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| TAYC > SEC Filings for TAYC > Form 10-K on 11-Mar-2009 | All Recent SEC Filings |
11-Mar-2009
Annual Report
Introduction
We are a bank holding company headquartered in Rosemont, Illinois, a suburb of Chicago. We derive substantially all of our revenue from our wholly-owned subsidiary, Cole Taylor Bank. We provide a range of banking services to our customers, with a primary focus on serving closely-held businesses in the Chicago metropolitan area and the people who own and manage those businesses.
The following discussion and analysis presents our consolidated financial condition at December 31, 2008 and 2007 and the results of operations for the years ended December 31, 2008, 2007 and 2006. This discussion should be read together with the "Selected Consolidated Financial Data," our audited consolidated financial statements and the notes thereto and other financial data contained elsewhere in this annual report. In addition to the historical information provided below, we have made certain estimates and forward-looking statements that involve risks and uncertainties. Our actual results could differ significantly from those anticipated in these estimates and forward-looking statements as a result of certain factors, including those discussed in the section captioned "Risk Factors" and elsewhere in this Annual Report on Form 10-K.
2008 Overview
Results of Operations
We reported a net loss applicable to common shareholders for the year ended December 31, 2008 of $143.4 million, or ($13.72) per common share, compared with a net loss of $9.6 million, or ($0.89) per common share, for the year ended December 31, 2007. The largest component of the net loss in 2008 was a $144.2 million provision for loan losses, compared with a provision of $31.9 million in 2007. The net loss in 2008 was also impacted by the establishment of a $46.4 million, or $4.44 per common share, valuation reserve against our deferred tax assets and preferred stock dividends of $18.8 million in 2008. The net loss in 2007 included a non-cash, after-tax charge of $23.2 million, or $2.14 per share, for the write-off of our goodwill.
Our total assets increased $832.4 million, or 23.4%, during 2008 to $4.39 billion at December 31, 2008, compared to $3.56 billion at December 31, 2007. Total loans increased $699.9 million, or 27.6%, to $3.2 billion at December 31, 2008, with the increase attributable to primarily commercial and industrial loans (C&I loans). C&I loans increased $635.5 million, or 74.7% during 2008, as we hired over 50 new commercial bankers and embarked on a significant growth strategy. Our new commercial bankers established 180 new commercial banking relationships and originated more than $750 million in new commercial loans.
Our senior management team changed beginning with the hiring of a new President in February 2008. During 2008, we recruited a new Chief Credit Officer, Chief Lending Officer, Chief Operating Officer and Chief Financial Officer. We also hired an Executive Vice President to lead an expanded asset-based lending capability. We launched our asset-based lending initiative, which operates under the name Cole Taylor Business Capital, and opened offices in Kansas City, Milwaukee, Houston and Baltimore to support these operations. All of our new executives' previous experience was with a substantially larger banking organization and included many years of experience in the Chicago banking market.
Series A Preferred Stock Issuance
On September 29, 2008, we completed a private placement of $60 million of 8% non-cumulative convertible perpetual preferred stock, Series A, to certain institutional and individual accredited investors. The preferred stock private placement included a total of 2.4 million shares of 8% non-cumulative convertible perpetual preferred stock, Series A, with a purchase price and liquidation preference of $25.00 per share. The preferred stock pays non-cumulative dividends at an annual rate of 8% of the liquidation preference beginning in January 2009. Each share of the preferred stock can be converted into 2.5 shares of our common stock at a
conversion price of $10.00 per common share. The preferred stock is convertible into an aggregate of 6.0 million shares of our common stock at the option of the preferred stockholders at any time, and will be convertible at our option on or after September 29, 2013. The preferred stock will cease to pay dividends after September 29, 2010, if the volume weighted average price of our common stock on the Nasdaq Global Select Market exceeds 200% of the then applicable conversion price ($20.00) for at least 20 trading days in any consecutive 30-day period, or after September 29, 2011, if the volume weighted average price of our common stock on the Nasdaq Global Select Market exceeds 130% ($13.00) of the then-applicable conversion price for at least 20 trading days in any consecutive 30-day period.
