CoBiz 10-K 2011
Documents found in this filing:
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
x Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
For the fiscal year ended December 31, 2010.
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 001-15955
COBIZ FINANCIAL INC.
(Exact name of registrant as specified in its charter)
Registrants telephone number, including area code: (303) 293-2265
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 x
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 x
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 x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of the registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. 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
The aggregate market value of the voting common equity held by non-affiliates of the registrant at June 30, 2010, computed by reference to the closing price on the NASDAQ Global Select Market was $152,652,691. Shares of voting stock held by each officer and director and by each person who owns 5% or more of the outstanding voting stock (as publicly reported by such persons pursuant to Section 13 and Section 16 of the Securities Exchange Act of 1934) have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.
The number of shares outstanding of the registrants sole class of common stock February 8, 2011, was 36,876,658.
Documents incorporated by reference: Portions of the registrants proxy statement to be filed with the Securities and Exchange Commission in connection with the registrants 2011 annual meeting of shareholders are incorporated by reference into Part III of this Form 10-K.
CoBiz Financial Inc. Annual Report 2010
A WARNING ABOUT FORWARD-LOOKING STATEMENTS
This report contains forward-looking statements that describe CoBiz Financials future plans, strategies and expectations. All forward-looking statements are based on assumptions and involve risks and uncertainties, many of which are beyond our control and which may cause our actual results, performance or achievements to differ materially from the results, performance or achievements contemplated by the forward-looking statements. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. They often include words such as believe, expect, anticipate, intend, plan, estimate or words of similar meaning, or future or conditional verbs such as would, should, could or may. Forward-looking statements speak only at the date they are made. Important factors that could cause actual results to differ materially from our expectations are disclosed under Risk Factors and elsewhere in this report, including, without limitation, in conjunction with the forward-looking statements included in this report.
We undertake no obligation to publicly update or otherwise revise any forward-looking statements, whether as a result of new information, future events or otherwise.
CoBiz Financial Inc. (CoBiz or the Company) is a diversified financial services company headquartered in Denver, CO. Through our subsidiary companies, we combine elements of personalized service found in community banks with sophisticated financial products and services traditionally offered by larger regional banks that we market to our targeted customer base of professionals, high-net-worth individuals and small to mid-sized businesses. At December 31, 2010, we had total assets of $2.4 billion, net loans of $1.6 billion and deposits of $1.9 billion. We were incorporated in Colorado on February 19, 1980, as Equitable Bancorporation, Inc.
Our wholly owned subsidiary CoBiz Bank (the Bank) is a full-service business banking institution serving two markets, Colorado and Arizona. In Colorado, the Bank operates under the name Colorado Business Bank and has 12 locations, including nine in the Denver metropolitan area, one in Boulder and two in the Vail area. In Arizona, the Bank operates under the name Arizona Business Bank and has seven locations serving the Phoenix metropolitan area and the surrounding area of Maricopa County. Each of the Banks locations is led by a local president with substantial decision-making authority. We focus on attracting and retaining high-quality personnel by maintaining an entrepreneurial culture and a decentralized business approach. We centrally support our bank and fee-based businesses with back-office services from our downtown Denver offices.
Our banking products are complemented by our fee-based business lines, which we first introduced in 1998 when we began offering trust and estate administration services. Through a combination of internal growth and acquisitions, our fee-based business lines have grown to include employee benefits brokerage and consulting, insurance brokerage, wealth transfer planning, investment banking and investment management services. We believe offering such complementary products allows us to both broaden our relationships with existing customers and attract new customers to our core business. In addition, we believe the fees generated by these services will increase our noninterest income and decrease our dependency on net interest income.
On December 31, 2007, we acquired Wagner Investment Management, Inc. (Wagner), a Denver-based SEC-registered investment advisory firm providing investment management services for high-net-worth individuals and families, foundations and non-profit organizations. The acquisition was accounted for
using the purchase method of accounting, and accordingly, the results of Wagner have been included in the consolidated financial statements since the date of purchase.
On January 2, 2008, we acquired all the assets and employees of Bernard Dietrich & Associates (BDA), a Phoenix-based property & casualty (P&C) insurance broker, through our subsidiary, CoBiz Insurance, Inc. Founded in 1993, BDA (which is now operated by CoBiz Insurance, Inc. under the name CoBiz Insurance-AZ) provides commercial and personal property and casualty insurance brokerage, as well risk management consulting services to individuals and businesses. The asset purchase was accounted for using the purchase method of accounting, and accordingly, the results of BDA have been included in the consolidated financial statements since the date of purchase.
In 2009, the Company hired a Director of Wealth Management to lead its wealth management initiative and to facilitate organic growth. The Companys wealth management initiative is comprised primarily of the activities in the Investment Advisory and Trust segment. One of the primary initiatives of this new role was to evaluate our current product offerings and to strategically focus our offerings to our customers, while also increasing the Companys operational efficiency. In conjunction with the strategic initiative to create a focused wealth management offering, the Company changed its operating segments in the third quarter of 2010 to reflect an internal realignment of its wealth management components. As part of this change, the Investment Advisory and Trust segment that was previously reported has been renamed Wealth Management and a business line has been moved from Insurance into the new Wealth Management segment. Concurrent with the segment realignment, the Company merged Wagner into Alexander Capital Management Group, LLC. (ACMG), another wholly-owned subsidiary that is a SEC-registered investment advisory firm, and renamed the surviving entity CoBiz Investment Management, LLC. All prior period disclosures have been adjusted to conform to the new presentation.
We operate five distinct segments, as follows:
· Commercial Banking
· Investment Banking
· Wealth Management
· Corporate Support and Other
These segments, excluding Corporate Support and Other, consist of various products and activities that are set forth in the following chart:
For a complete discussion of the segments included in our principal activities and certain financial information for each segment, see Note 19 to the Consolidated financial statements.
Our mission is to serve the complete financial needs of successful businesses, business owners, professionals and high-net worth individuals. We create thoughtful, integrated, comprehensive solutions tailored to each customers needs, thereby freeing them to succeed personally and professionally. Our long-term goal is to return economic value to our shareholders at a better risk-adjusted return than that of our competitors.
Our core values are:
· Focus on the customer
· Place people at the core
· Act with integrity
· Give back to the community
· Create sustained shareholder value
· Have fun and be well
Our primary strategy is to differentiate ourselves from our competitors by providing our local presidents with substantial decision-making authority, and expanding our products and services to build long-term relationships that meet the needs of professionals, small to medium-sized businesses and high-net-worth individuals. In all areas of our operations, we focus on attracting and retaining the highest-quality personnel by maintaining an entrepreneurial culture and decentralized business approach. In order to realize our strategic objectives, we are pursuing the following strategies:
Organic Growth. We believe the Colorado and Arizona markets provide us with significant long-term opportunities for internal growth. These markets continue to be dominated by a number of large regional
and national financial institutions that have acquired locally based banks. We believe this consolidation has created gaps in the banking industrys ability to serve certain customers in these market areas because small and medium-sized businesses often are not large enough to warrant significant marketing focus and customer service from large banks. In addition, we believe these banks often do not satisfy the needs of professionals and high-net-worth individuals who desire personal attention from experienced bankers. Similarly, we believe many of the remaining independent banks in the region do not provide the sophisticated banking products and services such customers require. Through our ability to combine personalized service, experienced personnel who are established in their community, sophisticated technology and a broad product line, we believe we will continue to achieve strong internal growth by attracting customers currently banking at both larger and smaller financial institutions and by expanding our business with existing customers.
The Company hired Colorado and Arizona market presidents for the Bank during 2009. The new market presidents are responsible for overseeing the Banks locations and providing direction for future growth. Both of the market presidents have substantial experience in the regional marketplace.
The following table details the percentage of deposits held by the Company in Arizona and Colorado, as well as other banks headquartered in our market areas and out-of-state banks as reported by the Federal Deposit Insurance Corporation (FDIC) at June 30, 2010.
De novo branching. We also intend to continue exploring growth opportunities to expand through de novo branching in areas with high concentrations of our target customers in Colorado, Arizona and other western states. This strategy has been successful in Colorado and Arizona. Since the acquisition of the Company by private investors in 1994, we have introduced 10 Colorado and four Arizona de novo locations. Management continues to monitor opportunities for expansion in the western United States.
Fee-based business lines. We began offering trust and estate administration services in 1998; employee benefits brokerage and consulting in 2000; P&C insurance brokerage and investment banking services in 2001; and high-end life insurance, wealth transfer planning and investment management services in 2003. The 2007 addition of Wagner to CoBizs investment management offerings increased our reach in the Colorado market. The 2008 acquisition of the assets and employees of BDA expanded the P&C business in the Arizona market.
When evaluating complementary business lines, the Company considers:
· Businesses where the revenue potential can be enhanced by our core banking franchise Businesses that provide financial services and related products to our target market.
· Businesses where clients value relationships, service and product quality over price.
· Businesses with sustainable operating margins.
Establish strong brand awareness. We have developed a cohesive and comprehensive approach to our internal and external communications efforts to leverage the power of each subsidiary as part of the larger company. Our brand platform has unified the look and feel of the CoBiz identity across the Company. With a target market that is similar across subsidiaries, our strong brand awareness helps generate cross-sell opportunities while strengthening client relationships.
Expanding existing banking relationships. We are normally not a transactional lender and typically require that borrowers enter into a multiple-product banking relationship with us, including deposits and
treasury management services, in connection with the receipt of credit from the Bank. We believe such relationships provide us the opportunity to introduce our customers to a broader array of the products and services offered by us and generate additional noninterest income. In addition, we believe this philosophy aids in customer retention.
Capitalizing on the use of technology. We believe we have been able to distinguish ourselves from traditional community banks operating in our market through the use of technology. Our data-processing system allows us to provide upgraded Internet banking, expanded treasury management products, check and document imaging, as well as a 24-hour voice response system. Other services currently offered by the Bank include retail and wholesale lockbox, positive pay, controlled disbursement, repurchase agreements and sweep investment accounts. In addition to providing sophisticated services for our customers, we utilize technology extensively in our internal systems and operational support functions to improve customer service, maximize efficiencies, and provide management with the information and analysis necessary to manage our growth effectively.
Emphasizing high-quality customer service. We believe our ability to offer high-quality customer service provides us with a competitive advantage over many regional banks that operate in our market areas. We emphasize customer service in all aspects of our operations and identify customer service as an integral component of our employee training programs. Moreover, we are constantly exploring methods to make banking an easier and more convenient process for our customers. For example, we offer a courier service to pick up deposits for customers who are not in close proximity to any of the Banks 19 locations, are not using our remote deposit capture product or simply do not have the time to go to the Bank.
Maintaining asset quality. We seek to maintain asset quality through a program that includes regular reviews of loans by responsible loan officers and ongoing monitoring of the loan portfolio by a loan review department that reports to the Chief Operations Officer of the Company but submits reports directly to the audit committee of our Board of Directors. At December 31, 2010, our ratio of nonperforming loans to total loans was 2.60%, compared to 4.44% at December 31, 2009.
The slowdown in the overall economy has negatively impacted our asset quality since the end of 2008. In response to the deteriorating economic conditions and the increase in our nonperforming assets, we created a Special Assets Group in 2009 to focus on resolving problem assets. This group is led by a senior banking officer who has been with the Bank for 14 years and previously served as the Banks Chief Operations Officer. All loans in a default or workout status are assigned to the Special Assets Group. The Special Assets Group meets with representatives from each bank location on a monthly basis. In addition, to further strengthen our procedures over asset quality, we divided our loan review function into two separate departments during 2009: loan review and credit administration. We believe these actions have facilitated recovery strategies, reduced credit losses and directly contributed to the reduction in the level of nonperforming loans during 2010.
Controlling interest rate risk. We seek to control our exposure to changing interest rates by attempting to maintain an interest rate profile within a narrow range around an earnings neutral position. An important element of this focus has been to emphasize variable-rate loans and investments funded by deposits that also mature or reprice over periods of 12 months or less. We have also implemented interest rate floors in many of our variable rate loans in order to preserve our net interest income in the event of interest rate decreases. We actively monitor our interest rate profile in regular meetings of our Asset-Liability Management Committee.
Achieving efficiencies and economies of scale through centralized administrative and support operations. We seek to maximize operational and support efficiencies in a manner consistent with maintaining high-quality customer service. We have consolidated various management and administrative functions including accounting, data processing, bookkeeping, credit administration, loan operations, and investment and treasury management services at our downtown Denver offices. Most recently, new positions within the Company including a Chief Operations Officer, Director of Deposit Services and a Director of Wealth Management were created to coordinate the growing operational departments, guide
deposit gathering efforts of the Bank and enhance our wealth management products. We believe this structure allows our business development professionals to focus on customer service and sales strategies directed at each community that we serve.
Acquisitions. We intend to continue to explore acquisitions of financial institutions or financial service entities, including opportunities in Colorado, Arizona and other western states. Our approach to expansion is predicated on recruiting key personnel to lead new initiatives. While we normally consider an array of new locations and product lines as potential expansion initiatives, we will generally proceed only upon identifying quality management personnel with a loyal customer following in the community or experienced in the product line that is the target of the initiative. We believe focusing on individuals who are established in their communities and experienced in offering sophisticated financial products and services will enhance our market position and add growth opportunities. We believe the downturn in the financial services market between 2008 and 2010 has increased acquisition opportunities as entities that are undercapitalized look to partner with a stronger financial entity.
Market Areas Served
We operate in two western markets in the United States Colorado and Arizona. These markets are currently dominated by a number of large regional and national financial institutions that have acquired locally based banks. The Companys success is dependent to a significant degree on the economic conditions of these two geographical markets. The current economic downturn has negatively impacted both markets. The Colorado market was slower to enter the recession than other areas of the Country. Conversely, the Arizona market was one of the states that led the nation into the recession and has been significantly impacted by unemployment, job losses and foreclosure rates. However, the long-term prospects of both markets remain solid due to the diversity of industry sectors, educated workforces and reputation as quality of life markets.
