Form 10-Q
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


FORM 10-Q

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2006

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission File Number: 000-51556

 


CENTENNIAL BANK HOLDINGS, INC.

(Exact name of registrant as specified in its charter)

 

DELAWARE   41-2150446

(State or other jurisdiction

of incorporation or organization)

  (I.R.S. Employer Identification Number)

1331 Seventeenth St., Suite 300

Denver, CO

  80202
(Address of principal executive offices)   (Zip Code)

303-296-9600

(Registrant’s telephone number, including area code)

 


Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “Accelerated Filer and Large Accelerated Filer” in Rule 12B-2 of the Exchange Act. (check one):

Large Accelerated Filer  ¨                    Accelerated Filer  ¨                    Non-accelerated Filer  x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.):

Yes  ¨    No   x

As of August 7, 2006 there were 58,713,782 shares of the registrant’s common stock outstanding, including 1,789,451 shares of unvested stock grants.

 



Table of Contents

TABLE OF CONTENTS

 

          Page
   Forward-Looking Statements and Factors that Could Affect Future Results    3

PART I—FINANCIAL INFORMATION

   4

ITEM 1.

   Unaudited Consolidated Financial Statements    4
   Unaudited Consolidated Balance Sheets    4
   Unaudited Consolidated Statements of Income    5
   Unaudited Consolidated Statements of Comprehensive Income    6
   Unaudited Consolidated Statements of Cash Flows    7
   Notes to Unaudited Condensed Consolidated Financial Statements    8

ITEM 2.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations    17

ITEM 3.

   Quantitative and Qualitative Disclosures About Market Risk    30

ITEM 4.

   Controls and Procedures    31

PART II—OTHER INFORMATION

   32

ITEM 1.

   Legal Proceedings    32

ITEM 1A.

   Risk Factors    32

ITEM 2.

   Unregistered Sale of Equity Securities and Use of Proceeds    33

ITEM 3.

   Defaults Upon Senior Securities    33

ITEM 4.

   Submission of Matters to a Vote of Security Holders    33

ITEM 5.

   Other Information    34

ITEM 6.

   Exhibits    35

 

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Table of Contents

Forward-Looking Statements and Factors that Could Affect Future Results

Certain statements contained in this Quarterly Report on Form 10-Q that are not statements of historical fact constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 (the “Act”), notwithstanding that such statements are not specifically identified. In addition, certain statements may be contained in our future filings with the SEC, in press releases, and in oral and written statements made by or with our approval that are not statements of historical fact and constitute forward-looking statements within the meaning of the Act. Examples of forward-looking statements include, but are not limited to: (i) projections of revenues, expenses, income or loss, earnings or loss per share, the payment or nonpayment of dividends, capital structure and other financial items; (ii) statements of plans, objectives and expectations of the Company or its management or board of directors, including those relating to products or services; (iii) statements of future economic performance; and (iv) statements of assumptions underlying such statements. Words such as “believes”, “anticipates”, “expects”, “intends”, “targeted”, “continue”, “remain”, “will”, “should”, “may” and other similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements.

Forward-looking statements involve risks and uncertainties that may cause actual results to differ materially from those in such statements. Factors that could cause actual results to differ from those discussed in the forward-looking statements include, but are not limited to:

 

    Local, regional, national and international economic conditions and the impact they may have on us and our customers, and our assessment of that impact.

 

    Changes in the level of nonperforming assets and charge-offs.

 

    The effects of and changes in trade and monetary and fiscal policies and laws, including the interest rate policies of the Federal Reserve Board.

 

    Inflation and interest rate, securities market and monetary fluctuations.

 

    Political instability, acts of war or terrorism and natural disasters.

 

    The timely development and acceptance of new products and services and perceived overall value of these products and services by customers.

 

    Changes in consumer spending, borrowings and savings habits.

 

    Changes in the financial performance and/or condition of our borrowers.

 

    Technological changes.

 

    Acquisitions of acquired businesses and greater than expected costs or difficulties related to the integration of acquired businesses.

 

    The ability to increase market share and control expenses.

 

    Changes in the competitive environment among financial or bank holding companies and other financial service providers.

 

    The effect of changes in laws and regulations with which we and our subsidiaries must comply.

 

    The effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board, the Financial Accounting Standards Board and other accounting standard setters.

 

    Changes in our organization, compensation and benefit plans.

 

    The costs and effects of legal and regulatory developments including the resolution of legal proceedings or regulatory or other governmental inquiries and the results of regulatory examinations or reviews.

 

    Our success at managing the risks involved in the foregoing items.

Forward-looking statements speak only as of the date on which such statements are made. We do not intend to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made, or to reflect the occurrence of unanticipated events.

 

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PART I—FINANCIAL INFORMATION

 

ITEM 1. Unaudited Consolidated Financial Statements

CENTENNIAL BANK HOLDINGS, INC. AND SUBSIDIARIES

Consolidated Balance Sheets (Unaudited)

 

     June 30,
2006
    December 31,
2005
 
     (In thousands, except for share data)  

Assets

    

Cash and due from banks

   $ 86,038     $ 88,815  

Interest bearing deposits at banks

     35       37  

Federal funds sold

     4,626       10,090  
                

Cash and cash equivalents

     90,699       98,942  
                

Securities available for sale, at fair value

     170,433       143,081  

Securities held to maturity (fair value of $6,719 and $5,686 at June 30, 2006 and December 31, 2005, respectively)

     7,012       5,798  

Bank stocks, at cost

     30,265       26,874  
                

Total investments

     207,710       175,753  
                

Loans held for sale

     4,588       6,820  

Loans, net of unearned discount

     1,927,222       2,067,593  

Less allowance for loan losses

     (25,297 )     (27,475 )
                

Net loans

     1,906,513       2,046,938  
                

Premises and equipment, net

     76,604       73,429  

Goodwill

     391,346       392,507  

Other intangible assets, net

     47,417       54,922  

Other assets

     35,582       39,996  

Assets held for sale

     94,410       98,270  
                

Total assets

   $ 2,850,281     $ 2,980,757  
                

Liabilities and Stockholders’ Equity

    

Liabilities:

    

Deposits:

    

Noninterest-bearing demand

   $ 528,943     $ 593,811  

Interest-bearing demand

     810,686       722,030  

Savings

     94,480       99,496  

Time

     563,945       633,015  
                

Total deposits

     1,998,054       2,048,352  

Securities sold under agreements to repurchase and federal fund purchases

     30,371       44,399  

Borrowings

     76,376       130,198  

Subordinated debentures

     41,239       41,275  

Interest payable and other liabilities

     30,759       37,368  

Liabilities associated with assets held for sale

     77,518       80,417  
                

Total liabilities

     2,254,317       2,382,009  
                

Stockholders’ equity:

    

Common stock—$.001 par value; 100,000,000 shares authorized, 63,733,702 shares issued, 59,189,674 shares outstanding at June 30, 2006 (includes 1,565,343 shares of unvested stock); 63,159,692 shares issued, 60,403,764 shares outstanding at December 31, 2005 (includes 1,278,631 shares of unvested stock)

     64       63  

Additional paid-in capital

     613,596       612,089  

Retained earnings

     31,633       18,478  

Accumulated other comprehensive income (loss)

     (475 )     93  

Treasury stock, at cost

     (48,854 )     (31,975 )
                

Total stockholders’ equity

     595,964       598,748  
                

Total liabilities and stockholders’ equity

   $ 2,850,281     $ 2,980,757  
                

See “Notes to Unaudited Condensed Consolidated Financial Statements.”

 

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CENTENNIAL BANK HOLDINGS, INC. AND SUBSIDIARIES

Consolidated Statements of Income

Unaudited

 

     Three Months Ended June 30,     Six Months Ended June 30,  
     2006    2005     2006     2005  
     (In thousands, except share data)  

Interest income:

         

Loans, including fees

   $ 40,644    $ 30,583     $ 81,165     $ 59,080  

Investment securities:

         

Taxable

     718      696       1,494       1,373  

Tax-exempt

     1,055      591       1,966       1,083  

Dividends

     433      199       860       369  

Federal funds sold and other

     116      299       191       506  
                               

Total interest income

     42,966      32,368       85,676       62,411  
                               

Interest expense:

         

Deposits

     11,533      4,765       21,680       8,393  

Federal funds purchased and repurchase agreements

     293      267       554       444  

Subordinated debentures

     901      596       1,748       1,170  

Borrowings

     851      870       2,399       1,206  
                               

Total interest expense

     13,578      6,498       26,381       11,213  
                               

Net interest income

     29,388      25,870       59,295       51,198  

Provision for credit losses

     —        —         —         1,700  
                               

Net interest income, after provision for loan losses

     29,388      25,870       59,295       49,498  

Noninterest income:

         

Customer service and other fees

     2,993      1,993       5,625       3,922  

Gain (loss) on sale of securities

     —        (14 )     (5 )     9  

Other

     612      360       1,097       986  
                               

Total noninterest income

     3,605      2,339       6,717       4,917  

Noninterest expense:

         

Salaries and employee benefits

     12,082      10,088       23,517       20,396  

Occupancy expense

     1,994      1,660       4,046       3,288  

Furniture and equipment

     1,231      881       2,396       1,666  

Amortization of intangible assets

     2,999      3,095       5,997       6,189  

Merger, acquisition and transition expenses

     1,539      2,762       1,627       5,448  

Other general and administrative

     5,159      2,731       9,161       9,213  
                               

Total noninterest expense

     25,004      21,217       46,744       46,200  
                               

Income before income taxes

     7,989      6,992       19,268       8,215  

Income tax expense

     2,612      2,431       6,602       2,734  
                               

Income from continuing operations

     5,377      4,561       12,666       5,481  

Income (loss) from discontinued operations, net of tax

     349      (971 )     489       (794 )
                               

Net income

   $ 5,726    $ 3,590     $ 13,155     $ 4,687  
                               

Earnings (loss) per share–basic:

         

Income from continuing operations

   $ 0.09    $ 0.09     $ 0.22     $ 0.10  

Income (loss) from discontinued operations, net of tax

     0.01      (0.02 )     —         (0.01 )

Net income

     0.10      0.07       0.22       0.09  

Earnings (loss) per share–diluted:

         

Income from continuing operations

   $ 0.09    $ 0.09     $ 0.22     $ 0.10  

Income (loss) from discontinued operations, net of tax

     0.01      (0.02 )     —         (0.01 )

Net income

     0.10      0.07       0.22       0.09  

Weighted average shares outstanding-basic

     58,053,314      52,179,857       58,552,516       52,256,172  

Weighted average shares outstanding-diluted

     58,352,355      52,179,857       58,849,243       52,256,172  

See “Notes to Unaudited Condensed Consolidated Financial Statements.”

 

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CENTENNIAL BANK HOLDINGS, INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income

Unaudited

 

     Three Months Ended
June 30,
   Six Months Ended
June 30,
     2006     2005    2006     2005
     (In thousands)

Net income

   $ 5,726     $ 3,590    $ 13,155     $ 4,687

Other comprehensive income (loss), net of tax:

         

Change in net unrealized loss on securities available for sale

     (422 )     538      (568 )     825
                             

Comprehensive income

   $ 5,304     $ 4,128    $ 12,587     $ 5,512
                             

See “Notes to Unaudited Condensed Consolidated Financial Statements.”

