses by separately evaluating impaired and nonimpaired loans. A specific allowance is assigned to an impaired loan when expected cash flows or collateral do not justify the carrying amount of the loan. The methodology used to assign an allowance to a nonimpaired
loan is much more subjective. Generally, the allowance assigned to nonimpaired loans is determined by applying historical loss rates to existing loans with similar risk characteristics and by exercising judgment to assess the value of collateral on loans, the impact of factors such as changes in economic conditions, changes in credit policies or underwriting standards, and changes in the level of credit risk associated with specific industries and markets. Because the economic and business climate in any given industry or market, and its impact on any given borrower, can change rapidly, the risk profile of the loan portfolio is continually assessed and adjusted when appropriate. Notwithstanding these procedures, there still exists the possibility that our assessment could prove to be significantly incorrect and that an immediate adjustment to the allowance for loan losses would be required.
We estimate the appropriate level of loan loss allowance by conducting a detailed review of a number of smaller portfolio segments that comprise our loan portfolios. We segment the loan portfolio into as many components as practical. Each component would normally have similar characteristics, such as risk classification, past due status, type of loan, industry or collateral. The risk profile of certain segments of the loan portfolio may be improving, while the risk profile of others may be deteriorating. As a result, changes in the appropriate level of the allowance for different segments may offset one another. Adjustments to the allowance represent the aggregate impact from the analysis of all loan segments.
Investment in Debt and Equity Securities
We classify our investments in debt and equity securities as either held-to-maturity or available-for-sale in accordance with Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities. Securities classified as held-to-maturity are recorded at cost or amortized cost. Available-for-sale securities are carried at fair value. Fair value calculations are based on quoted market prices when such prices are available. If quoted market prices are not available, estimates of fair value are computed using a variety of techniques, including extrapolation from the quoted prices of similar instruments or recent trades for thinly traded securities, fundamental analysis, or through obtaining purchase quotes. Due to the subjective nature of the valuation process, it is possible that the actual fair values of these investments could differ from the estimated amounts, thereby affecting our financial position and results of operations. If the estimated value of investments is less than the cost or amortized cost, we evaluate whether an event or change in circumstances has occurred that may have a significant adverse effect on the fair value of the investment. If such an event or change has occurred and we determine that the impairment is other-than-temporary, we expense the impairment of the investment in the period in which the event or change occurred.
Impairment of Goodwill and Intangible Assets
As a result of our acquisition activity, goodwill, an intangible asset with an indefinite life, and core deposit and customer relationships, which are intangible assets with a finite life, have been added to our balance sheet. Core deposit and customer relationship intangibles arising from our acquisitions are being amortized over their estimated useful lives of up to 15 years. Intangible assets, including our core deposit intangible assets, with finite lives will be tested for impairment when a change in events or circumstances indicate that its carrying amount may not be recoverable. Goodwill is evaluated for impairment annually, unless there are factors present that may be indicative of a potential impairment, in which case, a goodwill impairment test is performed more frequently than annually.
The process of evaluating goodwill for impairment requires us to make several assumptions and estimates. We begin the valuation process by identifying the reporting units related to the goodwill. We identified one reporting unit, banking operations, in relation to our goodwill asset. If our impairment analysis indicates that the fair value of our reporting unit is less than its carrying amount, then we will have to write down the amount of goodwill we carry on our balance sheet through a charge to our operations.
Our impairment analysis estimated the value of our reporting unit using a market transaction approach and discounted cash flow model. Each of these valuation methods includes assumptions, including forecasts of future
earnings of our reporting unit, discount rates, market trends and market multiples of companies engaged in similar lines of business. If any of the assumptions used in the valuation of our goodwill change over time, the estimated value assigned to our goodwill could differ significantly, including a decrease in the value of goodwill which would result in a charge to our operations. The most significant element in the goodwill evaluation is the level of our earnings. A decline in our earnings could cause our value to decline, which may not be sufficient to support the carrying value of goodwill.
Deferred Income Tax Assets
Our deferred income tax assets arise from differences in the dates that items of income and expense enter into our reported income and taxable income. Deferred tax assets are established for these items as they arise based on our judgments that they are realizable. From an accounting standpoint, we determine whether a deferred tax asset is realizable based on the historical level of our taxable income and estimates of our future taxable income. In most cases, the realization of the deferred tax asset is based on our future profitability. If we were to experience either reduced profitability or operating losses in a future period, the realization of our deferred tax assets would be questionable. In such an instance, we could be required to increase the valuation reserve on our deferred tax assets by charging earnings.