Our market areas include the Denver metropolitan area, which is comprised of the counties of Denver, Boulder, Adams, Arapahoe, Douglas, Broomfield and Jefferson; the Vail Valley, in Eagle County; and the Phoenix metropolitan area, which is located principally in Maricopa County.
Colorado. Denvers economy has diversified over the years with significant representation in various industries. The Denver metropolitan area is one of the fastest-growing regions in the nation, helping to make Colorado the seventh-fastest growing state in the United States in terms of percentage population growth from April 2000 to July 2009. We have two locations each in downtown Denver, Littleton and the Vail Valley, and one location each in Boulder, Commerce City, Cherry Creek, the Denver Technological Center (DTC), Golden and Louisville.
Arizona. Arizona consistently had one of the highest population growth rates in the nation during the latter half of the 20th century, including being the second fastest-growing states in terms of percentage population growth from April 2000 to July 2009. Our banks are located in Maricopa County, one of the nations largest counties in terms of population size.
Market Snapshot. The following table contains selected data for the markets we serve.
CoBiz and its subsidiaries face competition in all of our principal business activities, not only from other financial holding companies and commercial banks, but also from savings and loan associations, credit unions, finance companies, mortgage companies, leasing companies, insurance companies, investment advisors, mutual funds, securities brokers and dealers, investment banks, other domestic and foreign financial institutions, and various nonfinancial institutions.
Please see Risk Factors below for additional information.
At December 31, 2010, we had 558 employees, including 542 full-time equivalent employees. Employees of the Company are entitled to participate in a variety of employee benefit programs, including: stock option plans; an employee stock purchase plan; a 401(k) plan; various comprehensive medical, accident and group life insurance plans; and paid vacations. No Company employee is covered by a collective bargaining agreement and we believe our relationship with our employees to be excellent.
Supervision and Regulation
CoBiz and the Bank are extensively regulated under federal, Colorado and Arizona law. These laws and regulations are primarily intended to protect depositors and federal deposit insurance funds, not shareholders of CoBiz. The following information summarizes certain material statutes and regulations affecting CoBiz and the Bank, and is qualified in its entirety by reference to the particular statutory and regulatory provisions. Any change in applicable laws, regulations or regulatory policies may have a material adverse effect on the business, financial condition, results of operations and cash flows of CoBiz and the Bank. We are unable to predict the nature or extent of the effects that fiscal or monetary policies, economic controls, or new federal or state legislation may have on our business and earnings in the future.
The Holding Company
General. CoBiz is a financial holding company registered under the Bank Holding Company Act of 1956, as amended (the BHCA), and is subject to regulation, supervision and examination by the Board of Governors of the Federal Reserve System (FRB). CoBiz is required to file an annual report with the FRB and such other reports as may be required pursuant to the BHCA.
Securities Exchange Act of 1934. CoBiz has a class of securities registered with the Securities Exchange Commission (SEC) under the Securities Exchange Act of 1934 (the Exchange Act). The Exchange Act requires the Company to file periodic reports with the SEC, governs the Companys disclosure in proxy solicitations and regulates insider trading transactions. The Company is listed on The NASDAQ Global Select Market (NASDAQ) and is subject to the rules of the NASDAQ.
Emergency Economic Stabilization Act of 2008 (EESA). Deteriorating market conditions in 2008 led to the issuance of the EESA that was signed into law on October 3, 2008. The EESA authorized the Troubled Asset Relief Plan (TARP) with an objective to ease the downturn in the credit cycle. The TARP provided up to $700 billion to the Department of the Treasury (Treasury) to buy mortgages and other troubled assets, to provide guarantees and to inject capital into financial institutions. As part of the $700 billion TARP, the Treasury established a Capital Purchase Program (CPP), which allows the Treasury to purchase up to $250 billion of senior preferred shares issued by U.S. financial institutions. The EESA also temporarily raised the basic limit on federal deposit insurance coverage from $100,000 to $250,000 per depositor until December 31, 2009, and accelerated the date on which the FRB will begin paying interest on required and excess reserve balances. On May 20, 2009, President Obama signed the Helping Families Save Their Homes Act, which extended the temporary increase in the limit on federal deposit insurance coverage to $250,000 per depositor to December 31, 2013. The limit was originally scheduled to decrease to $100,000 on January 1, 2014. However, on July 21, 2010, President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act which made permanent the current standard maximum deposit insurance account of $250,000.
On December 19, 2008, the Company entered into an agreement with the Treasury pursuant to the CPP to issue shares of the Companys Fixed Rate Cumulative Perpetual Preferred Stock, Series B, par value $0.01 per share, having a liquidation preference of $1,000 per share (the Series B Preferred Stock) for an aggregate purchase price of $64.5 million. The Company also issued a warrant with a 10-year term to acquire 895,968 shares of its common stock at an exercise price of $10.79. Participation in the CPP limits the amount of executive compensation that is deductible for tax purposes to $500,000 per person; requires Treasury approval prior to any increase in common stock dividends; and requires Treasury approval prior to any common stock repurchases. In addition, if dividends on the Series B Preferred Stock are not paid in full for six dividend periods, the Treasury will have the right to elect two directors to the Companys Board of Directors. The right to elect directors will end when full dividends have been paid for four consecutive dividend periods.
American Recovery and Reinvestment Act of 2009 (ARRA). To further stimulate the lagging economy, President Obama signed the ARRA into law on February 17, 2009. Title VII of the ARRA contains limits on executive compensation for senior executive officers of participants in the CPP for as long as any financial assistance provided under the TARP remain outstanding. The limitations include a prohibition on incentives that may encourage unsafe behavior; a provision for the recovery of bonuses in the event of materially inaccurate financial statements; a prohibition on the payment of golden parachutes; and the prohibition of the accrual or payment of any bonus, retention award or incentive compensation. The prohibition on retention awards does not include the issuance of restricted stock as long as the restricted stock does not fully vest during the period in which the Series B Preferred Stock is outstanding and the fair value of the award does not exceed 1/3 of the receiving officers annual compensation. These limitations will apply to the five most highly compensated employees of the Company, or such number of employees as the Treasury may deem necessary. The ARRA also removed restrictions under the CPP plan that restricted the redemption of the Series B Preferred Stock by the Company unless certain conditions were met. The Series B Preferred Stock may be redeemed by the Company subject to approval from the FRB.
On June 15, 2009, the Treasury issued an interim final rule, TARP Standards For Compensation and Corporate Governance, to provide guidance on the executive compensation and corporate governance provisions of the EESA as amended by the ARRA.
Small Business Lending Fund (SBLF). Enacted as part of the Small Business Jobs Act, the SBLF is a $30 billion fund that encourages lending to small businesses by providing Tier 1 capital to qualified community banks with assets of less than $10 billion. Qualifying institutions are eligible to sell Tier 1-qualifiying preferred stock to the Treasury. The dividend rate on the preferred stock will initially be a maximum of 5%. The dividend rate decreases as the qualifying institutions small business lending increases by 10% or more, and can fall as low as 1%. However, if small business lending does not increase in the first two years, the rate will increase to 7%. After 4.5 years, the rate will increase to 9% if the bank has not repaid the SBLF funding.
The SBLF is available to participants in the CPP as a method to refinance preferred stock issued through that program. In addition to the requirements that apply to all SBLF participants, CPP participants must also meet the following requirements to refinance outstanding CPP securities: 1) the institution must be in material compliance with all terms, conditions, and covenants of any CPP agreement and financial instrument; 2) the institution must not have missed more than one dividend payment under CPP; and 3) the institution must pay, in immediately available funds, the amount of any unpaid dividends for the payment period prior to the SBLF closing date, plus accrued and unpaid dividends as of the date of refinancing for the payment period that includes the closing date. The maximum amount of available SBLF funding to a qualifying institution is limited to 5% of risk-weighted assets for institutions up to $1 billion in assets. For institutions with more than $1 billion and less than $10 billion in assets, the maximum is 3% of risk-weighted assets. The application deadline is March 31, 2011. At the date of this report, the Company had not applied to participate in the SBLF.
Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). On July 21, 2010, President Obama signed into law the Dodd-Frank Act. The Dodd-Frank Act comprehensively reforms the regulation of financial institutions, products and services. The Dodd-Frank Act will require publicly traded companies to give stockholders a non-binding vote on executive compensation and so-called golden parachute payments, and allow greater access by shareholders to the companys proxy material by authorizing the SEC to promulgate rules that would allow stockholders to nominate their own candidates using a companys proxy materials. The legislation also directs the Federal Reserve Board to promulgate rules prohibiting excessive compensation paid to bank holding company executives, regardless of whether the company is publicly traded.
Bank holding companies with assets of less than $15 billion at December 31, 2009, will be permitted to include trust preferred securities that were issued before May 19, 2010, as Tier 1 capital. Trust preferred securities issued by a bank holding company (other than those with assets of less than $500 million) after May 19, 2010, will no longer count as Tier 1 capital. However, new issuances of trust preferred securities will be entitled to be treated as Tier 2 capital.
The Dodd-Frank Act also broadens the base for Federal Deposit Insurance Corporation insurance assessments. Assessments will now be based on the average consolidated total assets less tangible equity capital of a financial institution. The Dodd-Frank Act also permanently increases the maximum amount of deposit insurance for banks, savings institutions and credit unions to $250,000 per depositor, retroactive to January 1, 2008, and noninterest-bearing transaction accounts have unlimited deposit insurance through December 31, 2012.
The Dodd-Frank Act creates a new Consumer Financial Protection Bureau with broad powers to supervise and enforce consumer protection laws. The Consumer Financial Protection Bureau has broad rule-making authority for a wide range of consumer protection laws that apply to all banks and savings institutions, including the authority to prohibit unfair, deceptive or abusive acts and practices. The Consumer Financial Protection Bureau has examination and enforcement authority over all banks and savings institutions with more than $10 billion in assets. Banks and savings institutions with $10 billion or less in assets such as the Bank will continue to be examined for compliance with the consumer laws by
their primary bank regulators. The Dodd-Frank Act also weakens the federal preemption rules that have been applicable for national banks and federal savings associations, and gives state attorneys general the ability to enforce federal consumer protection laws.
Certain provisions of the Dodd-Frank Act are expected to have a near-term impact on the Company. For example, effective July 21, 2011, a provision of the Dodd-Frank Act eliminates the federal prohibitions on paying interest on demand deposits, thus allowing businesses to have interest bearing checking accounts. Depending on competitive responses, this significant change to existing law could have an adverse impact on the Companys interest expense as the Company had $681.5 million in noninterest-bearing demand deposits at December 31, 2010.
On February 7, 2011, the FDIC approved a proposed rulemaking to prohibit incentive-based compensation arrangements that encourage inappropriate risk taking by covered financial institutions and are deemed excessive, or that may lead to material losses. The proposed rule would, for certain covered persons: require a deferral of a substantial portion of incentive compensation for executive officers of institutions with $50 billion or more in total assets; prohibit incentive-based compensation arrangements that would encourage inappropriate risks by providing excessive compensation; prohibit incentive-based compensation arrangements that would expose the institution to inappropriate risks by providing compensation that could lead to a material financial loss; require policies and procedures for incentive-based compensation arrangements that are commensurate with the size and complexity of the institution; and require annual reports on incentive compensation structures to the institutions appropriate Federal regulator.
The full impact of the Dodd-Frank Act on our business and operations will not be known for years until regulations implementing the statute are written and adopted. The Dodd-Frank Act may have a material impact on our operations, particularly through increased compliance costs resulting from possible future consumer and fair lending regulations.
Acquisitions. As a financial holding company, we are required to obtain the prior approval of the FRB before acquiring direct or indirect ownership or control of more than 5% of the voting shares of a bank or bank holding company. The FRB will not approve any acquisition, merger or consolidation that would result in substantial anti-competitive effects, unless the anti-competitive effects of the proposed transaction are outweighed by a greater public interest in meeting the needs and convenience of the public. In reviewing applications for such transactions, the FRB also considers managerial, financial, capital and other factors, including the record of performance of the applicant and the bank or banks to be acquired under the Community Reinvestment Act of 1977, as amended (the CRA). See The Bank Community Reinvestment Act below.
Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994, as amended (the 1994 Act). The 1994 Act displaces state laws governing interstate bank acquisitions. Under the 1994 Act, a financial or bank holding company may, subject to some limitations, acquire a bank outside of its home state without regard to local law. Thus, an out-of-state holding company could acquire the Bank, and we can acquire banks outside of Colorado.
All acquisitions pursuant to the 1994 Act require regulatory approval. In reviewing applications under the 1994 Act, an applicants record under the CRA must be considered, and a determination must be made that the transaction will not result in any violations of federal or state antitrust laws. In addition, there is a limit of 25% on the amount of deposits in insured depository institutions in both Colorado and Arizona that can be controlled by any bank or bank holding company.
The 1994 Act also permits bank subsidiaries of a financial or bank holding company to act as agents for affiliated institutions by receiving deposits, renewing time deposits, closing loans, servicing loans and receiving payments on loans. As a result, a relatively small Colorado or Arizona bank owned by an out-of-state holding company could make available to customers in Colorado and Arizona some of the services of a larger affiliated institution located in another state.
Gramm-Leach-Bliley Act of 1999 (the GLB Act). The GLB Act eliminates many of the restrictions placed on the activities of certain qualified financial or bank holding companies. A financial holding company such as CoBiz can expand into a wide variety of financial services, including securities activities, insurance and merchant banking without the prior approval of the FRB, provided that certain conditions are met, including a requirement that all subsidiary depository institutions be well capitalized.
Dividend Restrictions. Dividends on the Companys capital stock (common and preferred stock) are prohibited under the terms of the junior subordinated debenture agreements (see Note 9 to the Consolidated financial statements) if the Company is in continuous default on its payment obligations to the capital trusts, has elected to defer interest payments on the debentures or extends the interest payment period. At December 31, 2010, the Company was not in default, had not elected to defer interest payments and had not extended the interest payment period on any of the subordinated debt issuances.
