CoBiz 10-Q 2008
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the quarterly period ended March 31, 2008.
For the transitions 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)
(Former name, former address and former fiscal year, if changed since last report)
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 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. (Check one):
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
There were 23,070,222 shares of the registrants Common Stock, $0.01 par value per share, outstanding at May 8, 2008.
CoBiz Financial Inc.
Condensed Consolidated Balance Sheets
March 31, 2008 and December 31, 2007
See Notes to Condensed Consolidated Financial Statements
CoBiz Financial Inc.
Condensed Consolidated Statements of Income and Comprehensive Income
See Notes to Condensed Consolidated Financial Statements
CoBiz Financial Inc.
Condensed Consolidated Statements of Cash Flows
See Notes to Condensed Consolidated Financial Statements
CoBiz Financial Inc.
Notes to Condensed Consolidated Financial Statements
The accompanying unaudited condensed consolidated financial statements of CoBiz Financial Inc. (Parent), and its wholly owned subsidiaries: CoBiz ACMG, Inc.; CoBiz Bank (Bank); CoBiz Insurance, Inc.; CoBiz GMB, Inc.; GMB Equity Partners; Financial Designs Ltd. (FDL); and Wagner Investment Management, Inc. (Wagner), all collectively referred to as the Company or CoBiz, conform to accounting principles generally accepted in the United States of America for interim financial information and prevailing practices within the banking industry. The Bank operates in its Colorado market areas under the name Colorado Business Bank (CBB) and in its Arizona market areas under the name Arizona Business Bank (ABB).
The Companys name was changed from CoBiz Inc. to CoBiz Financial Inc. at the Annual Meeting of Shareholders held on May 17, 2007.
The Bank is a commercial banking institution with eight locations in the Denver metropolitan area; two locations in Boulder; two near Vail, Colorado; and seven in the Phoenix metropolitan area. In April 2007, the Bank converted from a national bank charter to a state bank charter. As a state chartered bank, deposits are insured by the Bank Insurance Fund of the FDIC and the Bank is subject to supervision, regulation and examination by the Federal Reserve, Colorado Division of Banking and the FDIC. Pursuant to such regulations, the Bank is subject to special restrictions, supervisory requirements and potential enforcement actions. CoBiz ACMG, Inc. provides investment management services to institutions and individuals through its subsidiary Alexander Capital Management Group, LLC (ACMG). FDL provides wealth transfer, employee benefits consulting, insurance brokerage and related administrative support to individuals, families and employers. CoBiz Insurance, Inc. provides commercial and personal property and casualty insurance brokerage, as well as risk management consulting services to small and medium-sized businesses and individuals. CoBiz GMB, Inc. provides investment banking services to middle-market companies through its wholly owned subsidiary, Green Manning & Bunch, Ltd. (GMB). Wagner was acquired on December 31, 2007, to supplement the investment services currently offered by ACMG. Wagner focuses on developing and delivering a proprietary investment approach with a growth bias. On January 2, 2008, CoBiz Insurance, Inc. acquired substantially all the assets of Bernard Dietrich & Associates (BDA), a commercial and personal property and casualty insurance brokerage serving the Phoenix, Arizona market. CoBiz Insurance, Inc. will operate in the Denver metropolitan market as CoBiz Insurance Colorado and in the Phoenix metropolitan market as CoBiz Insurance Arizona.
All significant intercompany accounts and transactions have been eliminated. These financial statements and notes thereto should be read in conjunction with and are qualified in their entirety by our Annual Report on Form 10-K for the year ended December 31, 2007, as filed with the Securities and Exchange Commission (SEC).
The condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and the instructions to Form 10-Q. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting only of normally recurring accruals) considered necessary for a fair presentation have been included. It is suggested that these condensed consolidated financial statements be read in conjunction with the financial statements and the notes thereto included in the Companys annual report on Form 10-K for the year ended December 31, 2007. Operating results for the three months ended March 31, 2008 are not necessarily indicative of the results that may be expected for the full year ending December 31, 2008.
