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| TAYC > SEC Filings for TAYC > Form 10-Q on 8-Aug-2012 | All Recent SEC Filings |
8-Aug-2012
Quarterly Report
The following discussion and analysis focuses on the significant factors affecting our financial condition and results of operations and should be read in conjunction with our consolidated financial statements and notes thereto appearing elsewhere in this Quarterly Report on Form 10-Q, as well as the consolidated financial statements and notes thereto for the year ended December 31, 2011, included in our 2011 Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 9, 2012. Operating results for the six months ended June 30, 2012 are not necessarily indicative of the results for the year ending December 31, 2012, or any other future period. 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 below under the caption "Cautionary Note Regarding Forward-Looking Statements".
Introduction
We are a $4.8 billion bank holding company of Cole Taylor Bank (the "Bank"), a commercial bank headquartered in Chicago. Cole Taylor specializes in the banking needs of closely held businesses and the people who own and manage them. The Bank provides asset based lending, residential mortgage loan, commercial equipment financing and depository services products through a growing network of offices throughout the United States.
Application of Critical Accounting Policies
Our accounting and reporting policies conform to United States of America generally accepted accounting principles ("GAAP") and general reporting practices within the financial services industry. Our accounting policies are described in the section captioned "Notes to Consolidated Financial Statements - Summary of Significant Accounting and Reporting Policies" in our 2011 Annual Report on Form 10-K.
The preparation of financial statements in conformity with GAAP 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 on historical experience, current information and 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 actual results. We consider our policies for the allowance for loan losses, income taxes, derivatives and the valuation of investment securities to be critical accounting policies.
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 and specific allowances for identified problem loans and portfolio categories. We maintain our allowance for loan losses at a level that we consider sufficient 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; changes in the size of our loan portfolio; changes in the composition of our loan portfolio and the volume of delinquent, criticized and impaired 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 Chicago area 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 periods until sale and the collateral liquidation method, our actual losses may materially vary from our current estimates.
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 the potential for higher losses for each loan. These larger 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 for any one loan may 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 an increase in uncollectible loans and 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 are subject to the income tax laws of the United States and the states and other jurisdictions in which we operate. The determination of income tax expense or benefit and the amounts of current and deferred income tax assets and liabilities involve the use of estimates, assumptions, interpretations, and judgment. Factors considered include interpretations of federal and state income tax laws, current financial accounting standards, the difference between tax and financial reporting bases of assets and liabilities (temporary differences), assessment of the likelihood that the reversal of deferred deductible temporary difference will yield tax benefits,
and estimates of reserves required for tax uncertainties. There can be no assurance that future events, such as court decisions or positions of federal and state taxing authorities, will not differ from management's current assessment, the impact of which could be significant to future results.
Deferred tax assets and liabilities are recorded for temporary differences between book and taxable income. Deferred tax assets and liabilities are measured using currently enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred taxes of a change in tax rates is recognized as an income tax benefit or income tax expense in the period that includes the enactment date.
The determination of the realizability of the net deferred tax assets is highly subjective and dependent upon judgment concerning management's evaluation of both positive and negative evidence, forecasts of future taxable income, applicable tax planning strategies, and assessments of current and future economic and business conditions. We currently do not maintain a valuation allowance against our net deferred tax assets because management has determined that it is more-likely-than-not that these net deferred tax assets will be realized.
Derivative Financial Instruments
We use derivative financial instruments ("derivatives"), including interest rate swaps and corridor agreements, interest rate swaptions, callable interest rate exchange agreements, as well as interest rate lock and forward loan sale commitments, to either accommodate individual customer needs or to assist in our interest rate risk management. All derivatives are measured and reported at fair value on our Consolidated Balance Sheets 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, is recognized in current earnings during the period of the change in the fair value. 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 OCI 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 or are not designated as an accounting hedge are also reported currently in earnings.
At the inception of a formally designated hedge and quarterly thereafter, an assessment is made to determine whether changes in the fair value or cash flows of the derivatives have been highly effective in offsetting the changes in the fair value 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 are reported currently in the Consolidated Statements of Operations in other noninterest income, which could result in greater volatility in our earnings.
The estimates of fair values of certain of our derivative instruments, such as interest rate swaps and corridors, are calculated by an independent pricing service which uses 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 earnings.
The fair value of forward loan sale commitments is based on quoted prices for similar assets in active markets that we have the ability to access. We use an internal valuation model to estimate the fair value of our interest rate lock commitments.