In June 2001, the Financial Accounting Standards Board issued SFAS No. 141, Business Combinations (SFAS No. 141), and SFAS No. 142, Goodwill and Other Intangible Assets (SFAS No. 142). SFAS No. 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001 as well as all purchase method business combinations completed after June 30, 2001. SFAS No. 141 also specifies that intangible assets acquired in a purchase method business combination must meet certain criteria to be recognized and reported apart from goodwill. In connection with our mergers and acquisitions, we estimate the fair value of assets and liabilities as required, including intangible assets, based on various methods, including market prices, discounted cash flows, and other present value valuation techniques. The valuation methods we use may require management to make numerous estimates and assumptions.
This discussion has highlighted those accounting policies that we consider to be critical to our financial reporting process. However, all the accounting policies are important, and therefore you are encouraged to review each of the policies included in Note 2 to our consolidated financial statements to gain a better understanding of how our financial performance is measured and reported.
RESULTS OF OPERATIONS
The following table presents certain key aspects of our performance. The comparability of these financial measures are significantly impacted by our fourth quarter 2005 acquisitions of First MainStreet and Foothills, our December 31, 2004 acquisition of Guaranty Corporation and the July 2004 acquisition of our Predecessor. Our operating results for 2004 reflect only the operations of Centennial Bank of the West.
2006 Compared to 2005
Net income for the year ended December 31, 2006 increased to $24.4 million from $14.7 million for the year ended December 31, 2005. Components of the increase in net income included an $8.3 million increase in our net interest income, a $2.4 million increase in noninterest income and a $1.1 million decrease in noninterest expense. For 2006, our noninterest expense included $11.8 million, or $7.3 million after the impact of taxes, of amortization on intangible assets associated with our acquisitions. Our 2005 intangible amortization was $12.5 million, or $7.7 million after the impact of taxes. We also recorded $2.0 million of income from discontinued operations, which includes a $0.8 million net gain after impairment of assets in the first quarter 2006 on the sale of Collegiate Peaks and $1.2 million of income earned from the 2006 operations of Collegiate Peaks and First MainStreet Insurance. Our goodwill and other intangible asset balances cause a proportional reduction in our return on average assets and return on average equity when compared to entities with minimal intangible asset balances. Our 2006 return on average assets and return on average equity both increased from 2005 to 0.9% and 4.1%, respectively. A substantial portion of the changes between 2006 and 2005 financial measures are attributable to our fourth quarter 2005 acquisitions of First MainStreet and Foothills.
2005 Compared to Combined 2004
Net income increased to $14.7 million for the year ended December 31, 2005 from $2.7 million for the year ended December 31, 2004. Our return on average assets was 0.6% and return on average stockholders equity was 2.7% for the year ended December 31, 2005, compared to 0.4% and 2.3% for the year ended December 31, 2004. Factors impacting our operations in 2005 consisted of the inclusion of the operations of Guaranty in 2005 as a result of our acquisition of Guaranty at December 31, 2004, the acquisitions of First MainStreet and Foothills in the fourth quarter of 2005 and expenses incurred to become a publicly traded company. Due to the significance of these factors, every aspect of our operations was significantly impacted. The acquisitions altered the components of our net interest income by changing the mix of loans and deposits. Our noninterest income and expenses were significantly impacted as we combined the operations of Guaranty Bank, Centennial Bank of the West and First MainStreet and went through the process of becoming a publicly traded company. In addition to the impact of these factors, our 2005 interest income and interest expense both increased from 2004 due to a rising rate environment.
Net Interest Income
Net interest income is our primary source of income and represents the difference between income on interest-earning assets and expense on interest-bearing liabilities.
2006 Compared to 2005
Net interest income for the year ended December 31, 2006 increased by $8.3 million over the year ended December 31, 2005 to $116.2 million. Our net interest margin for the year ended December 31, 2006 was 5.35% compared to 5.51% for the year ended December 31, 2005, which represented a decrease of 16 basis points. Our interest rate spread for the year ended December 31, 2006 was 4.48%, a decrease from the December 31, 2005 interest rate spread of 4.89%.
Interest income for the year ended December 31, 2006 increased by $34.2 million, or 24.5%, from the prior year. The rising interest rate environment, which saw four 25 basis point increases in the targeted federal funds rates between January 2006 and June 2006, and the fourth quarter 2005 acquisitions contributed to the increases. Interest income on loans, including loan fees for the year ended December 31, 2006, increased by $31.6 million to $163.8 million. This change consisted of an increase in interest on loans of $33.1 million to $157.3 million for the year ended December 31, 2006, while fees on loans, impacted by competitive pressures, decreased by $1.5 million to $6.6 million. Interest income earned on assets other than loans increased to $10.0 million for the year ended December 31, 2006, an increase of $2.6 million from the prior year, which was primarily driven by a $2.2 million increase in interest earned on tax-exempt securities.
