Guaranty Bancorp 10-K 2009
Documents found in this filing:
Commission file number: 000-51556
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 o No ý
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 o No ý
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o
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 registrant's 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. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer," and "smaller reporting company" in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act.) Yes o No ý
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 registrant's common stock as of the close of business on June 30, 2008, was approximately $135 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 February 1, 2009, there were 52,623,985 shares of the registrant's common stock outstanding, including 1,380,346 shares of unvested restricted stock and performance stock and excluding 4,777 shares to be issued under its deferred compensation plan.
DOCUMENTS INCORPORATED BY REFERENCE
The information required by Items 10, 11, 12, 13 and 14 of Part III of this Annual Report on Form 10-K will be found in the registrant's definitive proxy statement for its 2009 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended, and such information is incorporated herein by reference.
Table of Contents
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", "projected", "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.
We are 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 bank subsidiary. As of December 31, 2008, we had a single Bank subsidiary, Guaranty Bank and Trust Company ("Guaranty Bank" or "Bank").
When we say "we", "us", "our" or the "Company", we mean the Company on a consolidated basis with the Bank. When we refer to "Guaranty Bancorp" or the "holding company", we are referring to the parent company on a standalone basis.
On March 3, 2004, we were 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 (CBW) and changed our name to Centennial Bank Holdings, Inc. 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 acquired First MainStreet Financial, Ltd., pursuant to which First MainStreet Bank, N.A. was merged into CBW. On November 1, 2005, we acquired Foothills Bank, which was merged into Guaranty Bank.
On March 1, 2006, we sold substantially all of the assets of First MainStreet Insurance, Ltd., an independent insurance agency. 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 January 1, 2008, the Company completed the merger of CBW into Guaranty Bank.
On May 6, 2008, the stockholders of the Company approved the proposal to change the name of the holding company from Centennial Bank Holdings, Inc. to Guaranty Bancorp. This name change was effective on May 12, 2008.
At December 31, 2008, we had total assets of $2.1 billion, net loans of $1.8 billion, deposits of $1.7 billion and stockholders' equity of $161.6 million, and we operated 34 branches in Colorado through our banking subsidiary Guaranty Bank.
The Bank is a full-service community bank offering an array of banking products and services to the communities it serves along the Front Range of Colorado, including accepting time and demand deposits and originating commercial loans (including energy loans), real estate loans, and small business and consumer loans. The Bank also provides trust services, including personal trust administration, estate settlement, investment management accounts and self-directed IRAs. Substantially all loans are secured by specific items of collateral, including business assets, consumer assets and commercial and residential real estate. Commercial loans are expected to be repaid from cash flow from operations of business. There are no significant concentrations of loans to any one industry or customer. The customers' ability to repay their loans is dependent on the real estate and general economic conditions of the area, among other factors.
We concentrate our lending activities in the following principal areas:
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 borrower's 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, evaluate and sell. It may also depreciate more rapidly than real estate. Such risks can be significantly affected by economic conditions.
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 borrower's ability to repay the loan may be impaired.
Construction Loans: Our construction loan portfolio is comprised of single-family residential development, investor developer and owner occupied properties. In addition, this category includes loans for the construction of commercial buildings, which are primarily income producing properties. 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 borrower's ability to repay the loan. In addition, the ultimate sale or rental of the property may not occur as anticipated.
Installment Loans to Individuals and Other Loans: This category includes miscellaneous consumer loans including overdrafts and lines-of-credit. 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 borrower's 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.
Equity Lines of Credit: 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, primarily represent local relationships. The Company joined the Certificate of Deposit Account Registry Service (CDARS®) program in 2008, which enables our local customers to obtain expanded FDIC insurance coverage on their deposits. Our branch network enables us to offer a full range of deposits, loans and personalized services to our targeted commercial and consumer customers.
Our Philosophy and Strategy
We have established a philosophy of relationship banking: providing highly personalized and responsive services based on exceptional customer service.
Our strategy is to build a profitable, community-banking franchise along the Colorado Front Range spanning from Castle Rock to Fort Collins. 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.
Our Principal Markets
We have a single banking subsidiary, Guaranty Bank, following the merger of CBW into Guaranty Bank on January 1, 2008. We operate 34 branches located in the Denver metropolitan area and throughout Colorado's Northern Front Range.
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. Denver is the largest city within a 600-mile radius.
Colorado's 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. Colorado's Northern Front Range has a regional economy that is a diverse mix of agriculture, advanced technology, tourism, manufacturing, service firms, government, education, retail, small business and construction.
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 55% of our loan portfolio held for investment at December 31, 2008 consisted of real estate-related loans, including construction loans, miniperm loans and commercial real estate 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 and credit unions. 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 brokerage firms, 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. 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 community bank status permits, including an emphasis on specialized services, local promotional activity and personal contacts.
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), debit cards,
point-of-sale transactions, automated clearing house transactions (ACH), remote deposit, mobile banking via telephone or wireless devices and in-store 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 provide assurance 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.
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 the holding company or its subsidiaries could have a material effect on our business.
Guaranty Bancorp is a legal entity separate and distinct from its bank subsidiary, Guaranty Bank. As a bank holding company, Guaranty Bancorp 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. Guaranty Bancorp 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. Guaranty Bancorp is listed on The NASDAQ Stock Market LLC (Nasdaq) under the trading symbol "GBNK," and is subject to the rules of Nasdaq for listed companies.
As a Colorado-chartered bank, the Bank is subject to supervision, periodic examination, and regulation by the Colorado Division of Banking, or CDB. As a member of the Federal Reserve System, the Bank is also subject to supervision, periodic examination and regulation by the Federal Reserve Bank of Kansas City. If, as a result of an examination of the Bank, 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 our growth, to assess civil monetary penalties, to remove officers and directors, and ultimately to terminate our 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.
The BHC Act generally limits acquisitions by bank 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.
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 applicant's 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 the holding company's cash revenues is from dividends from its bank subsidiary, Guaranty Bank. 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 conduct business. For example, these include limitations on the ability of our bank subsidiary to pay dividends to the holding company 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 organization's 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 company's ability to serve as a source of strength to its banking subsidiary.
As a member of the Federal Reserve System, the 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 bank's 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 bank's 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 bank's outstanding stock have approved the dividend. Additionally, there are potential additional restrictions and prohibitions if a bank were to be less than well-capitalized.
As a Colorado state-chartered bank, the Bank is 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.
The holding company has expenses and repayment obligations with respect to our trust preferred securities and corresponding subordinated debt securities issued. As part of our capital and cash management practices at the holding company, management expects to utilize our bank subsidiary's excess capital above the well-capitalized requirement through the payment of dividends to the holding company to service the subordinated debt and meet operating needs. Due to the accumulated deficit as a result of goodwill impairments in 2007 and 2008, permission from the Federal Reserve and CDB is required before the Bank can pay a dividend to the holding company. In 2008, the Bank requested and was granted permission to pay $19 million in dividends to the holding company. The Bank remains well capitalized at December 31, 2008.
There are various restrictions on the ability of the holding company to borrow from, and engage in certain other transactions with, its bank subsidiary. 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 Guaranty Bank, to 10% of Guaranty Bank's capital stock and surplus, and, as to the holding company, to 20% of Guaranty Bank's capital stock and surplus.
Federal law also provides that extensions of credit and other transactions between Guaranty Bank and the holding company must be on terms and conditions, including credit standards, that are substantially the same or at least as favorable to Guaranty Bank 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, the holding company is expected to commit resources to support its bank subsidiary, including at times when the holding company may not be in a financial position to provide it. Any capital loans by a bank holding company to its subsidiary bank are subordinate in right of payment to deposits and to certain other indebtedness of such subsidiary bank. The BHC Act provides that, in the event of a bank holding company's bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a bank subsidiary 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 organization's assets and some of its specified off-balance sheet
commitments and obligations are assigned to various risk categories. A depository institution or holding company's capital, in turn, is classified in one of three tiers, depending on type:
Core Capital (Tier 1). Tier 1 capital includes common equity, retained earnings, qualifying trust preferred securities, qualifying noncumulative perpetual preferred stock, a limited amount of qualifying cumulative perpetual stock at the holding company level, minority interests in equity accounts of consolidated subsidiaries, less goodwill, most intangible assets and certain other assets.
Supplementary Capital (Tier 2). Tier 2 capital includes, among other things, perpetual preferred stock and trust preferred securities not meeting the Tier 1 definition, qualifying mandatory convertible debt securities, qualifying subordinated debt, and allowances for possible loan losses, subject to limitations.
Market Risk Capital (Tier 3). Tier 3 capital includes qualifying unsecured subordinated debt.
Guaranty Bancorp, 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). Guaranty Bank, like other depository institutions, is 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 institution's 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 organization's 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 bank holding companies and banks that either have the highest supervisory rating or have implemented the appropriate federal regulatory authority's risk-adjusted measure for market risk. All other bank 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, that federal banking agencies 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 institution's 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 institution's 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 bank's 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 bank's 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 institution's capital. In addition, for a capital restoration plan to be acceptable, the depository institution's 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 institution's 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 the holding company and its bank subsidiaries at December 31, 2008 and 2007, see the discussion under the section captioned "Capital" included in Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations and Note 19Regulatory Capital Matters 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 country's 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 sets capital requirements for operational risk and refines the existing capital requirements for market risk exposures.
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).
In July 2007, the U.S. banking and thrift agencies reached an agreement on the implementation of the capital adequacy regulations and standards based on BIS II. In November 2007, the agencies approved final rules to implement the new risk-based capital requirements in the United States for large, internationally active banking organizations, or "core banks"defined as those with consolidated total assets of $250 billion or more or consolidated on-balance sheet foreign exposures of $10 billion or more. The final rule was effective as of April 1, 2008.