On January 1, 2007, the Company adopted Emerging Issues Task Force (EITF) 06-5, Accounting for Purchases of Life Insurance Determining the Amount That Could be Realized in Accordance with FASB Technical Bulletin No. 85-4, Accounting for Purchases of Life Insurance (EITF 06-5). EITF 06-5,
addresses various issues in determining the amount that could be realized under an insurance contract. Upon adoption in 2007, the Company recorded a cumulative effect adjustment of approximately $134,000 that was charged to retained earnings to reduce the amount that can be realized on insurance contracts.
On January 1, 2007, the Company adopted FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes an Interpretation of SFAS No. 109 (FIN 48). FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The adoption of FIN 48 did not have a material impact on the consolidated financial statements.
On January 1, 2008, the Company adopted EITF 06-4, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements (EITF 06-4). The ratified final consensus on this issue requires companies to recognize an obligation for the future post-retirement benefits provided to employees in the form of death benefits to be paid to their beneficiaries through endorsement split-dollar policies carried in Bank-Owned Life Insurance (BOLI), the effects of which are to be recognized through either (a) a change in accounting principle through a cumulative-effect adjustment to retained earnings as of the beginning of the year of adoption, or (b) a change in accounting principle through retrospective application to all prior periods. Upon adoption, the Company recorded a cumulative effect adjustment of approximately $16,000 that was charged to retained earnings when it established the obligation for future post-retirement benefits relating to the Companys applicable endorsement split-dollar life insurance arrangements.
On January 1, 2008, the Company adopted SFAS No. 157, Fair Value Measurements (SFAS 157). SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. The provisions of this Statement will be applied prospectively as of the beginning of the fiscal year in which the Statement is initially applied. See Note 11 for additional discussion on fair value measurements.
On January 1, 2008, the Company adopted SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities Including an amendment of FASB Statement No. 115 (SFAS 159). SFAS 159 permits entities to choose to measure certain financial assets and liabilities at fair value at specified election dates. For financial instruments elected to be accounted for at fair value, an entity will report the unrealized gains and losses in earnings. The effect of the first remeasurement to fair value is to be recognized as a cumulative-effect adjustment to the opening balance of retained earnings. The Company has not elected the fair value option for any financial instruments since the adoption on January 1, 2008 and there was no impact on the consolidated financial statements relating to the adoption of SFAS 159.
In December 2007, the FASB issued SFAS No. 141, Business Combinations: (Revised 2007) (SFAS 141R). SFAS 141R is relevant to all transactions or events in which one entity obtains control over one or more other businesses. SFAS 141R requires an acquirer to recognize any assets and non-controlling interest acquired and liabilities assumed to be measured at fair value as of the acquisition date. Liabilities related to contingent consideration are recognized and measured at fair value on the date of acquisition rather than at a later date when the amount of the consideration may be resolved beyond a reasonable doubt. This revised approach replaces SFAS 141s cost allocation process in which the cost of an acquisition was allocated to the individual assets acquired and liabilities assumed based on their respective fair value. SFAS 141R requires any acquisition-related costs and restructuring costs to be expensed as incurred as opposed to allocating such costs to the assets acquired and liabilities assumed as previously required by SFAS 141. Under SFAS 141R, an acquirer recognizes liabilities for a restructuring plan in purchase accounting only if the requirements of SFAS 146, Accounting for Costs Associated with Exit or Disposal Activities, are met. SFAS 141R allows for the recognition of pre-acquisition contingencies at fair value only if these contingencies are likely to materialize. If this criterion is not met at the acquisition date, then the acquirer accounts for the non-contractual contingency in accordance with recognition criteria set forth under SFAS 5, Accounting for Contingencies, in which case nothing should be recognized in purchase accounting. SFAS 141R is effective as of the beginning of an entitys first fiscal year that begins after December 15, 2008. The Company will evaluate the impact SFAS 141R will have on its consolidated financial statements if an acquisition occurs.