Interest expense for the year ended December 31, 2006 increased by $25.9 million, or 81.7%, from the prior year. In addition to a rising interest rate environment, our interest expense increased due to increased competition for deposits and the fourth quarter 2005 acquisitions of First MainStreet and Foothills. The increase in our cost of funds exceeded the increased yield on interest earning assets, which led to the decline in our net interest margin and interest rate spread. Our yield on interest earning assets increased 87 basis points to 8%, while our cost of funds increased by 128 basis points to 3.52%.
The following table presents, for the years indicated, average assets, liabilities and stockholders equity, as well as the net interest income from average interest-earning assets and the resultant yields expressed in percentages. Non-accrual loans are included in the calculation of average loans and leases while non-accrued interest thereon, is excluded from the computation of yields earned.
The following table presents the dollar amount of changes in interest income and interest expense for the major categories of our interest-earning assets and interest-bearing liabilities. Information is provided for each category of interest-earning assets and interest-bearing liabilities with respect to (i) changes attributable to changes in volume (i.e., changes in average balances multiplied by the prior-period average rate) and (ii) changes attributable to rate (i.e., changes in average rate multiplied by prior-period average balances). For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately to the change due to volume and the change due to rate.
2005 Compared to Combined 2004
Our net interest income for 2005 increased $76.5 million from 2004. The acquisition of Guaranty contributed $71.2 million to this increase. Excluding the effect of the Guaranty acquisition, interest income increased $10.1 million and interest expense increased $4.8 million. Interest income and interest expense increased as a result of an increasing rate environment in 2005 and the acquisitions of First MainStreet Bank and Foothills Bank in the fourth quarter of 2005. Average interest-earning assets increased $1.3 billion from $0.7 billion for 2004 to $2.0 billion for 2005. The acquisition of Guaranty represents the majority of this increase.
The following table presents, for the years indicated, average assets, liabilities and stockholders equity, as well as the net interest income from average interest-earning assets and the resultant yields expressed in percentages. Non-accrual loans are included in the calculation of average loans and leases while non-accrued interest thereon, is excluded from the computation of yields earned.
The average yield on our interest-earning assets increased to 7.1% in 2005 from 6.4% in 2004. The average yield on the loan portfolio increased 82 basis points from 2004 to 2005 due to increases in interest rates. In addition, the average yield on the investment portfolio increased 98 basis points from 2004 to 2005 due to increases in interest rates and the addition of the higher yielding investment portfolio of Guaranty.
The cost of our average interest-bearing liabilities increased to 2.2% in 2005 from 2.0% in 2004. This increase was due to increased interest rates paid on deposits in response to intensified competition for deposit dollars as well as the use of higher cost borrowings as a result of our effort to reposition our interest-bearing deposits. This increase was mitigated by an increase in average non-interest bearing deposit balances to average total deposit balances from 16% in 2004 to 29% in 2005 due to the acquisition of Guaranty. Although the cost of time certificates of deposit increased to 2.7% in 2005 from 2.3% in 2004, the average time certificates of deposit as a percentage of average total deposits decreased from 50% in 2004 to 29% in 2005, reducing the impact of rising interest rates.
Although our net interest margin declined slightly in the fourth quarter 2005 due to the acquisitions of First MainStreet and Foothills, our net interest margin increased year over year to 5.5% in 2005 from 4.8% in 2004. This increase was a result of the factors discussed in the preceding paragraphs.
The following table presents the dollar amount of changes in interest income and interest expense for the major categories of our interest-earning assets and interest-bearing liabilities. Information is provided for each category of interest-earning assets and interest-bearing liabilities with respect to (i) changes attributable to changes in volume (i.e., changes in average balances multiplied by the prior-period average rate) and (ii) changes attributable to rate (i.e., changes in average rate multiplied by prior-period average balances). For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately to the change due to volume and the change due to rate.
Provision for Credit Losses
The provision for credit losses in each year represents a charge against earnings. The provision is the amount required to maintain the allowance for loan losses at a level that, in our judgment, is adequate to absorb probable loan losses in the loan portfolio and losses associated with unfunded commitments to loan to our customers. The provisions for credit losses are based on our reserve methodology and reflect our judgments about the adequacy of the allowance for loan losses and the reserve for unfunded loan commitments. In determining the amount of the provision, we consider certain quantitative and qualitative factors including our historical loan loss experience, the volume and type of lending we conduct, the results of our credit review process, the amounts of classified, criticized and nonperforming assets, regulatory policies, general economic conditions, underlying collateral values, off-balance sheet exposures, and other factors regarding collectibility and impairment. The amount of expected loss on our loan portfolio is influenced by the collateral value associated with our loans. Loans with greater collateral value lessen our exposure to loan loss expense.