 

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CENTENNIAL BANK HOLDINGS, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

Unaudited

 

     Six Months Ended June 30,  
     2006     2005  
     (In thousands)  

Cash flows from operating activities:

    

Net income

   $ 13,155     $ 4,687  

Adjustments to reconcile net income to net cash provided by operating activities:

    

Provision for loan losses

     15       1,700  

Stock compensation

     1,508       —    

Depreciation and amortization

     9,009       8,009  

Loss (gain) on sale of securities

     5       (9 )

Loss (gain) on sale of loans

     (545 )     (626 )

Loss (gain) on sale of real estate owned and assets

     (50 )     (348 )

Loss on discontinued operations

     201       1,244  

Other

     (173 )     (117 )

Proceeds from sales of loans held for sale

     39,711       47,185  

Originations of loans held for sale

     (36,935 )     (45,287 )

Net change in:

    

Accrued interest receivable and other assets

     8,835       (9,521 )

Accrued interest payable and other liabilities

     (6,182 )     5,095  
                

Net cash provided by operating activities

     28,554       12,012  
                

Cash flows from investing activities:

    

Activity in available-for-sale securities:

    

Maturities, prepayments, and calls

     20,652       100,252  

Purchases

     (53,735 )     (108,064 )

Activity in held-to-maturity securities:

    

Maturities, prepayments, and calls

     10       130  

Loan originations and principal collections, net

     137,316       (79,629 )

Proceeds from sales of foreclosed assets

     1,213       3,290  

Proceeds from sales of premises and equipment

     189       1,889  

Additions to premises and equipment

     (6,035 )     (4,806 )

Proceeds from sale of subsidiary

     1,835       —    
                

Net cash provided (used) by investing activities

     101,445       (86,938 )
                

Cash flows from financing activities:

    

Net change in deposits

     (54,817 )     (88,945 )

Net change in short-term borrowings

     (53,545 )     90,907  

Repayment of long-term debt

     (265 )     31,267  

Net change in federal funds purchased and repurchase agreements

     (12,480 )     23,806  

Repurchase of common stock

     (17,135 )     (4,659 )
                

Net cash provided (used) by financing activities

     (138,242 )     52,376  
                

Net change in cash and cash equivalents

     (8,243 )     (22,550 )

Cash and cash equivalents, beginning of period

     98,942       90,927  
                

Cash and cash equivalents, end of period

   $ 90,699     $ 68,377  
                

Supplemental disclosure of cash flow activity:

    

Interest paid on deposits and borrowed funds

   $ 27,002     $ 11,369  

Income taxes paid

     10,933       1,044  

Supplemental disclosure of non-cash activities:

    

Loans transferred to other real estate owned

     524       1,770  

See “Notes to Unaudited Condensed Consolidated Financial Statements.”

 

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CENTENNIAL BANK HOLDINGS, INC. AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements

 

(1) Organization, Operations and Basis of Presentation

Centennial Bank Holdings, Inc. is a financial holding company and a bank holding company registered under the Bank Holding Company Act of 1956, as amended. Our principal business is to serve as a holding company for our subsidiaries. As of June 30, 2006, those subsidiaries were Guaranty Bank and Trust Company, Centennial Bank of the West, and Collegiate Peaks Bank, referred to as Guaranty Bank, CBW, and Collegiate Peaks, respectively. Collegiate Peaks was held for sale as of June 30, 2006. Reference to “Banks” means Guaranty Bank and CBW, and “Company” means Centennial Bank Holdings, Inc. on a consolidated basis with the Banks, Collegiate Peaks and First MainStreet Insurance, which was sold on March 1, 2006.

The Banks are full-service community banks offering an array of banking products and services to the communities they serve, including accepting time and demand deposits and originating commercial loans, real estate loans, including construction loans and mortgage loans, Small Business Administration guaranteed loans and consumer loans. CBW also provides trust services, including personal trust administration, estate settlement, investment management accounts and self-directed IRAs.

 

  (a) Basis of Presentation

The accounting and reporting policies of the Company conform to U.S. generally accepted accounting principles. All significant intercompany balances and transactions have been eliminated. Our financial statements reflect all adjustments that are, in the opinion of management, necessary for a fair presentation of the financial position and results of operations for the periods presented. Certain information and note disclosures normally included in consolidated financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. The interim operating results are not necessarily indicative of operating results for the full year.

 

  (b) Use of Estimates

The preparation of the consolidated financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the dates of the consolidated balance sheet and income and expense for the periods. Actual results could differ significantly from those estimates. Material estimates that are particularly susceptible to significant changes include the allowance for loan losses, deferred tax assets and liabilities, and the initial valuation and periodic evaluation for impairment of goodwill and other intangible assets.

 

  (c) Allowance for Credit Losses

The allowance for loan losses and the reserve for unfunded loan commitments when combined are referred to as the allowance for credit losses. The allowance for loan losses is reported as a reduction of outstanding loan balances and the reserve for unfunded loan commitments is included within interest payable and other liabilities.

The allowance for credit losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. Loans that are deemed to be uncollectible are charged off and deducted from the allowance for loan losses. The provision for loan losses and recoveries on loans previously charged off are added to the allowance for loan losses. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available. The allowance for credit losses is maintained at a level deemed appropriate by management to adequately provide for known and inherent risks in the loan portfolio and other extensions of credit.

 

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  (d) Goodwill and Other Intangible Assets

Goodwill represents the excess of cost over the fair value of the net assets of businesses acquired. Goodwill and other intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but instead are tested for impairment at least annually. Other intangible assets with definite useful lives are amortized over their estimated useful lives to their estimated residual values. Goodwill is the only intangible asset with an indefinite life. Goodwill is reviewed for impairment at least annually or whenever events or changes in circumstance indicate that the carrying value may be greater than fair value. The goodwill impairment analysis is based on an evaluation of reporting units. The Company has one significant reporting unit – banking operations.

Core deposit intangible assets, referred to as CDI, and other definite-lived intangible assets are recognized apart from goodwill at the time of acquisition based on valuations prepared by independent third parties or other estimates of fair value. In preparing such valuations, the third parties consider variables such as deposit servicing costs, attrition rates, and market discount rates. CDI assets are amortized to expense over their useful lives, which we have estimated to range from 7 years to 15 years. The other definite-lived intangible assets are amortized over their useful lives, which range from 1 year to 7 years.

 

  (e) Impairment of Long-Lived Assets

Long-lived assets, such as premises and equipment, and definite-lived intangible assets subject to amortization, are reviewed for impairment whenever events or changes in circumstance indicate that the carrying value of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying value of the asset to the estimated undiscounted future cash flows expected to be generated by the asset. If the carrying value of an asset exceeds its estimated undiscounted future cash flows, an impairment charge is recognized by the amount by which the carrying value of the asset exceeds the fair value of the asset, less costs to sell. Assets to be disposed of are separately presented in the balance sheet and reported at the lower of the carrying value or fair value less costs to sell, and are no longer depreciated. The assets and liabilities of a disposal group classified as held for sale are presented separately in the appropriate asset and liability sections of the consolidated balance sheet. The gain or loss and income from a disposal group are recorded as discontinued operations on the consolidated statement of income.

 

  (f) Stock Incentive Plan

The Company’s Amended and Restated 2005 Stock Incentive Plan (“Plan”) provides for grants of stock options, restricted stock awards, restricted stock units awards, performance stock awards, stock appreciation rights, and other equity-based awards to key employees, nonemployee directors, consultants and prospective employees. The Company accounts for the equity-based compensation using the provisions of SFAS No. 123R, Share-Based Payment. The Company recognizes services received in a share-based payment transaction as services are received. The cost of employee services received in exchange for an award of equity instruments is based on the grant-date fair value of the award (as determined by quoted market prices). That cost is recognized over the period during which an employee is required to provide service in exchange for the award. The stock compensation expense recognized reflects estimated forfeitures, as adjusted as necessary based on actual forfeitures. The Company recognized $807,000 and $1,508,000 in compensation expense for services rendered for the three and six months ended June 30, 2006. The Company had no equity-based awards for the six months ended June 30, 2005. At June 30, 2006, the Company had a total of 1,565,343 unvested restricted shares of stock issued. At June 30, 2006, there was $11,342,000 of unrecognized compensation costs related to unvested share-based compensation granted under the Plan. That costs is expected to be recognized over a weighted-average period of 5.0 years.

 

     Shares     Weighted Average
Fair Value on
Award Date

Outstanding at December 31, 2005

   1,278,631     $ 10.88

Awarded

   574,010       10.96

Forfeited

   (254,500 )     10.86

Vested

   (32,798 )     10.50
        

Outstanding at June 30, 2006

   1,565,343     $ 10.91
        

 

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  (g) Reclassifications

Certain amounts in prior year financial statements have been reclassified to conform to the current year presentation.

 

(2) Securities

The amortized cost and estimated fair value of debt securities are as follows:

 

     June 30, 2006
    

Amortized

Cost

  

Gross

Unrealized

Gains

  

Gross

Unrealized

Losses

    Fair
Value
     (In thousands)

Securities available for sale:

          

U.S. treasuries

   $ 7,036    —      (37 )   6,999

U.S. government agencies

     5,408    —      (62 )   5,346

State and municipal

     113,521    1,019    (359 )   114,181

Mortgage-backed

     43,692    10    (1,520 )   42,182

Marketable equity securities

     1,719    6    —       1,725
                      

Securities available for sale

   $ 171,376    1,035    (1,978 )   170,433
                      

Securities held to maturity:

          

Mortgage-backed

   $ 7,012    —      (293 )   6,719
                      

 

     December 31, 2005
    

Amortized

Cost

  

Gross

Unrealized

Gains

  

Gross

Unrealized

Losses

    Fair
Value
     (In thousands)

Securities available for sale:

          

U.S. treasuries

   $ 13,165    —      (89 )   13,076

U.S. government agencies

     5,391    —      (24 )   5,367

State and municipal

     72,110    949    (166 )   72,893

Mortgage-backed

     50,797    29    (783 )   50,043

Marketable equity securities

     1,697    5    —       1,702
                      

Securities available for sale

   $ 143,160    983    (1,062 )   143,081
                      

Securities held to maturity:

          

Mortgage-backed

   $ 5,798    —      (112 )   5,686
                      

Certain individual securities have been in a continuous unrealized loss position for 12 months or longer at June 30, 2006. These securities have fluctuated in value since their purchase dates because of changes in market interest rates. The Company has concluded that the continuous unrealized loss position of 12 months or longer is a result of the level of market interest rates and not a result of the underlying issuers’ ability to repay and are, therefore, temporarily impaired. In addition, we have the ability to hold these securities until their fair value recovers to their cost. Accordingly, an impairment was not recognized in our consolidated statements of income.