We are not a core bank and do not apply the BIS II approach to computing risk-weighted assets.
In June 2008, the U.S. banking and thrift agencies announced a proposed rule that would provide all non-core banking organizations (that is, banking organizations not required to adopt the advanced approaches) with the option to adopt a way to determine required regulatory capital that is more risk sensitive than the current Basel I-based rules, yet is less complex than the advanced approach final rule. The proposed standardized framework addresses (i) expanding the number of risk-weight categories to which credit exposures may be assigned, (ii) using loan-to-value ratios to risk weight most residential mortgages to enhance the risk sensitivity of the capital requirement, (iii) providing a capital charge for operational risk using the Basic Indicator Approach under the international Basel II capital accord, (iv) emphasizing the importance of a bank's assessment of its overall risk profile and capital adequacy and (v) providing for comprehensive disclosure requirements to complement the minimum capital requirements and supervisory process through market discipline. This new proposal would replace the agencies' earlier BIS I-A proposal, issued in December 2006.
Emergency Economic Stabilization Act of 2008
In response to recent unprecedented market turmoil, the Emergency Economic Stabilization Act of 2008 ("EESA") was enacted on October 3, 2008. EESA authorizes the U.S. Treasury Department to provide up to $700 billion in funding for the financial services industry. Pursuant to the EESA, the Treasury was initially authorized to use $350 billion for the Troubled Asset Relief Program (TARP). Of this amount, Treasury allocated $250 billion to the TARP Capital Purchase Program (see description below). On January 15, 2009, the second $350 billion of TARP monies was released to the Treasury. The Secretary's authority under TARP expires on December 31, 2009 unless the Secretary certifies to Congress that extension is necessary provided that his authority may not be extended beyond October 3, 2010.
Pursuant to authority under EESA, the Treasury created the TARP Capital Purchase Program under which the Treasury will invest up to $250 billion in senior preferred stock of U.S. banks and savings associations or their holding companies. Qualifying financial institutions may issue senior preferred stock with a value equal to not less than 1% of risk-weighted assets and not more than the lesser of $25 billion or 3% of risk-weighted assets. The senior preferred stock will pay dividends at the rate of 5% per annum until the fifth anniversary of the investment and thereafter at the rate of 9% per annum. The senior preferred stock may not be redeemed for three years except with the proceeds from an offering of common stock or preferred stock qualifying as Tier 1 capital in an amount equal to not less than 25% of the amount of the senior preferred. After three years, the senior preferred may be redeemed at any time in whole or in part by the financial institution. No dividends may be paid on common stock unless dividends have been paid on the senior preferred stock. Until the third anniversary of the issuance of the senior preferred, the consent of the Treasury will be required for any increase in the dividends on the common stock or for any stock repurchases unless the senior preferred has been redeemed in its entirety or the Treasury has transferred the senior preferred to third parties. The senior preferred will not have voting rights other than the right to vote as a class on the issuance of any preferred stock ranking senior, any change in its terms or any merger, exchange or similar
transaction that would adversely affect its rights. The senior preferred will also have the right to elect two directors if dividends have not been paid for six periods. The senior preferred will be freely transferable and participating institutions will be required to file a shelf registration statement covering the senior preferred. The issuing institution must grant the Treasury piggyback registration rights. Prior to issuance, the financial institution and its senior executive officers must modify or terminate all benefit plans and arrangements to comply with EESA. Senior executives must also waive any claims against the Department of Treasury.
In connection with the issuance of the senior preferred, participating institutions must issue to the Treasury immediately exercisable 10-year warrants to purchase common stock with an aggregate market price equal to 15% of the amount of senior preferred. The exercise price of the warrants will equal the market price of the common stock on the date of the investment. The Treasury may only exercise or transfer one-half of the warrants prior to the earlier of December 31, 2009 or the date the issuing financial institution has received proceeds equal to the senior preferred investment from one or more offerings of common or preferred stock qualifying as Tier 1 capital. The Treasury will not exercise voting rights with respect to any shares of common stock acquired through exercise of the warrants. The financial institution must file a shelf registration statement covering the warrants and underlying common stock as soon as practicable after issuance and grant piggyback registration rights. The number of warrants will be reduced by one-half if the financial institution raises capital equal to the amount of the senior preferred through one or more offerings of common stock or preferred stock qualifying as Tier 1 capital. If the financial institution does not have sufficient authorized shares of common stock available to satisfy the warrants or their issuance otherwise requires shareholder approval, the financial institution must call a meeting of shareholders for that purpose as soon as practicable after the date of investment. The exercise price of the warrants will be reduced by 15% for each six months that lapse before shareholder approval, subject to a maximum reduction of 45%.
The Company has applied for up to three percent of its risk-weighted assets and is currently waiting to hear about the status of its application as of the filing date of this report.
The deposits of the Bank 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 bank's capital level and supervisory rating.
Effective January 1, 2007, the FDIC imposed deposit assessment rates based on the risk category of the bank. Risk Category I is the lowest risk category while Risk Category IV is the highest risk category. 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, have in recent years paid minimal premiums for FDIC insurance. With the additional deposit insurance, 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. For 2007, the holding company's two subsidiary banks utilized the credit offsets to eliminate nearly all of their 2007 FDIC insurance assessments.
For 2007 and 2008, the holding company's subsidiary banks qualified for Risk Category I. Risk Category I generally includes banks that are "well-capitalized" and that receive a composite CAMELS rating of 2 or higher. For banks under $10 billion in total assets in Risk Category I, the 2007 and 2008 deposit assessment ranged from 5 to 7 basis points of total qualified deposits. The actual assessment is dependent upon certain risk measures as defined in the final rule. For 2007, Guaranty Bank was assessed at the lowest point of the range, whereas CBW was assessed at a higher rate within the range. For 2008, Guaranty Bank was assessed at a higher point within the range.
On October 16, 2008, the FDIC published a restoration plan designed to replenish the Deposit Insurance Fund over a period of five years and to increase the deposit insurance reserve ratio, which decreased to 1.01% of insured deposits on June 30, 2008, to the statutory minimum of 1.15% of insured deposits by December 31, 2013. In order to implement the restoration plan, the FDIC proposes to change both its risk-based assessment system and its base assessment rates. For the first quarter of 2009 only, the FDIC increased all FDIC deposit assessment rates by 7 basis points. These new rates range from 12-14 basis points for Risk Category I institutions to 50 basis points for Risk Category IV institutions. Under the FDIC's restoration plan, the FDIC proposes to establish new initial base assessment rates that will be subject to adjustment as described below. Beginning April 1, 2009, the base assessment rates would range from 10-14 basis points for Risk Category I institutions to 45 basis points for Risk Category IV institutions. Changes to the risk-based assessment system would include increasing premiums for institutions that rely on excessive amounts of brokered deposits, including CDARS, increasing premiums for excessive use of secured liabilities, including Federal Home Loan Bank advances, lowering premiums for smaller institutions with very high capital levels, and adding financial ratios and debt issuer ratings to the premium calculations for banks with over $10 billion in assets, while providing a reduction for their unsecured debt. Either an increase in the Risk Category of the Bank or adjustments to the base assessment rates could have a material adverse effect on our earnings.
In addition, all institutions with deposits insured by the FDIC are required to pay assessments to fund interest payments on bonds issued by the Financing Corporation (FICO), a mixed-ownership government corporation established to recapitalize a predecessor to the Deposit Insurance Fund. The current annualized assessment rate is 1.14 basis points, or approximately .285 basis points per quarter. These assessments will continue until the Financing Corporation bonds mature in 2019.
The enactment of EESA temporarily raised the basic limit on federal deposit insurance coverage from $100,000 to $250,000 per depositor. The temporary increase in deposit insurance coverage became effective on October 3, 2008. EESA provides that the basic deposit insurance limit will return to $100,000 after December 31, 2009.
On October 14, 2008, the FDIC announced the Temporary Liquidity Guarantee Program (TLGP). The final rule was adopted on November 21, 2008. The FDIC stated that its purpose is to strengthen confidence and encourage liquidity in the banking system by guaranteeing newly issued senior unsecured debt of banks of 31 days or greater, thrifts, and certain holding companies, and by providing full coverage of all transaction accounts, regardless of dollar amount. Inclusion in the program was voluntary. Participating institutions are assessed fees based on a sliding scale, depending on length of maturity. Shorter-term debt has a lower fee structure and longer-term debt has a higher fee. The range is from 50 basis points on debt of 180 days or less, and a maximum of 100 basis points for debt with maturities of one year or longer, on an annualized basis. A 10-basis point surcharge is added to a participating institution's current insurance assessment in order to fully cover all transaction accounts. Guaranty Bank elected to participate in both parts of the TLGP, and the holding company elected to participate in the senior unsecured debt portion of the program. The amount of greater than 30 day unsecured senior debt that is eligible for the program is limited to 125% of the amount of such debt outstanding as of September 30, 2008. If there was no unsecured senior debt outstanding at September 30, 2008, the amount available under the program is limited to two percent of total liabilities as of September 30, 2008. As the Company did not have any unsecured senior debt outstanding as of September 30, 2008, the maximum amount of unsecured senior debt that can be issued under the program is limited to two percent of its total liabilities as of September 30, 2008 (approximately $38 million).
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.
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 Gramm-Leach-Bliley Financial Modernization Act of 1999, or 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 this decade 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 U.S. Treasury Department has issued a number of regulations that apply various requirements of the USA Patriot Act to financial institutions such as the Bank. 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"). 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 issuer's 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 Company's 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 issuer's disclosure controls and procedures and internal controls over financial reporting.
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, results of operations or cash flows. A change in statutes, regulations or regulatory policies applicable to Guaranty or any of its subsidiaries could have a material effect on our business.