Pursuant to the terms of the agreement executed in the issuance of the Series B Preferred Stock, the ability of the Company to declare or pay dividends or distributions on, or purchase, redeem or otherwise acquire for consideration, shares of its common stock will be subject to restrictions in the event that the Company fails to declare and pay full dividends on the Series B Preferred Stock. In addition, the Company may not increase its dividend prior to the earlier of 1) three years from the date of the issuance or 2) the date on which the Series B Preferred Stock is redeemed in whole.
Capital Adequacy. The FRB monitors, on a consolidated basis, the capital adequacy of financial or bank holding companies that have total assets in excess of $500 million by using a combination of risk-based and leverage ratios. Failure to meet the capital guidelines may result in the application by the FRB of supervisory or enforcement actions. Under the risk-based capital guidelines, different categories of assets, including certain off-balance sheet items, such as loan commitments in excess of one year and letters of credit, are assigned different risk weights, based generally on the perceived credit risk of the asset. These risk weights are multiplied by corresponding asset balances to determine a risk-weighted asset base. For purposes of the risk-based capital guidelines, total capital is defined as the sum of Tier 1 and Tier 2 capital elements, with Tier 2 capital being limited to 100% of Tier 1 capital. Tier 1 capital includes, with certain restrictions, common shareholders equity, perpetual preferred stock (no more than 25% of Tier 1 capital being comprised of cumulative preferred stock or trust preferred stock) and noncontrolling interests in consolidated subsidiaries. Tier 2 capital includes, with certain limitations, perpetual preferred stock not included in Tier 1 capital, certain maturing capital instruments and the allowance for loan losses (limited to 1.25% of risk-weighted assets). The regulatory guidelines require a minimum ratio of total capital to risk-weighted assets of 8% (of which at least 4% must be in the form of Tier 1 capital). The FRB has also implemented a leverage ratio, which is defined to be a companys Tier 1 capital divided by its average total consolidated assets. The FRB has established a minimum ratio of 3% for strong holding companies as defined by the FRB. For most other holding companies, the minimum required leverage ratio is 4%, but may be higher based on particular circumstances or risk profile.
For regulatory capital purposes, the Series B Preferred Stock is treated the same as noncumulative perpetual preferred stock as an unrestricted core capital element included in Tier 1 Capital.
The table below sets forth the capital ratios of the Company:
On May 7, 2009, the Board of Governors of the Federal Reserve System announced the results of the Supervisory Capital Assessment Program (SCAP), a review of the capital of the 19 largest U.S. banks instituted by the federal banking regulators. The SCAP was a forward-looking exercise designed to estimate losses, revenues and reserve trends under adverse macroeconomic scenarios. The purpose of the SCAP review was to evaluate the capital position of the 19 largest U.S. banking institutions to determine if additional capital was required to provide a buffer against future losses. Based on the SCAP review, federal banking regulators determined that 10 of the 19 banking institutions needed to raise additional capital.
Although we were not included in the group of 19 banking institutions reviewed under the SCAP, the results indicate that federal banking regulators are focused on the composition of regulatory capital, specifically that voting common equity should be the dominant element of Tier 1 capital. In addition, Tier 1 Common Capital was emphasized to reflect the fact that common equity is the first element of the capital structure to absorb losses, offering protection to more senior parts of the capital structure and lowering the risk of insolvency. The minimum Tier 1 Common Capital ratio specified in the SCAP review was 4%. In July 2010, the oversight body of the Basel Committee on Banking Supervision endorsed reforms that will increase the minimum common equity requirement from 2% to 4.5%. In addition, banks will be required to hold a capital conservation buffer of 2.5% to withstand future periods of stress bringing the total common equity requirement to 7%. In a revised addendum to SR Letter 09-4, the Federal Reserve has required the banks reviewed under the SCAP to submit a capital plan that reflects plans to address the increased capital proposal. While Tier 1 Common Capital is not an official regulatory capital ratio, we do give consideration to the SCAP review since it provides insight into the current regulatory environment.
Support of Banks. As discussed below, the Bank is also subject to capital adequacy requirements. Under the Federal Deposit Insurance Corporation Improvement Act of 1991 (the FDICIA), CoBiz could be required to guarantee the capital restoration plan of the Bank, should the Bank become undercapitalized as defined in the FDICIA and the regulations thereunder. See The Bank Capital Adequacy. Our maximum liability under any such guarantee would be the lesser of 5% of the Banks total assets at the time it became undercapitalized or the amount necessary to bring the Bank into compliance with the capital plan. The FRB also has stated that financial or bank holding companies are subject to the source of strength doctrine which requires such holding companies to serve as a source of financial and managerial strength to their subsidiary banks and to not conduct operations in an unsafe or unsound manner.
The FDICIA requires the federal banking regulators to take prompt corrective action with respect to capital-deficient institutions. In addition to requiring the submission of a capital restoration plan, the FDICIA contains broad restrictions on certain activities of undercapitalized institutions involving asset growth, acquisitions, branch establishment and expansion into new lines of business. With certain exceptions, an insured depository institution is prohibited from making capital distributions, including dividends, and is prohibited from paying management fees to control persons, if the institution would be undercapitalized after any such distribution or payment.
Sarbanes-Oxley Act of 2002 (the Sarbanes-Oxley Act). The Sarbanes-Oxley Act is intended to address systemic and structural weaknesses of the capital markets in the United States that were perceived to have contributed to corporate scandals. The Sarbanes-Oxley Act also attempts to enhance the responsibility of corporate management by, among other things, (i) requiring the chief executive officer and chief financial officer of public companies to provide certain certifications in their periodic reports regarding the accuracy of the periodic reports filed with the SEC, (ii) prohibiting officers and directors of public companies from fraudulently influencing an accountant engaged in the audit of the companys financial statements, (iii) requiring chief executive officers and chief financial officers to forfeit certain bonuses in the event of a restatement of financial results, (iv) prohibiting officers and directors found to be unfit from serving in a similar capacity with other public companies, (v) prohibiting officers and directors from trading in the companys equity securities during pension blackout periods, and (vi) requiring the SEC to issue standards of professional conduct for attorneys representing public companies. In addition, public companies whose securities are listed on a national securities exchange or association must
satisfy the following additional requirements: (a) the companys audit committee must appoint and oversee the companys auditors; (b) each member of the companys audit committee must be independent; (c) the companys audit committee must establish procedures for receiving complaints regarding accounting, internal accounting controls and audit-related matters; (d) the companys audit committee must have the authority to engage independent advisors; and (e) the company must provide appropriate funding to its audit committee, as determined by the audit committee.
General. The Bank is a state-chartered banking institution, the deposits of which are insured by the Deposit Insurance Fund (DIF) of the FDIC, and is subject to supervision, regulation and examination by the Colorado Division of Banking, the FRB and the FDIC. Prior to 2007, the Bank was a nationally chartered institution and also subject to the supervision of the Office of the Comptroller of the Currency (OCC). Pursuant to such regulations, the Bank is subject to special restrictions, supervisory requirements and potential enforcement actions. The FRBs supervisory authority over CoBiz can also affect the Bank.
Community Reinvestment Act. The CRA requires the Bank to adequately meet the credit needs of the communities in which it operates. The CRA allows regulators to reject an applicant seeking, among other things, to make an acquisition or establish a branch, unless it has performed satisfactorily under the CRA. Federal regulators regularly conduct examinations to assess the performance of financial institutions under the CRA. In its most recent CRA examination, the Bank received a satisfactory rating.
Federal Home Loan Bank Membership. The Bank is a member of the Federal Home Loan Bank of Topeka (FHLB). Each member of the FHLB is required to maintain a minimum investment in capital stock. The Board of Directors of the FHLB can increase the minimum investment requirements in the event it has concluded that additional capital is required to allow it to meet its own regulatory capital requirements. Any increase in the minimum investment requirements outside of specified ranges requires the approval of the Federal Housing Finance Board. Because the extent of any obligation to increase our investment in the FHLB depends entirely upon the occurrence of a future event, potential future payments to the FHLB are not determinable.
USA Patriot Act of 2001. The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the USA Patriot Act) is intended to allow the federal government to address terrorist threats through enhanced domestic security measures, expanded surveillance powers, increased information sharing and broadened anti-money-laundering requirements.
Among its provisions, the USA Patriot Act requires each financial institution to: (i) establish an anti-money-laundering program; (ii) establish due diligence policies, procedures and controls with respect to its private banking accounts and correspondent banking accounts involving foreign individuals and certain foreign banks; and (iii) avoid establishing, maintaining, administering or managing correspondent accounts in the United States for, or on behalf of, a foreign bank that does not have a physical presence in any country. In addition, the USA Patriot Act contains a provision encouraging cooperation among financial institutions, regulatory authorities and law enforcement authorities with respect to individuals, entities and organizations engaged in, or reasonably suspected of engaging in, terrorist acts or money laundering activities. Financial institutions must comply with Section 326 of the Act which provides minimum procedures for identification verification of new customers. On March 9, 2006, the USA Patriot Improvement and Reauthorization Act of 2005 (Reauthorization Act of 2005 ) was signed by the President to extend and modify the original Act. The Reauthorization Act of 2005 makes permanent 14 of the original provisions of the USA Patriot Act that had been set to expire.
Transactions with Affiliates. The Bank is subject to Section 23A of the Federal Reserve Act, which limits the amount of loans to, investments in and certain other transactions with affiliates of the Bank; requires certain levels of collateral for such loans or transactions; and limits the amount of advances to third parties that are collateralized by the securities or obligations of affiliates, unless the affiliate is a bank and is at least 80% owned by the Company. If the affiliate is a bank and is at least 80% owned by the Company, such transactions are generally exempted from these restrictions except as to low quality
assets as defined under the Federal Reserve Act, and transactions not consistent with safe and sound banking practices. In addition, Section 23A generally limits transactions with a single affiliate of the Bank to 10% of the Banks capital and surplus and generally limits all transactions with affiliates to 20% of the Banks capital and surplus.
Section 23B of the Federal Reserve Act requires that certain transactions between the Bank and any affiliate must be on substantially the same terms, or at least as favorable to the Bank, as those prevailing at the time for comparable transactions with, or involving, non-affiliated companies or, in the absence of comparable transactions, on terms and under circumstances, including credit standards, that in good faith would be offered to, or would apply to, non-affiliated companies. The aggregate amount of the Banks loans to its officers, directors and principal shareholders (or their affiliates) is limited to the amount of its unimpaired capital and surplus, unless the FDIC determines that a lesser amount is appropriate.
A violation of the restrictions of Section 23A or Section 23B of the Federal Reserve Act may result in the assessment of civil monetary penalties against the Bank or a person participating in the conduct of the affairs of the Bank or the imposition of an order to cease and desist such violation.
Regulation W of the Federal Reserve Act, which became effective on April 1, 2003, addresses the application of Sections 23A and 23B to credit exposure arising out of derivative transactions between an insured institution and its affiliates and intra-day extensions of credit by an insured depository institution to its affiliates. The rule requires institutions to adopt policies and procedures reasonably designed to monitor, manage and control credit exposures arising out of transactions and to clarify that the transactions are subject to Section 23B of the Federal Reserve Act.
Dividend Restrictions. Dividends paid by the Bank and management fees from the Bank and our fee-based business lines provide substantially all of our cash flow. The approval of the Colorado Division of Banking is required prior to the declaration of any dividend by the Bank if the total of all dividends declared by the Bank in any calendar year exceeds the total of its net profits of that year combined with the retained net profits for the preceding two years. In addition, the FDICIA provides that the Bank cannot pay a dividend if it will cause the Bank to be undercapitalized.
Capital Adequacy. Federal regulations establish minimum requirements for the capital adequacy of depository institutions that are generally the same as those established for bank holding companies. See The Holding Company Capital Adequacy. Banks with capital ratios below the required minimum are subject to certain administrative actions, including the termination of deposit insurance and the appointment of a receiver, and may also be subject to significant operating restrictions pursuant to regulations promulgated under the FDICIA. See The Holding Company Support of Banks.
The following table sets forth the capital ratios of the Bank:
Pursuant to the FDICIA, regulations have been adopted defining five capital levels: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. Increasingly severe restrictions are placed on a depository institution as its capital level classification declines. An institution is critically undercapitalized if it has a tangible equity to total assets ratio less than or equal to 2%. An institution is adequately capitalized if it has a total risk-based capital ratio less than 10%, but greater than or equal to 8%; or a Tier 1 risk-based capital ratio less than 6%, but greater than or
equal to 4%; or a leverage ratio less than 5%, but greater than or equal to 4% (3% in certain circumstances). An institution is well capitalized if it has a total risk-based capital ratio of 10% or greater, a Tier 1 risk-based capital ratio of 6% or greater, and a leverage ratio of 5% or greater; and the institution is not subject to an order, written agreement, capital directive or prompt corrective action directive to meet and maintain a specific capital level for any capital measure. Under these regulations, at December 31, 2010, the Bank was well capitalized, which places no significant restrictions on the Banks activities.
Examinations. The FRB and the Colorado Division of Banking periodically examines and evaluates banks. Based upon such an evaluation, the examining regulator may revalue the assets of an insured institution and require that it establish specific reserves to compensate for the difference between the value determined by the regulator and the book value of such assets.
Interest Rate Restrictions. Beginning January 1, 2010, insured depository institutions that are not well-capitalized are subject to limitations on interest rates paid on deposits. Pursuant to the FDIC regulations, these institutions will be limited to offering a maximum deposit rate of the national rate plus 75 basis points. The national rate is defined for deposits of similar size and maturity as a simple average of rates paid by all insured depository institutions and branches for which data are available.
Brokered Deposits. Well-capitalized institutions are not subject to limitations on brokered deposits, while an adequately capitalized institution is able to accept, renew or roll over brokered deposits only with a waiver from the FDIC and subject to certain restrictions on the yield paid on such deposits. Undercapitalized institutions are generally not permitted to accept brokered deposits.