 

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(3) Loans

A summary of net loans held for investment by loan type at the dates indicated is as follows:

 

     June 30,
2006
    December 31,
2005
 
     (In thousands)  

Loans on real estate:

    

Residential and commercial mortgage

   $ 854,826     $ 863,658  

Construction

     214,254       251,648  

Equity lines of credit

     64,355       70,386  

Commercial loans

     664,202       724,929  

Agricultural loans

     52,897       71,707  

Lease financing

     1,101       677  

Installment loans to individuals

     54,955       63,121  

Overdrafts

     1,993       2,006  

SBA and other

     23,376       24,321  
                
     1,931,959       2,072,453  

Less:

    

Allowance for loan losses

     (25,297 )     (27,475 )

Net of unearned discount

     (4,737 )     (4,860 )
                
   $ 1,901,925       2,040,118  
                

Loans available for sale

   $ 4,588     $ 6,820  
                

A summary of transactions in the allowance for loan losses for the period indicated is as follows:

 

     Six Months Ended
June 30, 2006
 
     (In thousands)  

Balance, beginning of period

   $ 27,475  

Provision for (recovery on) loan losses

     (283 )

Loans charged off

     (3,103 )

Recoveries on loans previously charged-off

     1,208  
        

Balance, end of period

   $ 25,297  
        

A summary of transactions in the allowance for losses on unfunded commitments for the period indicated is as follows:

 

     Six Months Ended
June 30, 2006
     (In thousands)

Balance, beginning of period

   $ 718

Provision for losses on unfunded commitments

     283
      

Balance, end of period

   $ 1,001
      

The following table details key information regarding the Company’s impaired loans at the dates indicated:

 

     June 30, 2006    December 31, 2005
     (In thousands)

Impaired loans with a specific valuation allowance

   $ 14,534    $ 44,267

Impaired loans without a specific valuation allowance

     32,400      6,023
             

Total impaired loans

   $ 46,934    $ 50,290
             

Valuation allowance related to impaired loans

   $ 5,685    $ 10,360
             

Average investment in impaired loans

   $ 45,909    $ 38,425
             

Interest income of $2,087,000 was recognized on impaired loans during the six months ended June 30, 2006. At June 30, 2006 and December 31, 2005, nonaccrual loans were $30,684,000 and $29,608,000, respectively.

 

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(4) Goodwill and Other Intangible Assets

Goodwill and other intangible assets arise from purchase business combinations. Goodwill and other intangible assets deemed to have indefinite lives generated from purchase combinations are tested for impairment no less frequently than annually.

Other intangible assets with definite lives are amortized over their respective estimated useful lives to their estimated residual values and reviewed for impairment annually. The amortization expense represents the estimated decline in the value of the underlying deposits or loan customers acquired.

The changes in the carrying amount of goodwill for the periods ended June 30, 2006 and December 31, 2005 are as follows:

 

     Six Months Ended
June 30, 2006
    Year Ended
December 31, 2005
     (In thousands)

Balance, beginning of period

   $ 392,507     $ 328,185

Goodwill acquired on October 1, 2005

     —         46,258

Goodwill acquired on November 1, 2005

     —         14,623

Goodwill associated with disposal of subsidiary (Note 10)

     (1,161 )     —  

Adjustment to goodwill-increase related to income taxes

     —         3,441
              

Balance, end of period

   $ 391,346     $ 392,507
              

With respect to the year ended December 31, 2005, the Company revised its estimated value for its discontinued operations in the second quarter of 2005 based on additional information available related to the sale of Collegiate Peaks. At that time, the Company determined that, upon consummation of the sale, it would have an estimated tax liability associated with the sale of Collegiate Peaks, resulting in additional goodwill of $3,441,000.

The following table presents the gross amounts of core deposit and customer relationship intangibles and the related accumulated amortization at the dates indicated:

 

     Useful life    June 30,
2006
    December 31,
2005
 
          (In thousands)  

Noncompete employment agreements

   2 years    $ 3,606     $ 3,706  

Core deposit intangible assets

   7 – 15 years      62,975       62,975  

Expirations – First MainStreet Insurance

   7 years      —         1,477  
                   
        66,581       68,158  

Accumulated amortization

        (19,164 )     (13,236 )
                   
      $ 47,417     $ 54,922  
                   

Amortization expense for intangible assets for the six months ended June 30, 2006 and 2005 was $5,997,000 and $6,189,000, respectively.

 

(5) Borrowings

Borrowings include Treasury Tax and Loan notes, Federal Home Loan Bank (“FHLB”) borrowings, and a revolving credit agreement with U.S. Bank National Association. The Company had $76,376,000 and $130,198,000 outstanding under these obligations at June 30, 2006 and December 31, 2005, with a total available commitment of $388,655,000 at June 30, 2006.

At June 30, 2006, borrowings consisted of a line of credit and term notes at the Federal Home Loan Bank, of $49,900,000 and $14,738,000, respectively, $10,964,000 under the U.S. Bank revolving credit agreement and a $774,000 Treasury Tax and Loan note balance.

The maximum allowable balance for borrowing at the Federal Home Loan Bank at June 30, 2006 was $317,655,000. The interest rate on the line of credit varies with the federal funds rate. The term notes have fixed interest rates that range from 2.52% to 6.22%. A blanket pledge and security agreement with the Federal Home Loan Bank, which encompasses certain loans and securities serves as collateral for these borrowings.

 

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The Company has a $70 million revolving credit agreement with U.S. Bank National Association that contains financial covenants, including maintaining a minimum return on average assets, a maximum nonperforming assets to total loans ratio and regulatory capital ratios that require the Company to qualify as well-capitalized. The interest rate on this revolving credit agreement, which varies based on a spread over the federal funds rate, was 6.6% at June 30, 2006. The Company was in compliance with all debt covenants at quarter end. This agreement is secured by Guaranty Bank stock.

 

(6) Subordinated Debentures and Trust Preferred Securities

The Company had a $41,239,000 and $41,275,000 aggregate principal balance of subordinated debentures outstanding with a weighted average cost of 8.9% and 8.3% at June 30, 2006 and December 31, 2006. The subordinated debentures were issued in four separate series. Each issuance has a maturity of thirty years from its date of issue. The subordinated debentures were issued to trusts established by the Company, which in turn issued $40 million of trust preferred securities. Generally and with certain limitations, the Company is permitted to call the debentures subsequent to the first five or ten years, as applicable, after issue if certain conditions are met, or at any time upon the occurrence and continuation of certain changes in either the tax treatment or the capital treatment of the trusts, the debentures or the preferred securities.

The following table summarizes the terms of each subordinated debenture issuance at June 30, 2006 (dollars in thousands):

 

Series

   Date Issued    Principal
Amount
   Maturity
Date
   Call Date*    Fixed or
Variable
Rate
   Rate Adjuster     Rate at
June 30,
2006
    Next Rate
Reset Date

CenBank Trust I

   9/7/2000    $ 10,310    9/7/2030    9/7/2010    Fixed    N/A     10.60 %   N/A

CenBank Trust II

   2/22/2001      5,155    2/22/2031    2/22/2011    Fixed    N/A     10.20 %   N/A

CenBank Trust III

   4/15/2004      15,464    4/15/2034    4/15/2009    Variable    LIBOR + 2.65 %   7.72 %   7/15/2006

Guaranty Capital Trust III

   7/7/2003      10,310    7/7/2033    7/7/2008    Variable    LIBOR + 3.10 %   8.17 %   7/15/2006

 

* Call date represents the earliest date the Company can call the debentures without penalty.

 

(7) Commitments

The Company is a party to credit related financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, stand-by letters of credit and commercial letters of credit. Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets.

The Company’s exposure to credit loss is represented by the contractual amount of these commitments. The Company follows the same credit policies in making commitments as it does for on-balance sheet instruments.

At the dates indicated, the following financial instruments were outstanding whose contract amounts represented credit risk:

 

     June 30,
2006
   December 31,
2005
     (In thousands)

Commitments to extend credit

   $ 594,321    $ 634,737

Standby letters of credit

     36,263      37,952

Commercial letters of credit

     318      472
             
   $ 630,902    $ 673,161
             

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Several of the commitments may expire without being drawn upon. Therefore, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained, if it is deemed necessary by the Company, is based on management’s credit evaluation of the customer.

 

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Commitments to extend credit under overdraft protection agreements are commitments for possible future extensions of credit to existing deposit customers. These lines of credit are uncollateralized and usually do not contain a specified maturity date and may not be drawn upon to the total extent to which the Company is committed.

Stand-by letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Those letters of credit are primarily issued to support public and private borrowing arrangements. Substantially all letters of credit issued have expiration dates within one year. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Company generally holds collateral supporting those commitments if deemed necessary.

The Company enters into commercial letters of credit on behalf of its customers, which authorize a third party to draw drafts on the Company up to a stipulated amount and with specific terms and conditions. A commercial letter of credit is a conditional commitment on the part of the Company to provide payment on drafts drawn in accordance with the terms of the commercial letter of credit.

 

(8) Capital Ratios

At June 30, 2006 and December 31, 2005, the Company had leverage ratios of 8.56% and 7.97%, Tier 1 risk-weighted capital ratios of 9.41% and 8.83%, and total risk-weighted capital ratios of 10.64% and 10.08%, respectively. The Company actively monitors its regulatory capital ratios to ensure that the Company and its bank subsidiaries are well capitalized under the applicable regulatory framework.

 

(9) Merger, Acquisition and Transition Expenses

The Company recorded merger, acquisition, and transition expenses of $1,539,000 and $1,627,000 for the three and six months ended June 30, 2006, respectively, and included $1,425,000 of contractual severance obligations associated with the management transition announced in May 2006.

 

(10) Assets Held for Sale and Discontinued Operations

Business Disposition — Discontinued Operations

On March 1, 2006, the Company sold substantially all of the assets of its First MainStreet Insurance, Ltd. subsidiary for $3,215,000, of which $1,835,000 was paid in cash at closing, and the release of the Company from certain contractual obligations. The sale of the subsidiary did not result in a gain or loss due to a reallocation of the initial goodwill allocated to First MainStreet Insurance, Ltd. First MainStreet Insurance, Ltd. net income for the period from January 1, 2006 to March 1, 2006 of $17,000 is included in income from discontinued operations for the three months ended March 31, 2006 and six months ended June 30, 2006.

Assets Held for Sale

On June 19, 2006, the Company signed a definitive agreement to sell Collegiate Peaks to a new group of investors. This agreement follows the August 25, 2005 definitive agreement for the sale of Collegiate Peaks that was terminated on April 25, 2006. Pursuant to the Company’s 2005 decision to sell Collegiate Peaks, the Company classified Collegiate Peaks’ assets and liabilities as held for sale at the lower of cost or fair value as of June 30, 2006 and December 31, 2005. The following tables present the assets and liabilities of Collegiate Peaks that are presented as held for sale in the consolidated balance sheets at June 30, 2006 and December 31, 2005, and the results of operations that are presented in discontinued operations for the six months ended June 30, 2006 and June 30, 2005.

 

     June 30,
2006
   December 31,
2005
     (In thousands)

Assets held for sale:

     

Cash and cash equivalents

   $ 14,703    $ 19,869

Investments

     16,997      16,647

Loans and leases, net

     49,544      48,150

Other intangible assets

     3,481      3,528

Goodwill

     8,922      8,922

Other assets

     763      1,154
             

Total assets held for sale

   $ 94,410    $ 98,270
             

Liabilities associated with assets held for sale:

     

Deposits

   $ 69,703    $ 74,069

Securities sold under repurchase agreements

     6,230      4,682

Other liabilities

     1,585      1,666
             

Total liabilities associated with assets held for sale

   $ 77,518    $ 80,417
             

 

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Table of Contents
     Six Months Ended
     June 30,
2006
   June 30,
2005
     (In thousands)

Interest income

   $ 2,646    $ 2,248

Noninterest income

     187      216

Net income

     681      450

Income from Discontinued Operations

The income from discontinued operations consisted of the following:

 

     Six Months Ended
June 30, 2006
 
     (In thousands)  

Net income – First MainStreet Insurance, Ltd.

