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Guaranty Bancorp 10-Q 2008
UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
FORM 10-Q
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2008
OR
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number: 000-51556
GUARANTY BANCORP (Exact name of registrant as specified in its charter)
303-293-5563 (Registrant’s telephone number, including area code)
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, as amended 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 x No 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 Exchange Act.): Yes o No x
As of July 31, 2008, there were 52,599,865 shares of the registrant’s common stock outstanding, including 1,612,141 shares of unvested stock grants and excluding 69,275 shares to be issued under its deferred compensation plan.
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Forward-Looking Statements and Factors that Could Affect Future ResultsCertain statements contained in this Quarterly Report on Form 10-Q that are not statements of historical fact constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 (the “Act”), notwithstanding that such statements are not specifically identified. In addition, certain statements may be contained in our future filings with the SEC, in press releases, and in oral and written statements made by or with our approval that are not statements of historical fact and constitute forward-looking statements within the meaning of the Act. Examples of forward-looking statements include, but are not limited to: (i) projections of revenues, expenses, income or loss, earnings or loss per share, the payment or nonpayment of dividends, capital structure and other financial items; (ii) statements of plans, objectives and expectations of the Company or its management or board of directors, including those relating to products or services; (iii) statements of future economic performance; and (iv) statements of assumptions underlying such statements. Words such as “believes”, “anticipates”, “expects”, “intends”, “targeted”, “continue”, “remain”, “will”, “should”, “may” and other similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements.
Forward-looking statements involve risks and uncertainties that may cause actual results to differ materially from those in such statements. Factors that could cause actual results to differ from those discussed in the forward-looking statements include, but are not limited to:
· Local, regional, national and international economic conditions and the impact they may have on us and our customers, and our assessment of that impact on our estimates including, but not limited to the allowance for loan losses and goodwill.
· Changes in the level of nonperforming assets and charge-offs.
· The effects of and changes in trade and monetary and fiscal policies and laws, including the interest rate policies of the Federal Open Market Committee of the Federal Reserve Board.
· Inflation and interest rate, securities market and monetary fluctuations.
· Political instability, acts of war or terrorism and natural disasters.
· The timely development and acceptance of new products and services and perceived overall value of these products and services by customers.
· Revenues are lower than expected.
· Changes in consumer spending, borrowings and savings habits.
· Changes in the financial performance and/or condition of our borrowers.
· Credit quality deterioration, which could cause an increase in the provision for loan losses.
· Technological changes.
· Acquisitions of acquired businesses and greater than expected costs or difficulties related to the integration of acquired businesses.
· The ability to increase market share and control expenses.
· Changes in the competitive environment among financial or bank holding companies and other financial service providers.
· The effect of changes in laws and regulations with which we and our subsidiaries must comply.
· Changes in the securities markets.
· The effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board, the Financial Accounting Standards Board and other accounting standard setters.
· Changes in our organization, compensation and benefit plans.
· The costs and effects of legal and regulatory developments, including the resolution of legal proceedings or regulatory or other governmental inquiries, the results of regulatory examinations or reviews,and the necessity of regulatory approval for dividend payments from the subsidiary bank to the Company.
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· Our success at managing the risks involved in the foregoing items.
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.
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PART I - FINANCIAL INFORMATION
ITEM 1. Unaudited Consolidated Financial Statements
GUARANTY BANCORP AND SUBSIDIARIES Unaudited Consolidated Balance Sheets
See “Notes to Unaudited Consolidated Financial Statements.”
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GUARANTY BANCORP AND SUBSIDIARIES Unaudited Consolidated Statements of Income
See “Notes to Unaudited Consolidated Financial Statements.”
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GUARANTY BANCORP AND SUBSIDIARIES Unaudited Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income
See “Notes to Unaudited Condensed Consolidated Financial Statements.”
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GUARANTY BANCORP AND SUBSIDIARIES Unaudited Consolidated Statements of Cash Flows
See “Notes to Unaudited Consolidated Financial Statements.”
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GUARANTY BANCORP AND SUBSIDIARIES Notes to Unaudited Condensed Consolidated Financial Statements
(1) Organization, Operations and Basis of Presentation
Guaranty Bancorp (formerly Centennial Bank Holdings, Inc.) is a financial holding company and a bank holding company registered under the Bank Holding Company Act of 1956, as amended. 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.
Our principal business is to serve as a holding company for our subsidiaries. As of June 30, 2008, Guaranty Bancorp has a single bank subsidiary, Guaranty Bank and Trust Company, referred to as Guaranty Bank or the Bank. At December 31, 2007, Guaranty Bancorp’s subsidiaries were Guaranty Bank and Centennial Bank of the West, referred to as CBW. CBW was merged into Guaranty Bank on January 1, 2008.
Reference to “Bank” means Guaranty Bank, and “we” or “Company” means Guaranty Bancorp on a consolidated basis with the Banks, if applicable. References to “Guaranty Bancorp” or to the holding company refer to the parent company on a stand-alone basis.