Issuance of Subordinated Bank Notes and Common Stock Warrants
Simultaneously with the issuance of the Series A preferred stock, we closed a sale of $60 million in principal amount of 10% subordinated notes issued by our Bank which included detachable warrants to purchase shares of our Company's common stock. The subordinated notes issued by the Bank bear interest at an annual rate of 10% and mature on September 29, 2016, but may be prepaid at the Bank's option after September 29, 2011. For every $1,000 in principal amount of the subordinated notes, investors in this transaction also received a warrant to purchase 15 shares of our common stock at an exercise price of $10.00 per share, which represents an aggregate of 900,000 shares of common stock. The warrants are not exercisable until March 29, 2009 and expire on September 29, 2013.
In connection with the private placement of Series A preferred stock, we also issued to Financial Investments Corporation ("FIC") warrants to purchase up to 500,000 shares of our common stock at an exercise price of $20.00 per share. The FIC warrants are not transferable or assignable after their initial issuance, and are exercisable anytime up to the September 29, 2018 expiration date.
Participation in U.S. Treasury Department's TARP Capital Purchase Program
On November 21, 2008, we received $104.8 million from the U.S. Treasury Department in exchange for the issuance of 104,823 shares of our Series B preferred stock and warrants to purchase 1,462,647 shares of our common stock as part of the federal government's TARP Capital Purchase Program. The Series B preferred shares pay a dividend of 5% per year for the first five years and reset to 9% per year thereafter. The Series B preferred shares are callable at par after three years and can be redeemed prior to then at 100% of the issue price, subject to the approval of our federal regulator. The warrants have a term of ten years and an exercise price of $10.75 per share.
Counterparty Borrowing Lines
During 2008, our pre-approved borrowing lines for federal funds purchased and repurchase agreements declined. Our approved overnight federal funds borrowing lines have declined to $95 million at December 31, 2008 from $260 million at December 31, 2007. Our pre-approved repurchase agreement lines have declined to $390 million at December 31, 2008 from $610 million at December 31, 2007. In response, we have increased our pledge of qualifying commercial loan collateral under the Federal Reserve Bank's Borrower-in-Custody Program, which increased our borrowing capacity to $640 million at December 31, 2008 from $307 million at December 31, 2007. Subsequent to year end, the Bank has increased its pre-approved borrowing lines for federal funds purchased by $35 million. The Bank has further increased its ability to purchase federal funds by cultivating relationships with a growing group of correspondent banking customers who may sell Federal Funds to the Bank in order to manage their excess liquidity.
In addition, an independent debt rating agency, Fitch Ratings, downgraded its ratings of the holding company and the Bank during 2008. Fitch reduced the long and short-term debt and deposit ratings from investment grade to non-investment grade and revised their ratings outlook to negative from stable. We have also experienced a decline in our ratings from entities such as IDC, LACE, and Bankrate.com. The Bank has not
experienced any difficulty acquiring deposits at market rates. However, these ratings declines could negatively impact our acquisition or retention of deposits in the future.
2007 Overview
We reported a net loss for the year ended December 31, 2007 of $9.6 million, or ($0.89) per share, compared with net income of $46.2 million, or $4.15 per diluted common share, for the year ended December 31, 2006. The net loss in 2007 included a non-cash, after-tax charge of $23.2 million, or $2.14 per share, for the write-off of our goodwill. In addition, the provision for loan losses was $31.9 million in 2007, compared with a provision of $6.0 million in 2006. Net income in 2006 included $15.5 million, or $1.39 per share, of tax benefits associated with the resolution of particular tax uncertainties. These tax benefits were recognized in the second half of 2006 because of the expiration of the statute of limitations on our 2002 income tax return and the completion of certain taxing authority examinations. Total assets at December 31, 2007 were $3.56 billion, compared to $3.38 billion at December 31, 2006, an increase of $176.8 million, or 5.2%.
Application of Critical Accounting Policies
Our accounting and reporting policies conform to accounting principles generally accepted in the United States of America and general reporting practices within the financial services industry. Our accounting policies are described in the section of this annual report captioned "Notes to Consolidated Financial Statements-Summary of Significant Accounting and Reporting Policies."