   $ 17  

Net income – Collegiate Peaks

     681  

Impairment of Collegiate Peaks assets

     (325 )

Tax benefit

     124  

Intercompany elimination

     (8 )
        

Income from discontinued operations

   $ 489  
        

 

(11) Contingencies

On December 31, 2004, an adversary proceeding was filed against Guaranty Bank in the United States Bankruptcy Court for the District of Colorado, by the trustees of the Will Hoover Company, or the Hoover Company, and William Gordon Hoover, Jr., or Hoover, seeking to avoid certain transfers that occurred over a four-year period commencing in 1999 under the United States Bankruptcy Code. The trustees allege that certain transfers were made by the Hoover Company and Hoover with actual fraudulent intent, that the transfers were made for less than reasonably equivalent value and occurred at a time when the Hoover Company and Hoover were insolvent, or were rendered insolvent by the transfers, and that certain other transfers were preferential as to other creditors, were made for less than reasonably equivalent value or were made by the Hoover Company or Hoover with actual fraudulent intent. On September 7, 2005, the Bankruptcy Court granted in part our motion for summary judgment and dismissed $8.5 million of the claims relating to alleged transfers for payment of items credited in the check collection process. On November 10, 2005, the trustees filed a motion in District Court requesting reconsideration of the Bankruptcy Court’s order dismissing those claims. On November 21, 2005, the District Court summarily denied the trustees’ motion. We continue to vigorously contest the remaining claims, which amount to approximately $2.8 million, approximately $2.5 million of which relate to overdraft-related claims and approximately $0.3 million of which relate to preferential transfer claims. We have established a reserve that, after consultation with our counsel, we have determined is appropriate for this litigation.

On July 22, 2005 and August 18, 2005, two separate but similar actions were filed against Guaranty Bank and a former officer in the Denver District Court, Denver, Colorado by investors who provided funds to Hoover, the Hoover Company or related entities. The investors allege that certain activities of Guaranty Bank and its former officer with respect to the customer relationship with Hoover, the Hoover Company and related entities aided and abetted Hoover and the Hoover Company in securities violations and violations of the Colorado Organized Crime Control Act and amounted to a civil conspiracy, causing the investors to incur damages. The investors are seeking actual and statutory treble damages against Guaranty Bank and its former officer. The alleged actual losses claimed in connection with such activities are in excess of $13.1 million. In a series of preliminary rulings in April 2006, the District Court dismissed a number of the claims representing alleged damages in excess of $1.0 million. We will continue to vigorously defend these actions.

 

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At this time, we cannot determine whether the outcome of the above matters will have a material adverse impact on our consolidated financial position or results of operations. To the extent that these suits are not settled or dismissed, the Company will incur ongoing legal costs, to the extent such legal costs will not be covered by insurance, that could have an adverse impact on our results of operations.

In the ordinary course of our business, we are party to various other legal actions, which we believe are incidental to the operation of our business. Although the ultimate outcome and amount of liability, if any, with respect to these other legal actions to which we are currently a party cannot presently be ascertained with certainty, in the opinion of management, based upon information currently available to us, any resulting liability is not likely to have a material adverse effect on the Company’s consolidated financial position, results of operations or cash flows.

 

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ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

This MD&A should be read together with our unaudited Consolidated Financial Statements and unaudited Statistical Information included elsewhere in this Report and Items 1, 1A, 6, 7, 7A and 8 of our 2005 Annual Report on Form 10-K. Also, please see the disclosure in the “Forward-Looking Statements and Factors that Could Affect Future Results” section in this report for certain other factors that could cause actual results or future events to differ materially from those anticipated in the forward-looking statements included in this report or from historical performance.

Overview

We are a financial holding company and a bank holding company providing banking and other financial services throughout our targeted Colorado markets to consumers and to small and medium-sized businesses, including the owners and employees of those businesses, through our bank subsidiaries. At June 30, 2006, those subsidiaries included Guaranty Bank and Trust Company, Centennial Bank of the West, and Collegiate Peaks Bank, which was held for sale at June 30, 2006. Unless the context requires otherwise, the terms “Company,” “us,” “we,” and “our” refers to Centennial Bank Holdings, Inc. on a consolidated basis. We refer to Guaranty Bank and Trust Company as Guaranty Bank, Centennial Bank of the West as CBW, and Collegiate Peaks Bank as Collegiate Peaks. We refer to Guaranty Bank and CBW as the Banks.

We offer an array of banking products and services to the communities we serve, including accepting time and demand deposits, originating commercial loans, real estate loans, including construction loans and mortgage loans, Small Business Administration guaranteed loans and consumer loans. We derive our income primarily from interest received on real estate related loans, commercial loans and leases and consumer loans and, to a lesser extent, fees from the sale or referral of loans, interest on investment securities and fees received in connection with servicing loan and deposit accounts. Our major operating expenses are the interest we pay on deposits and borrowings and general operating expenses. We rely primarily on locally generated deposits to provide us with funds for making loans. We are subject to competition from other financial institutions and our operating results, like those of other financial institutions operating exclusively or primarily in Colorado, are significantly influenced by economic conditions in Colorado, including the strength of the real estate market. In addition, both the fiscal and regulatory policies of the federal government and regulatory authorities that govern financial institutions and market interest rates also impact our financial condition, results of operations and cash flows.

On October 1, 2005, we consummated our stock-for-stock acquisition of First MainStreet Financial, Ltd., a financial holding company, pursuant to which its wholly owned subsidiary, First MainStreet Bank, N.A., merged with and into CBW. First MainStreet Financial’s insurance agency, First MainStreet Insurance, Ltd., was subsequently sold by us on March 1, 2006. The acquisition of First MainStreet resulted in the issuance of 9,517,727 shares of our common stock. We acquired $245.2 million of loans and $332.8 million of deposits as a result of the First MainStreet acquisition. On November 1, 2005, we completed the acquisition of Foothills Bank, which was merged into Guaranty Bank. Foothills had $90.8 million in loans and deposits of $114.2 million at consummation of the transaction.

On June 19, 2006, the Company signed a definitive agreement to sell Collegiate Peaks to a new group of management-led investors. This agreement follows the August 25, 2005 definitive agreement for the sale of Collegiate Peaks that was terminated on April 25, 2006. Pursuant to the Company’s 2005 decision to sell Collegiate Peaks, the Company classified Collegiate Peaks’ assets and liabilities as held for sale at the lower of cost or fair value as of June 30, 2006 and December 31, 2005.

 

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Table of Contents

Results of Operations

The following table summarizes certain key financial results for us for the periods indicated:

 

     Three Months Ended June 30,     Six Months Ended June 30,  
     2006    2005     Change -
Favorable
(Unfavorable)
    2006    2005     Change -
Favorable
(Unfavorable)
 

(In thousands, except share data)

                                  

Results of Operations:

              

Interest income

   $ 42,966    $ 32,368     $ 10,598     $ 85,676    $ 62,411     $ 23,265  

Interest expense

     13,578      6,498       (7,080 )     26,381      11,213       (15,168 )
                                              

Net interest income

     29,388      25,870       3,519       59,295      51,198       8,097  

Provision for loan losses

     —        —         —         —        1,700       1,700  
                                              

Net interest income after provision for loan losses

     29,388      25,870       3,519       59,295      49,498       9,797  

Noninterest income

     3,605      2,339       1,267       6,717      4,917       1,800  

Noninterest expense

     25,004      21,217       (3,787 )     46,744      46,200       (544 )
                                              

Income before income taxes

     7,989      6,992       999       19,268      8,215       11,053  

Income tax expense

     2,612      2,431       (182 )     6,602      2,734       (3,868 )
                                              

Income from continuing operations

     5,377      4,561       817       12,666      5,481       7,185  

Income (loss) from discontinued operations (net of tax)

     349      (971 )     1,319       489      (794 )     1,283  
                                              

Net income

   $ 5,726    $ 3,590     $ 2,136     $ 13,155    $ 4,687     $ 8,468  
                                              

Share Data:

              

Basic earnings per share

   $ 0.10    $ 0.07     $ 0.03     $ 0.22    $ 0.09     $ 0.13  

Diluted earnings per share

   $ 0.10    $ 0.07     $ 0.03     $ 0.22    $ 0.09     $ 0.13  

Average shares outstanding

     58,053,314      52,179,857       5,873,457       58,552,516      52,256,172       6,296,344  

Diluted average shares outstanding

     58,352,355      52,179,857       6,172,498       58,849,243      52,256,172       6,593,071  

Net income for the three and six month periods ended June 30, 2006 reflected increases over the same prior year periods by $2.1 million and $8.5 million. Several factors significantly contributed to this increase in net income. In the first quarter 2005, we incurred a charge of $4.9 million for change of control and retention bonuses related to the December 31, 2004 acquisition of Guaranty Corporation. We recorded a provision for loan losses of $1.7 million in the first quarter 2005. No provision was taken in the 2006 first or second quarters based on management’s assessment of the adequacy of our allowance for loan loss. Our 2006 net interest income, noninterest income, and noninterest expense categories, when compared to 2005, have all been impacted by the fourth quarter 2005 acquisitions of First MainStreet and Foothills Bank.

Net Interest Income and Net Interest Margin

Net interest income, which is our primary source of revenue, represents the difference between interest earned on assets and interest paid on liabilities. The interest rate spread is the difference between the yield on our interest bearing assets and liabilities. Net interest margin is net interest income expressed as a percentage of average interest-earning assets.

 

     Quarter Ended  
     June 30,
2006
    March 31,
2006
    December 31,
2005
    September 30,
2005
    June 30,
2005
 
     (Dollars in thousands)  

Net interest income

   $ 29,388     $ 29,907     $ 30,797     $ 25,873     $ 25,870  

Interest rate spread

     4.66 %     4.67 %     4.54 %     4.72 %     5.06 %

Net interest margin

     5.51 %     5.44 %     5.39 %     5.41 %     5.63 %

 

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Our net interest income has declined for the first two quarters of 2006 from the fourth quarter 2005. The decline in net interest income has been caused in part by a contraction in our loan portfolio. Our net interest margin has improved in the first two quarters of 2006 from the fourth quarter 2005 due mainly to continued increases in our prime lending rate in response to the rise in market interest rates combined with our disciplined approach to deposit pricing.

The following tables present, for the periods indicated, average assets, liabilities and stockholders’ equity, as well as the net interest income from average interest-earning assets and the resultant annualized yields expressed in percentages. Nonaccrual loans are included in the calculation of average loans while accrued interest thereon is excluded from the computation of yields earned.