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, Small Business Administration guaranteed loans 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.
(a) Basis of Presentation
The accounting and reporting policies of the Company conform to generally accepted accounting principles in the United States of America. All significant intercompany balances and transactions have been eliminated. Our financial statements reflect all adjustments that are, in the opinion of management, necessary for a fair presentation of the financial position and results of operations for the periods presented. Certain information and note disclosures normally included in consolidated financial statements prepared in accordance with generally accepted accounting principles in the United States of America have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. The interim operating results are not necessarily indicative of operating results for the full year.
(b) Use of Estimates
The preparation of the consolidated financial statements in conformity with generally accepted accounting principles in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the dates of the consolidated balance sheets and income and expense for the periods presented. Actual results could differ significantly from those estimates. Material estimates that are particularly susceptible to significant changes include the assessment for impairment of certain investment securities, the allowance for loan losses, valuation of other real estate owned, deferred tax assets and liabilities, goodwill and other intangible assets and stock compensation expense. Assumptions and factors are evaluated on an annual basis or whenever events or changes in circumstance indicate that the previous assumptions and factors have changed. The result of the analysis could result in adjustments to the estimates.
(c) Allowance for Loan Losses
The allowance for loan losses is reported as a reduction of outstanding loan balances. The allowance for loan losses is a valuation allowance for probable incurred loan losses.
The allowance for loan losses is evaluated on a regular basis by management and based upon management’s periodic review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect borrowers’ ability to repay, estimated value of
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GUARANTY BANCORP AND SUBSIDIARIES Notes to Unaudited Condensed Consolidated Financial Statements (continued)
any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.
In addition to the allowance for loan losses, the Company records a reserve for unfunded commitments. Similar to the allowance for loan losses, the reserve for unfunded commitments is evaluated on a regular basis by management. This reserve is recorded in other liabilities and the provision for unfunded commitments is included in other noninterest expense.
(d) Goodwill and Other Intangible Assets
Goodwill represents the excess of cost over the fair value of the net assets of businesses acquired. Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are tested for impairment and not amortized. Intangible assets with definite useful lives are amortized over their estimated useful lives to their estimated residual values.
Goodwill is our only intangible asset with an indefinite life. The annual impairment analysis of goodwill includes identification of reporting units, the determination of the carrying value of each reporting unit, including the existing goodwill and intangible assets, and estimating the fair value of each reporting unit. We have identified one significant reporting unit – banking operations. The Company tests for impairment of goodwill annually as of October 31, or if an event occurs or circumstances change that would more likely than not reduce the fair value of the reporting unit. We determine the fair value of our reporting unit and compare it to its carrying amount. If the carrying amount of a reporting unit exceeds its fair value, we are required to perform a second step to the impairment test to measure the extent of the impairment.
Core deposit intangible assets, referred to as CDI, are recognized apart from goodwill at the time of acquisition based on valuations prepared by independent third parties or other estimates of fair value. In preparing such valuations, variables such as deposit servicing costs, attrition rates, and market discount rates are considered. CDI assets are amortized to expense over their useful lives, which we have estimated to range from 7 years to 15 years.
(e) Stock Incentive Plan
The Company’s Amended and Restated 2005 Stock Incentive Plan (“Plan”) provides for up to 2,500,000 grants of stock options, stock awards, stock units awards, performance stock awards, stock appreciation rights, and other equity-based awards to key employees, nonemployee directors, consultants and prospective employees. Through June 30, 2008, the Company has only granted stock awards. The Company accounts for the equity-based compensation using the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123R, Share-Based Payment. The Company recognizes expense for services received in a share-based payment transaction as services are received. That cost is recognized on a straight-line basis over the period during which an employee or director provides service in exchange for the award. The Company has issued stock awards that vest based on service periods from one to four years, performance conditions, and awards with both service periods and performance conditions. The performance-based share awards expire December 31, 2012. The compensation cost of employee and director services received in exchange for stock awards is based on the grant-date fair value of the award (as determined by quoted market prices). The stock compensation expense recognized reflects estimated forfeitures, adjusted as necessary based on actual forfeitures.
(f) Deferred Compensation Plans
The Company has Deferred Compensation Plans (the “Plans”) that allow directors and certain key employees to voluntarily defer compensation. Compensation expense is recorded for the deferred compensation and a related liability is recognized. Participants may elect designated investment options for the notional investment of their deferred compensation. The recorded obligations are adjusted for deemed income or loss related to the investments selected. Participants in certain Plans are given the opportunity to elect to have all or a portion of their deferred compensation earn a rate of return equal to the total return on the Company’s common stock. The Plans do not provide for diversification of a participant’s assets allocated to Company common stock and assets allocated to Company common stock can only be settled with a fixed number of shares of stock. In accordance with Emerging Issues Task Force Issue 97-14, Accounting for
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GUARANTY BANCORP AND SUBSIDIARIES Notes to Unaudited Condensed Consolidated Financial Statements (continued)
Deferred Compensation Arrangements Where Amounts Earned Are Held in a Rabbi Trust and Invested, the deferred compensation obligation associated with Company common stock is classified as a component of stockholders’ equity and the related shares are treated as shares to be issued and are included in total shares outstanding for earnings per share and balance sheet purposes only. At June 30, 2008 and December 31, 2007, the total shares outstanding included 69,275 and 60,507 shares, respectively, to be issued. Subsequent changes in the fair value of the common stock are not reflected in earnings or stockholders’ equity of the Company. Actual Company stock held by the Company for the satisfaction of obligations of the Plans is classified as treasury stock.