The preparation of financial statements in conformity with these accounting principles requires management to make estimates, assumptions and judgments that affect the amounts reported in the consolidated financial statements and accompanying notes. These estimates, assumptions and judgments are based on information available to us as of the date of the consolidated financial statements and, accordingly, as this information changes, actual results could differ from the estimates, assumptions and judgments reflected in the financial statements. The estimates, assumptions and judgments made by us are based upon historical experience or other factors that we believe to be reasonable under the circumstances. Certain accounting policies inherently have greater reliance on the use of estimates, assumptions and judgments and as such, have a greater possibility of producing results that could be materially different than originally reported. We consider our policies for the allowance for loan losses, the valuation of deferred tax assets and establishment of tax liabilities and the valuation of financial instruments such as investment securities and derivatives to be critical accounting policies. In 2008, we revised which of our accounting policies we consider critical. We added as a critical accounting policy the valuation of investment securities, specifically our policy regarding other than temporary impairment. In addition, our policy regarding goodwill impairment was no longer critical as all of our goodwill was written off at the end of 2007.
The following accounting policies materially affect our reported earnings and financial condition and require significant estimates, assumptions and judgments.
Allowance for Loan Losses
We have established an allowance for loan losses to provide for loans in our portfolio that may not be repaid in their entirety. The allowance is based on our regular, quarterly assessments of the probable estimated losses inherent in our loan portfolio. Our methodology for measuring the appropriate level of the allowance relies on several key elements, which include a general allowance computed by applying loss factors to categories of loans outstanding in the portfolio, specific allowances for identified problem loans and portfolio segments, and an unallocated allowance. We maintain our allowance for loan losses at a level considered adequate to absorb probable losses inherent in our portfolio as of the balance sheet date. In evaluating the adequacy of our allowance for loan losses, we consider numerous quantitative factors, including historical charge-off experience, growth of our loan portfolio, changes in the composition of our loan portfolio and the volume of delinquent and criticized
loans. In addition, we use information about specific borrower situations, including their financial position, work-out plans and estimated collateral values under various liquidation scenarios to estimate the risk and amount of loss on loans to those borrowers. Finally, we also consider many qualitative factors, including general and economic business conditions, duration of the current business cycle, the impact of competition on our underwriting terms, current general market collateral valuations, trends apparent in any of the factors we take into account and other matters, which are by nature more subjective and fluid. Our estimates of risk of loss and amount of loss on any loan are complicated by the uncertainties surrounding not only our borrowers' probability of default, but also the fair value of the underlying collateral. The current illiquidity in the real estate market has increased the uncertainty with respect to real estate values. Because of the degree of uncertainty and the sensitivity of valuations to the underlying assumptions regarding holding period until sale and the collateral liquidation method, our actual losses may materially vary from our current estimates.
As a business bank, our loan portfolio is comprised primarily of commercial loans to businesses. These loans are inherently larger in amount than loans to individual consumers and, therefore, have higher potential losses on an individual loan basis. The individually larger commercial loans can cause greater volatility in our reported credit quality performance measures, such as total impaired or nonperforming loans. Our current credit risk rating and loss estimate with respect to a single sizable loan can have a material impact on our reported impaired loans and related loss estimates. Because our loan portfolio contains a significant number of commercial loans with relatively large balances, the deterioration of any one or a few of these loans can cause a significant increase in uncollectible loans and, therefore, our allowance for loan losses. We review our estimates on a quarterly basis and, as we identify changes in estimates, our allowance for loan losses is adjusted through the recording of a provision for loan losses.
Income Taxes
We have maintained significant net deferred tax assets for deductible temporary differences, the largest of which relates to the allowance for loan losses. For income tax return purposes, only net charge-offs are deductible, not the provision for loan losses. Under generally accepted accounting principles, a valuation allowance is required to be recognized if it is "more likely than not" that the deferred tax asset will not be realized. The determination of the realizability of the deferred tax assets is highly subjective and dependent upon judgment concerning management's evaluation of both positive and negative evidence, the forecasts of future income, applicable tax planning strategies, and assessments of the current and future economic and business conditions. We consider both positive and negative evidence regarding the ultimate realizability of our deferred tax assets. Positive evidence includes the existence of taxes paid in available carry-back years as well as the probability that taxable income will be generated in future periods, while negative evidence includes a cumulative loss in the current year and prior two years and general business and economic trends. At December 31, 2008, we recorded a valuation allowance relating to our deferred tax asset. This determination was based, largely, on the negative evidence of a cumulative loss in the most recent three year period caused primarily by the significant loan loss provisions made during 2008. In addition, general uncertainty surrounding the future economic and business conditions have increased the likelihood of volatility in our future earnings. We believe, based on our internal earnings projections, that we will generate future taxable income that will result in the realization of this deferred tax asset. However, this positive evidence was not sufficient to overcome the negative evidence of our recent cumulative loss.