Internal Operating Requirements. Federal regulations promote the safety and soundness of individual institutions by specifically addressing, among other things: (1) internal controls, information systems and internal audit systems; (2) loan documentation; (3) credit underwriting; (4) interest rate exposure; (5) asset growth; and (6) compensation and benefit standards for management officials.
Real Estate Lending Evaluations. Federal regulators have adopted uniform standards for the evaluation of loans secured by real estate or made to finance improvements to real estate. The Bank is required to establish and maintain written internal real estate lending policies consistent with safe and sound banking practices. The Company has established loan-to-value ratio limitations on real estate loans, which are more stringent than the loan-to-value limitations established by regulatory guidelines.
Deposit Insurance Premiums. Under current regulations, FDIC-insured depository institutions that are members of the FDIC pay insurance premiums at rates based on their assessment risk classification, which is determined, in part, based on the institutions capital ratios and factors that the FDIC deems relevant to determine the risk of loss to the FDIC. In 2007, the annual assessment rates changed to a range of 5-43 basis points, an increase from the 0-27 basis point range that had been in effect since 1996. In 2009, the base assessment rate range for Risk Category I institutions increased to 7-24 basis points as part of the FDICs Restoration Plan for the DIF. This increase is necessary to replenish the DIF due to the number of recent failures of FDIC-insured institutions. As part of the new assessments that began April 1, 2009, the FDIC introduced three new adjustments that may impact the assessment base. These adjustments are for 1) a potential decrease for long-term unsecured debt, 2) a potential increase for secured liabilities above a threshold amount and 3) for non-risk category 1 institutions, a potential increase for brokered deposits above a threshold amount. The base assessment rates for Risk Categories II IV range from 17-78 basis points. On February 7, 2011, the FDIC finalized new rules for an assessment calculation as required by the Dodd-Frank Act. The final rules change the assessment base from deposits to average daily consolidated assets less average monthly tangible equity (which is defined as Tier 1 Capital) and also changes the base assessment rates. The final rules take effect April 1, 2011. Under the new assessments, the base assessment rate for a Risk Category I institution is 5-9 basis points and the base assessment rates for Risk Categories II IV range from 14-35 basis points. Based on the final rule, the Company expects its assessments will decrease after the effective date. The amount an institution is assessed is based upon statutory factors that includes the degree of risk the institution poses to the insurance fund and may be reviewed semi-annually. A change in our risk category would negatively impact our assessment rates.
Additionally, all institutions insured by the FDIC Bank Insurance Fund are assessed fees to cover the debt of the Financing Corporation, the successor of the insolvent Federal Savings and Loan Insurance Corporation. The current assessment rate effective for the first quarter of 2011 is 0.255 basis points (1.02 basis points annually). The assessment rate is adjusted quarterly.
On May 22, 2009, the FDIC voted to levy a special assessment on insured institutions as part of the FDICs efforts to rebuild the DIF and help maintain public confidence in the banking system. The special assessment was 5 basis points on each FDIC-insured depository institutions assets, minus its Tier 1 capital, as of June 30, 2009. On September 30, 2009, the Company paid a special assessment of $1.2 million.
On November 12, 2009, the FDIC voted to require insured institutions to prepay slightly over three years of estimated insurance assessments. The pre-payment allows the FDIC to strengthen the cash position of the DIF immediately without immediately impacting earnings of the industry. At December 31, 2010, the Company had pre-paid estimated assessments of $6.1 million for the years 2011-2012. For risk-based capital purposes, the pre-payment was assigned a zero percent risk weighting.
Temporary Liquidity Guarantee Program (TLGP). On October 14, 2008, the FDIC announced the enactment of the Temporary Liquidity Guarantee Program to strengthen confidence and encourage liquidity in the banking system. Pursuant to the program, the FDIC will guarantee certain senior unsecured debt issued by participating financial institutions issued on or after October 14, 2008, and before June 30, 2009; and provide full FDIC deposit insurance coverage for noninterest-bearing transaction accounts at participating FDIC-insured institutions through December 31, 2009 (Transaction Account Guarantee program). All FDIC-insured institutions were covered under the program until December 5, 2008, at no cost. After December 5, 2008, the cost for institutions electing to participate was a 10-basis-point surcharge applied to balances covered by the noninterest-bearing deposit transaction account guarantee and 75 basis points of the eligible senior unsecured debt guaranteed under the program. The Company elected to participate in both the unlimited coverage for noninterest-bearing transaction accounts and the debt guarantee program.
On June 3, 2009, the FDIC amended the TLGP to provide a limited extension of the debt guarantee program. Effective October 1, 2009, the FDIC also extended the full FDIC deposit insurance coverage for noninterest-bearing transaction accounts at participating FDIC-insured institutions through June 30, 2010. As part of the extension, insured institutions electing to continue participation will pay an increased assessment ranging from 15-25 basis points depending on the entitys Risk Category. On April 13, 2010, the FDIC announced a second extension of the program until December 31, 2010, and that it retained the discretion to further extend the program until December 31, 2011, without further rulemaking. On November 9, 2010, the FDIC confirmed that it would not extend the transaction account guarantee beyond its sunset in 2010 since provisions within the Dodd-Frank Act provided separate coverage for noninterest-bearing accounts through December 31, 2012. The Company participated in the Transaction Account Guarantee Program through its expiration on December 31, 2010.
Restrictions on Loans to One Borrower. Under state law, the aggregate amount of loans that may be made to one borrower by the Bank is generally limited to 15% of its unimpaired capital, surplus, undivided profits and allowance for loan losses. The Bank seeks participations to accommodate borrowers whose financing needs exceed the Banks lending limits.
Fee-Based Business Lines
CoBiz Investment Management, LLC (CoBiz Investment), formerly ACMG, is registered with the SEC under the Investment Advisers Act of 1940. The Investment Advisers Act of 1940 imposes numerous obligations on registered investment advisers, including fiduciary duties, recordkeeping requirements, operational requirements and disclosure obligations. Virtually all aspects of CoBiz Investments management business are subject to various federal and state laws and regulations. These laws and regulations generally grant supervisory agencies and bodies broad administrative powers, including the
power to limit or restrict CoBiz Investment from carrying on its investment management business in the event that they fail to comply with such laws and regulations. In such event, the possible sanctions which may be imposed include the suspension of individual employees, business limitations on engaging in the investment management business for specified periods of time, the revocation of any such companys registration as an investment adviser, and other censures or fines.
Green Manning & Bunch, Ltd. (GMB), our investment banking subsidiary, is registered as a broker-dealer under the Exchange Act and is subject to regulation by the SEC and the Financial Industry Regulatory Authority (FINRA). GMB is subject to the SECs net capital rule designed to enforce minimum standards regarding the general financial condition and liquidity of a broker-dealer. Under certain circumstances, this rule limits the ability of the Company to make withdrawals of capital and receive dividends from GMB. GMBs regulatory net capital consistently exceeded such minimum net capital requirements in fiscal 2010. The securities industry is one of the most highly regulated in the United States, and failure to comply with related laws and regulations can result in the revocation of broker-dealer licenses; the imposition of censures or fines; and the suspension or expulsion from the securities business of a firm, its officers or employees.
Financial Designs Ltd. (FDL) provides wealth transfer planning through the use of life insurance products. State governments extensively regulate our life insurance activities. We sell our insurance products throughout the United States and the District of Columbia through licensed insurance producers. Insurance laws vary from state to state. Each state has broad powers over licensing, payment of commissions, business practices, policy forms and premium rates. While the federal government does not directly regulate the marketing of most insurance products, securities, including variable life insurance, are subject to federal securities laws. We market these financial products through M Holdings Securities, Inc., a registered broker-dealer and a member of the FINRA and Securities Investor Protection Corporation.
CoBiz Insurance Inc., acting as an insurance producer, must obtain and keep in force an insurance producers license with the State of Arizona and Colorado. In order to write insurance in other states, they are required to obtain non-resident insurance licenses. All premiums belonging to insurance carriers and all unearned premiums belonging to customers received by the agency must be treated in a fiduciary capacity.
Changing Regulatory Structure
Regulation of the activities of national and state banks and their holding companies imposes a heavy burden on the banking industry. The FRB, FDIC, OCC (national charters only) and State banking divisions all have extensive authority to police unsafe or unsound practices and violations of applicable laws and regulations by depository institutions and their holding companies. These agencies can assess civil monetary penalties, issue cease and desist or removal orders, seek injunctions, and publicly disclose such actions.
The laws and regulations affecting banks and financial or bank holding companies have changed significantly in recent years, and there is reason to expect changes will continue in the future, although it is difficult to predict the outcome of these changes. From time to time, various bills are introduced in the United States Congress with respect to the regulation of financial institutions. Certain of these proposals, if adopted, could significantly change the regulation of banks and the financial services industry.
The monetary policy of the FRB has a significant effect on the operating results of financial or bank holding companies and their subsidiaries. Among the means available to the FRB to affect the money supply are open market transactions in U.S. government securities, changes in the discount rate on member bank borrowings and changes in reserve requirements against member bank deposits. These means are used in varying combinations to influence overall growth and distribution of bank loans, investments and deposits, and their use may affect interest rates charged on loans or paid on deposits.
FRB monetary policies have materially affected the operations of commercial banks in the past and are expected to continue to do so in the future. The nature of future monetary policies and the effect of such policies on the business and earnings of the Company and its subsidiaries cannot be predicted.
Website Availability of Reports Filed with the SEC
The Company maintains an Internet website located at www.cobizfinancial.com on which, among other things, the Company makes available, free of charge, various reports that it files with or furnishes to the SEC, including its annual reports, quarterly reports, current reports and proxy statements. These reports are made available as soon as reasonably practicable after they are filed with or furnished to the SEC. The public may read and copy any materials we file with the SEC at the SECs Public Reference Room at 100 F Street, NE, Washington, DC 20549. Additional information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330. The SEC also maintains a website at www.sec.gov that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. The Company has also made available on its website its Audit, Compensation and Nominating Committee charters and corporate governance guidelines. The content on any website referred to in this filing is not incorporated by reference into this filing unless expressly noted otherwise.
Recent legislative and regulatory initiatives to address difficult market and economic conditions may not stabilize the U.S. economy or the U.S. banking system.
On October 3, 2008, President Bush signed into law the Emergency Economic Stabilization Act of 2008, or EESA, which, among other measures, authorizes Treasury to purchase from financial institutions and their holding companies up to $700 billion in mortgage loans, mortgage-related securities and certain other financial instruments, including debt and equity securities issued by financial institutions and their holding companies, under the Troubled Asset Relief Program, or TARP. The purpose of TARP is to restore confidence and stability to the U.S. banking system and to encourage financial institutions to increase their lending to customers and to each other. Treasury will purchase equity securities from participating institutions under the Capital Purchase Program authorized by TARP (as well as the Capital Assistance Program announced on February 25, 2009).
The EESA followed, and has been followed by, numerous actions by the Federal Reserve Bank, or FRB, the U.S. Congress, Treasury, the Federal Deposit Insurance Corporation, or the FDIC, the SEC and others to address the liquidity and credit crisis that followed the sub-prime meltdown that commenced in 2007. These measures include homeowner relief that encourages loan restructuring and modification; the establishment of significant liquidity and credit facilities for financial institutions and investment banks; the lowering of the federal funds rate; emergency action against short selling practices; a temporary guaranty program for money market funds; the establishment of a commercial paper funding facility to provide back-stop liquidity to commercial paper issuers; and coordinated international efforts to address illiquidity and other weaknesses in the banking sector. On February 17, 2009, the ARRA, was signed into law. ARRA, more commonly known as the economic stimulus bill or economic recovery package, is intended to stimulate the economy and provides for broad infrastructure, education and health spending. Most recently, the Dodd-Frank Act, signed into law on July 21, 2010, significantly reforms banking regulation and oversight.
The purpose of these and certain other legislative and regulatory actions is to stabilize the U.S. banking system. The EESA, ARRA, Dodd-Frank Act and other regulatory initiatives may not have their desired effects. If the volatility in the markets continues and economic conditions fail to improve or worsen, our business, financial condition, results of operations and cash flows could be materially and adversely affected.
Difficult conditions in the financial services markets have adversely affected the business and results of operations of the Company.
Dramatic declines in the housing market, with falling home prices and increasing foreclosures and unemployment, have resulted in significant write-downs of asset values by financial institutions, including government-sponsored entities and major commercial and investment banks. These write-downs, initially of mortgage-backed securities but spreading to credit default swaps and other derivative securities, have caused many financial institutions to seek additional capital, to merge with larger and stronger institutions and, in some cases, to fail. Many lenders and institutional investors have reduced and, in some cases, ceased to provide funding to borrowers including other financial institutions. The Company has historically used federal funds purchased as a short-term liquidity source and, while the Company continues to actively use this source, further credit tightening in the market could reduce funding lines available to the Company. This market turmoil and tightening of credit have led to an increased level of commercial and consumer delinquencies, lack of consumer confidence, increased market volatility and widespread reduction of business activity generally.
Weakness in the economy and in the real estate market, including specific weakness within the markets where our banks do business, has adversely affected us and may continue to adversely affect us.
In general, all of our business segments have been negatively impacted by current market conditions. There has been a downturn in the real estate market, a slow-down in construction and an oversupply of real estate for sale in both 2010 and 2009. This downturn, and any additional softening, in our real estate markets could hurt our business because a majority of our loans are secured by real estate. Real estate values and real estate markets are generally affected by changes in national, regional or local economic conditions, fluctuations in interest rates and the availability of loans to potential purchasers, changes in tax laws and other governmental statutes, regulations and policies and acts of nature.