At December 31, 2008, we employed 387 full-time equivalent employees. None of our employees are represented by collective bargaining agreements. We believe our employee relations to be good.
Guaranty Bancorp maintains an Internet website at www.gbnk.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 SEC's 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 Company's 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.gbnk.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 Guaranty Bancorp, 1331 Seventeenth Street, Suite 300, Denver, CO 80202, Attention: Investor Relations, telephone 303-293-5563, or via e-mail to firstname.lastname@example.org.
Except for the documents specifically incorporated by reference into this document, information contained on our website or information that can be accessed through our 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, results of operations or cash flows 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.
Our Business Has Been and May Continue to be Adversely Affected by Current Conditions in the Financial Markets And Economic Conditions Generally.
Negative developments in the latter half of 2007 and in 2008 in the financial services industry have resulted in uncertainty in the financial markets in general and a related general economic downturn, which have continued into 2009. In addition, as a consequence of the recession that the United States now finds itself in, business activity across a wide range of industries face serious difficulties due to the lack of consumer spending and the extreme lack of liquidity in the global credit markets. Unemployment has also increased significantly.
As a result of these financial economic crises, many lending institutions, including us, have experienced declines in the performance of their loans, including construction, land development and land loans, commercial loans and consumer loans. Moreover, competition among depository institutions for deposits and quality loans has increased significantly. In addition, the values of real estate collateral supporting many commercial loans and home mortgages have declined and may continue to decline. Bank and bank holding company stock prices have been negatively affected, as has the ability of banks and bank holding companies to raise capital or borrow in the debt markets has become more difficult compared to recent years. As a result, there is a potential for new federal or state laws and regulations regarding lending and funding practices and liquidity standards, and bank regulatory agencies are expected to be very aggressive in responding to concerns and trends identified in examinations, including the expected issuance of many formal or informal enforcement actions or orders. The impact of new legislation in response to those developments, may negatively impact our operations by restricting our business operations, including our ability to originate or sell loans, and adversely impact our financial performance or our stock price.
In addition, further negative market developments may affect consumer confidence levels and may cause adverse changes in payment patterns, causing increases in delinquencies and default rates, which may impact our charge-offs and provision for credit losses. A worsening of these conditions would likely exacerbate the adverse effects of these difficult market conditions on us and others in the financial services industry.
Overall, during the past year, the general business environment has had an adverse effect on our business, and there can be no assurance that the environment will improve in the near term. Until conditions improve, we expect our business, financial condition and results of operations to be adversely affected.
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, demand for loans, securities and deposits, 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, results of operations and cash flows. 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.
We seek to mitigate the risks inherent in our loan portfolio by adhering to specific underwriting practices. Although we believe that our underwriting criteria are appropriate for the various kinds of loans we make, we may incur losses on loans that meet our underwriting criteria, and these losses may exceed the amounts set aside as reserves in our allowance for loan losses. Due to recent economic conditions affecting the real estate market, many lending institutions, including us, have experienced substantial declines in the performance of their loans, including construction, land development loans and land loans. The value of real estate collateral supporting many construction and land development loans, land loans, commercial loans and multi-family loans have declined and may continue to decline. Recent negative developments in the financial industry and credit markets may continue to adversely impact our financial condition and results of operations.
Further Downturn in Our Real Estate Markets Could Hurt Our Business
Our business activities and credit exposure are primarily concentrated along the Front Range of Colorado. As of December 31, 2008, approximately 55% of the book value of our loan portfolio consisted of real estate loans. Substantially all of our real estate loans are located in Colorado. While we do not have any sub-prime loans, our construction, land development and land loan portfolio, along with our commercial and multi-family loan portfolios and certain of our other loans, have been affected by the recent downturn in the residential and commercial real estate market. 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. We anticipate that further declines in the real estate markets in our primary market areas would affect our business. If real estate values continue to decline, the collateral for our loans will provide less security. As a result, our ability to recover on defaulted loans by selling the underlying real estate will be diminished, and we would be more likely to suffer losses on defaulted loans. The events and conditions described in this risk factor could therefore have a material adverse effect on our business, results of operations and financial condition.
We May be Required to Make Further Increases in Our Provisions for Loan Losses and to Charge Off Additional Loans in the Future, Which Could Adversely Affect Our Results of Operations.
We maintain an allowance for loan losses, which is a reserve established through a provision for loan losses charged to expense, that represents management's best estimate of probable incurred losses 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 management's continuing evaluation of specific credit risks; loan loss experience; current loan portfolio quality; present economic, political and regulatory conditions; industry concentrations and other 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. Increases in nonperforming loans have a significant impact on our allowance for loan losses. Generally, our non-performing loans and assets reflect operating difficulties of individual borrowers resulting from weakness in the economy of the Front Range of Colorado. If current trends in the real estate markets continue, we expect that we will continue to experience increased delinquencies and credit losses, particularly with respect to construction, land development and land loans. Moreover, with the country currently in a recession, we expect that it will negatively impact economic conditions in our market areas and that we could experience significantly higher delinquencies and credit 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. If charge-offs in future periods exceed the allowance for loan losses, we will need additional provisions to increase the allowance for loan losses. Furthermore, growth in the loan portfolio would generally lead to an increase in the provision for loan losses.
Any increases in the allowance for loan losses will result in a decrease in net income and capital, and may have a material adverse effect on our financial condition, results of operations and cash flows. See the section captioned "Allowance for Loan Losses" in Item 7. Management's 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.
Liquidity Risk Could Impair Our Ability to Fund Operations and Jeopardize Our Financial Condition.
Liquidity is essential to our business. An inability to raise funds through traditional deposits, brokered deposits, borrowings, the sale of securities or loans and other sources could have a substantial negative effect on our liquidity. Our access to funding sources in amounts adequate to finance our activities or the terms of which are acceptable to us could be impaired by factors that affect us specifically or the financial services industry or economy in general. Factors that could detrimentally impact our access to liquidity sources include a decrease in the level of our business activity as a result of a downturn in the markets in which our loans are concentrated or adverse regulatory action against us. Our ability to borrow could also be impaired by factors that are not specific to us, such as a disruption in the financial markets or negative views and expectations about the prospects for the financial services industry in light of the recent turmoil faced by banking organizations and the continued deterioration in credit markets.
We rely on commercial and retail deposits, brokered deposits, advances from the Federal Home Loan Bank ("FHLB") of Topeka and other borrowings to fund our operations. Although we have historically been able to replace maturing deposits and advances as necessary, we might not be able to
replace such funds in the future if, among other things, our results of operations or financial condition or the results of operations or financial condition of the FHLB of Topeka or market conditions were to change. In addition, if we fall below the FDIC's thresholds to be considered "well capitalized", we will be unable to continue with uninterrupted access to the brokered funds markets.
Although we consider these sources of funds adequate for our liquidity needs, there can be no assurance in this regard and we may be compelled to seek additional sources of financing in the future. Likewise, we may seek additional debt in the future to achieve our business objectives, in connection with future acquisitions or for other reasons. There can be no assurance additional borrowings, if sought, would be available to us or, if available, would be on favorable terms. Bank and holding company stock prices have been negatively affected by the recent adverse economic trend, as has the ability of banks and holding companies to raise capital or borrow in the debt markets compared to recent years. If additional financing sources are unavailable or not available on reasonable terms, our financial condition, results of operations and future prospects could be materially adversely affected.
We actively monitor the depository institutions that hold our federal funds sold and due from banks cash balances. We are currently not able to provide assurances that access to our cash equivalents and federal funds sold will not be impacted by adverse conditions in the financial markets. Our emphasis is primarily on safety of principal and we diversify our due from banks and federal funds sold among counterparties to minimize exposure to any one of these entities. The financials of the counterparties are routinely reviewed as part of our asset/liability management process. Balances in our accounts with financial institutions in the U.S. may exceed the FDIC insurance limits. While we monitor and adjust the balances in our accounts as appropriate, these balances could be impacted if the financial institutions fail and could be subject to other adverse conditions in the financial markets.
Concern of Customers Over Deposit Insurance May Cause a Decrease in Deposits
With recent increased concerns about bank failures, customers increasingly are concerned about the extent to which their deposits are insured by the FDIC. Customers may withdraw deposits in an effort to ensure that the amount they have on deposit with their bank is fully insured. Decreases in deposits may adversely affect our funding costs and net income.
Our Deposit Insurance Premium Could be Substantially Higher in the Future, Which Could Have a Material Adverse Effect on Our Future Earnings
The FDIC insures deposits at FDIC insured financial institutions, including the Bank. The FDIC charges the insured financial institutions premiums to maintain the Deposit Insurance Fund at a certain level. Current economic conditions have increased bank failures and expectations for further failures, in which case the FDIC ensures payments of deposits up to insured limits from the Deposit Insurance Fund.
On October 16, 2008, the FDIC published a restoration plan designed to replenish the Deposit Insurance Fund over a period of five years and to increase the deposit insurance reserve ratio, which decreased to 1.01% of insured deposits on June 30, 2008, to the statutory minimum of 1.15% of insured deposits by December 31, 2013. In order to implement the restoration plan, the FDIC proposes to change both its risk-based assessment system and its base assessment rates. For the first quarter of 2009 only, the FDIC increased all FDIC deposit assessment rates by 7 basis points. These new rates range from 12-14 basis points for Risk Category I institutions to 50 basis points for Risk Category IV institutions. Under the FDIC's restoration plan, the FDIC proposes to establish new initial base assessment rates that will be subject to adjustment as described below. Beginning April 1, 2009, the base assessment rates would range from 10-14 basis points for Risk Category I institutions to 45 basis points for Risk Category IV institutions. Changes to the risk-based assessment system would include increasing premiums for institutions that rely on excessive amounts of brokered deposits, including
CDARS, increasing premiums for excessive use of secured liabilities, including Federal Home Loan Bank advances, lowering premiums for smaller institutions with very high capital levels, and adding financial ratios and debt issuer ratings to the premium calculations for banks with over $10 billion in assets, while providing a reduction for their unsecured debt. Either an increase in the Risk Category of the Bank or adjustments to the base assessment rates could have a material adverse effect on our earnings.