In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements An Amendment of ARB No. 5 (SFAS 160). This Statement amends ARB 51 to establish
accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity and should be reported as equity on the financial statements. SFAS 160 requires consolidated net income to be reported at amounts that include the amounts attributable to both the parent and the noncontrolling interest. Furthermore, disclosure of the amounts of consolidated net income attributable to the parent and to the noncontrolling interest is required on the face of the financial statements. SFAS 160 is effective as of the beginning of an entitys first fiscal year that begins after December 15, 2008. The Company is evaluating the impact, if any, SFAS 160 will have on its consolidated financial statements.
In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative instruments and Hedging Activities an amendment of FASB Statement No. 133 (SFAS 161). SFAS 161 enhances the required disclosures under SFAS 133 in order to provide the investing community additional transparency in an entitys financial statements and to more adequately disclose the impact investments in derivative instruments and use of hedging have on financial position, operating results and cash flows. SFAS 161 is effective for fiscal years and interim periods beginning after November 15, 2008 with early application allowed. The Company is currently evaluating the impact SFAS 161 will have on its consolidated financial statements as the Bank subsidiary utilizes a hedging strategy to manage its exposure to interest rate changes as well as offering certain derivative products to its customers.
Wagner Investment Management, Inc. On December 31, 2007, the Company acquired Wagner, an SEC-registered investment advisor located in Denver, Colorado. The acquisition was accounted for using the purchase method of accounting. The acquisition of Wagner was completed through the purchase of all of Wagners common stock as of the purchase date. At December 31, 2007, the Company had preliminarily allocated $3,198,000 of the purchase price to goodwill. In the first quarter of 2008, the Company allocated $1,116,000 out of goodwill and into certain intangible assets consisting of a customer list, trademark and a lease intangible. An adjustment of $11,000 related to direct acquisition costs was also allocated out of goodwill. The customer list and the lease intangible will be amortized over 12 years and two years (the remaining term of the lease), respectively. The trademark will be evaluated for impairment and will not be amortized. The preliminary values are subject to change upon the final valuations, which will be completed within one year of the acquisition.
Bernard Dietrich and Associates, Inc. On January 2, 2008, the Company acquired substantially all the assets of Bernard Dietrich & Associates, Inc., a provider of commercial and personal property and casualty insurance brokerage, and risk management consulting services located in Phoenix, Arizona. The results of operations of BDA have not been included prior to the closing date.
The initial purchase price was $6,781,000, consisting of $6,750,000 in cash and $31,000 in direct acquisition costs. A deposit of $750,000 was also put into escrow for potential additional consideration. The terms of the BDA asset purchase agreement provide for deferred payments for each of the calendar years 2009 and 2010 to be paid to the former shareholders of BDA in proportion to their respective ownership immediately prior to the acquisition. The deferred payments are payable in cash from the escrowed funds of $750,000 and any interest earned. The deferred payments will be a maximum of $375,000 and $750,000 for 2009 and 2010, respectively, with the aggregate amount of total deferred payments during this two-year period capped at $750,000. The yearly deferred payments will be based on maintaining a revenue threshold as defined in the BDA asset purchase agreement. The deferred payments will be treated as additional cost of the acquisition and recorded as goodwill in accordance with EITF Issue No. 95-08, Accounting for Contingent Consideration Paid to the Shareholders of an Acquired Enterprise in a Purchase Business Combination.
The Company has preliminarily allocated $3,525,000 of the purchase price to goodwill, which is expected to be tax deductible, $3,200,000 to a customer list intangible asset and $56,000 to other miscellaneous assets. The customer list will be amortized over 15 years. The preliminary values are subject to change upon the final valuations, which will be completed within one year of the acquisition.