(g) Income taxes
Effective January 1, 2007, the Company adopted FASB Interpretation 48, Accounting for Uncertainty in Income Taxes (“FIN 48”). A 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 recognized is the largest amount of tax benefit that is greater than 50% likely to be realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded. The adoption of FIN 48 on January 1, 2007 had no effect on the Company’s financial statements.
The Company and its subsidiaries are subject to U.S. federal income tax and State of Colorado tax. The Company is no longer subject to examination by Federal or state taxing authorities for years before 2004. At June 30, 2008 and December 31, 2007, the Company did not have any unrecognized tax benefits. The Company does not expect the total amount of unrecognized tax benefits to significantly increase in the next twelve months. The Company recognizes interest related to income tax matters in other interest expense and penalties related to income tax matters in other noninterest expense. At June 30, 2008 and December 31, 2007, the Company does not have any amounts accrued for interest and penalties.
(h) Earnings per Common Share
Basic earnings per share represents income available to common stockholders divided by the weighted average number of common shares outstanding during the period. Diluted earnings per share reflect additional common shares that would have been outstanding if potential dilutive common shares had been issued. In accordance with SFAS No. 128 (As Amended), Earnings per Share, the Company’s obligation to issue shares of stock to participants in its deferred compensation plan has been treated as outstanding shares of stock in the basic earnings per share calculation. Dilutive common shares that may be issued by the Company relate to unvested common share grants subject to a service condition for the six-month periods ended June 30, 2008 and 2007. Outstanding restricted shares with an anti-dilutive impact, which are excluded from the earnings per common share computation, include performance-based shares and service-based shares that are not considered dilutive. For the six-months ended June 30, 2008 and 2007, the anti-dilutive restricted shares excluded from the earnings per common share computation are 1,599,380 and 1,542,088, respectively.
Earnings per common share have been computed based on the following:
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GUARANTY BANCORP AND SUBSIDIARIES Notes to Unaudited Condensed Consolidated Financial Statements (continued)
(i) Recently Issued Accounting Standards
Adoption of New Accounting Standards: In September 2006, the FASB issued Statement No. 157, Fair Value Measurements. This Statement defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. This Statement establishes a fair value hierarchy about the assumptions used to measure fair value and clarifies assumptions about risk and the effect of a restriction on the sale or use of an asset. The standard is effective for fiscal years beginning after November 15, 2007. In February 2008, the FASB issued Staff Position (FSP) 157-2, Effective Date of FASB Statement No. 157. This FSP delays the effective date of FAS 157 for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value on a recurring basis (at least annually), to fiscal years beginning after November 15, 2008, and interim periods within those fiscal years. The adoption of FAS 157 on January 1, 2008 did not have a material impact on the Company’s consolidated financial position, results of operations or cash flows. See Note 8 for further disclosure regarding the implementation of this accounting pronouncement.
In February 2007, the FASB issued Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities. The standard provides companies with an option to report selected financial assets and liabilities at fair value and establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. The new standard became effective for the Company on January 1, 2008. Upon adoption of this accounting pronouncement on January 1, 2008, the Company did not elect the fair value option for any financial assets or financial liabilities.
In September 2006, the FASB Emerging Issues Task Force finalized Issue No. 06-4, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements. This issue requires that a liability be recorded during the service period when a split-dollar life insurance agreement continues after participants’ employment or retirement. The required accrued liability will be based on either the post-employment benefit cost for the continuing life insurance or based on the future death benefit, depending on the contractual terms of the underlying agreement. This issue is effective for fiscal years beginning after December 15, 2007. Upon adoption of this issue on January 1, 2008, the Company recorded a cumulative effect adjustment to reduce beginning retained earnings as of January 1, 2008 by $71,000.
On November 5, 2007, the SEC issued Staff Accounting Bulletin No. 109, Written Loan Commitments Recorded at Fair Value through Earnings (“SAB 109”). Previously, SAB 105, Application of Accounting Principles to Loan Commitments, stated that in measuring the fair value of a derivative loan commitment, a company should not incorporate the expected net future cash flows related to the associated servicing of the loan. SAB 109 supersedes SAB 105 and indicates that the expected net future cash flows related to the associated servicing of the loan should be included in measuring fair value for all written loan commitments that are accounted for at fair value through earnings. SAB 105 also indicated that internally-developed intangible assets should not be recorded as part of the fair value of a derivative loan commitment, and SAB 109 retains that view. SAB 109 is effective for derivative loan commitments issued or modified in fiscal quarters beginning after December 15, 2007. The adoption of this SAB on January 1, 2008 did not have a material impact on the Company’s consolidated financial position, results of operations or cash flows.