 

     Quarter Ended June 30,  
     2006     2005  
     Average
Balance
   Interest
Income
or
Expense
   Average
Yield or
Cost
    Average
Balance
   Interest
Income
or
Expense
   Average
Yield or
Cost
 
     (Dollars in thousands)  

ASSETS:

                

Interest-earning assets:

                

Gross loans, net of unearned fees (1)(2)(3)

   $ 1,958,639    $ 40,643    8.32 %   $ 1,682,734    $ 30,583    7.29 %

Investment securities (1)

                

Taxable

     72,183      718    3.99 %     80,524      696    3.47 %

Tax-exempt

     75,540      1,055    5.60 %     46,536      591    5.09 %

Equity securities (4)

     30,137      458    6.08 %     13,394      168    5.03 %

Other earning assets

     4,629      92    8.01 %     21,248      330    6.23 %
                                        

Total interest-earning assets

     2,141,128      42,966    8.05 %     1,844,436      32,368    7.04 %

Non-earning assets:

                

Cash and due from banks

     76,451         $ 54,495      

Other assets

     618,853           514,586      
                        

Total assets

   $ 2,836,432         $ 2,413,517      
                        

LIABILITIES AND STOCKHOLDERS’ EQUITY:

                

Interest-bearing liabilities:

                

Deposits:

                

Interest-bearing demand

   $ 175,008    $ 193    0.44 %   $ 117,604    $ 107    0.36 %

Money market

     637,214      5,405    3.40 %     512,736      1,974    1.54 %

Savings

     95,709      179    0.75 %     79,755      140    0.70 %

Time certificates of deposit

     566,560      5,749    4.07 %     419,987      2,544    2.43 %
                                        

Total interest-bearing deposits

     1,474,491      11,526    3.14 %     1,130,082      4,765    1.69 %

Borrowings:

                

Repurchase agreements

     26,419      283    4.30 %     31,547      210    2.67 %

Federal funds purchased

     145      2    4.95 %     6,901      57    3.31 %

Subordinated debentures

     41,239      901    8.76 %     41,809      596    5.72 %

Borrowings

     66,126      866    5.25 %     105,747      870    3.30 %
                                        

Total interest-bearing liabilities

     1,608,420      13,578    3.39 %     1,316,086      6,498    1.98 %

Noninterest bearing liabilities:

                

Demand deposits

     519,168           481,242      

Other liabilities

     108,888           95,403      
                        

Total liabilities

     2,236,476           1,892,731      

Stockholders’ equity

     599,956           520,786      
                        

Total liabilities and stockholders’ equity

   $ 2,836,432         $ 2,413,517      
                        

Net interest income

      $ 29,388         $ 25,870   
                        

Net interest margin

         5.51 %         5.63 %
                        

 

(1) Yields on loans and securities have not been adjusted to a tax-equivalent basis.

 

(2) The calculation of average gross loans includes nonaccrual loans.

 

(3) Net loan fees of $1.9 million for each of the three months ended June 30, 2006 and 2005 are included in the yield computation.

 

(4) Includes Bankers Bank of the West stock, Federal Agricultural Mortgage Corporation (Farmer Mac) stock, Federal Reserve Bank stock and Federal Home Loan Bank stock.

 

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Table of Contents
     Six Months Ended June 30,  
     2006     2005  
     Average
Balance
   Interest
Income
or
Expense
   Average
Yield or
Cost
    Average
Balance
   Interest
Income
or
Expense
   Average
Yield or
Cost
 
     (Dollars in thousands)  

ASSETS:

                

Interest-earning assets:

                

Gross loans, net of unearned fees (1)(2)(3)

   $ 2,003,053    $ 81,165    8.17 %   $ 1,662,796    $ 59,080    7.17 %

Investment securities (1)

                

Taxable

     72,536      1,494    4.15 %     89,578      1,373    3.09 %

Tax-exempt

     74,244      1,966    5.34 %     41,937      1,083    5.21 %

Equity securities (4)

     29,439      860    5.89 %     13,086      369    5.69 %

Other earning assets

     6,358      191    6.06 %     27,238      506    3.75 %
                                        

Total interest-earning assets

     2,185,630      85,676    7.90 %     1,834,635      62,411    6.86 %

Non-earning assets:

                

Cash and due from banks

     77,257           54,520      

Other assets

     621,854           514,091      
                        

Total assets

   $ 2,884,741         $ 2,403,246      
                        

LIABILITIES AND STOCKHOLDERS’ EQUITY:

                

Interest-bearing liabilities:

                

Deposits:

                

Interest-bearing demand

   $ 174,386    $ 345    0.40 %   $ 116,553    $ 197    0.34 %

Money market

     612,612      9,619    3.17 %     522,544      3,692    1.42 %

Savings

     97,438      362    0.75 %     81,860      286    0.70 %

Time certificates of deposit

     590,513      11,354    3.88 %     437,401      4,218    1.94 %
                                        

Total interest-bearing deposits

     1,474,949      21,680    2.96 %     1,158,358      8,393    1.46 %

Borrowings:

                

Repurchase agreements

     24,897      522    4.23 %     29,861      360    2.43 %

Federal funds purchased

     787      18    4.68 %     5,275      84    3.21 %

Subordinated debentures

     41,247      1,748    8.55 %     41,845      1,170    5.64 %

Borrowings

     100,899      2,413    4.82 %     75,763      1,206    3.21 %
                                        

Total interest-bearing liabilities

     1,642,779      26,381    3.24 %     1,311,102      11,213    1.72 %

Noninterest bearing liabilities:

                

Demand deposits

     529,433           479,144      

Other liabilities

     110,702           94,827      
                        

Total liabilities

     2,282,914           1,885,073      

Stockholders’ equity

     601,827           518,173      
                        

Total liabilities and stockholders’ equity

   $ 2,884,741         $ 2,403,246      
                        

Net interest income

      $ 59,295         $ 51,198   
                        

Net interest margin

         5.47 %         5.63 %
                        

 

(1) Yields on loans and securities have not been adjusted to a tax-equivalent basis.

 

(2) The calculation of average gross loans includes nonaccrual loans.

 

(3) Net loan fees of $3.9 million and $4.0 million for the six months ended June 30, 2006 and 2005, respectively, are included in the yield computation.

 

(4) Includes Bankers Bank of the West stock, Federal Agricultural Mortgage Corporation (Farmer Mac) stock, Federal Reserve Bank stock and Federal Home Loan Bank stock.

Our second quarter 2006 average yield on interest-earning assets increased by 1.0% to 8.1% from the second quarter of the prior year, while our average cost of interest-bearing liabilities increased by 1.4% to 3.4%. For the six months ended June 30, 2006, our average yield increased by 1.0% and interest costs increased by 1.5% from the prior year. The changes between the 2006 and 2005 periods have been impacted by the rising interest rate environment and the integration of the First MainStreet and Foothills Bank loan portfolios that were acquired in the fourth quarter of 2005.

 

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Table of Contents

The following table presents the dollar amount of changes in interest income and interest expense for the major categories of our interest-earning assets and interest-bearing liabilities. Information is provided for each category of interest-earning assets and interest-bearing liabilities with respect to (i) changes attributable to changes in volume (i.e., changes in average balances multiplied by the prior-period average rate) and (ii) changes attributable to rate (i.e., changes in average rate multiplied by prior-period average balances). For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately to the change due to volume and the change due to rate.

 

     Six Months Ended June 30, 2006 Compared to
Six Months Ended June 30, 2005
 
     Net Change     Rate     Volume  
     (In thousands)  

Interest income:

      

Loans held for investment

   $ 22,083     $ 8,986     $ 13,097  

Investment securities

      

Taxable

     98       241       (143 )

Tax-exempt

     884       29       855  

Equity securities

     538       70       468  

Other earning assets

     (338 )     841       (1,179 )
                        

Total interest income

     23,265       10,167       13,098  
                        

Interest expense:

      

Deposits:

      

Interest-bearing demand

     148       38       110  

Money market

     5,927       5,194       733  

Savings

     76       19       57  

Time certificates of deposit

     7,136       5,277       1,859  

Repurchase agreements

     162       209       (47 )

Federal funds purchased

     (65 )     70       (135 )

Subordinated debentures

     578       594       (16 )

Borrowings

     1,206       726       480  
                        

Total interest expense

     15,168       12,127       3,041  
                        

Net interest income

   $ 8,097     $ (1,960 )   $ 10,057  
                        

Provision for Credit Losses

The provision for credit losses represents a charge against earnings. The provision is the amount required to maintain the allowance for loan losses and the reserve for unfunded commitments at a level that, in our judgment, is adequate to absorb losses inherent in the loan portfolio. In periods when an existing allowance or reserve is determined to exceed the amount required, the allowance or reserve is reduced, which decreases the charge to earnings through the provision for loan losses. When an existing allowance or reserve is deemed to be understated, an additional provision is recorded, resulting in an additional charge to earnings through the provision for credit losses.

During the 2005 first quarter, we recorded a provision for loan loss of $1.7 million. During the same period of 2006, no provision was recorded. The provision taken in 2005 was primarily due to the deterioration of a commercial loan, requiring a provision of $0.9 million. In addition, in 2005 we recorded an additional provision of $0.4 million for conditions affecting our residential real estate portfolio. We did not record a charge to earnings for the second quarter of 2006 or 2005 for either our allowance for loan loss or reserve for unfunded commitments.

 

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Table of Contents

Noninterest Income

The following table presents the major categories of noninterest income:

 

     Quarter Ended  
     June 30,
2006
   March 31,
2006
    December 31,
2005
    September 30,
2005
   June 30,
2005
 
     (In thousands)  

Customer service and other fees

   $ 2,993    $ 2,632     $ 2,524     $ 2,035    $ 1,993  

Gain (loss) on sale of securities

     —        (5 )     (16 )     —        (14 )

Gain (loss) on sale of loans

     230      314       256       433      257  

Gain (loss) on sale of assets

     179      (91 )     (195 )     260      95  

Other

     203      262       97       4      8  
                                      

Total noninterest income

   $ 3,605    $ 3,112     $ 2,666     $ 2,732    $ 2,339  
                                      

Our quarterly noninterest income increased each quarter in 2006 from the quarter ended December 31, 2005 noninterest income. Customer service and other fees increased due to new deposit products and corresponding service charges implemented in early 2006. Other noninterest income increased primarily as the result of the $0.2 million sale of our CBW merchant credit card servicing rights during the first quarter 2006. Our increase in noninterest income for the second quarter 2006 over the second quarter 2005 was impacted by the fourth quarter 2005 acquisitions of First MainStreet and Foothills Bank.

Noninterest Expense

The following table presents, for the periods indicated, the major categories of noninterest expense:

 

     Quarter Ended
     June 30,
2006
   March 31,
2006
   December 31,
2005
   September 30,
2005
   June 30,
2005
     (In thousands)

Salaries and employee benefits

   $ 12,082    $ 11,435    $ 11,202    $ 9,828    $ 10,088

Occupancy expense

     1,994      2,052      1,947      1,651      1,660

Furniture and equipment

     1,231      1,165      1,188      924      881

Amortization of intangible assets

     2,999      2,998      3,232      2,968      3,095

Merger, acquisition and transition expenses

     1,539      88      1,995      752      2,762

Other general and administrative

     5,159      4,002      5,492      4,604      2,731
                                  

Total noninterest expense

   $ 25,004    $ 21,740    $ 25,056    $ 20,727    $ 21,217
                                  

Our second quarter 2006 noninterest expense increased from the first quarter 2006 and the second quarter 2005 by $3.3 million and $3.8 million, respectively. These increases in noninterest expenses were in part caused by a transition expense of $1.4 million due to contractual severance obligations incurred by the Company pursuant to its management transition announced in May 2006, salary and benefit expense increasing by $0.6 million, $0.4 million of which was associated with the hiring of new employees, and professional services increasing by $0.8 million, which included fees relating to the implementation of Sarbanes-Oxley Act Section 404 requirements. Our increase in noninterest expense for the second quarter 2006 over the second quarter 2005 was impacted by the fourth quarter 2005 acquisitions of First MainStreet and Foothills Bank.