We May Elect or be Compelled to Seek Additional Capital in the Future, But Capital May not be Available When it is Needed
We are required by federal and state regulatory authorities to maintain adequate levels of capital to support our operations. In addition, we may elect to raise additional capital to support our business or to finance acquisitions, if any, or we may otherwise elect to raise additional capital. In that regard, a number of financial institutions have recently raised considerable amounts of capital as a result of deterioration in their results of operations and financial condition arising from the turmoil in the mortgage loan market, deteriorating economic conditions, declines in real estate values and other factors, which may diminish our ability to raise additional capital.
On October 3, 2008, Congress approved the $700 billion Emergency Economic Stabilization Act of 2008 (EESA). The first phase of implementation of EESA included a $250 billion Treasury Capital Purchase Program. The Company applied for up to three-percent of its total risk-weighted assets in capital, which would be in the form of non-cumulative perpetual preferred stock of the institution with a dividend rate of 5% until the fifth anniversary of the investment, and 9% thereafter. If the Company's application is approved and the investment is completed, Treasury will also receive warrants for common stock of the Company equal to 15% of the capital invested. There is no guarantee that the Treasury will select the Company to participate in its Capital Purchase Program.
Our ability to raise additional capital, if needed, will depend on conditions in the capital markets, economic conditions and a number of other factors, many of which are outside our control, and on our financial performance. Accordingly, we cannot be assured of our ability to raise additional capital if needed or on terms acceptable to us. If we cannot raise additional capital when needed, it may have a material adverse effect on our financial condition, results of operations and prospects.
The Value of Securities in Our Investment Securities Portfolio May be Negatively Affected by Continued Disruptions In Securities Markets
The market for some of the investment securities held in our portfolio has become extremely volatile over the past twelve months. Volatile market conditions may detrimentally affect the value of these securities, such as through reduced valuations due to the perception of heightened credit and liquidity risks. There can be no assurance that the declines in market value associated with these disruptions will not result in other than temporary impairments of these assets, which would lead to accounting charges that could have a material adverse effect on our net income and capital levels.
The Soundness of Other Financial Institutions Could Adversely Affect Us
Since mid-2007, the financial services industry as a whole, as well as the securities markets generally, have been materially and adversely affected by very significant declines in the values of nearly all asset classes and by a very serious lack of liquidity. Financial institutions in particular have been subject to increased volatility and an overall loss in investor confidence.
Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services companies are interrelated as a result of trading, clearing, counterparty, or other relationships. We have exposure to many different industries and counterparties, and we routinely execute transactions with counterparties in the financial
services industry, including brokers and dealers, commercial banks, investment banks, mutual and hedge funds, and other institutional clients. As a result, defaults by, or even rumors or questions about, one or more financial services companies, or the financial services industry generally, have led to market-wide liquidity problems and could lead to losses or defaults by us or by other institutions. Many of these transactions expose us to credit risk in the event of default of our counterparty or client. In addition, our credit risk may be exacerbated when the collateral held by us cannot be realized or is liquidated at prices not sufficient to recover the full amount of the loan or derivative exposure due us. There is no assurance that any such losses would not materially and adversely affect our business, financial condition or 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.
The Bank is subject to regulations promulgated by the Colorado Division of Banking, as its chartering authority, and by the FDIC as the insurer of its deposits up to certain limits. The bank also belongs to the Federal Home Loan Bank System and, as a member, it is subject to certain limited regulations promulgated by the Federal Home Loan Bank of Topeka. In addition, the Federal Reserve Board regulates and oversees Guaranty Bancorp as a bank holding company, and the Bank, as a member 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 FDIC's 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 institution's 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, the Red Flag Identity Theft rules under the Fair and Accurate Credit Transactions Act and Colorado's 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. Given the current disruption in the financial markets and regulatory initiatives that are likely to be proposed by the new administration and Congress, new regulations and laws that may affect us are increasingly likely. Compliance with such regulations and laws may increase our costs and limit our ability to pursue business opportunities. Also, participation in specific government stabilization programs may subject us to additional restrictions. No assurance can be given that the foregoing regulations and supervision will not change so as to affect us adversely.
There can be no Assurance That the Recently Enacted Emergency Economic Stabilization Act of 2008 (the "EESA") and Other Recently Enacted Government Programs Will Help Stabilize the U.S. Financial System
On October 3, 2008, the Emergency Economic Stabilization Act of 2008 (the "EESA") was enacted. The U.S. Treasury and banking regulators are implementing a number of programs under this legislation and otherwise to address capital and liquidity issues in the banking system, including the TARP Capital Purchase Program. In addition, other regulators have taken steps to attempt to stabilize and add liquidity to the financial markets, such as the FDIC Temporary Liquidity Guarantee Program ("TLG Program"), which we did not "opt-out" of. However, there can be no assurance that we will
issue any guaranteed debt under the TLG Program, or that we will participate in any other stabilization programs in the future.
There can also be no assurance as to the actual impact that the EESA and other programs will have on the financial markets, including the extreme levels of volatility and limited credit availability currently being experienced. The failure of the EESA and other programs to stabilize the financial markets and a continuation or worsening of current financial market conditions could materially and adversely affect our business, financial condition, results of operations, access to credit or the trading price of our common stock.
The EESA is relatively new legislation and, as such, is subject to change and evolving interpretation. This is particularly true given the change in administration that occurred on January 20, 2009. There can be no assurances as to the effects that such changes will have on the effectiveness of the EESA or on our business, financial condition or results of operations.
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, results of operations and cash flows. Further deterioration in economic conditions, in particular within our primary market areas, could result in the following consequences, among others, any of which could hurt our business materially: loan delinquencies on real estate, commercial and consumer loans may increase; problem assets and foreclosures may increase; demand for our products and services may decline; and collateral for loans made by us, especially real estate, may decline in value, in turn reducing a customer's borrowing power and reducing the value of assets and collateral securing our loans. In view of the concentration of our operations and the collateral securing our loan portfolio in Colorado's 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 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. Additionally, we expect competition to intensify among financial services companies due to the recent consolidation of certain competing financial institutions and the conversion of certain investment banks to bank holding companies. 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, results of operations and cash flows.
We Rely on Dividends from Our Subsidiary for Most of Our Revenue
Because we are a holding company with no significant assets other than the Bank, we currently depend upon dividends from the Bank for a substantial portion of our revenues. Our ability to pay dividends to our stockholders will therefore continue to depend in large part upon our receipt of dividends or other capital distributions from the Bank. Our ability to pay dividends is subject to the restrictions of the Delaware General Corporation Law.
The ability of the Bank to pay dividends or make other capital distributions to the holding company is also subject to the regulatory authority of the Federal Reserve Board and the Colorado Division of Banking (CDB). Because of the accumulated deficit resulting from goodwill impairment charges in 2008 and 2007, the Bank will be required to obtain permission from the Federal Reserve Board and the CDB prior to making any dividend to the holding company, as further described in the "Supervision and Regulation" section of Item 1 of this report. During 2008, the Bank requested and received permission to pay $19 million in dividends from the Bank to the holding company.
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 bank subsidiary from declaring or paying dividends. Our holding company expenses and interest obligations on our trust preferred securities and corresponding subordinated debt securities issued by us may limit or impair our ability to declare or pay dividends. The holding company currently has approximately $3.5 million in cash on hand, which based on current projections, is sufficient to meet our short-term cash needs. If we are unable to obtain permission to pay dividends from the Bank to the holding company, or are unable to raise additional capital, it could cause us to elect to defer interest payments on the trust preferred securities and corresponding subordinated debt securities for up to 20 quarters. See "Item 5. Market for Registrant's 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 is highly dependent upon the abilities of our senior executive management. 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 one or more of them could harm our business.
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, cash flows and financial condition.
We are Subject to Security and Operational Risks Relating to Our Use of Technology That Could Damage Our Reputation and Our Business.
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. Additionally, we outsource our data processing to a third party. If our third party provider encounters difficulties or if we have difficulty in communicating with such third party, it will significantly affect our ability to adequately process and account for customer transactions, which would significantly affect our business operations. Furthermore, breaches of such third party's technology may also cause reimbursable loss to our consumer and business customers, through no fault of our own. The occurrence of any failures, interruptions or security breaches of information systems used to process customer transactions 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, results of operations and cash flows.
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, results of operations and cash flows.
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, results of operations and cash flows.
Concentrated Ownership of our Common Stock Creates a Risk of Sudden Changes in our Share Price
As of February 9, 2009, executive officers, directors and stockholders of more than 5% of our common stock owned or controlled approximately 40.3% of our common stock. Investors who purchase our common stock may be subject to certain risks due to the concentrated ownership of our common stock. The sale by any of our large stockholders of a significant portion of that stockholder's holdings could have a material adverse effect on the market price of our common stock.
We Face Risks Associated With Acquisitions or Mergers
We may pursue acquisition or merger opportunities in the future. Risks commonly encountered in merger and acquisitions include, among other things:
We may not be successful in overcoming these risks or any other problems encountered in connection with mergers or 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 or in a timely manner 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 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, cash flows, liquidity and results of operations could be materially and adversely affected.
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, results of operations and cash flows.
As of December 31, 2008, we had a total of 34 branch office properties, 21 of which we owned and 13 of which we leased. All of our properties are located in the Colorado Front Range. Each of Guaranty Bancorp's and Guaranty Bank's 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.
