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COBZ > SEC Filings for COBZ > Form 10-K on 14-Feb-2014All Recent SEC Filings

Show all filings for COBIZ FINANCIAL INC



Annual Report

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

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.

We concentrate on developing an organization with personnel, management systems and products that will allow us to compete effectively and position us for growth. Although we strive to minimize costs that do not impact customer service, we continue to invest in systems and business production personnel to strengthen our future growth prospects.

Industry Overview. At the December 2013 meeting, the Federal Open Market Committee (FOMC) kept the target range for federal funds rate at 0-25 basis points noting that a highly accommodative stance of monetary policy will remain appropriate after the economy strengthens to support maximum employment and price stability. The FOMC expects to maintain the target federal funds rate at 0-25 basis points for at least as long as the unemployment rate remains above 6.5%, inflation projections are no more than 0.5% above the FOMCs 2% long-run goal and longer-term inflation expectations continue to be well-anchored. The FOMC also announced that due to cumulative progress toward maximum employment and the improvement in the labor market outlook, it will reduce the purchase of agency mortgage-backed securities to $35 billion per month, down from the

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previous pace of $40 billion per month. The FOMC will also reduce the purchase of longer-term Treasury securities from its previous pace of $45 billion per month to $40 billion per month. These actions are intended to pressure longer-term interest rate and support the mortgage market, among other things.

The actions by the FOMC have compressed net interest income and net interest margins for the banking industry by maintaining low rates on interest-earning assets. Throughout 2013, margins in the banking industry were pressured downward as higher-yielding legacy assets rolled off and were reinvested in the current low rate environment. Low interest rates, coupled with a competitive lending environment, have proven challenging for the profitability of the banking industry. It is expected that these challenges will continue until interest rates rise.

The political landscape has also negatively impacted the industry. According to the Wells Fargo Small Business Index, the number of businesses indicating the government and healthcare as significant challenges increased in 2013. Although the expectation for capital spending increased during 2013, it is significantly lower than the pre-recession pace of 2006-2007. Reduced capital spending has resulted in record levels of deposits and tempered small businesses demand for loans. The high level of liquidity from the amount of deposits has exacerbated the pressure on net interest margins in the banking industry, as banks are challenged to deploy the excess liquidity at profitable spreads.

The banking industry continues to be impacted by new legislative and regulatory reform proposals. In July 2013, the Board of Governors of the Federal Reserve Bank, the FDIC, and the Office of the Comptroller of the Currency (OCC) approved the final U.S. version of the Basel III agreement. Basel III replaces the federal banking agencies' general risk-based capital rules, includes a narrower definition of capital and requires higher minimum capital levels. Basel III will be effective for the Company in 2015. In December 2013, the federal banking agencies also adopted final rules implementing a provision of the Dodd-Frank Act known as the Volcker Rule, a complex regulation that prohibits banks from engaging in proprietary trading and investments in certain asset classes. Upon initial issuance, a significant unintended consequence emerged, as banks faced impairments on certain investments that were no longer allowed to be held. While the federal banking agencies issued additional guidance in January 2014 allowing banks to retain certain investments that were originally prohibited by the Volcker Rule, it underscored the complexity of the Rule and the potential ramifications to the industry.

The national unemployment rate decreased from 7.9% in December 2012 to 6.7% at December 2013. The unemployment rate has steadily decreased during 2013 and is at the lowest level since October 2008. While decreasing, the unemployment rate still exceeds the maximum target level set by the FOMC.

There were 24 bank failures in 2013, the lowest level since 2008. From 2008 to 2012, 465 banks failed and went into receivership with the FDIC, causing estimated losses of $86.6 billion to the Depository Insurance Fund. This compares to only 10 bank failures in the years from 2003 to 2007. The FDIC's "problem list" stood at 515 at September 30, 2013, down from 651 at the end of 2012.

In the third quarter of 2013, FDIC-insured commercial banks reported a combined net income of $36 billion, the first year-over-year decline in over four years. The decrease in net income was driven by reduced revenue from mortgage banking and expenses from litigation reserves at certain large banks. Net interest income for the third quarter fell year-over-year, as interest income declined more rapidly than the decline in interest expense. Provision for loan losses continued to fall, as the industry recorded the lowest quarterly loan loss provision since the third quarter of 1999.

Company Overview. From December 31, 1995, the first complete fiscal year under the current management team, to December 31, 2013, 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 18 bank locations, three fee-based businesses and total assets of $2.8 billion.