Financial Condition

The following sets forth certain key consolidated balance sheet data:

 

     June 30,
2006
   March 31,
2006
   December 31,
2005
   September 30,
2005
   June 30,
2005
     (In thousands)

Net loans (including loans held for sale)

   $ 1,906,513    $ 1,983,882    $ 2,046,938    $ 1,744,529    $ 1,698,708

Total assets

     2,850,281      2,916,510      2,980,757      2,540,169      2,461,842

Total deposits

     1,998,054      2,077,076      2,048,352      1,721,609      1,589,180

 

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Table of Contents

Loans

The following table sets forth the amount of our loans outstanding at the dates indicated:

 

     June 30,
2006
    March 31,
2006
    December 31,
2005
    September 30,
2005
    June 30,
2005
 
     (In thousands)  

Real estate - mortgage

   $ 919,181     $ 946,202     $ 934,044     $ 583,795     $ 785,938  

Real estate - construction

     214,254       221,368       251,648       451,137       341,885  

Commercial

     664,202       702,556       724,929       587,762       449,028  

Agricultural

     52,897       57,054       71,707       65,466       64,485  

Consumer

     54,955       56,986       63,121       50,776       54,421  

Leases receivable and other

     26,470       25,714       27,004       26,341       23,608  
                                        

Total gross loans

     1,931,959       2,009,880       2,072,453       1,765,277       1,719,365  

Less: allowance for loan losses

     (25,297 )     (26,999 )     (27,475 )     (25,019 )     (25,535 )

Unearned discount

     (4,737 )     (4,729 )     (4,860 )     (1,744 )     (1,152 )
                                        

Net Loans

   $ 1,901,925     $ 1,978,152     $ 2,040,118     $ 1,738,514     $ 1,692,678  
                                        

Loans held for sale

   $ 4,588     $ 5,730     $ 6,820     $ 6,015     $ 6,030  
                                        

Our June 30, 2006 loan portfolio declined by $138.2 million from its December 31, 2005 balance, led by a $59.7 million decrease in our commercial loans and $52.3 million decrease in our real estate loans. The commercial loan portfolio decreased due to scheduled paydowns. In addition to the paydowns, our efforts to improve the credit quality of our commercial loan portfolio have limited commercial loan growth. The decline in the real estate portfolio was primarily due to an increased pace of loan repayments. However, a $40.0 million loan in the second quarter was structured as a municipal investment security, which is carried on the balance sheet as a security available for sale.

Nonperforming Assets

Credit risk related to nonperforming assets arises as a result of lending activities. To manage this risk, we employ frequent monitoring procedures and take prompt corrective action when necessary. We employ a risk rating system that identifies the overall potential amount of risk associated with each loan in our loan portfolio. This monitoring and rating system is designed to help management determine current and potential problems so that corrective actions can be taken promptly.

Generally, loans are placed on nonaccrual status when they become 90 days or more past due or at such earlier time as management determines timely recognition of interest to be in doubt. Accrual of interest is discontinued on a loan when we believe, after considering economic and business conditions and analysis of the borrower’s financial condition, that the collection of interest is doubtful.

 

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Table of Contents

The following table summarizes the loans for which the accrual of interest has been discontinued, loans with payments more than 90 days past due and still accruing interest, loans that have been restructured, and other real estate owned. For reporting purposes, other real estate owned (“OREO”) consists of all real estate, other than bank premises, actually owned or controlled by us, including real estate acquired through foreclosure.

 

     At or for the Quarter Ended  
     June 30,
2006
    March 31,
2006
    December 31,
2005
    September 30,
2005
    June 30,
2005
 
     (In thousands)  

Nonaccrual loans and leases, not restructured

   $ 30,684     $ 28,746     $ 29,608     $ 8,352     $ 9,975  

Accruing loans past due 90 days or more

     84       1       131       1,806       280  

Other real estate owned

     1,041       1,267       1,465       2,532       4,438  
                                        

Total nonperforming assets

   $ 31,809     $ 30,014     $ 31,204     $ 12,690     $ 14,693  
                                        

Nonperforming loans

   $ 30,768     $ 28,747     $ 29,739     $ 23,383     $ 10,255  

Other impaired loans

     16,166       11,841       20,551       4,374       22,422  
                                        

Total impaired loans

   $ 46,934     $ 40,588     $ 50,290     $ 27,757     $ 32,677  

Allocated allowance for loan losses

     (5,685 )     (9,296 )     (10,360 )     (10,445 )     (17,556 )
                                        

Net investment in impaired loans

   $ 41,249     $ 31,292     $ 39,930     $ 17,312     $ 15,121  
                                        

Charged-off loans

   $ (2,012 )   $ (1,091 )   $ (3,060 )   $ (592 )   $ (1,206 )

Recoveries

     593       615       679       76       180  
                                        

Net charge-off loans

   $ (1,419 )   $ (476 )   $ (2,381 )   $ (516 )   $ (1,026 )
                                        

Allowance for loan losses to loans, net of deferred fees and costs

     1.31 %     1.35 %     1.33 %     1.43 %     1.50 %

Allowance for credit losses to loans, net of deferred fees and costs

     1.36 %     1.38 %     1.36 %     1.43 %     1.50 %

Allowance for loan losses to nonaccrual loans

     82.44 %     93.92 %     92.80 %     299.56 %     255.99 %

Allowance for credit losses to nonaccrual loans

     85.71 %     96.42 %     95.22 %     299.56 %     255.99 %

Allowance for loan losses to nonperforming assets

     79.53 %     89.95 %     88.05 %     197.16 %     173.79 %

Allowance for credit losses to nonperforming assets

     82.68 %     92.35 %     90.35 %     197.16 %     173.79 %

Allowance for loan losses to impaired loans

     53.90 %     66.52 %     54.63 %     90.14 %     78.14 %

Nonperforming assets to loans, net of deferred fees, and other real estate owned

     1.65 %     1.50 %     1.51 %     0.73 %     0.86 %

Annualized net charge-offs to average loans

     (0.29 )%     (0.09 )%     (0.53 )%     (0.12 )%     (0.25 )%

Nonaccrual loans to loans, net of deferred fees and costs

     1.59 %     1.43 %     1.43 %     0.48 %     0.59 %

Nonperforming assets of $31.8 million at June 30, 2006 reflected increases of $1.8 million from March 31, 2006 and $0.6 million from December 31, 2005. Our loan portfolio continues to contain a few large loan relationships with credit quality issues, resulting in an increase in our June 30, 2006 nonaccrual balance. At June 30, 2006 and March 31, 2006, seven lending relationships at each date accounted for 57.6% and 65.1%, respectively, of the total nonperforming assets. In response to our increased level of nonperforming assets, we have further intensified our loan review process and have made several loan policy modifications. In addition, in early 2006, we appointed a chief credit officer to manage the credit processes at our subsidiary banks.

Allowance for Credit Losses

The allowance for loan losses and provision for unfunded commitments is maintained at a level that, in our judgment, is adequate to absorb probable loan losses in the loan portfolio. The amount of the allowance and reserve is based on management’s evaluation of the collectibility of the loan portfolio, historical loss experience, and other significant factors affecting loan portfolio collectibility, including the level and trends in delinquent, nonaccrual and adversely classified loans, trends in volume and terms of loans, levels and trends in credit concentrations, effects of changes in underwriting standards, policies, procedures and practices, national and local economic trends and conditions, changes in capabilities and experience of lending management and staff, and other external factors including industry conditions, competition and regulatory requirements.

 

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Table of Contents

Our methodology for evaluating the adequacy of the allowance for loan losses has two basic elements: first, the identification of impaired loans and the measurement of an estimated loss for each individual loan identified; and second, estimating an allowance for probable losses on other loans. The specific allowance for impaired loans and the remaining allowance are combined to determine the required allowance for loan losses. The amount calculated is compared to the actual allowance for loan losses and adjustments are recorded through the provision for loan losses.

 

     Six Months Ended

Allowance for Loan Losses

   June 30,
2006
    June 30,
2005
     (In thousands)

Balance, beginning of period

   $ 27,475     $ 25,022

Loan charge-offs:

    

Real estate - mortgage

     1,118       881

Real estate - construction

     1,033       20

Commercial

     684       526

Agricultural

     24       32

Consumer

     234       227

Lease receivable and other

     10       23
              

Total loan charge-offs:

     3,103       1,709
              

Recoveries:

    

Real estate - mortgage

     109       87

Real estate - construction

     41       84

Commercial

     909       190

Agricultural

     27       11

Consumer

     122       107

Lease receivable and other

     —         43
              

Total loan recoveries

     1,208       522
              

Net loan charge-offs

     1,895       1,187

Provision for loan losses

     (283 )     1,700
              

Balance, end of period

   $ 25,297     $ 25,535
              

The allowance for loan losses of $25.3 million at June 30, 2006 represented 1.3% of loans, net of unearned discount and 82.4% of nonaccrual loans as of that date. At December 31, 2005, the allowance for loan losses was 1.3% of the loans, net of unearned discount and 92.8% of nonaccrual loans. Nonperforming loans with high collateral value to loan value require a relatively smaller reserve than uncollateralized loans or loans with minimal collateral coverage. At June 30, 2006, our nonperforming loans continued to have estimated collateral values in relation to loan values that allow for an allowance to nonperforming loan ratio of less than 100%.

Investment Securities

We manage our investment portfolio principally to provide liquidity and balance our overall interest rate risk. To a lesser extent, we manage our investment portfolio to provide earnings with a view to minimizing credit risk.

 

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Table of Contents

The carrying value of our portfolio of investment securities at June 30, 2006 and December 31, 2005 was as follows:

 

     June 30,
2006
   December 31,
2005
   Increase
Decrease
    %
Change
 
     (In thousands)  

Securities available for sale:

          

U.S. Treasury securities

   $ 6,999    $ 13,076    $ (6,077 )   (46.5 )%

U.S. Government agencies

     5,346      5,367      (21 )   (0.4 )%

Obligations of states and political subdivisions

     114,181      72,893      41,288     56.6 %

Mortgage backed securities

     42,182      50,043      (7,891 )   (15.7 )%

Marketable equity securities

     1,725      1,702      23     1.4 %
                            

Total securities available for sale

   $ 170,433    $ 143,081    $ 27,352     19.1 %
                            

Securities held to maturity:

          
                            

Mortgage-backed

   $ 7,012    $ 5,798    $ 1,214     20.9 %
                            

The carrying value of our investment securities at June 30, 2006 was $170.4 million, compared to December 31, 2005 of $143.1 million. The most significant change in our investment portfolio was the addition of a $40.0 million municipal security. The decrease in U.S. Treasury securities was the result of the maturity of several U.S. Treasury securities, with the decrease in mortgage-backed securities caused by paydowns.

Deposits

At June 30, 2006, deposits were $2.0 billion, which reflects a decrease of $50.3 million from December 31, 2005. Our deposit strategy is to replace high cost deposits with lower cost core deposits, and in particular with demand deposit accounts. The percentage of time deposits to total deposits decreased 2.7 points, while the percentage of noninterest-bearing deposits and interest-bearing demand deposits decreased from 36.8% of total deposits to 34.5%, or 2.3 points.