Valuation of Investment Securities
The fair value of our investment securities portfolio is determined in accordance with GAAP, which requires that we classify financial assets and liabilities measured at fair value into a three-level fair value hierarchy. The determination of fair value is highly subjective and requires management to rely on estimates, assumptions, and judgments that can affect amounts reported in our financial statements. We obtain the fair value of investment securities from an independent pricing service. We periodically review the pricing methodology for each significant class of assets used by this third party pricing service to assess the compliance with accounting standards for fair value measurement and classification in the fair value measurement hierarchy. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information, including credit spreads and current rating from credit rating agencies, and the bond's terms and conditions, among other things. While we use an independent pricing service to obtain the fair values of our investment portfolio, we employ certain control procedures to determine the reasonableness of the valuations. We validate the overall reasonableness of the fair values by comparing information obtained from our independent pricing service to other third party valuation sources for selected assets and review the valuations and any significant differences in valuations with members of management who have the relevant technical expertise to assess the results. In addition, we review the third party valuation methodology on a periodic basis.
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, changes in credit ratings and a cash flow analysis, considering default rates, loss severities based upon the location of the collateral, and estimated prepayments. Those securities with unrealized losses for more than 12 months and for more than 10% of their carrying value are subjected to further analysis to determine if we expect to receive all the contractual cash flows. We use other independent pricing sources to obtain fair value estimates and perform
discounted cash flow analysis for selected securities. When the discounted cash flow analysis obtained from those independent pricing sources indicates that we expect all future principal and interest payments will be received in accordance with their original contractual terms, we do not intend to sell the security, and we more likely than not will not be required to sell the security before recovery, the unrealized loss is deemed temporary. If such analysis shows that we do not expect to be able to recover our entire investment, an other-than-temporary impairment charge will be recorded in current earnings for the amount of the credit loss component. The amount of impairment related to factors other than the credit loss is recognized in OCI. Our assessments of creditworthiness and the resultant expected cash flows are complicated by the 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 related securities are based on estimates of mortgage default rates, severity of loss and prepayments. 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 Consolidated Statements of Operations.
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
Certain of the statements under "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and elsewhere in this Quarterly
Report on Form 10-Q constitute forward-looking statements. These forward-looking
statements within the meaning of Section 27A of the Securities Act and
Section 21E of the Securities Exchange Act reflect our current expectations and
projections about our future results, performance, prospects and opportunities.
We have tried to identify these forward-looking statements by using words
including "may," "might," "contemplate," "plan," "predict," "potential,"
"should," "will," "expect," "anticipate," "believe," "intend," "could" and
"estimate" and similar expressions. These forward-looking statements are based
on information currently available to us and are subject to a number of risks,
uncertainties and other factors that could cause our actual results,
performance, prospects or opportunities in 2012 and beyond to differ materially
from those expressed in, or implied by, these forward-looking statements.
These risks, uncertainties and other factors include, without limitation:
• Our business may be adversely affected by the highly regulated environment in which we operate.
• Competition from financial institutions and other financial services providers may adversely affect our growth and profitability.
• Our business is subject to the conditions of the local economy in which we operate and continued weakness in the local economy and the real estate markets may adversely affect us.
• Our business is subject to domestic and to a lesser extent, international economic conditions and other factors, many of which are beyond our control and could adversely affect our business.
• Our allowance for loan losses may prove to be insufficient to absorb losses in our loan portfolio.
• Our residential mortgage loan repurchase reserve for losses could be insufficient.
• We are subject to interest rate risk, including interest rate fluctuations that could reduce our profitability.
• Certain hedging strategies that we use to manage investment in mortgage servicing rights may be ineffective to offset any adverse changes in the fair value of these assets due to changes in interest rates and market liquidity.
• Our residential mortgage lending profitability could be significantly reduced if we are not able to originate and resell a high volume of mortgage loans.
• We have counterparty risk and, therefore, we may be adversely affected by the soundness of other financial institutions.
• We are subject to certain operational risks, including but not limited to, data processing system failures and errors and customer or employee fraud. The Company's controls and procedures may fail or be circumvented.
• We are dependent on outside third parties for processing and handling of Company records and data.
• System failure or breaches of our network security, including with respect to our internet banking activities, could subject us to increased operating costs as well as litigation and other liabilities.
• We are subject to lending concentration risks.
• We may not be able to access sufficient and cost-effective sources of liquidity.
• We are subject to liquidity risk, including unanticipated deposit volatility.
• The recent repeal of federal prohibitions on payment of interest on business demand deposits could increase our interest expense.
• Changes in our credit ratings could increase our financing costs or make it more difficult for us to obtain funding or capital on commercially acceptable terms.
• We are a bank holding company and our sources of funds are limited.
• Our reputation could be damaged by negative publicity.
• New lines of business or new products and services may subject us to certain additional risks.
• We may experience difficulties in managing our future growth.