In the ordinary course of our business, we are party to various 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 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 Company's consolidated financial position, results of operations or cash flows.
No matters were submitted to a vote of the security holders during the fourth quarter 2008.
Common Stock Market Prices
Our common stock is traded on the Nasdaq Global Select Market ("Nasdaq") under the symbol "GBNK". The table below sets forth the high and low sales prices per share of our common stock as reported by Nasdaq for each quarter in the preceding two fiscal years.
On February 9, 2009, the closing price of our common stock on Nasdaq was $1.60 per share. As of that date, we believe, based on the records of our transfer agent, that there were approximately 240 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 bank subsidiary to the holding company, and such other factors as our board of directors may deem relevant.
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 subsidiary, we currently depend upon dividends from our bank subsidiary 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 subsidiary. See "Supervision and Regulation" in Item 1 of this report for a discussion of potential regulatory limitations on the holding company's receipt of funds from its bank subsidiary.
The ability of our bank subsidiary 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, and other factors, that the 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, and subject to approval from the Federal Reserve Board and the CDB, we will utilize a portion of our bank subsidiary's excess capital above the well-capitalized requirement through the
payment of dividends to the holding company. See "Item 1. BusinessSupervision and RegulationDividends".
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 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, 2008, regarding securities issued and to be issued under our equity compensation plans that were in effect during the year ended December 31, 2008:
Repurchases of Common Stock
Stock repurchase programs allow us to proactively manage our capital position and return excess capital to stockholders. See "Supervision and Regulation" in Item 1 of this report for a discussion of
potential regulatory limitations on the holdings company's receipt of dividends from its bank subsidiary, which may be used to repurchase our common stock. 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 2008.
Our common stock trades on the Nasdaq Global Select Market® under the symbol "GBNK". The following graph shows a comparison from October 3, 2005 (the date the Company's common stock commenced trading on Nasdaq) through December 31, 2008 of cumulative total return for the Company's 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 Company's common stock is determined based on the change in the price of the Company's 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, 2008. The losses in 2008 and 2007 were primarily related to goodwill impairment charges of $250.7 million and $142.2 million in 2008 and 2007, respectively. This data should be read in conjunction with our audited consolidated financial statements as of December 31, 2008 and 2007, and for each of the years in the three-year period ended December 31, 2008, and related Notes to Consolidated Financial Statements contained in "Item 8. Financial Statements and Supplementary Data." The financial information for Guaranty Bancorp (formerly Centennial Bank Holdings, Inc.) and subsidiaries 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 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 and originating commercial loans (including energy loans), real estate 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, interest on investment securities, fees received in connection with servicing loan and deposit accounts and fees from trust services. 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.
As detailed in Item 1Business, Centennial Bank Holdings, Inc. became Guaranty Bancorp effective May 12, 2008. Guaranty Bancorp has a single bank subsidiary, Guaranty Bank and Trust Company. This structure is a result of a combination of four separate acquisitions and two divestitures as follows:
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 management's 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 sheet. We determine probable incurred losses inherent in our loan portfolio and establish an allowance for those losses by considering factors including 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 more subjective. Generally, the allowance assigned to nonimpaired loans is determined by applying historical loss rates to existing loans with similar risk characteristics, adjusted for qualitative factors including the volume and severity of identified classified loans, 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.
Other Real Estate Owned and Foreclosed Assets
Other real estate owned or other foreclosed assets acquired through loan foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. The adjustment at the time of foreclosure is recorded through the allowance for loan losses. Due to the subjective nature of establishing the fair value when the asset is acquired, the actual fair value of the other real estate owned or foreclosed asset could differ from the original estimate. If it is determined that fair value declines subsequent to foreclosure, a valuation allowance is recorded through noninterest expense. Operating costs associated with the assets after acquisition are also recorded as noninterest expense. Gains and losses on the disposition of other real estate owned and foreclosed assets are netted and posted to other noninterest income.
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, results of operations and cash flows. 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.
Deferred Income Tax Assets/Liabilities
Our net deferred income tax asset arises from differences in the dates that items of income and expense enter into our reported income and taxable income. Deferred tax assets and liabilities are established for these items as they arise. From an accounting standpoint, deferred tax assets are reviewed to determine if they are realizable based on the historical level of our taxable income, estimates of our future taxable income and the reversals of deferred tax liabilities. In most cases, the realization of the deferred tax asset is based on our future profitability. If we were to experience net operating losses for tax purposes in a future period, the realization of our deferred tax assets would be evaluated for a potential valuation reserve. Although we had a loss for financial reporting purposes in 2007 and 2008, for income tax purposes the Company reported taxable income and paid federal and state income tax.
Additionally, the Company reviews its uncertain tax positions annually under FASB Interpretation 48, Accounting for Uncertainty in Income Taxes. An uncertain tax position is recognized as a benefit only if it is "more likely than not" that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount actually recognized is the largest amount of tax
benefit that is greater than 50% likely to be recognized on examination. For tax positions not meeting the "more likely than not" test, no tax benefit is recorded. A significant amount of judgment is applied to determine both whether the tax position meets the "more likely than not" test as well as to determine the largest amount of tax benefit that is greater than 50% likely to be recognized. Differences between the position taken by management and that of taxing authorities could result in a reduction of a tax benefit or increase to tax liability, which could adversely affect future income tax expense.
Impairment of Goodwill and Intangible Assets
Core deposit and customer relationships, which are intangible assets with a finite life, are recorded on our balance sheets. These intangible assets were capitalized as a result of past acquisitions and are being amortized over their estimated useful lives of up to 15 years. Core deposit intangible assets, with finite lives will be tested for impairment when changes in events or circumstances indicate that its carrying amount may not be recoverable. Core deposits were tested for impairment during 2008 and 2007, as part of the goodwill impairment test and no impairment was deemed necessary.
As a result of our acquisition activity, goodwill, an intangible asset with an indefinite life, was reflected on our balance sheet in prior periods. Goodwill was evaluated for impairment annually, unless there were factors present that indicated a potential impairment, in which case, the goodwill impairment test was performed more frequently than annually.
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 "Notes to Consolidated Financial Statements" in Item 8, "Financial Statements and Supplementary Data", 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 is impacted by the 2006 divestiture of Collegiate Peaks Bank.
2008 Compared to 2007
There was a net loss of $256.7 million for the year ended December 31, 2008 compared to a net loss of $138.1 million for the same period in 2007. Both years were affected by goodwill impairment charges of $250.7 million and $142.2 million in 2008 and 2007, respectively. Other changes in net income were a $22.7 million decrease in net interest income, primarily as a result of the Company being asset sensitive and interest rates being significantly lower in 2008 as compared to 2007. The increase in provision for loan losses of $9.1 million was primarily due to the increase in non-performing loans and the deterioration of the economic conditions during 2008 as compared to 2007. This is highlighted by a 102 basis point increase in our allowance for loan losses to loans, net to 2.46% at December 31, 2008 as compared to 1.44% at December 31, 2007. Without the goodwill impairment charges in both years, noninterest expense was $68.9 million and $84.3 million in 2008 and 2007, respectively. The decrease in noninterest expense, excluding goodwill impairment charges, is primarily a result of an $8.1 million decrease in salaries and employee benefits, as well as a $6.5 million decrease in other general and administrative expenses, as discussed below under noninterest expense.
Our goodwill and other intangible asset balances caused a proportional reduction in our return on average assets and return on average equity when compared to entities with minimal intangible asset balances.
Goodwill and other intangible assets have always been excluded from regulatory capital, and therefore had no impact on total risk based capital year over year. The ending total risk capital ratio decreased by 26 basis points to 10.61% at December 31, 2008 as compared to 10.87% at December 31, 2007. This decrease is a result of the significant provision for loan losses taken in 2008, as well as a $44.7 million increase in loans, net of unearned discount during 2008.
2007 Compared to 2006
The Company had a net loss of $138.1 million for the year ended December 31, 2007 compared to net income of $24.4 million for the year ended December 31, 2006. The primary reasons for the decrease in net income year-over-year were due to a $142.2 million goodwill impairment charge, as well as a $20.4 million increase to the provision for loan losses. Additionally, there was a $6.5 million charge recorded in 2007 for the settlement of a lawsuit, as discussed under noninterest expense below.
Net Interest Income and Net Interest Margin
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.
The following table summarizes the Company's net interest income and related spread and margin for the periods indicated:
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.
2008 Compared to 2007
Net interest income decreased by $22.7 million, or 22.2%, for 2008 as compared to 2007. This decrease is attributable to an $18.9 million unfavorable rate variance and a $3.8 million unfavorable volume variance as illustrated in Table 4 above.
The $18.9 million unfavorable rate variance is due mostly to a reduction in the yield on interest-earning assets during 2008. The yield on interest-earning assets fell from 7.89% to 6.17% year-over-year, a decrease of 172 basis points. This decrease lowered interest income by $35.0 million from 2007 to 2008. This decrease is primarily a result of 65% of our loan portfolio being variable rate loans tied to an index
such as prime, federal funds or LIBOR. During 2008, the prime rate fell from 7.25% at December 31, 2007 to 3.25% at December 31, 2008, a decrease of 400 basis points. In 2007, the prime rate was 8.25% for almost three-fourths of the year before three decreases totaling 100 basis points reduced it from 8.25% to 7.25% in the last three and half-months of 2007. For 2008, the rate decreases started early with a 125 basis point decrease in January 2008 alone. The federal funds rate has a direct impact on overall rates in the economy, and in particular on the prime rate. Decreases in prime rate are generally identical in the amount of basis points as changes to the target federal funds rate by the Federal Open Markets Committee of the Federal Reserve Board (FOMC). The prime rate fell by 400 basis points in 2008, whereas the targeted federal funds rate fell by 400 to 425 basis points, as the last decrease in rates by the FOMC took the targeted federal rates to a point between 0 and 25 basis points. Although 65% of the Company's loans are variable rate loans, approximately $823.1 million of the Company's loans, including approximately $535 million of variable rate loans, are subject to renewal during 2009. Most of the variable rate loans are expected to be renewed with new terms including a floor above the current rate. Therefore, it is expected that net interest income will increase during 2009 even if there are no increases to the targeted federal funds rate by the FOMC.