The weighted average shares outstanding used in the calculation of basic and diluted earnings per share are as follows:
For the three months ended March 31, 2008 and 2007, 1,230,591 and 416,159 options, respectively, were excluded from the earnings per share computation solely because their effect was anti-dilutive. Common stock issuances of 63,145 and 1,163,855 are included in shares outstanding for the three months ended March 31, 2008 and 2007, respectively.
Comprehensive income is the total of (1) net income plus (2) all other changes in net assets arising from non-owner sources, which are referred to as other comprehensive income. Presented below are the changes in other comprehensive income for the periods indicated.
At March 31, 2008, goodwill allocations for Wagner and BDA have not been completed. A summary of goodwill, preliminary adjustments to goodwill and total assets by operating segment at March 31, 2008 is noted below. See Note 3 for discussion of acquisitions and adjustments.
At March 31, 2008 and December 31, 2007, the Companys intangible assets and related accumulated amortization consisted of the following:
Amortization expense on intangible assets for each of the five succeeding years (excluding $534,000 to be recognized for the remaining nine months of fiscal 2008) is estimated in the following table:
A summary of outstanding derivatives is as follows:
A summary of the outstanding junior subordinated debentures at March 31, 2008 is as follows:
9. Share-Based Compensation Plans
During the first three months of 2008 and 2007, the Company recognized compensation expense, net of estimated forfeitures, of $423,000 and $280,000 for stock-based compensation awards for which the requisite service was rendered in the period. Estimated forfeitures are periodically evaluated and updated based on historical and expected future behavior. Stock-based compensation had the following effect on net income, earnings per share and cash flows for the three months ending March 31:
The Company uses the Black-Scholes model to estimate the fair value of stock options using management assumptions for risk-free interest rate, dividend, volatility and expected life. Expected life is evaluated on a periodic basis using historical experience and future expected exercise behavior assumptions.
A summary of changes in option awards for the three months ended March 31, 2008, is as follows:
The weighted average grant date fair value of options granted during the three months ended March 31, 2008 was $3.01.
A summary of changes in stock awards for the three months ended March 31, 2008, is as follows:
At March 31, 2008, there was $2,518,000 of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the Plans. The cost is expected to be recognized over a weighted average period of 1.92 years.
The Companys principal areas of activity consist of Commercial Banking, Investment Banking, Investment Advisory and Trust, Insurance, and Corporate Support and Other.
The CBB and ABB banking markets are presented as a single segment, commercial banking.
The Investment Banking segment consists of the operations of GMB, which provides middle-market companies with merger and acquisition advisory services, institutional private placements of debt and equity, and other strategic financial advisory services.
The Investment Advisory and Trust segment consists of the operations of ACMG, Wagner (acquired on December 31, 2007) and CoBiz Trust. ACMG and Wagner are SEC-registered investment management firms that manage stock and bond portfolios for individuals and institutions. CoBiz Trust offers wealth management and investment advisory services, fiduciary (trust) services, and estate administration services.
The Insurance segment includes the activities of FDL and CoBiz Insurance, Inc. which operates in metro Denver and metro Phoenix markets as CoBiz Insurance Colorado and Arizona, respectively. FDL provides employee benefits consulting and brokerage, wealth transfer planning and preservation for high-net-worth individuals, and executive benefits and compensation planning. FDL represents individuals and companies in the acquisition of institutionally priced life insurance products to meet wealth transfer and business needs. Employee benefit services include assisting companies in creating and managing benefit programs such as medical, dental, vision, 401(k), disability, life and cafeteria plans. CoBiz Insurance, Inc. provides commercial and personal property and casualty insurance brokerage, as well as risk management consulting services to individuals and small and medium-sized businesses. The majority of the revenue for both FDL and CoBiz Insurance, Inc. is derived from insurance product sales and referrals, and are paid by third-party insurance carriers. Insurance commissions are normally calculated as a percentage of the premium paid by our clients to the insurance carrier, and are paid to us by the insurance carrier for distributing and servicing their insurance products.