Substantially all of our real property collateral is located in Arizona and Colorado. Although the Colorado economy has outperformed the majority of other metropolitan areas nationally, it began to show increasing signs of weakness during the fourth quarter of 2008. These broader economic trends have impacted our Colorado loan portfolio, which has seen an increase in adversely graded credits. Additionally, the Arizona market continues to be negatively impacted by a severely depressed residential housing market. The receipt of borrower financial statements as well as focused portfolio reviews by our bankers contributed to an increase in adversely graded credits in both markets during 2009 and 2010. If real estate prices continue to decline, the value of real estate collateral securing our loans could be reduced. Our ability to recover on defaulted loans by foreclosing and selling the real estate collateral would then be further diminished, and we would be more likely to suffer losses on defaulted loans.
In addition, our Insurance segments revenues have been adversely affected by a continued soft premium market for property and casualty insurance; the decline in the broader equity market has negatively impacted Wealth Management earnings; and Investment Banking transactions have been curtailed due to market uncertainty and valuation issues.
Continued weakness could have a material adverse effect on our business, financial condition, results of operations and cash flows and on the market for our common stock.
Our allowance for loan losses may not be adequate to cover actual loan losses.
As a lender, we are exposed to the risk that our customers will be unable to repay their loans according to their terms and that any collateral securing the payment of their loans may not be sufficient to assure repayment. Credit losses are inherent in the lending business and could have a material adverse effect on our operating results. We make various assumptions and judgments about the collectibility of our loan portfolio and provide an allowance for potential losses based on a number of factors. If our assumptions are wrong, our allowance for loan losses may not be sufficient to cover our losses, thereby having an adverse effect on our operating results, and may cause us to increase the allowance in the future. In addition, we expect to increase the number and amount of loans we originate, and we cannot guarantee that we will not experience an increase in delinquencies and losses as these loans continue to age,
particularly if the economic conditions in Colorado and Arizona further deteriorate. The actual amount of future provisions for loan losses cannot be determined at any specific point in time and may exceed the amounts of past provisions. Additions to our allowance for loan losses would decrease our net income.
Our commercial real estate and construction loans are subject to various lending risks depending on the nature of the borrowers business, its cash flow and our collateral.
Our commercial real estate loans involve higher principal amounts than other loans, and repayment of these loans may be dependent on factors outside our control or the control of our borrowers. Repayment of commercial real estate loans is generally dependent, in large part, on sufficient income from the properties securing the loans to cover operating expenses and debt service. Rental income may not rise sufficiently over time to meet increases in the loan rate at repricing or increases in operating expenses, such as utilities and taxes. As a result, impaired loans may be more difficult to identify without some seasoning. Because payments on loans secured by commercial real estate often depend upon the successful operation and management of the properties, repayment of such loans may be affected by factors outside the borrowers control, such as adverse conditions in the real estate market or the economy or changes in government regulation. If the cash flow from the property is reduced, the borrowers ability to repay the loan and the value of the security for the loan may be impaired.
Repayment of our commercial loans is often dependent on cash flow of the borrower, which may be unpredictable, and collateral securing these loans may fluctuate in value. Generally, this collateral is accounts receivable, inventory, equipment or real estate. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers. Other collateral securing loans may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business.
Our construction loans are based upon estimates of costs to construct and the value associated with the completed project. These estimates may be inaccurate due to the uncertainties inherent in estimating construction costs, as well as the market value of the completed project and the effects of governmental regulation of real property making it relatively difficult to accurately evaluate the total funds required to complete a project and the related loan-to-value ratio. As a result, construction loans often involve the disbursement of substantial funds with repayment dependent, in part, on the success of the ultimate project and the ability of the borrower to sell or lease the property, rather than the ability of the borrower or guarantor to repay principal and interest. Delays in completing the project may arise from labor problems, material shortages and other unpredictable contingencies. If the estimate of construction costs is inaccurate, we may be required to advance additional funds to complete construction. If our appraisal of the value of the completed project proves to be overstated, we may have inadequate security for the repayment of the loan upon completion of construction of the project.
Our consumer loans generally have a higher risk of default than our other loans.
Consumer loans entail greater risk than residential mortgage loans, particularly in the case of consumer loans that are unsecured or secured by rapidly depreciating assets. In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of damage, loss or depreciation. The remaining deficiency often does not warrant further collection efforts against the borrower beyond obtaining a deficiency judgment. In addition, consumer loan collections are dependent on the borrowers continuing financial stability, and thus, are more likely to 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 that can be recovered on such loans.
We may not realize our deferred income tax assets. In addition, our net operating loss carryforwards and built in losses could be substantially limited if we experience an ownership change as defined in the Internal Revenue Code.
The Company may experience negative or unforeseen tax consequences. We review the probability of the realization of our net deferred tax assets each period based on forecasts of taxable income. This review uses historical results, projected future operating results based upon approved business plans, eligible carryforward and carryback periods, tax-planning opportunities and other relevant considerations. Adverse changes in the profitability and financial outlook in the U.S. and our industry may require the creation of an additional valuation allowance to reduce our net deferred tax assets. Such changes could result in material non-cash expenses in the period in which the changes are made and could have a material adverse impact on the Companys results of operations and financial condition.
In addition, the benefit of our built-in losses would be reduced if we experience an ownership change, as determined under Internal Revenue Code Section 382 (Section 382). A Section 382 ownership change occurs if a stockholder or a group of stockholders who are deemed to own at least 5% of our common stock increase their ownership by more than 50 percentage points over their lowest ownership percentage within a rolling three-year period. If an ownership change occurs, Section 382 would impose an annual limit on the amount of built-in losses we can use to reduce our taxable income equal to the product of the total value of our outstanding equity immediately prior to the ownership change (reduced by certain items specified in Section 382) and the federal long-term tax-exempt interest rate in effect for the month of the ownership change. A number of complex rules apply to calculating this annual limit.
While the complexity of Section 382s provisions and the limited knowledge any public company has about the ownership of its publicly traded stock make it difficult to determine whether an ownership change has occurred, we currently believe that an ownership change has not occurred. However, if an ownership change were to occur, the annual limit Section 382 may impose could result in a limitation of the annual deductibility of our built-in losses.
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 been volatile. Market conditions may negatively affect the value of securities. 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 Company may be adversely affected by the soundness of other financial institutions.
Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships. The Company has exposure to many different industries and counterparties, and routinely executes transactions with counterparties in the financial services industry including commercial banks, brokers and dealers, investment banks, and other institutional clients. Many of these transactions expose the Company to credit risk in the event of a default by a counterparty or client. In addition, the Companys credit risk may be exacerbated when the collateral held by the Company cannot be realized or is liquidated at prices not sufficient to recover the full amount of the credit or derivative exposure due to the Company. Any such losses could have a material adverse affect on the Companys financial condition and results of operations.
We are subject to executive compensation restrictions because of our participation in the Treasurys Capital Purchase Program.
We are subject to TARP rules and standards governing executive compensation, which generally apply to our Chief Executive Officer, Chief Financial Officer and the three next most highly compensated senior executive officers and, with recent amendments, a number of other employees. The standards include (i) a requirement to recover any bonus payment to senior executive officers or certain other employees if payment was based on materially inaccurate financial statements or performance metric criteria; (ii) a prohibition on making any golden parachute payments to senior executive officers and certain other employees; (iii) a prohibition on paying or accruing any bonus payment to certain employees, except as
otherwise permitted by the rules; (iv) a prohibition on maintaining any plan for senior executive officers that encourages such officers to take unnecessary and excessive risks that threaten the Companys value; (v) a prohibition on maintaining any employee compensation plan that encourages the manipulation of reported earnings to enhance the compensation of any employee; and (vi) a prohibition on providing tax gross-ups to senior executive officers and certain other employees. These restrictions and standards could limit our ability to recruit and retain executives.
The securities purchase agreement between us and Treasury permits Treasury to impose additional restrictions on us retroactively.
The securities purchase agreement we entered into with Treasury permits Treasury to unilaterally amend the terms of the securities purchase agreement to comply with any changes in federal statutes after the date of its execution. ARRA imposed additional executive compensation and expenditure limits on all current and future TARP recipients, including us, until we have repaid Treasury. These additional restrictions may impede our ability to attract and retain qualified executive officers. ARRA also permits TARP recipients to repay the Treasury without penalty or requirement that additional capital be raised, subject to Treasurys consultation with our primary federal regulator while the securities purchase agreement required that, for a period of three years, the Series B preferred stock could generally only be repaid if we raised additional capital to repay the securities and such capital qualified as Tier 1 capital. Additional unilateral changes in the securities purchase agreement could have a negative impact on our financial condition and results of operations.
Supervisory guidance on commercial real estate concentrations could restrict our activities and impose financial requirements or limitations on the conduct of our business.
The OCC, the FRB and the FDIC finalized joint supervisory guidance in 2006 on sound risk management practices for concentrations in commercial real estate lending. The guidance is intended to help ensure that institutions pursuing a significant commercial real estate lending strategy remain healthy and profitable while continuing to serve the credit needs of their communities. The agencies are concerned that rising commercial real estate loan concentrations may expose institutions to unanticipated earnings and capital volatility in the event of adverse changes in commercial real estate markets. The guidance reinforces and enhances existing regulations and guidelines for safe and sound real estate lending. The guidance provides supervisory criteria, including numerical indicators to assist in identifying institutions with potentially significant commercial real estate loan concentrations that may warrant greater supervisory scrutiny. The guidance does not limit banks commercial real estate lending, but rather guides institutions in developing risk management practices and levels of capital that are commensurate with the level and nature of their commercial real estate concentrations. Lending and risk management practices of the Company will be taken into account in supervisory evaluation of capital adequacy. Our commercial real estate portfolio at December 31, 2010, did not meet the definition of commercial real estate concentration as set forth in the final guidelines. If the Company is considered to have a concentration in the future and our risk management practices are found to be deficient, it could result in increased reserves and capital costs.
To the extent that any of the real estate securing our loans becomes subject to environmental liabilities, the value of our collateral will be diminished.
In certain situations, under various federal, state and local environmental laws, ordinances and regulations as well as the common law, a current or previous owner or operator of real property may be liable for the cost of removal or remediation of hazardous or toxic substances on such property or damage to property or personal injury. Such laws may impose liability whether or not the owner or operator was responsible for the presence of such hazardous or toxic substances. Environmental laws also may impose restrictions on the manner in which properties may be used or businesses may be operated, and these restrictions may require expenditures by one or more of our borrowers. Such laws may be amended so as to require compliance with stringent standards which could require one or more of our borrowers to make unexpected expenditures, some of which could be substantial. Environmental laws provide for sanctions in the event of noncompliance and may be enforced by governmental agencies or,
in certain circumstances, by private parties. One or more of our borrowers may be responsible for such costs which would diminish the value of our collateral. The cost of defending against claims of liability, of compliance with environmental regulatory requirements or of remediating any contaminated property could be substantial and require a material portion of the cash flow of one or more of our borrowers, which would diminish the ability of any such borrowers to repay our loans.
Changes in interest rates may affect our profitability.
Our profitability is, in part, a function of the spread between the interest rates earned on investments and loans, and the interest rates paid on deposits and other interest-bearing liabilities. Our net interest spread and margin will be affected by general economic conditions and other factors, including fiscal and monetary policies of the federal government, that influence market interest rates and our ability to respond to changes in such rates. At any given time, our assets and liabilities structures are such that they are affected differently by a change in interest rates. As a result, an increase or decrease in interest rates, the length of loan terms or the mix of adjustable and fixed-rate loans in our portfolio could have a positive or negative effect on our net income, capital and liquidity. We have traditionally managed our assets and liabilities in such a way that we have a positive interest rate gap. As a general rule, banks with positive interest rate gaps are more likely to be susceptible to declines in net interest income in periods of falling interest rates and are more likely to experience increases in net interest income in periods of rising interest rates. In addition, an increase in interest rates may adversely affect the ability of some borrowers to pay the interest on and principal of their loans.
Our ability to grow is substantially dependent upon our ability to increase our deposits.
Our primary source of funding growth is through deposit accumulation. Our ability to attract deposits is significantly influenced by general economic conditions, changes in money market rates, prevailing interest rates and competition. If we are not successful in increasing our current deposit base to a level commensurate with our funding needs, we may have to seek alternative higher-cost wholesale financing sources or curtail our growth.
Our fee-based businesses are subject to quarterly and annual volatility in their revenues and earnings.
Our fee-based businesses have historically experienced, and are likely to continue to experience, quarterly and annual volatility in revenues and earnings. With respect to our investment banking services segment, GMB, the delay in the initiation or the termination of a major new client engagement, or any changes in the anticipated closing date of client transactions can directly affect revenues and earnings for a particular quarter or year. With respect to our insurance segment, CoBiz Insurance Inc. and FDL-Employee Benefits division, our revenues and earnings also can experience quarterly and annual volatility, depending on the timing of the initiation or termination of a major new client engagement. In addition, a substantial portion of the revenues and earnings of our insurance segment are often generated during our fourth quarter as many of their clients seek to finalize their wealth transfer and estate plans by year end. With respect to our investment advisory business, our revenues and earnings are dependent on the value of our assets under management, which in turn are heavily dependent upon general conditions in debt and equity markets. Any significant volatility in debt or equity markets are likely to directly affect revenues and earnings of CoBiz Investment Management, LLC. for a particular quarter or year.
We rely heavily on our management, and the loss of any of our senior officers may adversely affect our operations.
Consistent with our policy of focusing growth initiatives on the recruitment of qualified personnel, we are highly dependent on the continued services of a small number of our executive officers and key employees. The loss of the services of any of these individuals could adversely affect our business, financial condition, results of operations and cash flows. The failure to recruit and retain key personnel could have a material adverse effect on our business, financial condition, results of operations and cash flows.
Our business and financial condition may be adversely affected by competition.