At times, we apply different tax treatment for selected transactions for tax return purposes than for income tax financial reporting purposes. The different positions result from the varying application of statutes, rules, regulations, and interpretations, and our accruals for income taxes include reserves for these differences in position. Our estimate of the value of these reserves contains assumptions based upon our past experience and judgments about potential actions by taxing authorities, and we believe that the level of these reserves is reasonable. We initially recognize the financial statement effects of a tax position when it is more likely than not, based on the technical merits, that the position will be sustained upon examinations. Subsequently, the reserves are then utilized or reversed when we determine the more likely than not threshold is no longer met, once the
statute of limitations has expired, or the tax matter is effectively settled. However, because reserve balances are estimates that are subject to uncertainties, the ultimate resolution of these matters may be greater or less than the amounts we have accrued.
Derivative Financial Instruments
We use derivative financial instruments (derivatives), including interest rate exchange and floor and collar agreements, to accommodate individual customer needs and to assist in our interest rate risk management. In accordance with Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"), all derivatives are measured and reported at fair value on our consolidated balance sheet as either an asset or a liability. For derivatives that are designated and qualify as a fair value hedge, the gain or loss on the derivative, as well as the offsetting loss or gain on the hedged item attributable to the effective portion of the hedged risk, are recognized in current earnings during the period of the change in the fair values. For derivatives that are designated and qualify as a cash flow hedge, the effective portion of the gain or loss on the derivative is reported as a component of other comprehensive income and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. For all hedging relationships, derivative gains and losses that are not effective in hedging the changes in fair value or expected cash flows of the hedged item are recognized immediately in current earnings during the period of the change in fair value. Similarly, the changes in the fair value of derivatives that do not qualify for hedge accounting under SFAS 133 or are not designated as an accounting hedge are also reported currently in earnings.
At the inception of a hedge and quarterly thereafter, a formal assessment is performed to determine whether changes in the fair values or cash flows of the derivatives have been highly effective in offsetting the changes in the fair values or cash flows of the hedged item and whether they are expected to be highly effective in the future. If it is determined that derivatives are not highly effective as a hedge, hedge accounting is discontinued for the period. Once hedge accounting is terminated, all changes in fair value of the derivatives flow through the consolidated statements of operations in other noninterest income, which results in greater volatility in our earnings.
The estimates of fair values of our derivatives are calculated using independent valuation models to estimate market-based valuations. The valuations are determined using widely accepted valuation techniques, including discounted cash flow analysis of the expected cash flow of each derivative. This analysis reflects the contractual terms of the derivative and uses observable market-based inputs, including interest rate curves and implied volatilities. In addition, the fair value estimate also incorporates a credit valuation adjustment to reflect the risk of nonperformance by both us and our counterparties in the fair value measurement. The resulting fair values produced by these proprietary valuation models are in part theoretical and, therefore, can vary between derivative dealers and are not necessarily reflective of the actual price at which the derivative contract could be traded. Small changes in assumptions can result in significant changes in valuation. The risks inherent in the determination of the fair value of a derivative may result in volatility in our statement of operations.
Valuation of Investment Securities
Each quarter we review our investment securities portfolio to determine whether unrealized losses are temporary or other than temporary, based on an evaluation of the creditworthiness of the issuers/guarantors, as well as the underlying collateral, if applicable. Our analysis includes an evaluation of the type of security, the length of time and extent to which the fair value has been less than the security's carrying value, the characteristics of the underlying collateral, the degree of credit support provided by subordinate tranches within the total issuance, independent credit ratings and discounted cash flow analysis. We utilize various independent pricing sources to obtain fair values and perform discounted cash flow analysis for selected securities. When the discounted cash flow analysis we obtain from those independent pricing sources indicates that it is probable that all future principal and interest payments would be received in accordance with their original contractual terms and we have both the intent and ability to hold the investment security until maturity, the unrealized loss is
deemed temporary. Our assessments of creditworthiness and the resultant expected cash flows are complicated by the significant uncertainties surrounding not only the specific security and its underlying collateral but also the severity of the current overall economic downturn. Our cash flow estimates for mortgage-backed securities are based on estimates of mortgage default rates and future housing prices, which are difficult to predict. Changes in assumptions can result in material changes in expected cash flows. Therefore, unrealized losses that we have determined to be temporary may at a later date be determined to be other than temporary and have a material impact on our statement of operations.