 

     At June 30, 2006     At December 31, 2005  
     Balance    % of
Total
    Balance    % of
Total
 
     (Dollars in thousands)  

Noninterest-bearing deposits

   $ 528,943    26.47 %   $ 593,811    28.99 %

Interest-bearing demand

     161,005    8.06 %     160,283    7.82 %

Money market

     649,681    32.52 %     561,747    27.42 %

Savings

     94,480    4.73 %     99,496    4.86 %

Time

     563,945    28.22 %     633,015    30.91 %
                          
   $ 1,998,054    100.00 %   $ 2,048,352    100.00 %
                          

Borrowings and Subordinated Debentures

At June 30, 2006, our outstanding borrowings were $76.4 million. These borrowings consisted of $49.9 million and $14.7 million on a line of credit and term notes at the Federal Home Loan Bank, respectively, $11.0 million on a U.S. Bank revolving credit agreement, and a $0.8 million Treasury Tax and Loan balance.

Our maximum credit allowance for total borrowings at the Federal Home Loan Bank as of June 30, 2006 was $388.7 million. The interest rate on the line of credit varies with the federal funds rate. The term notes have fixed

 

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interest rates that range from 2.52% to 6.22%. We have a blanket pledge and security agreement with the Federal Home Loan Bank, which encompasses certain loans and securities as collateral for these borrowings.

We have a $70 million revolving credit agreement, as amended, with U.S. Bank National Association that contains financial covenants, including maintaining a minimum return on average assets, a maximum nonperforming assets to total loans ratio and regulatory capital ratios that permit the Company to qualify as well-capitalized. The interest rate on this revolving credit agreement, which varies based on a spread over the federal funds rate, was 6.6% at June 30, 2006. We were in compliance with all debt covenants at quarter end. This agreement is secured by Guaranty Bank stock. U.S. Bank performs various banking services for the Company for which they receive usual and customary fees in addition to providing us with this credit facility.

At June 30, 2006, we had a $41,239,000 aggregate principal balance of subordinated debentures outstanding with a weighted average cost of 8.9%. The subordinated debentures were issued in four separate series. Each issuance has a maturity of thirty years from its date of issue. The subordinated debentures were issued to trusts established by us, which in turn issued $40 million of trust preferred securities. Generally and with certain limitations, the Company is permitted to call the debentures subsequent to the first five or ten years, as applicable, after issue if certain conditions are met, or at any time upon the occurrence and continuation of certain changes in either the tax treatment or the capital treatment of the trusts, the debentures or the preferred securities.

Capital Resources

Current risk-based regulatory capital standards generally require banks and bank holding companies to maintain a ratio of “core” or “Tier 1” capital (consisting principally of common equity) to risk-weighted assets of at least 4%, a ratio of Tier 1 capital to average total assets (leverage ratio) of at least 4% and a ratio of total capital (which includes Tier 1 capital plus certain forms of subordinated debt, a portion of the allowance for loan losses and preferred stock) to risk-weighted assets of at least 8%. Risk-weighted assets are calculated by multiplying the balance in each category of assets by a risk factor, which ranges from zero for cash assets and certain government obligations to 100% for high-risk loans, and adding the products together.

At June 30, 2006, the Company had a total risk-weighted capital ratio of 10.64%, a Tier 1 risk-weighted capital ratio of 9.41% and a leverage ratio of 8.56%. The Company actively monitors its regulatory capital ratios to ensure that the Company and its bank subsidiaries are well capitalized under the applicable regulatory framework.

Contractual Obligations and Off-Balance Sheet Arrangements

The Company is a party to credit-related financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, stand-by letters of credit and commercial letters of credit. Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets.

The Company’s exposure to credit loss is represented by the contractual amount of these commitments. The Company follows the same credit policies in making commitments as it does for on-balance sheet instruments.

At June 30, 2006, the following financial instruments were outstanding whose contract amounts represented credit risk:

 

     June 30, 2006
     (In thousands)

Contractual Obligations

  

Commitments to extend credit

   $ 594,321

Standby letters of credit

     36,263

Commercial letters of credit

     318
      

Totals

   $ 630,902
      

 

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Liquidity

Based on our existing business plan, we believe that our level of liquid assets is sufficient to meet our current and presently anticipated funding needs.

We rely on dividends from our Banks as a primary source of liquidity for the holding company. We plan to continue to utilize the available dividends from the Banks for holding company operations, subject to regulatory and other restrictions. In general, the Banks are able to dividend earnings to the holding company, subject to the Banks maintaining a well-capitalized ratio. We require liquidity for the payment of interest on the subordinated debentures, for operating expenses, principally salaries and benefits, for repurchases of our common stock, and, if declared by our board of directors, for the payment of dividends to our stockholders.

The Banks rely on deposits as their principal source of funds and, therefore, must be in a position to service depositors’ needs as they arise. Historically, our deposits tend to be cyclical, decreasing at the beginning of the year and ramping up during the balance of the year. In addition, while fluctuations in the balances of a few large depositors may cause temporary increases and decreases in liquidity from time to time, we have not experienced difficulty in dealing with such fluctuations from existing liquidity sources.

We believe that if the level of liquid assets (our primary liquidity) does not meet our liquidity needs, other available sources of liquid assets (our secondary liquidity), including the purchase of federal funds, sales of securities under agreements to repurchase, sales of loans, discount window borrowings from the Federal Reserve Bank and our lines of credit with the Federal Home Loan Bank of Topeka and U.S. Bank could be employed to meet those current and presently anticipated funding needs.

Application of Critical Accounting Policies and Accounting Estimates

Our accounting policies are integral to understanding the financial results reported. Our most complex accounting policies require management’s judgment to ascertain the valuation of assets, liabilities, commitments and contingencies. We have established detailed policies and control procedures that are intended to ensure valuation methods are well controlled and consistently applied from period to period. In addition, the policies and procedures are intended to ensure that the process for changing methodologies occurs in an appropriate manner. The following is a brief description of our current accounting policies that we believe are critical and involve significant management judgment.

Allowance for Loan Losses — The loan portfolio is the largest category of assets on our balance sheet. We determine probable losses inherent in our loan portfolio and establish an allowance for those losses by considering factors including historical loss rates, expected cash flows and estimated collateral values. In assessing these factors, we use organizational history and experience with credit decisions and related outcomes. The allowance for loan losses represents our best estimate of losses inherent in the existing loan portfolio. The allowance for loan losses is increased by the provision for loan losses charged to expense and reduced by loans charged off, net of recoveries. We evaluate our allowance for loan losses quarterly. If our underlying assumptions later prove to be inaccurate based on subsequent loss evaluations, the allowance for loan losses is adjusted.

We estimate the appropriate level of allowance for loan losses by separately evaluating impaired and nonimpaired loans. A specific allowance is assigned to an impaired loan when expected cash flows or collateral do not justify the carrying amount of the loan. The methodology used to assign an allowance to a nonimpaired loan is much more subjective. Generally, the allowance assigned to nonimpaired loans is determined by applying historical loss rates to existing loans with similar risk characteristics and by exercising judgment to assess the impact of factors such as changes in economic conditions, changes in credit policies or underwriting standards, and changes in the level of credit risk associated with specific industries and markets. Because the economic and business climate in any given industry or market, and its impact on any given borrower, can change rapidly, the risk profile of the loan portfolio is continually assessed and adjusted when appropriate. Notwithstanding these procedures, there still exists the possibility that our assessment could prove to be significantly incorrect and that an immediate adjustment to the allowance for loan losses would be required.

We estimate the appropriate level of loan loss allowance by conducting a detailed review of a significant number of much smaller portfolio segments that comprise the consumer and commercial loan portfolios. We segment the loan portfolio into as many components as practical. Each component would normally have similar characteristics, such as risk classification, past due status, type of loan, industry or collateral. The risk profile of

 

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certain segments of the loan portfolio may be improving, while the risk profile of others may be deteriorating. As a result, changes in the appropriate level of the allowance for different segments may offset one another. Adjustments to the allowance represent the impact from the analysis of all loan segments.

Investment in Debt and Equity Securities — We classify our investments in debt and equity securities as either held-to-maturity or available-for-sale in accordance with Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities. Securities classified as held-to-maturity are recorded at cost or amortized cost. Available-for-sale securities are carried at fair value. Fair value calculations are based on quoted market prices when such prices are available. If quoted market prices are not available, estimates of fair value are computed using a variety of techniques, including extrapolation from the quoted prices of similar instruments or recent trades for thinly traded securities, fundamental analysis, or through obtaining purchase quotes. Due to the subjective nature of the valuation process, it is possible that the actual fair values of these investments could differ from the estimated amounts, thereby affecting our financial position and results of operations. If the estimated value of investments is less than the cost or amortized cost, we evaluate whether an event or change in circumstances has occurred that may have a significant adverse effect on the fair value of the investment. If such an event or change has occurred and we determine that the impairment is other-than-temporary, we expense the impairment of the investment in the period in which the event or change occurred.

Impairment of Goodwill — Goodwill represents the excess of the purchase price over the fair value of net assets acquired. Goodwill is evaluated for impairment annually, unless there are factors present that may be indicative of a potential impairment, in which case, a goodwill impairment test is performed more frequently than annually. The first step in testing for impairment is to determine the fair value of each reporting unit. If the carrying amount of any reporting unit exceeds its fair value, an impairment to goodwill is recorded. The evaluation of goodwill involves estimations of discount rates, the timing of projected future cash flows, and utilization of market based valuation techniques. The assumptions used in the evaluation of goodwill are subject to change with changes in economic conditions and other factors. Changes in assumptions used to evaluate this intangible asset affect its value and could have a material adverse impact on our results of operations.

This discussion has highlighted those accounting policies that we consider to be critical to our financial reporting process. However, all the accounting policies are important, and therefore you are encouraged to review each of the policies included in Note 1 to our consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2005 to gain a better understanding of how our financial performance is measured and reported.

 

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ITEM 3. Quantitative and Qualitative Disclosure about Market Risk

Market risk is the risk of loss in a financial instrument arising from adverse changes in market prices and rates, foreign currency exchange rates, commodity prices and equity prices. Our market risk arises primarily from interest rate risk inherent in our lending and deposit taking activities. To that end, management actively monitors and manages our interest rate risk exposure. We do not have any market risk sensitive instruments entered into for trading purposes. We manage our interest rate sensitivity by matching the re-pricing opportunities on our earning assets to those on our funding liabilities. We use various asset/liability strategies to manage the re-pricing characteristics of our assets and liabilities designed to ensure that exposure to interest rate fluctuations is limited within our guidelines of acceptable levels of risk-taking. Hedging strategies, including the terms and pricing of loans and deposits and managing the deployment of our securities, are used to reduce mismatches in interest rate re-pricing opportunities of portfolio assets and their funding sources.

Our Asset Liability Management Committee, or ALCO, addresses interest rate risk. The committee is comprised of members of our senior management. The ALCO monitors interest rate risk by analyzing the potential impact on the net portfolio of equity value and net interest income from potential changes in interest rates, and considers the impact of alternative strategies or changes in balance sheet structure. The ALCO manages our balance sheet in part to maintain the potential impact on net portfolio value and net interest income within acceptable ranges despite changes in interest rates.

Our exposure to interest rate risk is reviewed on at least a quarterly basis by the ALCO and our board of directors. Interest rate risk exposure is measured using interest rate sensitivity analysis to determine our change in net portfolio value and net interest income in the event of hypothetical changes in interest rates. If potential changes to net portfolio value and net interest income resulting from hypothetical interest rate changes are not within board-approved limits, the board may direct management to adjust the asset and liability mix to bring interest rate risk within board-approved limits.

We monitor and evaluate our interest rate risk position on a quarterly basis using traditional gap analysis, earnings at risk analysis and economic value at risk analysis under 100 and 200 basis point change scenarios. Each of these analyses measures different interest rate risk factors inherent in the balance sheet. Traditional gap analysis, although not a complete view of these risks, provides a fair representation of our current interest rate risk exposure.