For discussion of impaired loans and associated collateral values and additional analysis of factors impacting the provision for loan losses, see Financial ConditionNonperforming Assets and Potential Problem Loans below.
2006 Compared to 2005
In response to loan portfolio changes occurring in the third and fourth quarters of 2006, we recorded a $1.6 million and $2.7 million charge, respectively, to earnings through the provision for credit losses in each of those quarters, for a total of $4.3 million for the year ended December 31, 2006. In 2005, we recorded $3.4 million charge to earnings through the provision for credit losses, consisting of $1.7 million in both the first and fourth quarters of 2005. The provisions for credit losses recorded in 2006 and 2005 were in response to loan portfolio and unfunded commitment changes.
2005 Compared to Combined 2004
We recorded a charge to earnings through the provision for loan losses of $3.4 million during 2005 and $4.7 million during 2004. Our 2005 loan charge-offs net of recoveries was $4.1 million compared to $4.6 million in 2004.
During the first quarter of 2005, we downgraded several loans, resulting in the recording of a $1.5 million charge to provision expense. In addition, we charged our provision for $0.2 million in the first quarter of 2005 for a nonaccrual commercial loan due to the deterioration of collateral value. In the fourth quarter of 2005, we downgraded a $7.2 million construction loan relationship due to borrowings reaching the fully funded commitment prior to the completion of the construction project.
The following table presents our major categories of noninterest income:
2006 Compared to 2005
Our 2006 noninterest income of $12.7 million represented an increase of $2.4 million from 2005. The most significant factor in our noninterest income increase was the fourth quarter 2005 acquisitions of First MainStreet and Foothills. In addition to the impact of the acquisitions, we experienced declines in our nonsufficient fund charges in the last six months of 2006 compared to the first six months of 2006. We averaged $714 thousand per
quarter in the second half of 2006 compared to an average of $853 thousand per quarter in the first half of 2006. As a result of new deposit products and corresponding service charges implemented in early 2006, our service charge and analysis fees increased through the first three quarters of 2006 from $697 thousand in the first quarter to $765 thousand in the third quarter, with a decline to $670 thousand in the fourth quarter 2006. Our gain on sale of loans decreased in 2006 from 2005 by $0.6 million due primarily to the discontinuation of our residential mortgage group at the end of the third quarter 2006.
2005 Compared to Combined 2004
Noninterest income increased to $10.3 million in 2005 from $4.2 million in 2004 for an increase of $6.1 million. The increase in 2005 was primarily related to the acquisition of Guaranty. Noninterest income of $6.5 million, or 63.1% of the $10.3 million, is related to noninterest income from Guaranty. Partially offsetting this increase was the decline in service charges in 2005 associated with the increase in interest rates related to earnings credits for business accounts.
The following table presents the major categories of noninterest expense:
Our $90.9 million of noninterest expense in 2006 represents a decrease of $1.1 million from 2005. Our merger, acquisition and transition expense decreased by $8.6 million for 2006. In 2005, we incurred costs associated with the integration of our acquisitions, which included the integration of the 2004 Centennial Bank and Guaranty acquisitions, and the 2005 First MainStreet and Foothills acquisitions. We had substantially completed the integration and transition efforts associated with the acquisitions by the end of 2005, which resulted in the $8.6 million decrease in expense. The acquisitions of First MainStreet and Foothills in the fourth quarter 2005 is the primary cause of our increase in most noninterest expense categories in 2006.
During 2006, we experienced a decline in technology and processing costs of $0.9 million from the prior year, while incentive compensation, and advertising and business development expenses decreased by $0.9 million and $0.2 million, respectively. The decline in technology and processing was primarily the result of the integration of Centennial Bank onto the Guaranty operating platform that was completed in July 2005. Our
incentive compensation expense decreased due to changes to the compensation plan implemented for 2006 and the decline in our loan portfolio. The improvement in advertising and business development and office and operating supplies expenses reflected an increased emphasis on cost control, with a portion of the decline in office and operating supplies attributable to one-time costs incurred in connection with the 2005 acquisitions and integration efforts.
2005 Compared to Combined 2004
Total noninterest expense for 2005 was $92.0 million, representing an increase of $66.5 million from the 2004 combined total of $25.5 million. The primary cause of the increase was the inclusion of expenses from Guaranty in the 2005 balances. During 2005, we incurred $12.4 million of amortization expense related to core deposit intangible assets and noncompete agreements that resulted from the acquisition of Predecessor, Guaranty, First MainStreet and Foothills. We also incurred $10.4 million of costs associated with the acquisitions and the integration of the banks into our financial and operational systems. The following table presents the major categories of noninterest expense:
2006 Compared to 2005
Our effective tax rate for each of the years ended December 31, 2006 and 2005 was 33.5%, with $11.3 million and $7.6 million, respectively, recorded as tax provision expense. The impact of tax-exempt interest income is the primary reason for an effective rate of 33.5% that is 4.5% less than our 38.0% statutory rate.