Partially offsetting the $42.3 million decrease in interest income was a reduction in the interest paid on deposits and other borrowings of $19.7 million. The cost of funds decreased from 3.95% in 2007 to 2.82% in 2008. The cost of funds decreased by 113 basis points, as compared to the 172 basis point decrease in the yield on earning assets. Although interest rates on interest-bearing demand, savings and money market accounts can be changed at any time, the interest rate on time deposits and long-term borrowings cannot be changed until the time deposit or borrowing matures. Further, competition for deposits kept rates on deposits from decreasing at the same pace as the declines in yield on earning assets. During 2009, approximately $564 million of time deposits will mature. These time deposits have an existing weighted-average rate of 4.25%, which are expected to be renewed at current market rates on the renewal date. As current market rates on time deposits are significantly below 4.25%, it is expected that the cost of funds related to time deposits will decline in 2009 if there are no increases to the targeted federal funds rate by the FOMC.
The $3.8 million unfavorable volume variance is due mostly to a $74.3 million decrease in the average balances of gross loans, net of unearned discount and a $34.8 million decrease in average tax-exempt bonds in 2008 as compared to 2007. Although average loans decreased during 2008, the actual ending balance of loans increased by $44.7 million at December 31, 2008 as compared to December 31, 2007. All other average interest-earning assets increased by $2.2 million year-over-year as average interest-earning assets decreased by $106.9 million in 2008 as compared to 2007. The 2008 decrease in average loans is mostly attributable to an $87.9 million year-over-year decrease in average construction loans and a $10.6 million year-over-year decrease in average real estate mortgage loans, partially offset by a year-over-year increase in average commercial loans.
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.
2007 Compared to 2006
Net interest income decreased by $13.9 million, or 12%, for 2007 as compared to 2006. This decrease is attributable to a $9.1 million unfavorable rate variance and a $4.8 million unfavorable volume variance as illustrated in Table 6 above.
The $9.1 million unfavorable rate variance is due mostly to an increase in the cost of funds in 2007 as compared to 2006. The cost of funds increased from 3.52% in 2006 to 3.95% in 2007, primarily due to higher rates paid on certificates of deposits. The rates on certificates of deposits increased to 5.05% in 2007 from 4.22% in 2006 due mostly to increased competition. Despite a 2.1% decline in average balances of certificate of deposits from 2006 to 2007, the interest expense related to these accounts
increased by $4.2 million, or 17.2%. The actual balance of time deposit accounts fell by $97.5 million, or 16.9%, from December 31, 2006 to December 31, 2007.
During the second half of 2007, the FOMC decreased the federal funds rate three separate times by a total of 100 basis points. The overall federal funds rate declined from 5.25% at December 31, 2006 to 4.25% at December 31, 2007. The prime rate declined by 100 basis points to 7.25% at December 31, 2007 as compared to 8.25% at December 31, 2006.
The $4.8 million unfavorable volume variance is due mostly to a $98.6 million, or 4.5%, decline in average interest-earning assets from 2006 to 2007 as highlighted in Table 5 above. This decrease is mostly attributable to a decrease in overall loan balances. Specifically, the actual balance of construction loans declined by $192.2 million, or 45.0%, from 2006 to 2007 as part of a strategy to reduce the overall risk of the loan portfolio. This decline in construction loans was partially offset by increases in commercial real estate loans and commercial loans. In particular, the areas of focus have been on the energy and middle-market loan portfolios, which saw a $123.6 million increase in balances from 2006 to 2007.
Provision for Loan Losses
The provision for loan 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 incurred loan losses in the loan portfolio. The provision for loan losses is based on our reserve methodology and reflects our judgments about the adequacy of the allowance for loan losses. 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 and severity of classified, criticized and nonperforming assets, regulatory policies, general economic conditions, underlying collateral values and other factors regarding collectability 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 provision.
For further discussion of the methodology and factors impacting management's estimate of the allowance for loan losses, see "Financial ConditionAllowance for Loan Losses" below. For a discussion of impaired loans and associated collateral values, see "Financial ConditionNonperforming Assets and Other Impaired Loans" below.
2008 Compared to 2007
The provision for loan losses increased by $9.1 million to $33.8 million for the year ended December 31, 2008 as compared to $24.7 million in 2007.
The Company has determined that the provision for loan losses made during 2008 of $33.8 million is necessary to have an allowance for loan losses (2.46% of total loans as of December 31, 2008) at a level necessary for the probable incurred losses inherent in the loan portfolio as of December 31, 2008. Specifically, the increase in impaired loans (impaired loans were $54.8 million at December 31, 2008 as compared to $23.3 million at December 31, 2007) and a corresponding higher specific allocation related to such loans accounted for approximately $21.3 million of provision for loan losses made during the year. Of this $21.3 million, $14.5 million was charged off during 2008. In addition to the $21.3 million, the impact of the level of charge-offs and the current economic climate on our historical loss and economic concerns components of our allowance for loan losses resulted in an additional provision for loan losses of $12.5 million. The provision for loan losses was driven primarily from an increase in nonperforming assets and related charge-offs, primarily due to weakness in the performance of residential construction, land and land development loans. We believe that continued economic weakness will likely result in elevated credit costs.
Our allowance for loan losses compared to loans, net increased to 2.46% at December 31, 2008 compared to 1.44% at December 31, 2007.
2007 Compared to 2006
The provision for loan losses increased by $20.4 million to $24.7 million for the year ended December 31, 2007 as compared to $4.3 million in 2006.
In the second and third quarter of 2007, the Company recorded a provision for loan losses of $20.8 million primarily as a result of a modification of its credit management philosophy during the second quarter 2007 and a sale of nonperforming and classified loans in a bulk sale, rather than continuing to work out each credit individually. Specifically, the Company enhanced its risk rating methodology in 2007 and adopted an accelerated disposition strategy regarding problem credits.
The following table presents our major categories of noninterest income:
2008 Compared to 2007
Overall noninterest income remained relatively flat in 2008 as compared to 2007. Customer service and other fees increased by $0.2 million, or 1.8% in 2008 as compared to 2007, primarily due to an increase in analysis fee income. Analysis fee income is generally offset by an earnings credit rate. As interest rates decline, the earnings credit rate offset also decreases, which in turn increases analysis fees. As most of this increase occurred in the second half of 2008 with the lowering of the earnings credit rate, it is expected that this trend will continue in 2009 unless overall interest rates increase or if we have to increase our earnings credit rate due to competition.
Other income decreased by $0.4 million in 2008 as compared to 2007. Included in other income is net income on assets held by the Company for purposes of funding its nonqualified deferred compensation plan. These assets are required to be marked-to-market through the income statement. As income from these assets is used to offset the cost of our deferred compensation plan, they are invested in similar assets that are used to determine the value of the accounts of our deferred compensation plan participants. The value of these assets declined in 2008, which caused a decrease in other noninterest income. However, there was an offsetting reduction in compensation expense, which is recorded as a part of salaries and employee benefit expense, as discussed below under noninterest expense.
2007 Compared to 2006
Overall noninterest income declined by $2.0 million, or 15.9%, in 2007 as compared to 2006. This decline was due in part to a $0.7 million decline in the gain on sale of loans as a result of the discontinuation of the Company's residential mortgage group at the end of the third quarter of 2006, as well as a $0.9 million decline in customer service and other fees. Customer service and other fees declined mostly due to a $0.5 million decrease in loan placement fees as a result of the discontinuation of the Company's residential mortgage group in 2006, as well as a $0.5 million decline in analysis charges as a result of greater earnings credits on compensating balances. Earnings credits on compensating balances are used by corporate deposit account customers to offset banking fees. As interest rates increase, the amount of service charge income generally declines.
Other income also decreased by $0.4 million, or 26.6%, from 2006 to 2007. Included in other income are net gains and losses on the sale of other real estate. There was a $0.4 million decrease in the gain on sale of other real estate and foreclosed assets from 2006 to 2007.
The following table presents the major categories of noninterest expense:
2008 Compared to 2007
Overall noninterest expense increased by $93.1 million in 2008 as compared to 2007. This increase was mostly due to a $250.7 million goodwill impairment charge in 2008 as compared to a $142.2 million goodwill impairment charge in 2007. At December 31, 2008, there was no goodwill asset recorded on the Company's consolidated balance sheet.
Excluding the goodwill impairment charge in both years, noninterest expense would have been $68.9 million in 2008 as compared to $84.3 million in 2007, a decrease of $15.4 million.
Salaries and employee benefits decreased by $8.1 million, or 20.7%, from 2007 to 2008. The decrease is partially attributable to a $4.1 million decrease in base salaries and employee benefits expense in connection with a decline in full-time equivalent employees by 89 from December 2007 to December 2008. Of the remaining $4.0 million decrease, approximately $3.3 million is related to a decrease in equity-based compensation and $0.7 million is related to a decrease in bonus and incentive expense in 2008 as compared to 2007. The decline in equity-based compensation is mostly due to a change in expectation regarding the vesting criteria for performance-based shares. It is no longer expected that the performance-based shares will meet their vesting condition, which is based on earnings per share, prior to their expiration date of December 31, 2012. Should this expectation change, additional expense could be recorded in future periods. This change accounted for
approximately $2.9 million of the total $3.3 million decrease in equity based compensation expense. Overall base salary and employee benefit expense is expected to remain lower throughout 2009 due to fewer employees. In the second quarter of 2008, we announced a major effort to better align our expenses with the current size of our business. This effort was expected to reduce overall noninterest expense by approximately $6.0 million once fully implemented. A significant portion of these annualized savings are expected to be from salaries and employee benefits expense and most of the progress toward the salary and employee benefit portion of this goal had been achieved by December 31, 2008.