The banking business in the Denver and Phoenix metropolitan areas is highly competitive and is currently dominated by a number of large regional and national financial institutions. In addition to these regional and national banks, there are a number of smaller commercial banks that operate in these areas. We compete for loans and deposits with banks, savings and loan associations, finance companies, credit unions, and mortgage bankers. In addition to traditional financial institutions, we also compete for loans with brokerage and investment banking companies, and governmental agencies that make available low-cost or guaranteed loans to certain borrowers. Particularly in times of high interest rates, we also face significant competition for deposits from sellers of short-term money market securities and other corporate and government securities.
By virtue of their larger capital bases or affiliation with larger multibank holding companies, many of our competitors have substantially greater capital resources and lending limits than we have and perform other functions that we offer only through correspondents. Interstate banking and unlimited state-wide branch banking are permitted in Colorado and Arizona. As a result, we have experienced, and expect to continue to experience, greater competition in our primary service areas. Our business, financial condition, results of operations and cash flows may be adversely affected by competition, including any increase in competition. Moreover, recently enacted and proposed legislation has focused on expanding the ability of participants in the banking and thrift industries to engage in other lines of business. The enactment of such legislation could put us at a competitive disadvantage because we may not have the capital to participate in other lines of business to the same extent as more highly capitalized financial service holding companies.
We may be required to make capital contributions to the Bank if it becomes undercapitalized.
Under federal law, a bank holding company may be required to guarantee a capital plan filed by an undercapitalized bank subsidiary with its primary regulator. If the subsidiary defaults under the plan, the holding company may be required to contribute to the capital of the subsidiary bank in an amount equal to the lesser of 5% of the Banks assets at the time it became undercapitalized or the amount necessary to bring the Bank into compliance with applicable capital standards. Therefore, it is possible that we will be required to contribute capital to our subsidiary bank or any other bank that we may acquire in the event that such bank becomes undercapitalized. If we are required to make such capital contribution at a time when we have other significant capital needs, our business, financial condition, results of operations and cash flows could be adversely affected.
We continually encounter technological change, and we may have fewer resources than our competitors to continue to invest in technological improvements.
The financial services industry is undergoing rapid technological changes, with frequent introductions of new technology-driven products and services. In addition to better serving customers, the effective use of technology increases efficiency and enables financial institutions to reduce costs. Our future success will depend, 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 for convenience, as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements. We cannot assure you that we will be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers.
An interruption in or breach in security of our information systems may result in a loss of customer 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, deposits, and servicing or loan origination systems. The occurrence of any failures or interruptions could result in a loss of customer business and have a material adverse effect on our business, financial condition, results of operations and cash flows.
We are subject to significant government regulation, and any regulatory changes may adversely affect us.
The banking industry is heavily regulated under both federal and state law. These regulations are primarily intended to protect customers, not our creditors or shareholders. As a financial holding company, we are also subject to extensive regulation by the FRB, in addition to other regulatory and self-regulatory organizations. Regulations affecting banks and financial services companies undergo continuous change, and we cannot predict the ultimate effect of such changes, which could have a material adverse effect on our business, financial condition, results of operations and cash flows.
At December 31, 2010, we had 12 bank locations, four fee-based locations and an operations center in Colorado and seven bank locations and a fee-based location in Arizona. Our executive offices are located at 821 17th St., Denver, Colorado, 80202. We lease our executive offices, our Northeast office and our Surprise office locations from entities partly owned or controlled by a director of the Company. See Certain Relationships and Related Transactions and Director Independence under Item 13 of Part III and Note 15 to the Consolidated financial statements. The terms of these leases expire between 2013 and 2016. The Company leases all of its facilities with the exception of the Prince bank in Littleton, Colorado which the Company purchased during 2010. The following table sets forth specific information on each location.
All locations are in good operating condition and are believed adequate for our present and foreseeable future operations. We do not anticipate any difficulty in leasing additional suitable space upon expiration of any present lease terms.
Periodically and in the ordinary course of business, various claims and lawsuits which are incidental to our business are brought against or by us. We believe, based on the dollar amount of the claims outstanding at the end of the year, the ultimate liability, if any, resulting from such claims or lawsuits will not have a material adverse effect on the business, financial condition, results of operations or cash flows of the Company.
Item 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market for Registrants Common Equity
The common stock of the Company is traded on the NASDAQ Global Select Market under the symbol COBZ. At February 8, 2011, there were approximately 484 shareholders of record of CoBiz common stock.
The following table presents the range of high and low sale prices of our common stock for each quarter within the two most recent fiscal years as reported by the NASDAQ Global Select Market and the per-share dividends declared in each quarter during that period.
The timing and amount of future dividends declared by the Board of Directors of the Company will depend upon the consolidated earnings, financial condition, liquidity and capital requirements of the Company and its subsidiaries, the amount of cash dividends paid to the Company by its subsidiaries, applicable government regulations and policies, and other factors considered relevant by the Board of Directors of the Company. The Company is subject to certain covenants pursuant to the issuance of its junior subordinated debentures as described in Note 9 to the Consolidated financial statements, that could limit our ability to pay dividends.
Pursuant to the terms of the Purchase Agreement executed in the issuance of the Series B Preferred Stock, the ability of the Company to declare or pay dividends or distributions on, or purchase, redeem or otherwise acquire for consideration, shares of its common stock will be subject to restrictions in the event that the Company fails to declare and pay full dividends on the Series B Preferred Stock. In addition, the Company may not increase its dividend prior to the earlier of 1) three years from the date of the Purchase Agreement or 2) the date on which the Series B Preferred Stock is redeemed in whole. At December 31, 2010, the Company has paid all required dividends under the Purchase Agreement when due.
Capital distributions, including dividends, by institutions such as the Bank are subject to restrictions tied to the institutions earnings. See Supervision and Regulation The Bank and The Holding Company Dividend Restrictions included under Item 1 of Part I.
The following table compares the cumulative total return on a hypothetical investment of $100 in CoBiz common stock on December 31, 2005 and the closing prices on each of the five years in the period ended December 31, 2010, with the hypothetical cumulative total return on the Russell 2000 Index and the NASDAQ Bank Index for the comparable period.
The following table sets forth selected financial data for the Company for the periods indicated. During the periods reported, the Company has completed two acquisitions of companies as described in Part I, Item 1.
(1) Efficiency ratio is computed by dividing noninterest expense by the sum of net interest income before provision for loan losses and noninterest income, excluding gains and losses on asset sales and valuation adjustments.
NM - Not Meaningful
The Company is a financial holding company that offers a broad array of financial service products to its target market of professionals, small and medium-sized businesses, and high-net-worth individuals. Our operating segments include: Commercial Banking, Investment Banking, Wealth Management, and Insurance.
Earnings are derived primarily from our net interest income, which is interest income less interest expense, and our noninterest income earned from fee-based business lines and banking service fees, offset by noninterest expense. As the majority of our assets are interest-earning and our liabilities are interest-bearing, changes in interest rates impact our net interest margin, the largest component of our operating revenue (which is defined as net interest income plus noninterest income). We manage our interest-earning assets and interest-bearing liabilities to reduce the impact of interest rate changes on our operating results. We also have focused on reducing our dependency on our net interest margin by increasing our noninterest income.
During the economic and industry turmoil since 2008, we have continued to focus on developing an organization with personnel, management systems and products that will allow us to compete effectively and position us for growth. Many of our competitors have drastically cut costs by closing locations and reducing employee bases during this time. Although we have also focused on reducing costs that do not impact customer service, we have also continued to invest in systems and business production personnel to strengthen our future growth prospects. The economic downturn has also negatively impacted our customer base and our levels of nonperforming assets have increased as a result. The combination of the increased levels of nonperforming assets and continued investment in the business has caused relatively high levels of noninterest expense that has adversely affected our earnings over the past several years. Salaries and employee benefits, loan workout costs and losses on Other Real Estate Owned (OREO) have comprised most of this overhead category.
Industry Overview. The U.S. commercial banking industry has been significantly impacted between 2008 and 2010 by decreased values in real estate related assets, a downturn in the financial markets and a significant tightening in the credit market. The weakened U.S. housing market has caused the industry to realize significant losses on write-downs of investment securities securitized by real estate and higher credit costs for write-downs of loans issued for investment. The November 2010 S&P/Case-Shiller Home Price Indices data indicated that the real estate market is still struggling. November 2010 was the sixth consecutive month where annual growth rates moderated from the prior months pace. In addition, nine metropolitan areas hit their lowest price levels since home prices peaked in 2006 and 2007.
The Chairman of the Federal Reserve indicated in a speech on August 27, 2010, that economic activity that appeared in the second half of 2009 has continued, but at a pace lower than projected earlier in the year. Based on the Federal Reserves projection of economic activity, it is expected that the current pace of economic activity will accelerate in 2011. Based on those projections, the unemployment rate would reduce over time. While consumer spending and business fixed investment continue to restrict economic recovery, business investment in equipment and software increased to a rate of more than 20% in the first half of 2010. However, disappointing labor market data coupled with low consumer spending and lower than expected growth in housing indicates that the recovery of output and employment has slowed.
During 2010, the Federal Reserve continued to take action to encourage growth in the U.S economy. In November 2010, the Federal Reserve announced plans to buy up to $600 billion in long-term Treasuries during the second quarter of 2011 and reiterated its intentions to reinvest up to $300 billion in proceeds from earlier investments, bringing total new investment up to $900 billion. These stimulus efforts, collectively referred to as the central banks quantitative easing policy, are intended to promote economic growth by keeping access to credit markets open and interest rates low.
The national unemployment rate slightly decreased from 10.0% in December 2009 to 9.4% as of December 2010. The high unemployment rate is another driving factor that could prolong a weak economy. During 2008-2009, 165 banks failed and went into receivership with the FDIC, causing estimated losses of $53.6 billion to the Depository Insurance Fund. In 2010, 157 banks went into
receivership. The FDIC has also taken possession of 11 banks in the first month of 2011, including two Colorado banks. This compares to only 10 bank failures in the years 2003 to 2007. The FDICs problem list stood at 860 at September 30, 2010, up from 702 at the end of 2009 and 252 at the end of 2008.
In the third quarter of 2010, FDIC-insured commercial banks reported a combined net income of $14.5 billion, the fifth consecutive quarterly year-over-year earnings improvement. Driving the increase in earnings were reductions in loan loss provisions and goodwill impairments. Provision for loan losses was at the lowest quarterly total since the fourth quarter of 2007. Net charge-offs decreased for the second consecutive quarter as compared to the previous and year-earlier quarters. In addition, noncurrent loans decreased during the quarter after posting the first quarterly decline in more than four years during the second quarter of 2010. Prior to the second quarter of 2010, noncurrent loan balances had risen for 16 consecutive quarters.
The overall market conditions led the Federal Open Markets Committee (FOMC) to maintain the target federal funds rate at a range of 0 to 25 basis points in 2010 since it was initially set in December 2008. At the January 2011 FOMC meeting the Committee again decided to maintain the target at 0 to 25 basis points since the rate of the economic recovery has been insufficient to bring about a significant improvement in labor market conditions.
Company Overview. From December 31, 1995, the first complete fiscal year under the current management team, to December 31, 2010, our organization has grown from a bank holding company with two bank locations and total assets of $160.4 million to a diversified financial services holding company with 19 bank locations, four fee-based businesses and total assets of $2.4 billion. As discussed in Item 1. Business and Note 19 to the Consolidated financial statements, the Company changed its operating segments in 2010 to reflect an internal realignment of its wealth management components. The prior period disclosures in the following table have been adjusted to conform to the new presentation. Certain key metrics of our operating segments at or for the years ended December 31, 2010, 2009 and 2008 are as follows:
Noted below are some of the significant financial performance measures and operational results for 2010 and 2009:
· Commercial Banking broke even on a per share basis in 2010 compared to a loss of $1.64 per diluted share in 2009. Our commercial banking franchise recognized provision for loan losses of $30.2 million in 2010, a significant reduction compared to $103.4 million in 2009. Nonperforming assets decreased to $67.8 million at the end of 2010, from $104.5 million at the end of 2009. The Banks ratio of allowance for loan and credit losses to total loans ended the year at 4.01% and the allowance exceeds 154% of nonperforming loans. During the fourth quarter of 2010, the segment recorded a deferred tax valuation charge of $4.1 million. Also contributing to the improvement was the absence of a goodwill impairment that negatively impacted the 2009 results.
· Investment Banking broke even on a per share basis in 2010, compared to a loss of $0.16 per diluted share in 2009. After muted mergers and acquisition activity in 2009 due to the adverse impact of severe macro economic conditions, the segment significantly improved the number of successful deals closed in 2010. Also contributing to the improvement was the absence of a goodwill impairment that negatively impacted the 2009 results.
· Wealth Management lost $0.04 per diluted share in 2010, an improvement over the loss of $0.76 in 2009. The segment recorded a $0.3 million deferred tax valuation allowance during 2010. Most of the major market indices rose during 2010, contributing to higher revenue for the segment. However, the integration of the Companys investment advisory firms into one legal entity and the subsequent marketing campaign of Wealth Management increased operating expenses. Wealth transfer revenue increased in 2010 over 2009, as the economy improved. Also contributing to the improvement was the absence of a goodwill impairment that negatively impacted the 2009 results.
· Insurance lost $0.02 per diluted share in 2010, an improvement over the $0.09 loss in 2009. A deferred tax valuation allowance of $0.3 million impacted the segments earnings during 2010. The Companys P&C revenues are generated as a percentage of its clients insurance premiums. As client payrolls, revenues and business assets have shrunk due to economic conditions, premiums have also decreased. The Company continues to realize lower revenues on a large part of its existing client base. The improvement in the 2010 net loss per share was primarily due to the absence of a goodwill impairment that negatively impacted the 2009 results.
· Corporate Support and Other lost $0.66 per diluted share in 2010, down from a loss of $0.33 in 2009. The increase in the net loss per share was primarily due to an $11.0 million deferred tax valuation charge recorded in the fourth quarter of 2010, a $2.5 million increase in provision for loan loss expense for non-performing assets held at the parent company and a $2.0 million increase in valuation losses on OREO also held at the parent company.
