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COBZ > SEC Filings for COBZ > Form 10-K on 21-Feb-2017All 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

Company Overview. 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 and Fee-Based Lines.

From December 31, 1995, the first complete fiscal year under the current management team, to December 31, 2016, 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 15 bank locations (excluding one bank location closed in January 2017) and total assets of $3.6 billion. We have also expanded into wealth and insurance services. The Company has a well-capitalized balance sheet that includes common equity, subordinated notes payable and subordinated debentures.

Earnings are derived primarily from our net interest income, which is interest income less interest expense, and our noninterest income earned from Fee-Based Lines and banking service fees, offset by noninterest

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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.

The Company is focused on achieving four financial objectives as part of its three to five year plan. Those objectives are 10% loan and deposit growth, 8% noninterest income growth and limiting noninterest expense growth to 4%. We anticipate that achieving these objectives, coupled with maintaining our asset quality, will enable us to enhance shareholder return.

Steps taken in 2016 to realize progress on the loan, deposit and noninterest income goals include: aligning production employee variable compensation with these objectives; strengthening internal networking to enhance synergies between product lines within the Company; formalizing a leadership development program; structuring management roles to provide more accountability; setting clear expectations for all producers and continuing to work with producers who are not meeting their goals; and building customer relationships.

To further the noninterest expense objective in 2016, the Company conducted a comprehensive review of its staffing levels and expenditures in each functional area to identify areas for improvement. The Company intends to update this study annually to continually monitor incremental improvement and new areas for emphasis. The Company also completed a thorough analysis of its loan origination and credit underwriting process. Based on this review, the Company intends to implement procedural changes and clarify employee responsibilities in 2017, which we believe will improve operational efficiencies, reduce costs, and improve customer satisfaction and employee morale. Finally, the Company has initiated an ongoing review of its facility strategy with a goal of servicing its customer base in a cost-effective manner. In 2016, this resulted in the closure of two bank locations, the combination of two bank locations in downtown Denver into one location, a planned closure of a bank location in 2017, and the relocation of the Company's principal executive offices. As a result of the relocation of our principal executive offices, all of our revenue producing employees in the downtown area are in one location for the first time. The Company believes this will further strengthen internal synergies and will provide a broader platform to service the financial needs of its customers.

As discussed in "Item 1. Business" and Note 2 to the consolidated financial statements, the Company ceased the operations of its investment banking division in the first quarter of 2015. The results of operations related to investment banking have been reported as discontinued operations. The prior period disclosures in the following table have been adjusted to conform to the new presentation.

Internally, management measures the contribution of the Fee-Based Lines before parent company management fees and overhead allocations. The Company believes this to be a more useful measurement as centralized administration expenses and overhead are generally not impacted by the Fee-Based Lines, but are most affected by the operations of the Bank. While the Company allocates a portion of the costs related to shared resources to the Fee-Based Lines, we measure their profitability based on a pre-allocation basis as it approximates the operating cash flow generated by the segment. A description of each segment is provided in Note 19 to the consolidated financial statements.

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Certain key metrics of our operating segments at or for the years ended December 31, 2016, 2015 and 2014 are as follows:

                            Commercial      Fee-Based          and
                             Banking          Lines           Other         Consolidated
 (in thousands)                                        2016
 Operating revenue (1)    $      137,026    $   18,259    $     (5,074)    $      150,211
 Net income (loss)        $       40,165    $  (1,208)    $     (4,058)    $       34,899

 Operating revenue (1)    $      127,376    $   17,837    $     (2,870)    $      142,343
 Net income (loss)        $       29,786    $    (542)    $     (3,175)    $       26,069

 Operating revenue (1)    $      119,434    $   16,851    $     (2,488)    $      133,797
 Net income (loss)        $       32,264    $      115    $     (3,372)    $       29,007

(1) Net interest income plus noninterest income.