Furniture and equipment expense increased by $0.4 million, or 8.8%, in 2008 as compared to 2007. This increase is mostly due to accelerating depreciation expense for assets that were abandoned upon the closing of two branches during 2008, as well as accelerated depreciation related to certain computer equipment no longer in service as of year-end as a result of our outsourcing of item processing and data processing in December 2008.
A goodwill impairment charge of $250.7 million was recorded in 2008 as compared to a goodwill impairment charge of $142.2 million in 2007. As of December 31, 2008, there was no goodwill asset recorded on the Company's balance sheet, therefore no future goodwill impairment charges are expected in 2009. Goodwill is recorded in nearly every purchase transaction when a company buys another entity. The purchase price is allocated among the various components of the acquired business. This allocation is based on the appraised value of the underlying assets. If the purchase price is higher than the fair market value of the acquired business' identifiable net assets, the excess purchase price is labeled goodwill and is recorded as an intangible non-earning asset as well as capital for financial reporting purposes, but not regulatory purposes. Prior to the implementation of Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, goodwill was written off as an expense over the estimated life of the goodwill. This caused the goodwill value to be reduced gradually over time. Under current accounting rules, goodwill is no longer written off slowly. Instead, a company must evaluate the value of goodwill each year, and write down any goodwill in excess of its current value. As goodwill is based on the purchase price paid, declines in value can cause goodwill impairment, which is recorded as a non-cash adjustment to income and a decrease to the value of the intangible asset. All of the Company's acquisitions occurred after the implementation of new accounting guidance in 2002, which ceased the amortization of goodwill. Thus, the Company has traditionally had a high level of goodwill to total equity. This made our goodwill more susceptible to the accounting considerations of market volatility in the financial services industry.
Step one of the impairment test involves comparing the fair value of the reporting unit which, in our case, is the entire entity to the carrying value of the reporting unit. If the fair value of the reporting unit is greater than the carrying value of the reporting unit, no additional testing is required. If the fair value of the reporting unit is less than the carrying value of the reporting unit, step two of the impairment test must be performed. Step two requires that the implied fair value of the reporting unit goodwill be compared to the carrying amount of that goodwill. The implied fair value of goodwill is determined by allocating the fair value determined in step one to all of the individual assets and liabilities of the reporting unit, including any unrecognized identifiable intangible assets. This allocation process is only performed for purposes of testing goodwill for impairment, as the other assets and liabilities are not actually written up or written down, nor is any additional unrecognized identifiable intangible asset recorded as a part of this process. Step one of the impairment test in 2008 indicated that the fair value of the reporting unit was $230.6 million less than its carrying value. The valuation employed in step one utilized different valuation techniques including the discounted cash flows method, as well as the change of control valuation method. The lower value in step one of the impairment test is attributable to lower market valuations for banking institutions in the latter part of 2008, the continued weakening of the credit market, and the decline in real estate values in our markets. The difference between fair value and carrying value in step one of the impairment test was
increased by approximately $20.1 million as a result of overall increases to values of the remainder of the Company's assets and liabilities as determined in step two of the impairment test. The combined step one and step two impairments resulted in an overall non-cash goodwill impairment of $250.7 million (the entire balance of goodwill). This non-cash accounting write-off had no impact on our cash flow, liquidity or regulatory capital. The 2007 goodwill impairment charge is discussed below.
Amortization expense decreased in 2008 by $1.2 million, or 14.2%, as a result of accelerated amortization methods. Amortization expense is projected to decrease by $1.2 million, or 15.6%, in 2009 as compared to 2008 as presented in Note 8, Other Intangible Assets, to "Item 8. Financial Statements and Supplemental DateNotes to Consolidated Financial Statements".
Other general and administrative expenses decreased by $6.5 million, or 27.5%, to $17.3 million in 2008 as compared to $23.8 million in 2007. The decrease is mostly due to a $6.5 million charge in 2007 as a result of a settlement of the Barnes action lawsuit. In 2008, the Company also recorded approximately $1.5 million of charges related to the reduction of the carrying value of other real estate owned, an increase of $0.9 million over 2007 for similar charges. Additionally, there was a $1.0 million increase in FDIC insurance on customer deposits in 2008 as compared to 2007. In 2007, the Company was able to utilize its one-time credit provided by the FDIC to offset the cost of its FDIC insurance premiums. It is expected that FDIC insurance premiums will increase by approximately $1.3 million in 2009 as compared to 2008, due to the FDIC increasing deposit rates by 7 basis points in 2009, as well as the 10 basis point additional assessment on certain deposits in 2009 for unlimited FDIC insurance coverage of non-interest bearing transaction accounts. If the proposed changes to FDIC insurance rates are finalized by the FDIC, or if our risk category changes, our FDIC insurance premiums will increase even further. In 2007 the Company recorded a $1.0 million charge for expenses associated with the combination of its subsidiary banks on January 1, 2008. The year-over-year impact of the increase in charges related to other real estate owned, the increase in FDIC insurance premiums was offset by the decrease in charges related to the combination of its subsidiary banks and overall decreases in other noninterest expense items, particularly professional fees and business development.
2007 Compared to 2006
Overall noninterest expense increased by $135.6 million in 2007 as compared to 2006. This increase was mostly due to a $142.2 million goodwill impairment charge taken in the fourth quarter 2007. Additionally, other general and administrative expenses increased mostly due to settlement of a lawsuit during the second quarter 2007. These increases were partly offset by decreases in salaries and employee benefits, as well as amortization of intangible assets.
Salaries and employee benefits decreased by $7.0 million, or 15.2%, from 2006 to 2007. The decrease is mostly attributable to a $5.0 million decrease in bonus and incentive expense in 2007. The remainder of the decrease from 2007 is due mostly to overall decreases in salary expense as a result of an 8% decline in full-time equivalent employees.
Goodwill impairment was $142.2 million in 2007 as compared to none in the prior year. Step one of the impairment test in 2007 indicated that the fair value of the reporting unit was $133.1 million less than its carrying value. The valuation employed in step one utilized different valuation techniques including the discounted cash flows method, as well as the change of control valuation method. The lower value in step one of the impairment test is attributable to lower market valuations for banking institutions in the latter part of 2007, the weakening of the credit market in the second half of 2007 and the decline in real estate values, particularly in Northern Colorado. The difference between fair value and carrying value in step one of the impairment test was increased by approximately $9.1 million as a result of the overall increase to values of the remainder of the Company's assets and liabilities as determined in step two of the impairment test.
Amortization expense decreased in 2007 by $3.2 million, or 26.7%, as a result of accelerated amortization methods and the expiration of certain identifiable intangible assets including noncompete agreements.
Other general and administrative expenses increased by $3.8 million, or 18.7%, to $23.8 million in 2007 as compared to $20.1 million in 2006. The increase is mostly due to a $6.5 million charge in the second quarter 2007 as a result of a settlement of a lawsuit. Additionally, the Company incurred a $1.0 million charge as a result of merging its two subsidiary banks. Excluding these two charges, other general and administrative expense would have declined by $3.7 million in 2007 as compared to 2006. The largest portion of this decline relates to $1.8 million of expenses related to a management transition in 2006. The remainder of the decline is due to an overall decrease in several categories such as professional fees, and business development and office-related expenses.
Income Taxes Expense (Benefit)
2008 Compared to 2007
The effective tax benefit in 2008 was 2.5% as compared to 0.1% in 2007. The reason for the benefit in 2008 is due to tax-exempt income further reducing the net loss before taxes. No tax benefit was recorded in 2008 or 2007 as a result of the goodwill impairment charges, as goodwill impairment is not tax deductible. The taxable loss before taxes for financial reporting purposes in 2008 was $263.3 million. After adding back the nondeductible goodwill impairment charge of $250.7 million, the 2008 taxable loss before taxes for financial reporting purposes would have been $12.5 million. This was further decreased by tax-exempt income causing an overall $6.5 million tax benefit in 2008.
For 2007, the effective tax benefit was 0.1%. After adding back the nondeductible goodwill impairment charge of $142.2 million, the 2007 taxable income before taxes for financial reporting purposes would have been $3.9 million. This was mostly offset by tax-exempt income causing an overall small tax benefit in 2007.
2007 Compared to 2006
The effective tax benefit in 2007 was 0.1%, as compared to an effective tax rate of 33.5% in 2006. The reason for the small benefit in 2007 is mostly due to tax-exempt income offsetting most of the net income before taxes, but after the goodwill impairment charge.
For 2006, the effective tax rate was 33.5%. The primary difference between the expected tax rate of 35% and the effective tax rate was due to tax-exempt income, partially offset by state income tax.
At December 31, 2008, we had total assets of $2.1 billion, compared to $2.4 billion and $2.7 billion at December 31, 2007 and 2006, respectively. The overall $268.9 million decline in total assets in 2008 as compared to 2007 is mostly attributable to a $258.2 million decrease in goodwill and other intangible assets.
The overall $348.9 million decline in total assets in 2007 as compared to 2006 is mostly attributable to a $163.7 million decrease in net loans, and a $150.9 million decrease in goodwill and other intangible assets. 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:
There were $998.6 million of real estate loans at December 31, 2008. Management continues its efforts to decrease its exposure to residential real-estate and residential land and land development loans. The increase in construction loans in 2008 as compared to 2007 was due primarily to draws on existing commercial real estate construction projects during 2008.