· During the fourth quarter of 2010, the Company established a deferred tax asset valuation allowance in the amount of $15.6 million based on its assessment of the amount of deferred tax assets that are more likely than not to be realized.
· The Company recognized losses of $8.4 million in 2010 on valuation adjustments of other real estate owned and other-than-temporary impairments on investments.
· The net interest margin on a tax-equivalent basis remained steady at 4.37% compared to 4.38% in 2009.
· Total noninterest-bearing demand accounts represented 36.1% of total deposits at December 31, 2010, the highest level in the Companys history.
· The Companys total risk-based capital ratio was to 15.5% at the end of 2010, down from 16.1% at the end of 2009.
· The Company recognized a $46.2 million goodwill impairment charge in 2009.
· Commercial Banking lost $1.64 per diluted share in 2009, down from a contribution of $0.28 in 2008. Our commercial banking franchise recognized provision for loan losses of $103.4 million in 2009, compared to $39.8 million in 2008. Net charge-offs for 2009 totaled $73.5 million, compared to $17.0 million for 2008. Nonperforming assets also increased to $104.5 million at the end of 2009, from $47.0 million at the end of 2008. The Banks ratio of allowance for loan and
credit losses to total loans ended the year at 4.23%, the highest ratio the Bank has had at the end of a year in its history, and the allowance exceeds 97% of nonperforming loans. The segment also realized a goodwill impairment charge of $15.4 million.
· The increase in provision for loan loss expense was the primary driver in the decrease in net income for both the commercial banking segment and the Company. The Companys land acquisition and development portfolio represented 8.6% of total loans, but accounted for approximately 61% of the provision for loan losses and 59% of the gross charge-offs.
· Investment Banking lost $0.16 per diluted share in 2009, down from a $0.01 loss in 2008. Mergers and acquisition activity was muted in 2009 due to the adverse impact of severe macro economic conditions. The segment also realized a goodwill impairment charge of $5.3 million.
· Wealth Management lost $0.76 per diluted share in 2009, down from a loss of $0.03 in 2008. While the major market indices rose during 2009, the market growth did not fully recapture the losses realized in 2008. The segment was also adversely impacted by a decrease in wealth transfer cases, as clients conserved cash reserves due to the recession. The decline in average market values in 2009 compared to 2008 continued to pressure top line revenue. The segment also realized a goodwill impairment charge of $21.4 million.
· Insurance lost $0.09 per diluted share in 2009, down from a contribution of $0.03 in 2008.The Companys P&C revenues are generated as a percentage of its clients insurance premiums. As client payrolls, revenues and business assets have shrunk due to economic conditions, premiums have also decreased. Thus, the Company has realized lower revenues on a large part of its existing client base. The segment also realized a goodwill impairment charge of $4.1 million.
· Corporate Support and Other lost $0.33 per diluted share in 2009, down from a loss of $0.22 in 2008. The increase in the net loss per share was primarily due to the inclusion of the preferred stock dividends for a full year in 2009. The preferred stock was outstanding for less than a month in 2008. In addition, the segment recorded $2.4 million in provision for loan loss expense for non-performing assets held at the parent company.
· During the third quarter of 2009, the Company successfully completed a common equity offering of $55.8 million, net of expenses.
· The Company recognized losses of $5.6 million in 2009 on valuation adjustments of other real estate owned and other-than-temporary impairments on investments.
· The net interest margin on a tax-equivalent basis was 4.38% compared to 4.08% in 2008.
· The Companys total risk-based capital ratio increased to 16.1% at the end of 2009 from 14.5% at the end of 2008.
Bank. The commercial bank segment, the cornerstone of our franchise, has been adversely impacted by the slowdown in the economy and the tightening in the credit markets over the past three years. While the Bank has recognized elevated levels of loan losses, net charge-offs fell to $44.4 million in 2010 from $73.6 million in 2009 (both years include net charge-offs of loans that were transferred to the parent company). The negative impact of asset quality not only affected the level of provision for loan losses, but also impacted net interest income as earning assets decreased. The Bank, and the industry as a whole, continues to be challenged by new loan generation. Muted loan growth in the future will negatively impact the Banks earnings as net interest income is the largest driver of operating income.
Fee-Based Business Lines. The Companys fee-based business lines Investment Banking, Insurance, and Wealth Management operated at a loss for 2010 on a combined basis for the second consecutive
year. However, our ratio of noninterest income to total operating revenues increased to 27% for 2010 compared to 21% in 2009.
We believe that through the combination of our Commercial Banking franchise and our fee-based businesses, we are uniquely situated to service our commercial clients throughout their business lifecycle. We are able to help our customers grow by providing banking services from our bank franchise, capital planning from GMB, and employee and executive benefits packages from FDL. We can assist in planning for the future with wealth transfer and business succession planning from FDL. We are able to protect assets with P&C insurance from CoBiz Insurance. We can facilitate exit and retirement strategies with merger and acquisition services from GMB. We are also able to preserve our customers wealth with trust and fiduciary services from CoBiz Trust, investment management services from CoBiz Investment Management, and wealth transfer services from FDL.
This discussion should be read in conjunction with the consolidated financial statements and notes thereto included in this Form 10-K beginning on page F-1. For a discussion of the segments included in our principal activities and for certain financial information for each segment, see Segment Results discussed below and Note 19 to the consolidated financial statements.
Critical Accounting Policies
The Companys discussion and analysis of its consolidated financial condition and results of operations are based upon the Companys consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. In making those critical accounting estimates, we are required to make assumptions about matters that are highly uncertain at the time of the estimate. Different estimates we could reasonably have used, or changes in the assumptions that could occur, could have a material effect on our consolidated financial condition or consolidated results of operations.
Allowance for Loan Losses
The allowance for loan losses is a critical accounting policy that requires subjective estimates in the preparation of the consolidated financial statements. The allowance for loan losses is evaluated on a regular basis by management and is based upon managements periodic review of the collectibilty of loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrowers ability to repay, estimated value of 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.
We maintain a loan review program independent of the lending function that is designed to reduce and control risk in the lending function. It includes the monitoring of lending activities with respect to underwriting and processing new loans, preventing insider abuse, and timely follow-up and corrective action for loans showing signs of deterioration in quality. We also have a systematic process to evaluate individual loans and pools of loans within our loan portfolio. We maintain a loan grading system whereby each loan is assigned a grade between 1 and 8, with 1 representing the highest quality credit, 7 representing a loan where collection or liquidation in full is highly questionable and improbable, and 8 representing a loss that has been or will be charged-off. Loans that are graded 5 or lower are categorized as non-classified credits, while loans graded 6 and higher are categorized as classified credits that have a higher risk of loss. Grades are assigned based upon the degree of risk associated with repayment of a loan in the normal course of business pursuant to the original terms. Loans above a certain dollar amount that are adversely graded are reported to the Loan Committee and the Chief Credit Officer along with current financial information, a collateral analysis and an action plan. Individual loans that are deemed to be impaired are evaluated in accordance with Accounting Standards Codification (ASC) Topic 310-10-35, Receivables Subsequent Measurement.
In determining the appropriate level of the allowance for loan losses, we analyze the various components of the loan portfolio, including all significant credits, on an individual basis. When analyzing the adequacy, we segment the loan portfolio into components with similar characteristics, such as risk classification, past due status, type of loan, industry or collateral. Possible factors that may impact the allowance for loan losses include, but are not limited to:
· Changes in lending policies and procedures, including underwriting standards as well as collection, charge-off and recovery practices;
· Changes in national and local economic and business conditions and developments, including the condition of various market segments;
· Changes in the nature and volume of the portfolio;
· Changes in the experience, ability, and depth of lending management and staff;
· Changes in the trend of the volume and severity of past-due and classified loans; and trends in the volume of non-accrual loans, troubled debt restructurings, and other loan modifications;
· The existence and effect of any concentrations of credit, and changes in the level of such concentrations; and
· The effect of external factors such as competition and legal and regulatory requirements on the level of estimated credit losses in the current portfolio.
See Note 4 to the consolidated financial statements for further discussion on managements methodology.
Other Real Estate Owned
Other Real Estate Owned (OREO) represents properties acquired through foreclosure or physical possession. Write-downs to fair value at the time of transfer to OREO are charged to the allowance for loan losses. Subsequent to foreclosure, we periodically evaluate the value of OREO held for sale and record a valuation allowance for any subsequent declines in fair value less selling costs. Subsequent declines in value are charged to operations. Fair value is based on our assessment of information available to us at the end of a reporting period and depends upon a number of factors, including our historical experience, economic conditions, and issues specific to individual properties. Our evaluation of these factors involves subjective estimates and judgments that may change.
Recoverability of Goodwill
ASC Topic 350, Intangibles Goodwill and Other (ASC 350), requires that we evaluate on an annual basis (or whenever events occur which may indicate possible impairment) whether any portion of our recorded goodwill is impaired. The recoverability of goodwill is a critical accounting policy that requires subjective estimates in the preparation of the consolidated financial statements. Goodwill impairment is determined using a two-step process. In the first step, the fair value of a reporting unit is compared to its carrying amount, including goodwill. If the fair value of the reporting unit exceeds its carrying amount, goodwill of the reporting unit is not considered impaired and it is not necessary to continue to step two of the impairment process. If the fair value of the reporting unit is less than the carrying amount, step two is performed, where the implied fair value of goodwill is compared to the carrying value of the reporting units goodwill. Implied goodwill is computed as a residual value after allocating the fair value of the reporting unit to its assets and liabilities We estimate the fair value of our reporting units using market multiples of comparable entities, including recent transactions, or a combination of market multiples and a discounted cash flow methodology.
Determining the fair value of a reporting unit requires a high degree of subjective management assumption. Discounted cash flow valuation models utilize variables such as revenue growth rates, expense trends, discount rates and terminal values. Based upon an evaluation of key data and market factors, management selects from a range the specific variables to be incorporated into the valuation model.
We conducted evaluations of our reporting units during 2009 due to triggering events noted in the first and third quarters. As discussed in Note 6 to the consolidated financial statements, the estimated fair value of all reporting units was less than their carrying values and goodwill impairment was deemed to exist. During 2009, the Company recorded a goodwill impairment of $46.2 million, eliminating all goodwill from the balance sheet.
The Company uses the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. If current available information raises doubt as to the realization of the deferred tax assets, a valuation allowance may be established. We consider the determination of this valuation allowance to be a critical accounting policy because of the need to exercise significant judgment in evaluating the amount and timing of recognition of deferred tax liabilities and assets, including projections of future taxable income. These judgments and estimates are reviewed on a continual basis as regulatory and business factors change. At December 31, 2010, the Company has recorded a valuation allowance of $15.6 million. An additional valuation allowance for deferred tax assets may be required if the amounts of taxes recoverable through loss carry backs decline, if we project lower levels of future taxable income, or we project lower levels of tax planning strategies. Such additional valuation allowance would be established through a charge to income tax expense that would adversely affect our operating results.
On January 1, 2006, we adopted guidance now included in ASC Topic 718, Compensation Stock Compensation (ASC 718) (originally issued as SFAS No. 123(R), Share-Based Payment), using the modified prospective method. Under this method, compensation cost is recognized for (1) all awards granted after the required effective date and to awards modified, cancelled or repurchased after that date and (2) the portion of prior awards for which the requisite service has not yet been rendered, based on the grant-date fair value of those awards calculated for pro forma disclosures under SFAS No. 123, Accounting for Stock Based Compensation (SFAS 123).
ASC 718 requires that the cash retained as a result of the tax deductibility of employee share-based awards be presented as a component of cash flows from financing activities in the consolidated statement of cash flows.
Under ASC 718, we use the Black-Scholes option valuation model to determine the fair value of our stock options as discussed in Note 14 to the consolidated financial statements. The Black-Scholes fair value model includes various assumptions, including the expected volatility, expected life and expected dividend rate of the options. In addition, the Company is required to estimate the amount of options issued that are expected to be forfeited. These assumptions reflect our best estimates, but they involve inherent uncertainties based on market conditions generally outside of our control. As a result, if other assumptions had been used, stock-based compensation expense, as calculated and recorded under ASC 718, could have been materially impacted. Furthermore, if we use different assumptions in future periods, stock-based compensation expense could be materially impacted in future periods.
The Company has adopted ASC Topic 820, Fair Value Measurements and Disclosures (ASC 820) (originally issued as SFAS No. 157, Fair Value Measurements), as it applies to financial assets and liabilities effective January 1, 2008. ASC 820 defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles and enhances disclosures about fair value measurements. Fair value is defined under ASC 820 as the exchange price that would be received for an
asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.
As a basis for considering market participant assumptions in fair value measurements, ASC 820 establishes a fair value hierarchy that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity (observable inputs that are classified within Levels 1 and 2 of the hierarchy) and the reporting entitys own assumptions about market participant assumptions (unobservable inputs classified within Level 3 of the hierarchy). Fair value may be used on a recurring basis for certain assets and liabilities such as available for sale securities and derivatives in which fair value is the primary basis of accounting. Similarly, fair value may be used on a nonrecurring basis to evaluate certain assets or liabilities such as impaired loans. Depending on the nature of the asset or liability, the Company uses various valuation techniques and assumptions in accordance with ASC 820 to determine the instruments fair value. At December 31, 2010, $642.7 million of total assets, consisting of $637.4 million in available for sale securities and $5.3 million in derivative instruments, represented assets recorded at fair value on a recurring basis. At December 31, 2009, $536.9 million of total assets, consisting of $529.2 million in available for sale securities and $7.7 million in derivative instruments, represented assets recorded at fair value on a recurring basis. At December 31, 2010 and 2009, $6.9 million and $3.7 million, respectively, of total liabilities represented derivative instruments recorded at fair value on a recurring basis. Assets recorded at fair value on a nonrecurring basis consisted of impaired loans totaling $47.6 million at December 31, 2010. Certain private label MBS valued using broker-dealer quotes based on proprietary broker models, which are considered by the Company an unobservable input (Level 3), totaled $2.4 million of total assets at December 31, 2010 and 2009. The Company recognized $0.4 million and $1.3 million in other-than-temporary impairments on the private label MBS for the year-ended December 31, 2010 and 2009, respectively. For additional information on the fair value of certain financial assets and liabilities see Note 18 to the consolidated financial statements.