Newly Issued But Not Yet Effective Accounting Standards: In December 2007, the FASB issued Statement No. 141R, Business Combinations (Revised) (“SFAS 141R”). SFAS 141R replaces the current standard on business combinations and will significantly change the accounting for and reporting of business combinations in consolidated financial statements. This statement requires an entity to measure the business acquired at fair value and to recognize goodwill attributable to any noncontrolling interests (previously referred to as minority interests) rather than just the portion attributable to the acquirer. The statement will also result in fewer exceptions to the principle of measuring assets acquired and liabilities assumed in a business combination at fair value. In addition, the statement will result in payments to third parties for consulting, legal, audit, and similar services associated with an acquisition to be recognized as expenses when incurred rather than capitalized as part of the business combination. SFAS 141R is effective for fiscal years beginning on or after December 15, 2008.
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GUARANTY BANCORP AND SUBSIDIARIES Notes to Unaudited Condensed Consolidated Financial Statements (continued)
In March 2008, the FASB issued Statement No. 161, Disclosures about Derivative Instruments and Hedging Activities an Amendment of FASB Statement No. 133 (“SFAS 161”). SFAS 161 amends Statement 133 by requiring expanded disclosures about an entity’s derivative instruments and hedging activities, but does not change Statement 133’s scope or accounting. This statement requires increased qualitative, quantitative, and credit-risk disclosures. SFAS 161 also amends Statement No. 107 to clarify that derivative instruments are subject to Statement 107’s concentration-of-credit-risk disclosures. SFAS 161 is effective for fiscal years beginning on or after November 15, 2008. The Company does not expect the adoption of SFAS 161 to have a material impact on the Company’s consolidated financial position, results of operations or cash flows.
In May 2008, the FASB issued Statement No. 162 The Hierarchy of Generally Accepted Accounting Principles (“SFAS 162”). SFAS 162 identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with GAAP in the United States (the GAAP Hierarchy). The Board issued this Statement because it is the entity (not its auditor) that is responsible for selecting accounting principles for financial statements that are presented in conformity with GAAP. Accordingly, the Board concluded that the GAAP hierarchy should reside in the accounting literature established by the FASB as opposed to auditing literature established by the AICPA and PCAOB. SFAS 162 is effective 60 days following the SEC’s approval of the PCAOB’s amendments to AU Section 411, The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles. The Company does not expect the adoption to have a material impact on the Company’s consolidated financial position, results of operations or cash flows.
In June 2008, the FASB issued Staff Position No. EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities (“FSP EITF 03-6-1”). The FSP addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting and, therefore, need to be included in the earnings allocation in computing EPS under the two-class method. The FSP affects entities that accrue cash dividends on share-based payment awards during the awards’ service period when the dividends do not need to be returned if the employees forfeit the awards. FSP EITF 03-6-1 is effective for fiscal years beginning after December 15, 2008. However, the Company does not accrue cash dividends and therefore does not anticipate there to be an impact on the Company’s consolidated financial position, results of operations or cash flows.
(2) Securities
The amortized cost and estimated fair value of debt securities are as follows:
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GUARANTY BANCORP AND SUBSIDIARIES Notes to Unaudited Condensed Consolidated Financial Statements (continued)
All individual securities that have been in a continuous unrealized loss position for 12 months or longer at June 30, 2008, have fluctuated in value since their purchase dates as a result of changes in market interest rates. These securities include securities issued by U.S. government agencies and government-sponsored entities that have an AAA credit rating as determined by various rating agencies or state and municipal bonds that have either been rated as investment grade or higher by various rating agencies or have been subject to an annual internal review process by management. This annual review process was updated in the second quarter 2008 for the largest non-rated municipal security in our portfolio. This particular bond had an increase in unrealized loss at June 30, 2008, as compared to December 31, 2007, as the rates on unsecured non-bank qualified securities increased during the period. The unrealized loss on this security comprises nearly 100% of the overall unrealized loss on state and municipal bonds. Based on the second quarter 2008 credit analysis of this particular bond, including a review of the issuer’s current financial statements, the related cash flows and interest payments, management concluded that the continuous unrealized loss position on this security was a result of the level of market interest rates and not a result of the underlying issuer’s ability to repay. Similarly, management concluded that the continuous unrealized loss position on all other securities was also a result of the level of market interest rates and not a result of the underlying issuers’ ability to repay. In addition, we have the ability and intent to hold these securities until their fair value recovers to their cost, which may be maturity. Accordingly, we have not recognized any other-than-temporary impairment in our consolidated statements of income.