• We, and our subsidiaries, are subject to changes in federal and state tax laws and changes in interpretation of existing laws.
• Regulatory requirements (including rules recently jointly proposed by the federal bank regulatory agencies to implement Basel III), growth plans or operating results may require us to raise additional capital, which may not be available on favorable terms or at all.
• We have not paid a dividend on our common stock since the second quarter of 2008. In addition, regulatory restrictions and liquidity constraints at the holding company level could impair our ability to make distributions on our outstanding securities.
For further information about these and other risks, uncertainties and factors, please review the disclosure included in the section captioned "Risk Factors" in our December 31, 2011 Annual Report on Form 10-K filed with the SEC on March 9, 2012. You should not place undue reliance on any forward-looking statements. We undertake no obligation to publicly update or revise any forward-looking statements or risk factors, whether as a result of new information, future events, changed circumstances or any other reason after the date of this filing.
RESULTS OF OPERATIONS
The profitability of our operations is in part dependent on our net interest income after provision for loan losses, which is the difference between interest earned on interest earning assets and interest paid on interest bearing liabilities less provision for loan losses. The provision for loan losses is dependent on changes in our loan portfolio and management's assessment of the collectability of our loan portfolio as well as prevailing economic and market conditions. Our net income is also affected by noninterest income and noninterest expenses. Noninterest income consists of deposit service fees, mortgage origination and servicing revenue, loan service fees, net gains on the sales of investment securities, customer swap fees, and other operating income. Noninterest expense typically includes salaries and employee benefits, occupancy and equipment expense, computer and telecommunication services expense, advertising and marketing expense, professional and legal expense, FDIC insurance premiums, nonperforming asset expense, early extinguishment of debt expense, and other operating expenses. Additionally, income taxes, dividends, and discount accretion on preferred shares reduce the amount of net income available to common stockholders.
Overview
Net income applicable to common stockholders was $12.5 million, or $0.41 per diluted common share for the second quarter of 2012, compared to a net loss applicable to common stockholders of $3.9 million, or $0.19 per diluted common share, in the second quarter of 2011. For the six months ended June 30, 2012, net income applicable to common stockholders was $20.2 million, or $0.66 per diluted common share outstanding, compared to a net loss applicable to common stockholders of $5.9 million, or $0.32 per diluted common share outstanding, for the six months ended June 30, 2011. This increase in income applicable to common stockholders for the six months ended June 30, 2012, was primarily the result of strong mortgage banking revenue and a decrease in credit costs, which includes the provision for loan losses and nonperforming asset expense.
Highlights
• Pre-tax, pre-provision operating earnings (a non-GAAP financial measure in which provision for loan losses, nonperforming asset expense and certain non-recurring items, such as gains and losses on investment securities, debt extinguishment expense and derivative termination fees, are excluded) increased 90.2% to $25.1 million for the quarter ended June 30, 2012, as compared to $13.2 million for the quarter ended June 30, 2011. During the six months ended June 30, 2012, pre-tax, pre-provision operating earnings increased by 81.9% to $49.1 million from $27.0 million as compared to the six months ended June 30, 2011.
• In the second quarter of 2012, total revenue (a non-GAAP financial measure calculated as net interest income plus noninterest income less gains and losses on investment securities and derivative termination fees) was $65.2 million, an increase from $39.0 million for the second quarter of 2011. For the six months ended June 30, 2012, total revenue was $124.2 million, an increase from $78.1 million for the same period in 2011.
• Noninterest income (including gains on sales of investment securities and impairment losses on investment securities) increased to $31.9 million for the second quarter of 2012 from $6.4 million in the second quarter of 2011, an increase of $25.5 million. For the six months ended June 30, 2012, noninterest income was $55.8 million, an increase of $42.5 million as compared to $13.3 million of noninterest income during the six months ended June 30, 2011.
• Noninterest expense increased to $44.0 million in the second quarter of 2012, as compared to $27.8 million during the second quarter of 2011. For the six months ended June 30, 2012, noninterest expense was $80.6 million, an increase of $24.2 million as compared to $56.4 million of noninterest expense during the six months ended June 30, 2011.
• Net interest margin on a tax equivalent basis was 3.23% for the second quarter of 2012, an increase of 14 basis points as compared to the second quarter of 2011. Net interest margin on a tax equivalent basis was 3.26% during the six months ended June 30, 2012 as compared to 3.08% during the six months ended June 30, 2011.
Our accounting and reporting policies conform to GAAP and general practice within the banking industry. Management uses certain non-GAAP financial measures to evaluate the Company's financial performance such as the non-GAAP measures of pre-tax, pre-provision operating earnings and of revenue. Management believes . . .
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