Corporate Support and Other includes activities that are not directly attributable to the other reportable segments and primarily consist of the activities of the Parent.
The financial information for each business segment reflects that information which is specifically identifiable or which is allocated based on an internal allocation method. Results of operations and selected financial information by operating segment are as follows:
11. Fair Value
On January 1, 2008, the Company adopted SFAS 157, which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. SFAS No. 157 applies to reported balances that are required or permitted to be measured at fair value under existing accounting pronouncements; accordingly, the standard does not require any new fair value measurements of reported balances. The effective date of SFAS 157 for all nonrecurring fair value measurements of nonfinancial assets and nonfinancial liabilities has been delayed until fiscal years beginning after November 15, 2008. Accordingly, the Company will apply the requirements of SFAS 157 to the evaluation of goodwill impairment, indefinite-lived intangible assets and long-lived assets measured at fair value for impairment assessment beginning January 1, 2009.
SFAS 157 emphasizes that fair value is a market-based measurement, not an entity-specific measurement. Therefore, a fair value measurement should be determined based on the assumptions that market participants would use in pricing an asset or liability. As a basis for considering market participant assumptions in fair value measurements, SFAS 157 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).
Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access.
Level 2 inputs are inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs may include quoted prices for similar assets and liabilities in active markets, as well as inputs that are observable for the asset or liability (other than quoted prices), such as interest rates, foreign exchange rates and yield curves that are observable at commonly quoted intervals.
Level 3 inputs are unobservable inputs for the asset or liability, which are typically based on an entitys own assumptions, as there is little, if any, related market activity.
In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety. The Companys assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.
A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below. These valuation methodologies were applied to all of the Companys financial assets and financial liabilities carried at fair value effective January 1, 2008.
Available for sale securities At March 31, 2008, the Company holds, as part of its investment portfolio, available for sale securities reported at fair value and consisting of mortgage-backed securities, U.S. Government agencies, and obligations of states and political subdivisions. The value of the majority of these securities is provided by an independent pricing service and are determined using widely accepted valuation techniques including matrix pricing and broker-quote based applications. Inputs include benchmark yields, reported trades, broker-dealer quotes, issuer spreads, prepayment speeds and other relevant items. As a result, the Company has determined that these valuations fall within Level 2 of the fair value hierarchy. The Company also holds trust preferred securities that are recorded at fair value based on quoted market prices. As a result, the Company has determined that the valuation of its trust preferred securities falls within Level 1 of the fair value hierarchy.
Derivative financial instruments Currently, the Company uses interest rate swaps as part of its cash flow strategy to manage its interest rate risk. The fair value of the derivative instruments is provided by an independent valuation service. The valuation of these instruments is determined using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including strike price, forward rates, volatility estimates, and discount rates. The fair values of interest rate swaps are determined using the market standard methodology of netting the discounted future fixed cash receipts (or payments) and the discounted expected variable cash payments (or receipts). The variable cash payments (or receipts) are based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves.
To comply with the provisions of SFAS 157, credit valuation adjustments are incorporated into the valuation to appropriately reflect both the Companys own nonperformance risk and the respective counterpartys nonperformance risk in the fair value measurements. In adjusting the fair value of its derivative contracts for the effect of nonperformance risk, the Company has considered the impact of netting and any applicable credit enhancements, such as collateral postings and thresholds.
Although the Company has determined that the majority of the inputs used to value its derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by itself and its counterparties. However, at March 31, 2008, the Company has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and has
determined that the credit valuation adjustments are not significant to the overall valuation of its derivatives. As a result, the Company has determined that its derivative valuations in their entirety are classified in Level 2 of the fair value hierarchy.