2005 Compared to Combined 2004
Our effective tax rates were 33.5% for 2005 and 50.0% for 2004. The 2005 effective rate was less than the statutory rate of 38.0% primarily due to tax-exempt interest income. Nondeductible expenses associated with the 2004 acquisitions were the primary cause of the 50% effective tax rate in 2004. We recorded tax provisions of $7.6 million in 2005 and $2.7 million in 2004.
At December 31, 2006, we had total assets of $2.7 billion, compared to $3.0 billion and $2.4 billion at December 31, 2005 and 2004, respectively. Collegiate Peak Banks assets, which were sold in November 2006, accounted for a decrease of $98.3 million and $89.6 million of December 31, 2005 and 2004, respectively, in total assets. We acquired assets valued at $595.5 million in the fourth quarter 2005 acquisitions of First MainStreet and Foothills. The following table sets forth certain key consolidated balance sheet data:
The following table sets forth the amount of our loans outstanding at the dates indicated.
We had no foreign loans at December 31, 2006 or 2005.
Our $1.9 billion loan portfolio at December 31, 2006 decreased by $120.5 million from December 31, 2005. The decline is due in part to our strategy to reduce our concentration in construction, land development and land
loans. In 2006, construction, land development and land loans included in the real estate portfolio decreased by $90.6 million, which led our real estateconstruction loans category to decrease as a percentage of our total loan portfolio by 4% to 22%, down from 26% at December 31, 2005. Adjusting for the decrease in construction, land development and land loans, our real estate portfolio increased by $74.9 million. Our commercial and other loans decreased by $105.1 million, with commercial loans accounting for $77.0 million of that decline. We experienced 84% of the decline in commercial and other loans through June 30, 2006, with the remaining 16% decline from July 2006 through December 2006. We discontinued our residential mortgage group at the end of the third quarter 2006, which accounted for the elimination of loans held for sale at December 31, 2006.
The following table shows the amounts of loans outstanding at December 31, 2006, which, based on remaining scheduled repayments of principal, were due in one year or less, more than one year through five years, and more than five years. Demand or other loans having no stated maturity and no stated schedule of repayments are reported as due in one year or less. The table also presents, for loans with maturities over one year, an analysis with respect to fixed interest rate loans and floating interest rate loans.
Nonperforming Assets and Other Impaired Loans
Credit risk related to nonperforming assets arises as a result of lending activities. To manage this risk, we employ frequent monitoring procedures, and take prompt corrective action when necessary. We employ a risk rating system that identifies the overall potential amount of risk associated with each loan in our loan portfolio. This monitoring and rating system is designed to help management determine current and potential problems so that corrective actions can be taken promptly.
Generally, loans are placed on nonaccrual status when they become 90 days or more past due or at such earlier time as management determines timely recognition of interest to be in doubt. Accrual of interest is discontinued on a loan when we believe, after considering economic and business conditions and analysis of the borrowers financial condition, that the collection of interest is doubtful.
A loan is impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired loans consist of our nonaccrual loans, loans that are 90 days or more past due, and other loans for which we determine that noncompliance with contractual terms of the loan agreement is probable. The acquired impaired loans are valued at the present value of expected cash flows at the date of acquisition. Losses on individually identified impaired loans that are not collateral dependent are measured based on the present value of expected future cash flows discounted at the original effective interest rate of each loan. For loans that are collateral dependent, impairment
is measured based on the fair value of the collateral less estimated selling costs. Impaired loans that have been purchased or acquired in a transfer are considered impaired when, based on current information and events, it is probable that we will be unable to collect all cash flows expected at acquisition.
Nonperforming assets of $34.1 million at December 31, 2006 reflected an increase of $2.9 million from December 31, 2005. Our nonaccrual loans increased in 2006 by $3.2 million while OREO decreased by $0.3 million. Our December 31, 2006 impaired loans of $38.8 million reflected a decrease of $11.5 million from December 31, 2005. Our percentage of nonaccrual loans to loans increased from 1.4% at December 31, 2005 to 1.7% at December 31, 2006. Our allowance for loan losses as a percentage of nonperforming loans decreased by 7.5%, while our allowance as a percentage of impaired loans increased by 17.2%. We discuss our allowance further in the following Allowance for Loan Losses section.