(3) Loans
A summary of net loans held for investment by loan type at the dates indicated is as follows:
A summary of transactions in the allowance for loan losses for the period indicated is as follows:
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GUARANTY BANCORP AND SUBSIDIARIES Notes to Unaudited Condensed Consolidated Financial Statements (continued)
The following table details key information regarding the Company’s impaired loans at the dates indicated:
The gross interest income that would have been recorded in the year-to-date periods ended June 30, 2008 and June 30, 2007, if the loans had been current in accordance with their original terms and had been outstanding throughout the period or since origination, if held for part of the period, was $1,432,000 and $2,212,000, respectively. At June 30, 2008 and December 31, 2007, nonaccrual loans were $29,742,000 and $19,309,000, respectively.
(4) Goodwill and Other Intangible Assets
Goodwill and other intangible assets arise from business combinations. Goodwill and other intangible assets deemed to have indefinite lives generated from purchase combinations are tested for impairment no less than annually.
Other intangible assets with definite lives are amortized over their respective estimated useful lives to their estimated residual values. The amortization expense represents the estimated decline in the value of the underlying deposits or loan customers acquired.
The carrying amount of goodwill was $250,748,000 for the periods ended June 30, 2008 and December 31, 2007.
The following table presents the gross amounts of core deposit and customer relationship intangibles and the related accumulated amortization at the dates indicated:
Following is the aggregate amortization expense recognized in each period:
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GUARANTY BANCORP AND SUBSIDIARIES Notes to Unaudited Condensed Consolidated Financial Statements (continued)
(5) Borrowings
At June 30, 2008, our outstanding borrowings were $147,117,000 as compared to $63,715,000 at December 31, 2007. These borrowings at June 30, 2008 consisted of term notes at the Federal Home Loan Bank (“FHLB”). There was also a line of credit at the FHLB at June 30, 2008, but there was no balance outstanding on this line of credit on such date. At December 31, 2007, borrowings consisted of a line of credit and term notes at the Federal Home Loan Bank of $15,160,000 and $47,356,000 respectively, and a $1,199,000 Treasury Tax and Loan note balance.
The total commitment, including balances outstanding, for borrowings at the Federal Home Loan Bank for the term notes and line of credit at June 30, 2008 and December 31, 2007 was $341.5 million and $316.2 million, respectively. The interest rate on the line of credit varies with the federal funds rate, and was 2.55% and 5.51% at June 30, 2008 and December 31, 2007, respectively. The term notes have fixed interest rates that range from 2.52% to 6.22%. A blanket pledge and security agreement with the Federal Home Loan Bank, which encompasses certain loans and securities, serves as collateral for these borrowings.
We have a revolving credit agreement with U.S. Bank National Association which contains financial covenants, including maintaining a minimum return on average assets, a maximum nonperforming assets to total loans ratio, a minimum allowance for loan losses to nonperforming loan ratio and regulatory capital ratios that qualify the Company as well-capitalized. As of August 6, 2008, the amount of the line of credit was decreased from $70 million to $40 million. As of June 30, 2008, the Company did not have any amount drawn on this line. As of June 30, 2008, the Company is in compliance with all outstanding financial covenants, as amended. The interest rate varies based on a spread over the federal funds rate, with a rate of 3.49% at June 30, 2008. The credit agreement is secured by Guaranty Bank stock.
(6) Subordinated Debentures and Trust Preferred Securities
The Company had $41,239,000 in aggregate principal balances of subordinated debentures outstanding with a weighted average cost of 7.39% and 8.97% at June 30, 2008 and December 31, 2007, respectively. The subordinated debentures were issued in four separate series. Each issuance has a maturity of thirty years from its date of issue. The subordinated debentures were issued to trusts established by the Company, which in turn issued $40 million of trust preferred securities. Generally and with certain limitations, the Company is permitted to call the debentures subsequent to the first five or ten years, as applicable, after issue if certain conditions are met, or at any time upon the occurrence and continuation of certain changes in either the tax treatment or the capital treatment of the trusts, the debentures or the preferred securities. As of June 30, 2008, the Company was in compliance with all covenants of these subordinated debentures.
These securities are currently included in Tier I capital for purposes of determining the Company’s Tier I and total risk-based capital ratios. The Board of Governors of the Federal Reserve System, which is the holding company’s banking regulator, has promulgated a modification of the capital regulations affecting trust preferred securities. Under this modification, beginning March 31, 2009, the Company will be required to use a more restrictive formula to determine the amount of trust preferred securities that can be included in regulatory Tier I capital. At that time, the Company will be allowed to include in Tier I capital an amount of trust preferred securities equal to no more than 25% of the sum of all core capital elements, which is generally defined as stockholders’ equity less certain intangibles, including goodwill, core deposit intangibles and customer relationship intangibles, net of any related deferred income tax liability. The regulations currently in effect limit the amount of trust preferred securities that can be included in Tier I capital to 25% of the sum of core capital elements without a deduction for permitted intangibles.
The Guaranty Capital Trust III trust preferred issuance on June 30, 2003, was callable as of July 7, 2008. The Company did not call this security on July 7, 2008. After July 7, 2008, this issuance is callable on each quarterly interest payment date.