Private equity investments The valuation of nonpublic Private equity investments requires significant management judgment due to the absence of quoted market prices, inherent lack of liquidity and the long-term nature of such assets. The carrying values of private equity investments are adjusted either upwards or downwards from the transaction price to reflect expected exit values as evidenced by financing and sale transactions with third parties, or when determination of a valuation adjustment is confirmed through ongoing reviews by management. A variety of factors are reviewed and monitored to assess positive and negative changes in valuation including, but not limited to, current operating performance and future expectations of the particular investment, industry valuations of comparable public companies, changes in market outlook and the third-party financing environment. In determining valuation adjustments resulting from the investment review process, emphasis is placed on current company performance and market conditions. As a result, the Company has determined that private equity investments are classified in Level 3 of the fair value hierarchy. The value of private equity investments was not material at March 31, 2008.
Impaired Loans Certain collateral-dependent impaired loans are reported at the fair value of the underlying collateral. Impairment is measured based on the fair value of the collateral, which is typically derived from appraisals that take into consideration prices in observed transactions involving similar assets and similar locations, in accordance with SFAS 114. The fair value of other impaired loans is measured using a discounted cash flow analysis.
The following table presents the Companys assets measured at fair value on a recurring basis at March 31, 2008, aggregated by the level in the fair value hierarchy within which those measurements fall.
Fair value is used on a nonrecurring basis to evaluate certain financial assets and financial liabilities in specific circumstances. The following table presents the Companys assets measured at fair value on a nonrecurring basis at March 31, 2008, aggregated by the level in the fair value hierarchy within which those measurements fall.
This discussion should be read in conjunction with our condensed consolidated financial statements and notes thereto included in this Form 10-Q. Certain terms used in this discussion are defined in the notes to these financial statements. For a description of our accounting policies, see Note 1 of Notes to Consolidated Financial Statements included in our Form 10-K for the year ended December 31, 2007. For a discussion of the segments included in our principal activities, see Note 10 to these financial statements.
The Company is a financial holding company that offers a broad array of financial service products to its target market of small and medium-sized businesses and high-net-worth individuals. Our operating segments include commercial banking; investment banking; investment advisory and trust; and insurance.
Earnings are derived primarily from our net interest income, which is interest income less interest expense, and our noninterest income earned from our 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 have also focused on reducing our dependency on our net interest margin by increasing our noninterest income.
Our Company has focused on developing an organization with personnel, management systems and products that will allow us to compete effectively and position us for growth. The cost of this process relative to our size has been high. In addition, we have operated with excess capacity during the start-up phases of various projects. As a result, relatively high levels of noninterest expense have adversely affected our earnings over the past several years. Salaries and employee benefits comprised most of this overhead category. However, we believe that our compensation levels have allowed us to recruit and retain a highly qualified management team capable of implementing our business strategies. We believe our compensation policies, which include the granting of options to purchase common stock to many employees and the offering of an employee stock purchase plan, have highly motivated our employees and enhanced our ability to maintain customer loyalty and generate earnings.
Financial and Operational Highlights
· Net income for the three months ended March 31, 2008, was $1.6 million compared to $5.9 million for the year-earlier period.
· Diluted earnings per share for the quarter ended March 31, 2008, was $0.07 compared to $0.24 for the year-earlier period.
· Net interest margin on a tax-equivalent basis was 4.01% for the three months ended March 31, 2008 compared to 4.21% for the three months ended December 31, 2007, and 4.38% for the year-earlier period.
· Provision for loan and credit losses for three months ended March 31, 2008, was $5.0 million compared to $0.2 million for the year-earlier period and $3.9 million for fiscal 2007.
· Gross loans increased $29.0 million during the quarter or 6.3% on an annualized basis.
· Net loan charge-offs totaled $1.7 million compared to $1.8 million for fiscal 2007.
· Nonperforming assets increased to $17.8 million or 0.73% of total assets at March 31, 2008, compared to $3.5 million or 0.15% at December 31, 2007.