The following table presents our nonperforming assets at the dates indicated:
Allowance for Loan Losses
The allowance for loan losses is maintained at a level that, in our judgment, is adequate to absorb probable loan losses in the loan portfolio. The amount of the allowance is based on managements evaluation of the collectibility of the loan portfolio, historical loss experience, and other significant factors affecting loan portfolio collectibility, including the level and trends in delinquent, nonaccrual and adversely classified loans, trends in volume and terms of loans, levels and trends in credit concentrations, effects of changes in underwriting standards, policies, procedures and practices, national and local economic trends and conditions, changes in capabilities and experience of lending management and staff, and other external factors including industry conditions, competition and regulatory requirements.
Our methodology for evaluating the adequacy of the allowance for loan losses has two basic elements: first, the specific identification of impaired loans and the measurement of an estimated loss for each individual loan identified; and second, estimating a nonspecific allowance for probable losses on all other loans. Impaired loans are discussed in the previous section.
In estimating the nonspecific allowance for loan losses, we group the balance of the loan portfolio into segments that have common characteristics, such as loan type, collateral type or risk rating. Loans typically segregated by risk rating are those that have been assigned risk ratings using regulatory definitions of special mention, substandard, and doubtful. Loans graded as loss are generally charged off immediately.
For each nonspecific allowance portfolio segment, we apply loss factors to calculate the required allowance. These loss factors are based upon three years of historical loss rates and adjusted for qualitative factors affecting loan portfolio collectibility as described above.
The specific allowance for impaired loans and the allowance calculated for probable losses on other loans are combined to determine the required allowance for loan losses. The amount calculated is compared to the actual allowance for loan losses at each quarter end and any shortfall is covered by an additional provision for loan losses.
The table below summarizes loans held for investment, average loans held for investment, nonperforming loans and changes in the allowance for loan losses arising from loan losses and additions to the allowance from provisions charged to operating expense:
At December 31, 2006, the allowance for loan losses was $27.9 million, which represents an increase of $0.4 million from December 31, 2005. The ratio of the allowance for loan losses to nonperforming loans was 84.9% at December 31, 2006, and represented a decrease of 7.5 percentage points from December 31, 2005. The
ratio of the allowance for loan losses to loans, net of unearned discount, was 1.43% at December 31, 2006, as compared to 1.33% at December 31, 2005. For the year ended December 31, 2006, we had net charge-offs of $4.2 million and provision for credit losses of $4.3 million. The Companys loss exposure on its substandard loans continues to be mitigated by collateral positions on these loans. Management continues to monitor the allowance for loan losses closely and will adjust the allowance when necessary, based on its analysis, which includes ongoing evaluation of substandard loans and their collateral positions.
The following table allocates the allowance for loan losses based on our judgment of inherent losses in the respective categories. While we have allocated the allowance to various portfolio segments for purposes of this table, the allowance for loan losses is general and is available for the portfolio in its entirety:
We manage our investment portfolio principally to provide liquidity and to balance our overall interest rate risk. To a lesser extent, we manage our investment portfolio to provide earnings with a view to minimizing credit risk. The carrying value of our portfolio of investment securities at December 31, 2006, 2005 and 2004 was as follows:
The carrying value of our investment securities at December 31, 2006 totaled $200.3 million compared to $175.8 million at December 31, 2005. The makeup of our investment portfolio shifted during 2006 away from U.S. government securities to obligations of states and political subdivisions, which have a higher yield and earn tax-exempt income. In 2006, we financed a hospital construction project through the purchase of $40 million of the hospitals bonds, which is recorded as an available-for-sale security. At December 31, 2006 and 2005, we had $62.5 million and $20.0 million, respectively, of million of lending arrangements structured as investment securities and carried as obligations of states and political subdivisions at December 31, 2006.
The following table shows the maturities of investment securities at December 31, 2006, and the weighted average yields of such securities, excluding the benefit of tax-exempt securities:
At December 31, 2006 and 2005, we held $31.8 million and $26.9 million, respectively, of other securities consisting of equity securities with no maturity date, which are not reflected in the above schedule.
Total deposits were $2.0 billion at both December 31, 2006 and 2005. Our 2006 average noninterest bearing deposits constituted 26.2% of our 2006 average total average deposits, which compares to 2005 average noninterest bearing deposits to 2005 total average deposits of 28.8%. Our noninterest-bearing demand deposits decreased by $76.2 million, while our interest bearing demand deposits, including money market and savings accounts, increased by $43.3 million. Our certificates of deposit decreased by $55.4 million to $577.6 million at December 31, 2006, or 29.5% of total deposits, compared to 30.9% at December 31, 2005. Our 2006 cost on interest-bearing liabilities increased to 3.2% from 2.0% for 2005. We increased the interest rates paid on money market accounts and certificates of deposit in response to increased competition for deposits and a rising interest rate environment through June 2006.