Gap Analysis — A traditional measure of a financial institution’s interest rate risk is the static gap analysis. Traditional gap analysis calculates the dollar amount of mismatches between assets and liabilities, at certain time periods, whose interest rates are subject to repricing at their contractual maturity date or repricing period. A static gap is the difference between the amount of assets and liabilities that are expected to mature or re-price within a specific period. Generally, a positive gap benefits an institution during periods of rising interest rates, and a negative gap benefits an institution during periods of declining interest rates.

 

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At June 30, 2006, we had a negative gap of 4.6% of our total assets, which represents the $130.5 million deficiency of interest-earning assets under interest-bearing liabilities that would reprice within one year. Our cumulative gap indicates that we have $486.9 million of assets in excess of liabilities that are subject to repricing. The following table sets forth information concerning repricing opportunities for our interest-earning assets and interest-bearing liabilities as of June 30, 2006. The amount of assets and liabilities shown within a particular period were determined in accordance with their contractual maturities, except that adjustable rate products are included in the period in which they are first scheduled to adjust and not in the period in which they mature. Such assets and liabilities are classified by the earlier of their maturity or repricing date:

 

     Less Than 3
Months
    3 Months to
1 Year
    1 to 5
Years
    Over 5
Years
    Nonrate
Sensitive
    Total
     (Dollars in thousands)

Interest-bearing cash and cash equivalents

   $ 4,661     $ —       $ —       $ —       $ —       $ 4,661

Investment securities

     31,293       15,694       28,323       102,135       30,265       207,710

Loans, gross

     1,102,759       235,149       450,589       113,620       29,693       1,931,810

All other assets

     35,501       9,761       23,510       6,790       630,538       706,100
                                              

Totals

   $ 1,174,214     $ 260,604     $ 502,422     $ 222,545     $ 690,496     $ 2,850,281
                                              

Deposits

   $ 1,093,032     $ 312,244     $ 63,835     $ —       $ 528,943     $ 1,998,054

Assets under repurchase agreements and federal funds purchases

     30,371       —         —         —         —         30,371

Borrowings

     65,412       10,964       —         —         —         76,376

Subordinated debentures

     —         —         —         41,239       —         41,239

All other liabilities

     45,916       7,365       2,520       —         52,476       108,277

Stockholders’ equity

     —         —         —         —         595,964       595,964
                                              

Totals

   $ 1,234,731     $ 330,573     $ 66,355     $ 41,239     $ 1,177,383     $ 2,850,281
                                              

Period gap (assets minus liabilities)

   $ (60,517 )   $ (69,969 )   $ 436,067     $ 181,306     $ (486,887 )  

Cumulative gap

   $ (60,517 )   $ (130,486 )   $ 305,581     $ 486,887      

Cumulative rate sensitive gap %

     (2.1 )%     (4.6 )%     10.7 %     17.1 %    

 

ITEM 4. Controls and Procedures

As of the end of the period covered by this report, an evaluation was carried out by the Company’s management, with the participation of the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 15d-15(e) under the Securities Exchange Act of 1934). The Company’s disclosure controls were designed to provide a reasonable assurance that information required to be disclosed in reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission. It should be noted that the design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote. However, the controls have been designed to provide reasonable assurance of achieving the controls’ stated goals. Based on that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer, have concluded that the Company’s disclosure controls and procedures are effective at June 30, 2006 to ensure that information required to be disclosed in the reports that we file or submit under the Securities Exchange Act of 1934 was (i) accumulated and communicated to management, including the Company’s Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure and (ii) recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission.

There have been no changes in the Company’s internal control over financial reporting (as defined in Rule 15d-15(f) under the Securities Exchange Act of 1934) during our most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

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PART II—OTHER INFORMATION

 

ITEM 1. Legal Proceedings

On December 31, 2004, an adversary proceeding was filed against Guaranty Bank in the United States Bankruptcy Court for the District of Colorado, by the trustees of the Will Hoover Company, or the Hoover Company, and William Gordon Hoover, Jr., or Hoover, seeking to avoid certain transfers that occurred over a four-year period commencing in 1999 under the United States Bankruptcy Code. The trustees allege that certain transfers were made by the Hoover Company and Hoover with actual fraudulent intent, that the transfers were made for less than reasonably equivalent value and occurred at a time when the Hoover Company and Hoover were insolvent, or were rendered insolvent by the transfers, and that certain other transfers were preferential as to other creditors, were made for less than reasonably equivalent value or were made by the Hoover Company or Hoover with actual fraudulent intent. On September 7, 2005, the Bankruptcy Court granted in part our motion for summary judgment and dismissed $8.5 million of the claims relating to alleged transfers for payment of items credited in the check collection process. On November 10, 2005, the trustees filed a motion in District Court requesting reconsideration of the Bankruptcy Court’s order dismissing those claims. On November 21, 2005, the District Court summarily denied the trustees’ motion. We continue to vigorously contest the remaining claims, which amount to approximately $2.8 million, approximately $2.5 million of which relate to overdraft-related claims and approximately $0.3 million of which relate to preferential transfer claims. We have established a reserve that, after consultation with our counsel, we have determined is appropriate for this litigation.

On July 22, 2005 and August 18, 2005, two separate but similar actions were filed against Guaranty Bank and a former officer in the Denver District Court, Denver, Colorado by investors who provided funds to Hoover, the Hoover Company or related entities. The investors allege that certain activities of Guaranty Bank and its former officer with respect to the customer relationship with Hoover, the Hoover Company and related entities aided and abetted Hoover and the Hoover Company in securities violations and violations of the Colorado Organized Crime Control Act and amounted to a civil conspiracy, causing the investors to incur damages. The investors are seeking actual and statutory treble damages against Guaranty Bank and its former officer. The alleged actual losses claimed in connection with such activities are in excess of $13.1 million. In a series of preliminary rulings in April 2006, the District Court dismissed a number of the claims representing alleged damages in excess of $1.0 million. We will continue to vigorously defend these actions.

At this time, we cannot determine whether the outcome of the above matters will have a material adverse impact on our consolidated financial position or results of operations. To the extent that these suits are not settled or dismissed, the Company will incur ongoing legal costs, to the extent such legal costs will not be covered by insurance, that could have an adverse impact on our results of operations.

In the ordinary course of our business, we are party to various other legal actions, which we believe are incidental to the operation of our business. Although the ultimate outcome and amount of liability, if any, with respect to these other legal actions to which we are currently a party cannot presently be ascertained with certainty, in the opinion of management, based upon information currently available to us, any resulting liability is not likely to have a material adverse effect on the Company’s consolidated financial position, results of operations or cash flows.

 

ITEM 1A. Risk Factors

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2005, which could materially affect our business, financial condition and/or operating results. The risks described in our Annual Report on Form 10-K are not the only risks facing the Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially affect our business, financial condition and/or operating results.

 

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ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds

(a) None.

(b) None.

(c) The following table provides information with respect to purchases made by or on behalf of the Company or any “affiliated purchaser” (as defined in Rule 10b-18(a)(3) under the Securities Exchange Act of 1934), of our common stock during the 2006 second quarter.

 

Period

   Total Number
of Shares
Purchased(1)
   Average Price
Paid Per Share
   Total Number of
Shares Purchased
as Part of
Publicly
Announced
Plans(2)
   Maximum Number
of Shares that May
Yet Be Purchased
Under the Plans at
the End of the
Period

April 1 to April 30, 2006

   425,000    $ 11.20    425,000    2,286,400

May 1 to May 31, 2006

   820,000      10.68    820,000    1,466,400

June 1 to June 30, 2006

   N/A      N/A    N/A    N/A

Total

   1,245,000    $ 10.87    1,245,000    1,466,400

 

(1) No shares were purchased other than as part of a publicly announced plan.

 

(2) On March 2, 2006, we announced a stock repurchase program to repurchase up to 3,000,000 shares of our common stock from time to time over a one-year period in the open market or through private transactions. Shares purchased through June 30, 2006 under this plan were 1,533,600.

 

ITEM 3. Defaults Upon Senior Securities

None.

 

ITEM 4. Submission of Matters to a Vote of Security Holders

 

  (a) The Company held its annual meeting of stockholders on May 16, 2006.

 

  (b) The following directors were elected at the annual meeting to serve until the next annual meeting of stockholders and thereafter until their successors are duly elected and qualified:

David C. Boyles

G. Hank Brown

Edward B. Cordes

John M. Eggemeyer, III

William R. Farr

Stephen D. Joyce

Richard G. McClintock

Daniel M. Quinn

Stephen B. Shraiberg

Matthew P. Wagner

Albert C. Yates

 

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  (c) At the annual meeting, stockholders voted on the election of the Company’s directors. All nominees for director were elected. The results of the voting were as follows:

 

Matter

   For   

Against/

Withheld

   Abstentions    Broker
Non-votes

Election of Directors:

           

David C. Boyles

   42,271,942    212,066    —      —  

G. Hank Brown

   42,174,392    309,816    —      —  

Edward B. Cordes

   40,161,097    2,323,111    —      —  

John M. Eggemeyer, III

   42,248,159    236,049    —      —  

William R. Farr

   42,135,789    348,419    —      —  

Stephen D. Joyce

   42,306,274    177,934    —      —  

Richard G. McClintock

   42,174,392    309,816    —      —  

Daniel M. Quinn

   41,992,545    491,663    —      —  

Stephen B. Shraiberg

   41,253,739    230,469    —      —  

Matthew P. Wagner

   42,135,789    348,419    —      —  

Albert C. Yates

   42,323,145    161,063    —      —  

 

ITEM 5. Other Information

None.

 

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ITEM 6. Exhibits

 

Exhibit

Number

  

Description

  3.1    Amended and Restated Certification of Incorporation of the Registrant (incorporated by reference to Exhibit 3.1 to Registrant’s Form S-1 Registration Statement (No. 333-124855)).
  3.2    Amended and Restated Bylaws of the Registrant (incorporated by reference to Exhibit 3.2 to Registrant’s Form S-1 Registration Statement (No. 333-124855)).
10.1    Employment Agreement, dated May 16, 2006, between Daniel M. Quinn and the Registrant (incorporated by reference to Exhibit 10.1 to Registrant’s Form 8-K filed on May 17, 2006).
10.2    Transition Agreement, dated May 16, 2006, between David C. Boyles and the Registrant (incorporated by reference to Exhibit 10.2 to Registrant’s Form 8-K filed on May 17, 2006).
10.3    Transition Agreement, dated May 16, 2006, between John W. Perkins and the Registrant (incorporated by reference to Exhibit 10.3 to Registrant’s Form 8-K filed on May 17, 2006).
10.4    Transition Agreement, dated May 16, 2006, between Daryll D. Southwick and the Registrant (incorporated by reference to Exhibit 10.4 to Registrant’s Form 8-K filed on May 17, 2006).
31.1    Section 302 Certification of Chief Executive Officer.
31.2    Section 302 Certification of Chief Financial Officer.
32.1    Section 906 Certification of Chief Executive Officer.
32.2    Section 906 Certification of Chief Financial Officer.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

Date: August 11, 2006     CENTENNIAL BANK HOLDINGS, INC.
      /s/    PAUL W. TAYLOR        
    Paul W. Taylor
    Executive Vice President and Chief Financial Officer

 

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