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GUARANTY BANCORP AND SUBSIDIARIES Notes to Unaudited Condensed Consolidated Financial Statements (Continued)
The following table summarizes the terms of each subordinated debenture issuance at June 30, 2008 (dollars in thousands):
* Call date represents the earliest date the Company can call the debentures.
(7) Commitments
The Company is a party to credit-related financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, stand-by letters of credit and commercial letters of credit. Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets.
The Company’s exposure to credit loss is represented by the contractual amount of these commitments. The Company follows the same credit policies in making commitments as it does for on-balance sheet instruments.
At the dates indicated, the following commitments were outstanding:
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Several of the commitments may expire without being drawn upon. Therefore, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained, if it is deemed necessary by the Company, is based on management’s credit evaluation of the customer.
Commitments to extend credit under overdraft protection agreements are commitments for possible future extensions of credit to existing deposit customers. These lines of credit are uncollateralized and usually do not contain a specified maturity date and might not be drawn upon to the total extent to which the Company is committed.
Stand-by letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Those letters of credit are primarily issued to support public and private borrowing arrangements. Substantially all letters of credit issued have expiration dates within one year. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Company generally holds collateral supporting those commitments if deemed necessary.
The Company enters into commercial letters of credit on behalf of its customers, which authorize a third party to draw drafts on the Company up to a stipulated amount and with specific terms and conditions. A commercial letter of credit is a conditional commitment on the part of the Company to provide payment on drafts drawn in accordance with the terms of the commercial letter of credit.
(8) Fair Value Measurements and Fair Value of Financial Instruments
Effective January 1, 2008, the Company adopted FASB Statement No. 157, Fair Value Measurements (“SFAS No. 157”). SFAS No. 157 clarifies that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. Under SFAS No. 157, fair value measurements are not adjusted for transaction costs. SFAS No. 157 establishes a fair value hierarchy
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GUARANTY BANCORP AND SUBSIDIARIES Notes to Unaudited Condensed Consolidated Financial Statements (Continued)
that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1measurements) and the lowest priority to unobservable inputs (level 3 measurements). The three levels of the fair value hierarchy under SFAS No. 157 are described below:
Basis of Fair Value Measurement:
Level 1 - Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets.
Level 2 - Significant other observable inputs other than Level 1 prices such as quoted prices in markets that are not active, quoted prices for similar assets, or other inputs that are observable, either directly or indirectly, for substantially the full term of the asset.
Level 3 - Prices or valuation techniques that require inputs that are both significant to the fair value measurement and are unobservable (i.e., supported by little or no market activity).
A financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.
The fair values of securities available for sale 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 (Level 2 inputs).
Level 3 is for positions that are not traded in active markets or are subject to transfer restrictions, and/or where valuations are adjusted to reflect illiquidity and/or non-transferability. Such adjustments are generally based on available market evidence. In the absence of such evidence, management’s best estimate is used. Management’s best estimate consists of both internal and external support on certain Level 3 investments. Internal cash flow models using a present value formula along with indicative exit pricing obtained from broker/dealers were used to fair value support certain Level 3 investments. Subsequent to inception, management only changes level 3 inputs and assumptions when corroborated by evidence such as transactions in similar instruments, completed or pending third-party transactions in the underlying investment or comparable entities, subsequent rounds of financing, recapitalizations and other transactions across the capital structure, offerings in the equity or debt markets, and changes in financial ratios or cash flows.
Impaired loans are evaluated and valued at the time the loan is identified as impaired, at the lower of cost or fair value. Fair value is measured based on the value of the collateral securing these loans and is classified at a level 3 in the fair value hierarchy. Collateral may be real estate and/or business assets including equipment, inventory and/or accounts receivable and is determined based on appraisals by qualified licensed appraisers hired by the Company. Appraised and reported values may be discounted based on management’s historical knowledge, changes in market conditions from the time of valuation, and/or management’s expertise and knowledge of the client and client’s business. Impaired loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly, based on the same factors identified above.
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GUARANTY BANCORP AND SUBSIDIARIES Notes to Unaudited Condensed Consolidated Financial Statements (Continued)
The following table sets forth the Company’s financial assets that were accounted for at fair value and are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.
The following represent assets and liabilities measured at fair value on a non-recurring basis:
Impaired loans with a valuation allowance based upon fair value of the underlying collateral had a carrying amount of $22,454,000 at June 30, 2008 as compared to $14,757,000 at March 31, 2008 and $16,663,000 at December 31, 2007. The valuation allowance on impaired loans was $6,295,000 at June 30, 2008 as compared to $5,368,000 at March 31, 2008 and $4,283,000 at December 31, 2007. During the three and six-month periods ended June 30, 2008, additional provisions for loan losses of approximately $0.9 million and $2.0 million were made for impaired loans, respectively.