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Noted below are some of the significant financial performance measures and operational results for 2016 and 2015:

                  2016                                    2015
Commercial Banking operating revenue     Commercial Banking operating revenue
increased 7.6% in 2016 to $137.0         increased 6.6% in 2015, while net
million, while net income increased      income declined $2.5 million, primarily
34.8% to $40.2 million.  The increase in due to a $10.2 million increase in the
net income was due to an $8.7 million    provision for loan losses.
decrease in the provision for loan
losses and a $7.0 million increase in
net interest income.
Operating revenue from the Fee-Based     Operating revenue from the Fee-Based
Lines increased 2.4% in 2016, while the  Lines increased 5.9% in 2015 and
net loss increased $0.7 million to a net noninterest expense increased 7.9% in
loss of $1.2 million in 2016.            the same period.
Operating revenue declined and the net   The Corporate Support segment benefited
loss increased on the Corporate Support  from the recapture of past due interest
and Other segment in 2016, primarily due income on a nonperforming loan
to the additional interest expense on    portfolio that increased interest
the subordinated notes that were issued  income $1.0 million in 2015. Offsetting
in June 2015.                            this increase was additional interest
                                         expense of $1.8 million from the new
                                         subordinated notes issuance.
Total assets grew $278.5 million to $3.6 Total assets grew $289.6 million to
billion during 2016, primarily due to a  $3.4 billion during 2015, primarily due
9.1% year-over-year increase in net      to a 12% year-over-year increase in net
loans.                                   loans.
Average noninterest bearing deposits,    Average noninterest bearing
the most valuable part of the deposit    deposits represented 41.2% of total
portfolio, represented 43.3%  of total   average deposits in 2015, compared to
average deposits in 2016, compared to    42.5% in 2014.
41.2% in 2015.
The net interest margin on a             The net interest margin on a
tax-equivalent basis declined 13 basis   tax-equivalent basis contracted 5 basis
points to 3.73%, due to the first full   points to 3.86%, due to the increased
year of interest expense on the new      interest expense on the new
subordinated notes and to a decline in   subordinated notes that reduced the net
loan yields.                             interest margin by 6 basis points in
Net income increased 33.9% to $34.9      Net income declined 10% to $26.1
million in 2016 from $26.1 million in    million in 2015 from $29.0 million in
2015. Positively impacting net income    2014. Negatively impacting net income
was an $8.5 million decrease in          was a $10.6 million increase in
provision for loan losses in 2016.       provision for loan losses in 2015.
The Company had net charge-offs of $5.3  In the first quarter of 2015, the
million in 2016, compared to a net       Company ceased the operations of its
recovery of $1.5 million in 2015.        investment banking division in order to
                                         focus on noninterest income sources
                                         that were less transactional in
Two bank locations were closed in 2016   In the first quarter of 2015, the
and another is planned for 2017. Over    Company transferred securities with a
the past five years, the Company has     book value of $279.8 million and a fair
closed seven bank locations.  The        value of $288.6 million from the
closures were part of the Company's      available for sale category to the held
ongoing evaluation of its                to maturity category.
operations. The Company remains
committed to growing its presence in the
Colorado and Arizona markets while
efficiently managing the Company's cost
structure, including its occupancy
The Company's principal executive        On June 25, 2015, the Company issued
offices were moved to a new location in  $60.0 million of unsecured
downtown Denver. Overall square footage  fixed-to-floating rate subordinated
in our executive offices was reduced     notes due 2030 (Notes). Unless
28%.                                     redeemed, the Notes will bear 5.625%
                                         annual interest until June 25, 2025 and
                                         thereafter until maturity in June 2030
                                         at a floating rate equal to LIBOR plus
                                         317 basis points.
The Company's total risk-based capital   On July 22, 2015, the Company redeemed
ratio was 14.5% at the end of 2016.      the $57.4 million in preferred stock
Implementation of the Capital            issued to the Treasury. The dividend
Conservation Buffer required by Basel    rate on the preferred stock was
III increased the minimum capital        scheduled to increase from 1.0% in 2015
requirements.  See Note 17 - Regulatory  to 9.0% in 2016.
Matters for additional information.
                                         The Company's total risk-based capital
                                         ratio was 13.7% at the end of
                                         2015. Implementation of Basel III in
                                         2015 had the effect of reducing total
                                         risk-based capital. Also impacting the
                                         composition of risk-based capital
                                         during 2015 was the issuance of the
                                         Notes which increased Tier 2 capital,
                                         while the redemption of the SBLF
                                         preferred stock in July 2015 decreased
                                         Tier 1 capital.

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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 19 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.

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 $1.5 million of provision for loan losses would be required. Conversely, a $25.0 million decrease in classified loans would result in a $1.5 million reversal of provision for loan losses.

See Note 4 - Loans for further discussion on management's methodology.