Critical Accounting Policies
The Companys discussion and analysis of its financial condition and results of operations are based upon the Companys condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and the instructions to Form 10-Q. 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 financial condition or results of operations. A description of our critical accounting policies was provided in the Managements Discussion and Analysis of Financial Condition and Results of Operation section of our Annual Report on Form 10-K for the year ended December 31, 2007. With the exception of the adoption of SFAS 157 (see discussion at Note 11 to the Condensed Consolidated Financial Statements), there have been no changes in our critical accounting policies and no other significant changes to the assumptions and estimates related to them.
Total assets were $2.4 billion at March 31, 2008, an increase of $58.3 million since December 31, 2007, relating primarily to growth in the investment and loan portfolios.
Investments. Investments increased $15.3 million from $395.7 million at December 31, 2007 to $410.9 million at March 31, 2008. The increase related to the purchase of approximately $50.8 million of high-quality FNMA and FHLMC mortgage-backed securities, offset by the maturity of approximately $36.5 million in U.S. government agency securities. The Company manages its investment portfolio to provide interest income and to meet the collateral requirements for public deposits, a customer repurchase program and wholesale borrowings. During the third quarter of 2007, the Company introduced a non-collateralized Eurodollar sweep product as an alternative to the collateralized customer repurchase product. The Eurodollar product provides a slightly better rate to compensate customers for the lack of collateral. At March 31, 2008, the investment portfolio comprised 16.8% of total assets, a historically lower percentage made possible in part by the decreasing collateral burden of the customer repurchase agreement product and migration of customer funds into the Eurodollar product.
Loans. Gross loans increased by $29.0 million from December 31, 2007, to $1.9 billion at March 31, 2008, representing annualized growth of 6.31%. The first quarter is typically a slow period for loan growth. In addition, the portfolio realized significant growth of 22.24% (annualized) in the fourth quarter of 2007 which partially depleted the lending pipeline. The current quarter increase in loans is primarily due to growth from the Colorado market of $35.7 million offset by net paydowns of $6.8 million on the Arizona portfolio. Approximately 63% of the total loan portfolio is in the Colorado market.
Goodwill. Goodwill increased by $2.4 million to $45.8 million at March 31, 2008, from $43.4 million at December 31, 2007. Goodwill was increased by $3.5 million related to the BDA asset acquisition and offset by a decrease of $1.1 million in adjustments related to the reclassification of intangible assets on the Wagner acquisition. Goodwill is subject to purchase price allocation adjustments for one year following an acquisition.
Accrued Interest Receivable. Accrued interest receivable decreased by $1.1 million to $9.1 million at March 31, 2008, from $10.2 million at December 31, 2007. The decrease is related to the collection of accrued interest on matured agency debentures and a decrease in the yield on the loan portfolio.
Deferred Income Taxes. Deferred income taxes increased slightly by $0.1 million since December 31, 2007, the net result of changes in the allowance for loan losses, unrealized gains and losses in the securities portfolio and the fair market value of our interest rate swaps.
Other Assets. Other Assets increased $3.4 million to $21.1 million at March 31, 2008, from $17.7 million at December 31, 2007. Contributing to the increase was $1.2 million from an income tax receivable, a $1.5 million increase in the fair value of interest rate swaps and a $0.7 million increase in other miscellaneous assets.
Deposits. Total deposits increased by $38.7 million during the quarter to $1.78 billion at March 31, 2008 compared to $1.74 billion at December 31, 2007. The increase is largely due to gains in NOW and money market accounts of $66.6 million and $18.6 million in Eurodollar deposits, offset by declines in certificates of deposit of $38.4 million. The Eurodollar sweep product introduced in 2007 continues to attract both new and existing customers, with a significant portion migrating from the customer repurchase product. Core-deposit growth continues to be a challenge due to competition from other banks and financial service providers as well as current economic conditions.