(9) Stock-Based Compensation
Under the Company’s Amended and Restated 2005 Stock Incentive Plan (the “Incentive Plan”), the Company may grant stock-based compensation awards to nonemployee directors, key employees, consultants and prospective employees under the terms described in the Incentive Plan. The allowable stock-based compensation awards include the grant of Options, Restricted Stock Awards, Restricted Stock Unit Awards, Performance Stock Awards, Stock Appreciation Rights and other Equity-Based Awards. The Incentive Plan provides that eligible participants may be granted shares of Company common stock that are subject to forfeiture until the grantee vests in the stock award based on the established conditions, which include service conditions and established performance measures.
Prior to vesting of the stock awards with a service vesting condition, each grantee shall have the rights of a stockholder with respect to voting of the granted stock. The recipient is not entitled to dividend rights with respect to the shares of granted stock until vesting occurs. Prior to vesting of the stock awards with performance vesting conditions, each grantee shall have the rights of a stockholder with respect to voting of the granted stock. The recipient is not entitled to dividend rights with respect to the shares of granted stock until initial vesting occurs, at which time the dividend rights will exist on vested and unvested shares of granted stock, subject to termination of such rights under the terms of the Incentive Plan.
Other than the stock awards with service and performance-based vesting conditions, no grants have been made under the Incentive Plan. The Incentive Plan authorizes grants of stock-based compensation awards of up to 2,500,000 shares of Company common stock, subject to adjustments provided by the Incentive Plan. As of June 30, 2008 and December 31, 2007, there were 1,689,608 and 1,651,345 shares of unvested stock granted (net of forfeitures and vestings), with 625,044 and 754,644 shares available for grant under the Incentive Plan, respectively.
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GUARANTY BANCORP AND SUBSIDIARIES Notes to Unaudited Condensed Consolidated Financial Statements (Continued)
A summary of the status of our outstanding stock awards and the change during the period is presented in the table below:
The Company recognized $1,550,000 and $1,708,000 in stock-based compensation expense for services rendered for the six months ended June 30, 2008 and 2007, respectively. The total income tax benefit recognized in the consolidated income statement for share-based compensation arrangements was $385,153 and $650,000 for the six months ended June 30, 2008 and 2007, respectively. At June 30, 2008, compensation cost of $6,101,000 related to nonvested awards not yet recognized is expected to be recognized over a weighted-average period of 1.8 years. During the first six months of 2008, the value of the vested awards was approximately $479,000. Of the 1,689,608 shares outstanding at June 30, 2008, approximately 1,223,000 shares are expected to vest.
(10) Capital Ratios
At June 30, 2008 and December 31, 2007, the Company had leverage ratios of 9.51% and 8.55%, Tier 1 risk-weighted capital ratios of 9.75% and 9.62%, and total risk-weighted capital ratios of 11.01% and 10.87%, respectively.
The Company actively monitors its regulatory capital ratios to ensure that the Company and its bank subsidiary are well capitalized under the applicable regulatory framework.
(11) Total Comprehensive Income (Loss)
The following table presents the components of other comprehensive loss and total comprehensive income (loss) for the periods presented:
(12) Contingencies
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 other legal actions to which we are currently a party, cannot presently be ascertained with certainty, in the opinion of management, based upon information currently available to us, any resulting liability is not likely to have a material adverse effect on the Company’s consolidated financial position, results of operations or cash flows.
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ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This MD&A should be read together with our unaudited Condensed Consolidated Financial Statements and unaudited Statistical Information included elsewhere in this Report and Items 1, 1A, 6, 7, 7A and 8 of our 2007 Annual Report on Form 10-K. Also, please see the disclosure in the “Forward-Looking Statements and Factors that Could Affect Future Results” section in this report for certain other factors that could cause actual results or future events to differ materially from those anticipated in the forward-looking statements included in this Report or from historical performance.
Overview
Guaranty Bancorp is a financial holding company and a bank holding company with the principal business to serve as a holding company to its subsidiaries. Unless the context requires otherwise, the terms “Company,” “us,” “we,” and “our” refers to Guaranty Bancorp on a consolidated basis.
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.
Through our banking subsidiary, we provide 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. These banking products and services include accepting time and demand deposits, originating commercial loans including energy loans, real estate loans, including construction and mortgage loans, Small Business Administration guaranteed loans and consumer loans. We derive our income primarily from interest received on real estate-related loans, commercial loans and leases and consumer loans and, to a lesser extent, from fees on the referral of loans, interest on investment securities and fees received in connection with servicing loan and deposit accounts. Our major operating expenses are the interest we pay on deposits and borrowings and general operating expenses. We rely primarily on locally generated deposits to provide us with funds for making loans.
We are subject to competition from other financial institutions and our operating results, like those of other financial institutions operating exclusively or primarily in Colorado, are significantly influenced by economic conditions in Colorado, including the strength of the real estate market. In addition, both the fiscal and regulatory policies of the federal government and regulatory authorities that govern financial institutions and market interest rates also impact our financial condition, results of operations and cash flows.
As of December 31, 2007, we had two banking subsidiaries. Those subsidiaries were Guaranty Bank and Trust Company and Centennial Bank of the West, which we sometimes refer to as Guaranty Bank and CBW, respectively. On January 1, 2008, CBW was merged into Guaranty Bank.