Fair Value

The Company has adopted ASC Topic 820, Fair Value Measurements and Disclosures (ASC 820), as it applies to financial assets and liabilities. 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

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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, 2016, $136.3 million of total assets, consisting of $133.0 million in available for sale securities and $3.3 million in derivative instruments, represented assets recorded at fair value on a recurring basis. At December 31, 2015, $157.6 million of total assets, consisting of $153.7 million in available for sale securities and $3.9 million in derivative instruments, represented assets recorded at fair value on a recurring basis. At December 31, 2016, the Company had $9.4 million of single-issuer trust preferred securities (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, 2016 and 2015, $11.2 million and $9.9 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 and OREO totaling $1.4 million and $5.4 million, at December 31, 2016. Impaired loans and OREO were $6.3 million and $5.4 million at December 31, 2015. For additional information on the fair value of certain financial assets and liabilities see Note 18 - Fair Value Measurements.

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. See Note 11 - Income Taxes 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 valuation allowance would be established through a charge to income tax expense that would adversely affect our operating results.

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.

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Financial Condition

The Company had total assets of $3.6 billion and total liabilities of $3.3 billion at December 31, 2016 compared to total assets of $3.4 billion and total liabilities of $3.1 billion at December 31, 2015. 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, 2016 and 2015.

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, 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, 2016, 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 the last economic downturn, the Company expanded the resources of the credit and loan review departments to provide for a more proactive identification and management 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, the credit administration department establishes a watch list of loans to be reviewed by the Board 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.

The Company's credit approval process is as follows:

Internal lending limits for loans extended to a single borrower are established by the Board of Directors of the Bank.

Credits equal to the Bank's internal lending limit require two signatures from either the CEO of the Bank, Chief Credit Officer or a Bank President/Senior Credit Officer.

Loan authority of officers is approved by the Bank's Board of Directors, reviewed annually and updated according to the growth of the Bank. The Board of Directors may designate different approval authorities depending on loan grade, loan type, and whether the loan is a new credit or renewal of credit.

The Board of Directors of the Bank designates the approval authority of the loan committee. The presence of two of the following is required for any committee loan approval: CEO, Chief Credit Officer or a Market President. A quorum requires at least three designated committee members to be in attendance.

Loan officers are permitted within a 12-month period to approve up to $0.2 million in new credit per customer aggregate loan relationship. In cases where the aggregate credit size exceeds the loan credit officer's individual authority, the Bank President may approve the additional credit.

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Composition of Loan Portfolio. The following table sets forth the composition of our loan portfolio at the dates indicated.

                                                                       At December 31,
                               2016                   2015                   2014                   2013                   2012
(in thousands)            Amount        %        Amount        %        Amount        %        Amount        %        Amount        %
Commercial              $ 1,217,732    42.0 %  $ 1,175,379    44.2 %  $   977,699    41.2 %  $   824,453    40.3 %  $   729,442    38.8 %
Real estate -
mortgage                  1,171,123    40.4 %    1,016,268    38.2 %      989,719    41.7 %      900,864    44.0 %      880,377    46.8 %
Construction & land         174,451     6.0 %      201,281     7.6 %      181,864     7.7 %      127,952     6.2 %      120,584     6.4 %
Consumer                    267,013     9.2 %      253,317     9.5 %      207,955     8.8 %      181,056     8.8 %      149,638     8.0 %
Other                       103,786     3.5 %       52,960     2.0 %       48,338     2.0 %       50,034     2.5 %       46,391     2.5 %
Total loans             $ 2,934,105   101.1 %  $ 2,699,205   101.5 %  $ 2,405,575   101.4 %  $ 2,084,359   101.8 %  $ 1,926,432   102.5 %
Less allowance for
loan losses                (33,293)   (1.1) %     (40,686)   (1.5) %     (32,765)   (1.4) %     (37,050)   (1.8) %     (46,866)   (2.5) %
Net loans               $ 2,900,812   100.0 %  $ 2,658,519   100.0 %  $ 2,372,810   100.0 %  $ 2,047,309   100.0 %  $ 1,879,566   100.0 %

Total loans increased $234.9 million and $293.6 million in 2016 and 2015, respectively. The Real estate - mortgage loan segment contributed 65.9% of the loan portfolio growth in 2016, increasing $154.9 million. Other loan categories with modest growth in 2016 include Commercial ($42.4 million), Consumer ($13.7 million), and Other ($50.8 million) loans, while construction & land declined $26.8 million.

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