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The Company has a well-capitalized balance sheet that includes common equity, preferred equity and subordinated debentures. The Company currently has $57.4 million in preferred stock issued to the Treasury in September 2011 through the SBLF program. The SBLF preferred stock has a fixed rate of 1% until 2016, when the rate will increase to 9%. The Company expects to repay the preferred stock to the Treasury when the rate increases to 9%.

As discussed in "Item 1. Business" and Note 2 to the consolidated financial statements, the Company sold its wealth transfer division that focused on high-end life insurance and closed its trust department during the fourth quarter of 2012. The results of operations related to these areas have been reported as discontinued operations. 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, 2013, 2012 and 2011 are as follows:

                                             Commercial     Investment       Wealth                      Support
                                              Banking        Banking       Management     Insurance     and Other     Consolidated
(in thousands, except per share data)                                                2013
Operating revenue(1)                         $   112,431    $     2,306    $     5,029    $   11,193    $   (4,346 )  $     126,613
Net income (loss)                            $    32,134    $    (1,019 )  $       259    $       67    $   (3,830 )  $      27,611
Diluted income (loss) per common share(2)    $      0.81    $     (0.03 )  $      0.01    $        -    $    (0.13 )  $        0.66

Operating revenue(1)              $ 111,517   $ 3,839   $ 4,164   $ 9,682   $ (5,265 ) $ 123,937
Net income (loss)                 $  31,210   $  (318 ) $  (717 ) $  (312 ) $ (5,293 ) $  24,570
Diluted income (loss) per
common share(2)                   $    0.81   $ (0.01 ) $ (0.02 ) $ (0.01 ) $  (0.22 ) $    0.55

Operating revenue(1)              $ 111,907   $ 7,245   $ 4,263   $ 9,270   $ (5,461 ) $ 127,224
Net income (loss)                 $  31,393   $   686   $  (293 ) $   (33 ) $  1,709   $  33,462
Diluted income (loss) per
common share(2)                   $    0.86   $  0.02   $ (0.01 ) $     -   $  (0.11 ) $    0.76


Net interest income plus noninterest income.

The per share impact of preferred stock dividends and earnings allocated to participating securities are included in Corporate Support and Other.

Noted below are some of the significant financial performance measures and operational results for 2013 and 2012:


Commercial Banking earnings per share were $0.81 in both 2013 and 2012. An improvement in operating revenue and a higher negative loan loss provision in 2013 were mostly offset by higher noninterest expense and higher internal overhead allocations. A decrease in nonperforming assets and classified loans resulted in a negative provision for loan losses of $7.3 million in 2013.

Investment Banking lost $0.03 on a per share basis in 2013, an increase from the $0.01 loss per share in 2012, as the number of transactions closed by the segment fell in 2013.

Wealth Management contributed $0.01 on a per share basis in 2013, a $0.03 increase over the $0.02 per share loss in 2012. An increase in operating revenue of 20.8% in 2013 contributed to

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the improvement. In addition, severance and contract termination costs of $0.5 million recognized during 2012 on discontinued operations did not impact 2013 results.

Insurance broke even in 2013 after losing $0.01 on a per share basis in 2012 due to an increase in revenue.

Corporate Support and Other lost $0.13 per diluted share in 2013, an improvement over the loss of $0.22 in 2012. The improvement in earnings was due to a reduction in interest expense (as discussed below, the Company redeemed its 9% subordinated notes in 2013) and higher internal management fee allocations.

The net interest margin on a tax-equivalent basis declined to 3.88% in 2013 compared to 4.08% in 2012. Although the net interest margin has declined, net interest income has increased due to growth in the loan portfolio.

The Company maintained a very favorable funding mix, with total noninterest-bearing demand accounts representing 42.2% of total deposits at December 31, 2013.

The Company exceeded the small-business loan growth threshold of 10% required under the SBLF program to achieve the lowest dividend tier on its Series C Preferred Stock. The dividend rate on the Series C Preferred Stock will be fixed at 1% through the end of 2015.

In August 2013, the Company redeemed $21.0 million of 9.0% subordinated notes payable. This redemption increased the net interest margin by 0.03% during 2013 and will benefit future years by a larger amount. After redemption, the Company still maintains capital levels above the well-capitalized requirement.

On July 10, 2013, the Company announced its plans to enter two new markets in Colorado and the formation of a private banking division. The Company received regulatory approval to open bank locations in Fort Collins and Colorado Springs in September 2013. Noninterest expense associated with these initiatives was $1.0 million in 2013.


Commercial Banking earnings per share fell $0.05 to $0.81 in 2012 from 2011, primarily due to the increase in average shares outstanding. Nonperforming assets decreased to $30.3 million at the end of 2012, from $45.7 million at the end of 2011. The decrease in nonperforming assets resulted in a provision for loan loss reversal of $3.5 million in 2012.