We also have other policies that we consider to be significant accounting policies; however, these policies, which are disclosed in Note 1 of Notes to Consolidated Financial Statements, do not meet the definition of critical accounting policies because they do not generally require us to make estimates or judgments that are difficult or subjective.
Recent Accounting Pronouncements
Effective January 1, 2010, the Company adopted the guidance in ASU No. 2010-06, Fair Value Measurements and Disclosures (Topic 820) Improving Disclosures About Fair Value Measurements (ASU 2010-06), which adds new requirements for disclosures for Levels 1 and 2, separate disclosures of purchases, sales, issuances, and settlements relating to Level 3 measurements and clarification of existing fair value disclosures. ASU 2010-06 was effective for interim and annual periods beginning after December 15, 2009, except for the requirement to provide Level 3 activity of purchases, sales, issuances, and settlements on a gross basis, was effective for fiscal years beginning after December 15, 2010. The adoption of the update effective in 2010 did not have a material impact on the consolidated financial statements. The Company is evaluating the effect, if any, the update effective in 2011 will have on the consolidated financial statements.
In July 2010, the FASB issued ASU No. 2010-20, Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses (ASU 2010-20). ASU 2010-20 is intended to provide financial statement users with greater transparency about the nature of credit risk in an entitys portfolio of financing receivables; how risk is analyzed in arriving at the allowance for credit losses; and the changes and reasons for those changes in the allowance for credit losses. ASU 2010-20 is effective for interim and annual reporting periods ending after December 15, 2010, except for certain disclosures related to activity occurring during a reporting period which was effective for interim and annual reporting periods beginning after December 15, 2010. The adoption of the update effective in 2010 did not have a material impact on the consolidated financial statements. The Company is evaluating the effect, if any, the update effective in 2011 will have on the consolidated financial statements.
The Company had total assets of $2.40 billion and total liabilities of $2.19 billion at December 31, 2010, compared to $2.47 billion in assets and $2.23 billion in liabilities at December 31, 2009. The following sections address the specific components of the balance sheets and significant matters relating to those components at and for the years ended December 31, 2010 and 2009.
General. We provide a broad range lending services, including commercial loans, commercial and residential real estate construction loans, commercial and residential real estate mortgage loans, consumer loans, revolving lines of credit, and tax-exempt financing. Our primary lending focus is commercial and real estate lending to small and medium-sized businesses with annual sales of $5.0 million to $75.0 million, and businesses and individuals with borrowing requirements of $250,000 to $15.0 million. At December 31, 2010, substantially all of our outstanding loans were to customers within Colorado and Arizona. Interest rates charged on loans vary with the degree of risk, maturity, underwriting and servicing costs, principal amount, and extent of other banking relationships with the customer. Interest rates are further subject to competitive pressures, money market rates, availability of funds, and government regulations. See Net Interest Income for an analysis of the interest rates on our loans.
Credit Procedures and Review. We address credit risk through internal credit policies and procedures, including underwriting criteria, officer and customer lending limits, a multi-layered loan approval process for larger loans, periodic document examination, justification for any exceptions to credit policies, loan review and concentration monitoring. In response to current conditions and heightened default risk due to depressed real estate and collateral values, Management expanded the resources of the credit and loan review departments to provide for a more proactive identification of problem credits. In addition, we provide ongoing loan officer training and review. We have a continuous loan review process designed to promote early identification of credit quality problems, assisted by a dedicated Senior Credit Officer in each geographic market. All loan officers are charged with the responsibility of reviewing, at least on a monthly basis, all past due loans in their respective portfolios. In addition, each of the loan officers establishes a watch list of loans to be reviewed by the boards of directors of the Bank. The loan portfolio is also monitored regularly by a loan review department that reports to the Chief Operations Officer of the Company and submits reports directly to the audit committee of the board of directors and the credit administration department.
In order to effectively respond to the current credit cycle, declining asset quality and increasing foreclosures, the Company made a significant investment in 2009 to establish a Special Assets Group comprised of seasoned specialists to efficiently manage nonperforming assets. Management believes having the specialized function will allow our bankers to focus on seeking new lending and deposit relationships while troubled asset levels are effectively managed.
Composition of Loan Portfolio. The following table sets forth the composition of our loan portfolio at the dates indicated.
Gross loans decreased $139.0 million to $1.6 billion at December 31, 2010. The decline in the overall gross loan balance is primarily attributable to a decrease in the land acquisition and development loan
portfolio, which contributed to 50% or $68.8 million of the overall decline of the loan portfolio. Due to overall market illiquidity and the significant value declines on raw land, the Company has ceased lending activities for the acquisition and future development of land. The real estate mortgage and real estate construction loan portfolios decreased significantly during 2010; $48.8 million and $57.2 million, respectively. The aforementioned declines were offset by increases in other loan categories, primarily the consumer loan category. The growth in the consumer loan portfolio is due to a new product offering, jumbo mortgage loans ($24.9 million at December 31, 2010). The recent adverse economic conditions have contributed to a challenging operating environment and a downward trend in loan demand. However, the shift in loan concentration is primarily attributed to successful efforts to further diversify the Companys loan portfolio. The Companys primary focus was to reduce high risk loan concentration levels and grow other loan categories mainly by exploring new niche lending opportunities.
Gross loans decreased $250.4 million to $1.78 billion at December 31, 2009. The decline was driven by customer paydowns in each major category of the portfolio outpacing new loan demand and the increased level of charge-offs. Loan generation slowed in 2009 as businesses de-leveraged their balance sheets and accumulated cash reserves in response to economic factors. The decrease in total loans was equally shared between the Colorado and Arizona markets.
Under state law, the aggregate amount of loans we can make to one borrower is generally limited to 15% of our unimpaired capital, surplus, undivided profits and allowance for loan losses. At December 31, 2010, our individual legal lending limit was $38.7 million. The Banks Board of Directors has established an internal lending limit of $15.0 million for normal credit extensions and $20.0 million for the highest rated credit types. To accommodate customers whose financing needs exceed our internal lending limits and to address portfolio concentration concerns, we sell loan participations to outside participants. At December 31, 2010 and 2009, the outstanding balance of loan participations sold by us was $18.4 million and $30.8 million, respectively. At December 31, 2010 and 2009, we had loan participations purchased from other banks totaling $43.3 million and $37.3 million, respectively. We use the same analysis in deciding whether or not to purchase a participation in a loan as we would in deciding whether to originate the same loan.
Due to the nature of our business as a commercial banking institution, our lending relationships are typically larger than those of a retail bank. The following table describes the number of relationships and the percentage of the dollar value of the loan portfolio by the size of the credit relationship.
The majority of the loan relationships exceeding $3.0 million are in our real estate and commercial portfolios. At December 31, 2010, 2009, and 2008, there were no concentrations of loans related to any single industry in excess of 10% of total loans. The Company may be subject to additional regulatory supervisory oversight if its concentration in commercial real estate lending exceeds regulatory parameters. Pursuant to interagency guidance issued by the Federal Reserve and other federal banking agencies, supervisory criteria were put in place to define commercial real estate concentrations as:
· Construction, land development and other land loans that represent 100% or more of total risk-based capital; or
· Commercial real estate loans (as defined in the guidance) that represent 300% or more of total risk-based capital and the real estate portfolio has increased more than 50% or more during the prior 36 months.
At December 31, 2010, the Company had reduced its exposure to commercial real estate lending below the parameters discussed above. However, at December 31, 2009, the Company was considered to have a commercial real estate concentration.
In the ordinary course of business, we enter into various types of transactions that include commitments to extend credit. We apply the same credit standards to these commitments as we apply to our other lending activities and have included these commitments in our lending risk evaluations. Our exposure to credit loss under commitments to extend credit is represented by the amount of these commitments. See Note 15 to the consolidated financial statements for additional discussion on our commitments.
Commercial Loans. Commercial loans increased $5.5 million, or 1.0%, from $559.6 million at December 31, 2009 to $564.9 million at December 31, 2010. Commercial lending consists of loans to small and medium-sized businesses in a wide variety of industries. We provide a broad range of commercial loans, including lines of credit for working capital purposes and term loans for the acquisition of equipment and other purposes. Commercial loans are generally collateralized by inventory, accounts receivable, equipment, real estate and other commercial assets, and may be supported by other credit enhancements such as personal guarantees. However, where warranted by the overall financial condition of the borrower, loans may be unsecured and based on the cash flow of the business. Terms of commercial loans generally range from one to five years, and the majority of such loans have floating interest rates.
The following table summarizes the Companys commercial loan portfolio, segregated by the North American Industry Classification System (NAICS).
Real Estate Mortgage Loans. Real estate mortgage loans decreased $48.8 million, or 5.9%, from $832.5 million at December 31, 2009 to $784.0 million at December 31, 2010. Real estate mortgage loans include various types of loans for which we hold real property as collateral. We generally restrict commercial real estate lending activity to owner-occupied properties or to investor properties that are owned by customers with which we have a current banking relationship. We make commercial real estate loans at both fixed and floating interest rates, with maturities generally ranging from five to 20 years. The Banks underwriting standards generally require that a commercial real estate loan not exceed 75% of the appraised value of the property securing the loan. In addition, we originate Small Business Administration 504 loans (SBA) on owner-occupied properties with maturities of up to 25 years in which the SBA allows for financing of up to 90% of the project cost and takes a security position that is subordinated to us, as well as U.S. Department of Agriculture (USDA) Rural Development loans.
The properties securing the Companys real estate mortgage loan portfolio are located primarily in the states of Colorado and Arizona. At December 31, 2010 and 2009, 59% and 57%, respectively, of the Companys outstanding real estate mortgage loans were in the Colorado market.
The following table summarizes the Companys real estate mortgage portfolio, segregated by property type.
Land Acquisition and Development Loans. Land acquisition and development loans decreased $68.8 million, or 45.1%, from $152.7 million at December 31, 2009 to $83.9 million at December 31, 2010. We have a portfolio of loans for the acquisition and development of land for residential building projects. Due to overall market illiquidity and the significant value declines on raw land, the Company has ceased lending activities for the acquisition and future development of land. However, the Company may still pursue loans secured by finished lots that are prepared to enter the construction phase. Land acquisition and development loans may be more adversely affected by conditions in the real estate markets or in the general economy. The Company continued its focus on reducing its exposure to this portfolio in 2010. This portfolio has been continuously decreasing since 2006, when it comprised 14.3% or $218.6 million of the total loan portfolio. The properties securing the land acquisition and development portfolio are generally located in the states of Arizona and Colorado. At December 31, 2010 and 2009, the majority (approximately 60%) of the loans were generated in the Colorado market.
Real Estate Construction Loans. Real estate construction loans decreased $57.2 million, or 39.7%, from $144.1 million at December 31, 2009 to $86.9 million at December 31, 2010. We originate loans to finance construction projects involving one- to four-family residences. We provide financing to residential developers that we believe have demonstrated a favorable record of accurately projecting completion dates and budgeting expenses. We provide loans for the construction of both pre-sold projects and projects built prior to the location of a specific buyer (Speculative loan), although Speculative loans are provided on a more selective basis. Residential construction loans are due upon the sale of the completed project and are generally collateralized by first liens on the real estate and have floating interest rates. In addition, these loans are generally secured by personal guarantees to provide an additional source of repayment. We generally require a permanent financing commitment or prequalification be in place before we make a residential construction loan. Moreover, we generally monitor construction draws monthly and inspect property to ensure that construction is progressing as projected. Our underwriting standards generally require that the principal amount of a speculative loan be no more than 75% of the appraised value of the completed construction project or 80% of pre-sold projects. Values are determined primarily by approved independent appraisers. With the deep valuation declines in the real estate markets during recent years, the Company has become very selective in the extension of credit for new construction projects.
We also originate loans to finance the construction of multi-family, office, industrial, retail and tax credit projects. These projects are predominantly owned by the user of the property, or are sponsored by financially strong developers who maintain an ongoing banking relationship with us. Our underwriting standards generally require that the principal amount of these loans be no more than 75% of the appraised value. Values are determined primarily by approved independent appraisers. The properties securing the Companys real estate loan portfolio are generally located in the states of Arizona and Colorado. At December 31, 2010 and 2009, the majority (63% and 60%, respectively) of the Companys real estate construction loans were generated in the Colorado market.
Consumer Loans. Consumer loans increased $18.5 million, or 24.3%, from $76.1 million at December 31, 2009 to $94.6 million at December 31, 2010. We provide a broad range of consumer loans to customers, including personal lines of credit, home equity loans and automobile loans. In order to improve customer service, continuity and customer retention, the same loan officer often services the banking relationships of both the business and business owners or management. In 2010, the Company introduced a new product line, jumbo mortgage loans. This residential mortgage financing program offers competitive pricing and terms for the purchase, refinance or permanent financing for non-conforming mortgage loans, which generally exceed $417,000. For primary residences, the maximum loan-to-value is 70% for loans up to $1.5 million. The loan-to-value decreases as the size of the loan increases, with a maximum loan-to-value of 50% on loans in excess of $3.0 million. In addition, we generally only finance
3/1, 5/1, and 7/1 adjustable-rate mortgage loans and broker 15- and 30-year fixed products. Jumbo mortgage loans at December 31, 2010, totaled $24.9 million or 26.3% of the consumer loan portfolio.
Our nonperforming assets consist of nonaccrual loans, restructured loans, loans past due 90 days or more, OREO and other repossessed assets. Nonaccrual loans are those loans for which the accrual of interest has been discontinued. Impaired loans are defined as loans for which, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement (all of which were on a non-accrual basis). The following table sets forth information with respect to these assets at the dates indicated.