Total loans, net of unearned discount (excluding loans held for sale), increased by $44.7 million, or 2.5%, from December 31, 2008 to December 31, 2007. Average loans declined by $74.3 million in 2008 as compared to 2007. The increase in commercial loans outstanding is primarily due to increases in middle-market and energy loan portfolios.
During 2007 and throughout 2008, the Company's approach to loan underwriting placed more emphasis on the borrower's cash equity invested in the project being financed, expertise and experience as it relates to the project, the borrower's capacity and ability to carry the projects beyond the underlying collateral pledged and continued efforts to reduce exposure with respect to residential construction and land development loans.
With respect to group concentrations, most of the Company's business activity is with customers in the state of Colorado. At December 31, 2008, the Company did not have any significant concentrations in any particular industry.
The following table shows the amounts of loans outstanding at December 31, 2008, 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. The table excludes unearned discount.
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.
Loans are generally placed on nonaccrual status when they become 90 days or more past due or at such time as management determines, after considering economic and business conditions and an analysis of the borrower's financial condition, that the timely recognition of principal and 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. 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.
Nonperforming assets of $55.3 million at December 31, 2008 reflected an increase of $31.9 million from the December 31, 2007 balance of $23.4 million. The increase in nonperforming assets in 2008 occurred mostly in the second half of the year due to continued deterioration of the real estate market in Colorado.
The Company's loss exposure on its nonperforming loans continues to be mitigated by collateral positions on these loans. The value of these collateral positions further deteriorated during 2008 causing an increase in both nonperforming assets and the related allocated allowance for loan losses. The allocated allowance for loan losses associated with impaired loans is computed based upon related collateral value of the loans. The collateral values are determined by recent appraisals, but are generally discounted significantly by management based on historical collateral dispositions, changes in market conditions since the last valuation and management's expertise and knowledge of the client and the client's business.
At December 31, 2008, no additional funds are committed to be advanced in connection with impaired loans.
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 incurred loan losses in the loan portfolio. The amount of the allowance is based on management's evaluation of the collectability of the loan portfolio, historical loss experience, and other significant factors affecting loan portfolio collectability, 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. The specific allowance for impaired loans and the allowance calculated for probable incurred 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.
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. 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 collectability as described above. Higher net charge-offs during 2008 and 2007 directly increased the historical loss factor. This also had a direct impact on the economic concerns factor which looks at historical losses by type of loan and applies a loss factor based on both historical losses and management's estimate of the economic climate for the remaining loans in the portfolio. Management also looks at risk weightings of loans and computes a factor for the volume and severity of classified loans using assigned risk ratings under regulatory definitions of "watch", "substandard"', "doubtful" and "loss". Loans graded as either doubtful or loss are treated as impaired and are included as part of the specific reserve computed above. Loans segregated by risk weighting categories watch or substandard are evaluated for trends in volume and severity.
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, 2008, the allowance for loan losses was $45.0 million, or 2.46% of total loans held for investment. This compares to an allowance for loan loss of $25.7 million, or 1.44% of total loans held for investment at December 31, 2007.
The increase in the allowance for loan losses is due primarily to the increase in the level of nonperforming loans during 2008. Actual net charge-offs related to loans were $14.5 million in 2008, as compared to $26.9 million in 2007, a decrease of $12.4 million. This decrease in charge-offs is mostly attributable to a loan sale in 2007, where the Company sold a portion of its nonperforming and classified loans.
Approximately $11.1 million, or 24.6%, of the $45.0 million allowance for loan losses at December 31, 2008, relates to loans specifically reserved. This compares to a specific reserve of $4.3 million, or 16.7% of the total allowance for loan losses at December 31, 2007. The increase in the percent of the portfolio from specific reserves is attributable to a higher overall balance of impaired loans at December 31, 2008 as compared to 2007, along with lower collateral values assigned, especially for construction loans. The general reserve as a percent of overall loans, net of unearned discount, was 1.86% at December 31, 2008 as compared to 1.21% at December 31, 2007. The increase in the general reserve as a percent of loans, net of unearned discount, is due to actual historical losses increased by management's review of internal classified loans, management's expectation of overall economic conditions in the areas in which we operate and management's expected losses with the overall level of real estate loans within our portfolio.
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:
During 2008, the allocation of the allowance for losses attributable to real estate construction loans increased by $14.5 million to $18.7 million at December 31, 2008 compared to $4.2 million at December 31, 2007. The increase in this allocation is due to a higher specific reserve attributable to construction loans at December 31, 2008 as compared to December 31, 2007, as well as a higher general reserve associated with construction loans. The increase in the general reserve associated with construction loans is due to management assigning a higher risk adjustment to the construction loan portfolio due to declines in real estate market conditions during 2008.
During 2007, the allocation of the reserve to real estate-mortgage loans is primarily attributable to higher balances of nonperforming and classified loans being associated with real estate mortgage loans. This was due in part to a general deterioration in real estate values, particularly in Northern Colorado, during 2007.
We manage our investment portfolio principally to provide collateral for certain deposits, in particular public deposits, as well as 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. At December 31, 2008 and 2007, we did not own any preferred stock in either the Federal National Mortgage Association (FNMA) or the Federal Home Loan Mortgage Corporation (FHLMC). Additionally, we did own any private collateralized mortgage obligations, private mortgage backed securities or any trust preferred securities in other institutions.
The carrying value of our portfolio of investment securities at the dates indicated are as follows:
Securities available-for-sale are carried at fair value, while securities held-to-maturity and bank stocks are carried at historical cost.
Fair values for municipal securities are generally determined by matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities' relationship to other benchmark quoted securities. Characteristics utilized by matrix pricing include insurer, credit support, state of issuance, and bond rating. These factors are used to incorporate additional spreads and municipal curves. A separate curve structure is used for bank-qualified municipal bonds versus general market municipals. For the bank-qualified municipal bonds, active quotes are obtained when available.
Fair values for U.S. Treasury securities, U.S. government agencies and government-sponsored entities are determined using a combination of daily closing prices, evaluations, income data, security master (descriptive) data, and terms and conditions data. Additional data used to compute the fair value of U.S. mortgage-backed pass-through issues (FHLMC, FNMA, GNMA, and SBA pools) includes daily composite seasoned, pool-specific, and generic coupon evaluations, and factors and descriptive data for individual pass-through pools. Additional data used to compute the fair value of U.S. collateralized mortgage obligations include daily evaluations and descriptive data.
One municipal bond related to a hospital was priced using significant unobservable inputs. Management reviewed the financials of the hospital, had discussions with hospital management and reviewed the underlying collateral for the municipal bond to determine an appropriate benchmark risk-adjusted interest rate based on transactions with similar risks. This benchmark rate was applied to a discounted cash flow analysis to determine the fair value as of December 31, 2008.
The carrying value of our investment securities at December 31, 2008 totaled $144.3 million compared to $166.3 million at December 31, 2007. The decline in securities during 2008 was mostly due to a decline in municipal bonds, as well as bonds issued by U.S. government agencies and government-sponsored entities. Generally, we did not replace the maturities or calls of agency and municipal bonds in 2008 or 2007.
Bank stocks are comprised mostly of stock of the Federal Reserve Bank of Kansas City, the Federal Home Loan Bank of Topeka and Bankers' Bank of the West. These stocks have restrictions placed on their transferability as only members of the entities can own the stock. During 2008, the Company reduced its required holdings in the Federal Reserve Bank of Kansas City by $4.6 million.
The following table shows the maturities of investment securities at December 31, 2008, and the weighted average yields of such securities, excluding the benefit of tax-exempt securities:
The marketable equity securities yield includes accretion income related to a purchase price adjustment on a security that will be redeemed at par in April 2009.
At December 31, 2008 and 2007, we held $28.3 million and $32.5 million, respectively, of other equity securities consisting of bank stocks with no maturity date, which are not reflected in the above schedule.
Total deposits were $1.7 billion at December 31, 2008, as compared to $1.8 billion at December 31, 2007. Our 2008 average noninterest bearing deposits constituted 26.2% of our 2008 average total deposits, which compares to 2007 average noninterest bearing deposits to 2007 total average deposits of 24.9%. Our noninterest-bearing demand deposits decreased by $81.5 million, to $433.8 million at December 31, 2008. Our interest bearing demand deposits, including money market and savings accounts, decreased by $275.2 million, to $528.9 million at December 31, 2008. This decrease is primarily attributable to a shift in the mix of deposits primarily between money markets and time deposits. The Company joined the Certificate of Deposit Account Registry Service (CDARS®) program in 2008, and a part of the shift to time deposits was a result of existing customers moving funds into the CDARS® program in order to obtain expanded FDIC insurance coverage on their deposits. Additionally, the Company shifted its own funding sources from short-term and overnight funds to brokered deposits in order to provide longer-term funding to mitigate the impact of potential short-term liquidity fluctuations with the overall financial services industry in the second half of 2008.
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, including brokered deposits, at the dates indicated:
The following table presents the mix of our deposits by type based on average balances for each of the periods indicated.
Overall average time deposits decreased by $47.7 million, or 8.5%, to $514.4 million for 2008 compared to $562.1 million for 2007. The actual balance of time deposits increased by $255.9 million during 2008 to $736.0 million at December 31, 2008 compared to $480.1 million at December 31, 2007. Of the ending time deposit balance, approximately $63.2 million is from the CDARS® program, and $189.2 million is from brokered deposits, compared to $60.2 million at December 31, 2007. Overall time deposits as a percent of total deposits were 43.3% at December 31, 2008 as compared to 26.7% at December 31, 2007. The overall cost of time deposits decreased