Investment Banking lost $0.01 on a per share basis in 2012, a decrease from the $0.02 earnings per share in 2011. The number of transactions closed by the segment fell in 2012, while Investment Banking revenue in 2011 was at the highest level for the segment since 2004.

Wealth Management lost $0.02 on a per share basis in 2012, an increased loss over the $0.01 loss in 2011. As discussed above, the segment sold its wealth planning division and discontinued its trust department. As part of these transactions, the segment incurred severance and contract termination costs of $0.5 million.

Insurance lost $0.01 on a per share basis in 2012 after breaking even in 2011. In 2012, the segment purchased two small books of business to enhance the employee benefits consulting division and to expand its medical malpractice specialty.

Corporate Support and Other lost $0.22 per diluted share in 2012, an increased loss over the $0.11 loss in 2011. The increase in the loss in 2012 is due to the reversal of a deferred tax valuation allowance of $11.0 million that benefited the segment in 2011, but had no impact in 2012.

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During the first quarter of 2012, the Company completed a common stock offering of 2,100,000 shares at a $6.00 per share price that generated net proceeds of $11.8 million.

At December 31, 2012, the Company grew small business lending sufficient to reduce its future dividend rate on the Series C Preferred Stock issued to Treasury under the SBLF to 1% effective for the second quarter of 2013.

The net interest margin on a tax-equivalent basis declined to 4.08% in 2012 compared to 4.35% in 2011. The Company's net interest margin declined due to the low rate environment.

Total noninterest-bearing demand accounts represented 40.4% of total deposits at December 31, 2012.

The Company's total risk-based capital ratio was 16.5% at the end of 2012, up from 16.3% at the end of 2011.

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 "Segments" discussed below and Note 18 to the consolidated financial statements.

Critical Accounting Policies

The Company's discussion and analysis of its consolidated financial condition and results of operations are based upon the Company's 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 management's periodic review of the collectability of loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower's 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.

In determining the appropriate level of the allowance for loan losses, we analyze the various components of the loan portfolio, including impaired loans, 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. We 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.

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Differences between the actual credit outcome of a loan and the risk assessment made by the Company could negatively impact the Company's earnings by requiring additional provision for loan losses. As a hypothetical example, if $25.0 million of grade 3, non-classified loans were downgraded as classified at the same historical loss factor of existing classified loans, an additional $2.7 million of provision for loan losses would be required. Conversely, a $25 million decrease in classified loans would result in a $2.7 million reversal of provision for loan losses.

See Note 4 to the consolidated financial statements for further discussion on management's 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.

Deferred Taxes

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, 2011, the Company reversed the valuation allowance of $15.6 million it established during the fourth quarter of 2010. See Note 11 to the consolidated financial statements for additional information. A valuation allowance for deferred tax assets may be required in the future 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.

Share-based Payments

Under ASC Topic 718, Compensation-Stock Compensation (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, share-based compensation expense, as calculated and recorded under ASC 718, could have been materially impacted. Furthermore, if we use different assumptions in future periods, share-based compensation expense could be materially impacted in future periods.

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ASC 718 requires that 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.

Fair Value

The Company has adopted ASC Topic 820, Fair Value Measurements and Disclosures (ASC 820), 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 entity's 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 instrument's fair value. At December 31, 2013, $543.4 million of total assets, consisting of $535.1 million in available for sale securities and $8.3 million in derivative instruments, represented assets recorded at fair value on a recurring basis. At December 31, 2012, $567.2 million of total assets, consisting of $558.2 million in available for sale securities and $9.0 million in derivative instruments, represented assets recorded at fair value on a recurring basis. The Company has $6.0 million of single-issuer TPS classified as Level 3. The fair value of these TPS is determined using broker-dealer quotes and trade data that may not be current. These TPS are classified as Level 3 due to lack of current market data and their illiquid nature. At December 31, 2013 and 2012, $10.4 million and $18.4 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 $22.2 million and $16.1 million at December 31, 2013 and 2012, respectively. For additional information on the fair value of certain financial assets and liabilities see Note 17 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 the 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.

Financial Condition

The Company had total assets of $2.8 billion and total liabilities of $2.5 billion at December 31, 2013 compared to total assets of $2.7 billion and total liabilities of $2.4 billion at December 31, 2012. 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, 2013 and 2012.

Lending Activities

General. We provide a broad range of lending services, including commercial loans, commercial and residential real estate construction loans, commercial and residential real estate-mortgage loans,

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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, 2013, 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, . . .

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