Results of Operations as of and for the Years Ended December 31, 2008, 2007, and 2006
Net Interest Income
Net interest income is the difference between total interest income and fees generated by interest-earning assets and total interest expense paid on interest-bearing liabilities. Net interest income is our principal source of earnings. The amount of net interest income is affected by changes in the volume and mix of interest-earning assets and interest-bearing liabilities, and the level of rates earned or paid on those assets and liabilities.
Year Ended December 31, 2008 as Compared to Year Ended December 31, 2007. Net interest income was $92.4 million for the year ended December 31, 2008, as compared to $104.7 million for 2007, a decrease of $12.4 million, or 11.8%. With an adjustment for tax-exempt income, our consolidated net interest income was $95.6 million, $12.6 million, or 11.6%, less than tax equivalent net interest income of $108.2 million during 2007. These non-GAAP tax-equivalent measures are discussed more fully below.
Our tax-equivalent net interest margin was 2.55% during 2008, 78 basis points lower than the net interest margin of 3.33% during 2007. The decline in the net interest margin resulted from the decline in earning asset yields outpacing the decline in our interest-bearing funding cost. The yield on our interest-earning assets decreased 155 basis points to 5.54% in 2008 from 7.09% during 2007, primarily as a result of the decline in short term market interest rates driving down the yield on variable rate loans. The percentage of fixed rate loans declined to 31% of the portfolio at December 31, 2008, as compared to 43% at December 31, 2007. This change in the mix of our loans also contributed to the decline in our net interest margin. This decline in loan yield was offset by an increase in loan volume and an increase in both volume and rate on the investment portfolio. Over the same time period, the cost of our interest-bearing liabilities decreased 101 basis points to 3.61% during 2008 from 4.62% during 2007.
Average interest-earning assets increased $495.8 million, or 15.2%, to $3.75 billion during 2008, compared to $3.25 billion during 2007. Average loans were $2.79 billion in 2008, an increase of $283.3 million, or 11.3%, as compared to average loans of $2.51 billion in 2007. Average investment securities increased $184.2 million, or 25.9%, to $895.4 million during 2008, as compared to average investment securities of $711.2 million during 2007.
Average interest-bearing liabilities increased $457.5 million, or 17.3%, to $3.11 billion during 2008, compared to $2.65 billion during 2007. Average total deposits increased $352.0 million, or 13.7%, in 2008 to $2.92 billion from $2.57 billion. See "Deposits" below for further discussion of the changes in our deposit balances during 2008. In addition, increases in average borrowings of $49.2 million and FHLB advances of $57.9 million supported interest-earning asset growth in 2008.
Year Ended December 31, 2007 as Compared to Year Ended December 31, 2006. Net interest income was $104.7 million for the year ended December 31, 2007, as compared to $111.2 million for 2006, a decrease of $6.5 million, or 5.8%. With an adjustment for tax-exempt income, our consolidated net interest income was $108.2 million, $6.3 million, or 5.5%, less than tax equivalent net interest income of $114.5 million during 2006. These non-GAAP tax-equivalent measures are discussed more fully below. The decrease in net interest income was a result of a decline in our net interest margin.
Our tax-equivalent net interest margin was 3.33% during 2007, 27 basis points lower than the net interest margin of 3.60% during 2006. The decline in the net interest margin resulted from our funding cost outpacing the increase in our total earning asset yield. While investment yields during 2007 benefited from increases in term market interest rates that occurred during 2007, competitive pricing pressure for loans and the impact of higher nonaccrual loans resulted in a decline in the yield on total loans. Our funding costs increased as a result of changes in funding mix and the repricing of term deposits to higher interest rates.
Our tax-equivalent net interest spread, which is determined by subtracting the yield on interest-earning assets from the cost of interest-bearing liabilities, declined 36 basis points during 2007 to 2.47%, compared to 2.83% in 2006. During . . .
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