Securities Sold Under Agreements to Repurchase. Securities sold under agreement to repurchase are transacted with customers as a way to enhance our customers interest-earning ability. Management does not consider customer repurchase agreements to be a wholesale funding source, but rather an additional treasury management service provided to our customer base. Our customer repurchase agreements are based on an overnight investment sweep that can fluctuate based on our customers operating account balances. Securities sold under agreements to repurchase decreased $16.7 million, partially due to the migration of funds to the Eurodollar sweep product. Although the customer repurchase sweep continues to be a popular product with $151.7 million at March 31, 2008, the Company anticipates that the balance will continue to decrease in future periods as additional customers move to the Eurodollar sweep.
Other Short-Term Borrowings. Other short-term borrowings increased $37.3 million to $234.7 million at March 31, 2008, from $197.4 million at December 31, 2007. Other short-term borrowings consist of federal funds purchased, overnight and term borrowings from the Federal Home Loan Bank (FHLB), advances on a revolving line-of-credit and short-term borrowings from the U.S. Treasury. Other short-term borrowings are used as part of our liquidity management strategy and fluctuate based on the Companys cash position. The Companys wholesale funding needs are largely dependent on core deposit levels, which have proven to be more volatile due to increased competition and slowing economic conditions. If we are unable to maintain deposit balances at a level sufficient to fund our asset growth, our composition of interest-bearing liabilities will shift toward additional wholesale funds, which typically have a higher interest cost than our core deposits.
Accrued Interest and Other Liabilities. Accrued interest and other liabilities decreased $3.9 million to $17.2 million at March 31, 2008, from $21.1 million at December 31, 2007. The decrease was primarily related to a $4.6 million reduction in accrued bonuses caused by the payment of year-end bonuses in the first quarter, offset by a $0.9 million increase in commissions payable caused by the acquisition of BDA.
Results of Operations
The following table presents the condensed consolidated statements of income for the three months ended March 31, 2008 and 2007.
Annualized return on average assets for the three months ended March 31, 2008, was 0.27%, compared to 1.13% for the same period in 2007. Annualized return on average common shareholders equity for the three months ended March 31, 2008 was 3.29%, compared to 13.19% for the same period in 2007. The decrease in our return on average assets and average equity ratios is primarily the result of a $5.0 million loan loss provision recorded during the first quarter of 2008. The Company actively monitors the quality of its loan portfolio, including construction and development credits in Arizona, which are being impacted by the continuing deterioration of real estate values. The increase in the provision for loan losses during the three months ended March 31, 2008 was a reflection of this deterioration. The Company was also negatively impacted by a slow quarter for revenue transactions by its fee-based businesses. Management anticipates an increased momentum from our fee-based business, particularly in the Investment Banking and Wealth Transfer divisions as the year progresses.
Net Interest Income. The largest component of our net income is our net interest income. Net interest income is the difference between interest income, principally from loans and investment securities, and interest expense, principally on customer deposits and borrowings. Changes in net interest income result from changes in volume, net interest spread and net interest margin. Volume refers to the average dollar levels of interest-earning assets and interest-bearing liabilities. Net interest spread refers to the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities. Net interest margin refers to net interest income divided by average interest-earning assets and is influenced by the level and relative mix of interest-earning assets and interest-bearing liabilities.
As the majority of our assets are interest-earning and our liabilities are interest-bearing, changes in interest rates may impact our net interest margin. Falling short-term rates have compressed the net interest margin as rate decreases to our deposit portfolio do not occur as fast as decreases to our loan and investment portfolios. The Federal Open Markets Committee (FOMC) uses the federal funds rate, which is the interest rate used by banks to lend to each other, to influence interest rates and the economy. Changes in the federal funds rate have a direct correlation to changes in the prime rate, the underlying index for most of the variable rate loans issued by the Company. In the fourth quarter of 2007, the FOMC lowered the target federal funds rate by 50 basis points. Since the end of 2007, the FOMC has lowered the target federal funds rate an additional 200 basis points to 2.25%.
The following tables set forth the average amounts outstanding for each category of interest-earning assets and interest-bearing liabilities, the interest earned or paid on such amounts, and the average rate earned or paid for the three months ended March 31, 2008 and 2007.