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Earnings Summary
Table 1 summarizes certain key financial results for the periods indicated:
Table 1
The $2.0 million second quarter 2008 net income is $8.8 million higher than the second quarter 2007 net loss primarily due to the after-tax impact of a $11.9 million decrease in the provision for loan losses and a $7.9 million decrease in noninterest expense, partially offset by a $5.6 million decline in net interest income. The decrease in noninterest expense is due mostly to additional charges of $6.5 million in connection with the settlement of a lawsuit and $1.0 million related to the merger of our subsidiary banks recorded in the second quarter 2007.
On a year-to-date basis, net income for the first six months of 2008 is $6.7 million higher than the same period in 2007, due mostly to a $11.8 million reduction in the provision for loan losses and a $9.9 million reduction in noninterest expense, partially offset by a decrease in net interest income. The decline in noninterest expense is mostly attributable to additional charges of $6.5 million in connection with the settlement of a lawsuit and $1.0 million related to the merger of our subsidiary banks recorded in the second quarter 2007. Additionally, salaries and employee benefit expense decreased by $2.8 million.
Net Interest Income and Net Interest Margin
Net interest income, which is our primary source of income, represents the difference between interest earned on assets and interest paid on liabilities. The interest rate spread is the difference between the yield on our interest-bearing assets and liabilities. Net interest margin is net interest income expressed as a percentage of average interest-earning assets.
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The following table summarizes the Company’s net interest income and related spread and margin for the current quarter and prior four quarters:
Table 2
Second quarter 2008 net interest income of $20.4 million declined by $5.6 million from the second quarter 2007. This decrease is a result of a $4.9 million unfavorable rate variance and a $0.7 million unfavorable volume variance (see Table 5).
The unfavorable rate variance from the prior year second quarter is primarily attributable to lower yields on earnings assets, and in particular loans. The yield on earning assets declined by 180 basis points from 8.02% for the second quarter 2007 to 6.22% for the second quarter 2008. During that same period, the Federal Open Markets Committee (FOMC) of the Federal Reserve Board decreased the target federal funds rate seven times by a total of 325 basis points. Similarly, the prime rate decreased by 325 basis points during this same period. Approximately 66% of the Company’s outstanding loan balances are variable rate loans and are tied to indices such as prime, LIBOR or federal funds. As a result of these rate declines, the average yield on loans for the Company decreased by 201 basis points from 8.33% for the quarter ended June 30, 2007 to 6.32% for the same period in 2008. Rates paid on interest-bearing liabilities also declined during this same period by 132 basis points, for a net decrease in the net interest spread of 48 basis points over this same period. Although the net interest spread decreased by 48 basis points, the overall net interest margin declined by 80 basis points. The cause for the larger impact on net interest margin as compared to the interest rate spread is that the benefit from noninterest bearing deposits had a smaller impact in 2008 compared to 2007 due to the lower interest rate environment.
The unfavorable volume variance is mostly attributable to a $131.3 million decrease in average earning assets for the second quarter 2008 as compared to the same period in 2007. The average balance of loans declined from the prior year by $94.2 million. Most of this decline is attributable to management’s decision to reduce the number of construction loans. The construction loan balance decreased by $89.5 million from June 30, 2007 to June 30, 2008. Additionally, approximately $48 million of certain nonperforming and classified loans were sold in October 2007.
The following table summarizes the Company’s net interest income and related spread and margin for the year-to-date periods presented:
Table 3
For the six-month period ended June 30, 2008, net interest income decreased by $10.8 million, or 20.4%, as compared to the same period in 2007. This decrease is due to a $8.5 million unfavorable rate variance and a $2.3 million unfavorable volume variance (see Table 5).
The unfavorable rate variance for year-to-date 2008 is mostly due to a decrease in the yield on earning assets. The yield on earning assets decreased by 156 basis points to 6.52% for the six months ended June 30, 2008 from 8.08% for the same period in 2007. During that same period, the Federal Open Markets Committee (FOMC) of the Federal Reserve Board decreased the target federal funds rate seven times by a total of 325 basis points. Similarly,
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the prime rate decreased by 325 basis points during this same period. These rate decreases were partially offset by a 103 basis point decrease in the cost of interest-bearing liabilities. The cost of interest-bearing liabilities was 2.98% for the first six months of 2008 as compared to 4.01% for the same period in 2007.
The unfavorable volume variance is mostly a result of lower average earning assets. Average earning assets decreased by $136.3 million for the year-to-date 2008 as compared to the same period in 2007. Approximately $118.1 million of this decrease was mostly due to a decline in construction loans, as well as a sale of a portion of certain nonperforming and classified loans in October 2007. Most of the remainder of the decrease is due to a decrease in the average balance of tax-exempt securities.
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The following table presents, for the periods indicated, average assets, liabilities and stockholders’ equity, as well as the net interest income from average interest-earning assets and the resultant annualized yields expressed in percentages. Nonaccrual loans are included in the calculation of average loans while accrued interest thereon is excluded from the computation of yields earned.
Table 4
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