The following table shows the average amount and average rate paid on the categories of deposits for each of the periods indicated:
Additionally, the following table shows the maturities of time certificates of deposit and other time deposits of $100,000 or more at December 31, 2006 and December 31, 2005.
The following table presents the mix of our deposits by type based on average balances for each of the periods indicated. Our acquisitions were the primary driver in the 2004 to 2005 change of deposit mix.
Subordinated Debentures and Trust Preferred Securities
In September 2000, our Predecessor formed CenBank Statutory Trust I and completed an offering of $10.0 million 10.6% Cumulative Trust Preferred Securities, which are guaranteed by us. The Trust also issued common securities to Predecessor and used the net proceeds from the offering to purchase $10.3 million in principal amount of 10.6% Subordinated Debentures issued by our predecessor. Interest paid on the 10.6% Debentures will be distributed to the holders of the 10.6% Preferred Securities. Distributions payable on the 10.6% Preferred Securities are recorded as interest expense in the consolidated statements of income. These 10.6% Debentures are unsecured, junior rank and are subordinate in right of payment to all senior debt of the Company. The 10.6% Preferred Securities are subject to mandatory redemption upon repayment of the 10.6% Debentures. We have the right, subject to events of default, to defer payments of interest on the 10.6% Debentures at any time by extending the interest payment period for a period not exceeding 10 consecutive semi-annual periods with respect to each deferral period, provided that no extension period may extend beyond the redemption or maturity date of the 10.6% Debentures. The 10.6% Debentures mature on September 7, 2030, which may be shortened by us to not earlier than September 7, 2010, if certain conditions are met, or at any time upon the occurrence and continuation of certain changes in either the tax treatment or the capital treatment of the Trust, the 10.6% Debentures or the 10.6% Preferred Securities.
In February 2001, our Predecessor formed CenBank Statutory Trust II and completed an offering of $5.0 million 10.2% Cumulative Trust Preferred Securities, which are guaranteed by us. The Trust also issued common securities to Predecessor and used the net proceeds from the offering to purchase $5.2 million in principal amount of 10.2% Subordinated Debentures issued by our predecessor. Interest paid on the 10.2% Debentures will be distributed to the holders of the 10.2% Preferred Securities. Terms and conditions of the 10.2% Debentures are substantially similar to those as described under the CenBank Statutory Trust I. The 10.2% Debentures mature on February 22, 2031, which may be shortened by us to not earlier than February 22, 2011, if certain conditions are met, or at any time upon the occurrence and continuation of certain changes in either the tax treatment or the capital treatment of the Trust, the 10.2% Debentures or the 10.2% Preferred Securities.
In April 2004, our Predecessor formed CenBank Statutory Trust III and completed an offering of $15.0 million LIBOR plus 2.65% Cumulative Trust Preferred Securities, which are guaranteed by us. The Trust also issued common securities to Predecessor and used the net proceeds from the offering to purchase $15.5 million in principal amount of floating rate Subordinated Debentures issued by our predecessor. Interest paid on the floating rate Debentures will be distributed to the holders of the floating rate Preferred Securities. Terms and conditions of the floating rate Debentures are substantially similar to those as described under the CenBank Statutory Trust I. The floating rate Debentures mature on April 15, 2034, which may be shortened by us to not earlier than April 15, 2009, if certain conditions are met, or at any time upon the occurrence and continuation of certain changes in either the tax treatment or the capital treatment of the Trust, the floating rate Debentures or the floating rate Preferred Securities.
In June 2003, Guaranty Corporation formed Guaranty Capital Trust III and completed an offering of $10.0 million LIBOR plus 3.10% Cumulative Trust Preferred Securities, which are guaranteed by us. The Trust also issued common securities to Guaranty and used the net proceeds from the offering to purchase $10.3 million in principal amount of Junior Subordinated Debt Securities issued by Guaranty. We assumed Guarantys obligations relating to such securities upon our acquisition of Guaranty. Interest paid on the debt securities will be distributed to the holders of the Preferred Securities. We have the right, subject to events of default, to defer payments of interest on the subordinated debt securities at any time by extending the interest payment period for a period not exceeding 20 consecutive quarterly periods with respect to each deferral period, provided that no extension period may extend beyond the redemption or maturity date of the subordinated debt securities. The subordinated debt securities mature on July 7, 2033, which may be shortened by us to not earlier than July 7, 2008, if certain conditions are met, or at any time upon the occurrence and continuation of certain changes in either the tax treatment or the capital treatment of the trust, the subordinated debt securities or the trust preferred securities.
For financial reporting purposes, the trusts were treated as our non-banking subsidiaries and consolidated in the consolidated financial statements prior to December 31, 2003. Since our adoption of FIN 46R on December 31, 2003, the trusts are treated as investments and not consolidated in the consolidated financial statements. Although the securities issued by each of the trusts are not included as a component of stockholders equity in the consolidated balance sheets, the securities are treated as capital for regulatory purposes. Specifically, under applicable regulatory guidelines, the securities issued by the trusts qualify as Tier 1 capital up to a maximum of 25% of Tier 1 capital on an aggregate basis. Any amount that exceeds 25% qualifies as Tier 2 capital. At December 31, 2006, all of the trusts securities outstanding qualified as Tier 1 capital.
In March 2005, the Federal Reserve Board issued a final rule that continues to allow the inclusion of trust preferred securities in Tier 1 capital, but with stricter quantitative limits. Under the final rule, after a five-year transition period ending March 31, 2009, the aggregate amount of trust preferred securities and certain other capital elements would be limited to 25% of Tier 1 capital elements, net of goodwill, less any associated deferred tax liability. The amount of trust preferred securities and certain other elements in excess of the limit could be included in Tier 2 capital, subject to restrictions.
We have a revolving line of credit and several term notes with the Federal Home Loan Bank. At December 31, 2006, we had $55.2 million and $9.1 million, respectively. The maximum credit allowance for future borrowings was $301.0 million at December 31, 2006 and includes term notes and the line of credit. The interest rate on the line of credit varies daily with the federal funds rate. The term notes have fixed interest rates that range from 2.52% to 6.22%. We have executed a blanket pledge and security agreement with the Federal Home Loan Bank, which encompasses certain loans and securities as collateral for these borrowings.
We have a $70 million revolving credit agreement, as amended, with U.S. Bank National Association that contains financial covenants, including maintaining a minimum return on average assets, a maximum nonperforming assets to total loans ratio, and regulatory capital ratios that qualify the Company as well-capitalized. As of December 31, 2006, we had an outstanding balance of $2.5 million and were in compliance with all debt covenants. The line of credit has a variable rate based on the federal funds rate, which was 6.7% at December 31, 2006. The line of credit is secured by the stock of Guaranty Bank. U.S. Bank performs various commercial banking services for the Company for which they receive usual and customary fees.
Current risk-based regulatory capital standards generally require banks and bank holding companies to maintain a ratio of core or Tier 1 capital to total risk-weighted assets of at least 4%, a ratio of Tier 1 capital to total average assets (leverage ratio) of at least 4% and a ratio of total capital (which includes Tier 1 capital plus certain forms of subordinated debt, a portion of the allowance for loan and lease losses and preferred stock) to total risk-weighted assets of at least 8%. Total risk-weighted assets are calculated by multiplying the balance in each category of assets by a risk factor, which ranges from zero for cash assets and certain government obligations to 100% for high risk loans, and adding the products together.
Based on our existing business plan, we believe that our level of liquid assets is sufficient to meet our current and presently anticipated funding needs.
We rely on dividends, management fees, and charges for services from our subsidiary banks as primary sources of liquidity for the holding company. We plan to continue to utilize the available dividends from the Banks for holding company operations, subject to regulatory and other restrictions. In general, the Banks are able to dividend earnings to the holding company, subject to the Banks maintaining capital ratios that meet the minimum requirement for classification for well-capitalized institutions. In addition to our bank subsidiaries, we also utilize our $70 million revolving credit agreement for liquidity management purposes. All lines of credit are expected to be renewed. We require liquidity for the payment of interest on the subordinated debentures, for operating expenses, principally salaries and benefits, for repurchases of our common stock, and, if declared by our board of directors, for the payment of dividends to our stockholders.
The Banks rely on deposits as their principal source of funds and, therefore, must be in a position to service depositors needs as they arise. In addition, while fluctuations in the balances of large depositors may cause temporary increases and decreases in liquidity from time to time, we have not experienced difficulty in dealing with such fluctuations from existing liquidity sources.
Liquid assets represented approximately 7.6% of total assets at December 31, 2006. We believe that if the level of liquid assets (our primary liquidity) does not meet our liquidity needs, other available sources of liquid assets (our secondary liquidity), including the purchase of federal funds, sales of securities under agreements to repurchase, sales of loans, discount window borrowings from the Federal Reserve Bank and our lines of credit with the Federal Home Loan Bank of Topeka and U.S. Bank, could be employed to meet those current and presently anticipated funding needs.
OFF BALANCE SHEET ARRANGEMENTS, COMMITMENTS, GUARANTEES, AND CONTRACTUAL OBLIGATIONS
The following table sets forth our significant contractual obligations at December 31, 2006: