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MBFI > SEC Filings for MBFI > Form 10-Q on 30-Oct-2012All Recent SEC Filings

Show all filings for MB FINANCIAL INC /MD

Form 10-Q for MB FINANCIAL INC /MD


30-Oct-2012

Quarterly Report


Item 2. - Management's Discussion and Analysis of Financial Condition and Results of Operations

The following is a discussion and analysis of MB Financial, Inc.'s financial condition and results of operations and should be read in conjunction with the consolidated financial statements and notes thereto appearing elsewhere in this report. The words "the Company," "we," "our" and "us" refer to MB Financial, Inc. and its majority owned subsidiaries, unless we indicate otherwise.

Overview

The profitability of our operations depends primarily on our net interest income after provision for credit losses, which is the difference between interest earned on interest earning assets and interest paid on interest bearing liabilities less provision for credit losses. The provision for credit 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 other (non-interest) income and other expenses. During the periods under report, other income consisted of capital markets and international banking fees, commercial deposit and treasury management fees, net lease financing income, trust and asset management fees, card fees, loan service fees, retail and other deposit service fees, brokerage fees, net gain (loss) on investment securities, increase in cash surrender value of life insurance, net (loss) gain on sale of assets, accretion of the FDIC indemnification asset, net loss recognized on other real estate owned, net gain on sale of loans and other operating income. During the periods under report, other expenses included salaries and employee benefits, occupancy and equipment expense, computer services and telecommunication expense, advertising and marketing expense, professional and legal expense, other intangibles amortization expense, FDIC insurance premiums, branch impairment charges, other real estate expenses (net of rental income), prepayment fees on interest bearing liabilities and other operating expenses. Additionally, dividends and discount accretion on preferred shares reduced net income available to common stockholders through the first quarter of 2012.

Net interest income is affected by changes in the volume and mix of interest earning assets, interest earned on those assets, the volume and mix of interest bearing liabilities and interest paid on interest bearing liabilities. Other income and other expenses are impacted by growth of operations and changes in the number of loan and deposit accounts through both acquisitions and dispositions and core banking business growth. Growth in operations affects other expenses primarily as a result of additional employees, branch facilities and promotional marketing expense. Changes in the number of loan and deposit accounts affects other income, including service fees as well as other expenses such as computer services, supplies, postage, telecommunications and other miscellaneous expenses. Changes in the levels of non-performing assets affect salaries and benefits because of changes in problem loan remediation staffing needs. Changes in the levels of non-performing assets also affect legal expenses and other real estate owned expenses.

The Company had net income and net income available to common stockholders of $23.1 million for the third quarter of 2012 compared to net income of $19.7 million and net income available to common stockholders of $17.1 million for the third quarter of 2011. Our 2012 third quarter results generated an annualized return on average assets of 0.97% and an annualized return on average common equity of 7.38% compared to 0.80% and 5.86%, respectively, for the same period in 2011. Fully diluted earnings per common share for the third quarter of 2012 were $0.42 compared to $0.31 for the third quarter of 2011.

On March 14, 2012, we repurchased all $196.0 million of preferred stock issued in 2008 to the U.S. Department of Treasury as part of the Troubled Asset Relief Program ("TARP") Capital Purchase Program. No equity or long term debt was issued in conjunction with the repurchase. The repurchase resulted in a one-time, non-cash after-tax charge of approximately $1.2 million or $0.02 per common share in the first quarter of 2012, related to unaccreted discount recorded at the date of issuance.

The Company recorded $12.7 million in prepayment fees on interest bearing liabilities as a result of the prepayment of certain brokered certificates of deposits and an FHLB advance in efforts to lower our future funding costs and improve our funding mix. We also repaid $6.2 million of junior subordinated notes related to the FOBB Statutory Trust I with a 10.6% interest rate.


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Critical Accounting Policies

Our consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of America and follow general practices within the industries in which we operate. This preparation requires management to make estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions, and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, actual results could differ from the estimates, assumptions, and judgments reflected in the financial statements. Certain policies inherently have a 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. Management believes the following policies are both important to the portrayal of our financial condition and results of operations and require subjective or complex judgments; therefore, management considers the following to be critical accounting policies. Management has reviewed the application of these polices with the Audit Committee of our Board of Directors.

Allowance for Loan Losses. Subject to the use of estimates, assumptions, and judgments in management's evaluation process used to determine the adequacy of the allowance for loan losses, which combines several factors: management's ongoing review and grading of the loan portfolio, consideration of past loan loss experience, trends in past due and nonperforming loans, risk characteristics of the various classifications of loans, existing economic conditions, the fair value of underlying collateral, and other qualitative and quantitative factors which could affect probable credit losses. Because current economic conditions can change and future events are inherently difficult to predict, the anticipated amount of estimated loan losses, and therefore the adequacy of the allowance, could change significantly. As an integral part of their examination process, various regulatory agencies also review the allowance for loan losses. Such agencies may require that certain loan balances be charged off when their credit evaluations differ from those of management or require that adjustments be made to the allowance for loan losses, based on their judgments about information available to them at the time of their examination. We believe the allowance for loan losses is adequate and properly recorded in the financial statements. See "Allowance for Loan Losses" section below for further analysis.

Residual Value of Our Direct Finance, Leveraged, and Operating Leases. Lease residual value represents the present value of the estimated fair value of the leased equipment at the termination date of the lease. Realization of these residual values depends on many factors, including management's use of estimates, assumptions, and judgment to determine such values. Several other factors outside of management's control may reduce the residual values realized, including general market conditions at the time of expiration of the lease, whether there has been technological or economic obsolescence or unusual wear and tear on, or use of, the equipment and the cost of comparable equipment. If, upon the expiration of a lease, we sell the equipment and the amount realized is less than the recorded value of the residual interest in the equipment, we will recognize a loss reflecting the difference. On a quarterly basis, management reviews the lease residuals for potential impairment. If we fail to realize our aggregate recorded residual values, our financial condition and profitability could be adversely affected. At September 30, 2012, the aggregate residual value of the equipment leased under our direct finance, leveraged, and operating leases totaled $48.2 million. See Note 1 and Note 7 of the notes to our December 31, 2011 audited consolidated financial statements contained in our Annual Report Form 10-K for the year ended December 31, 2011 for additional information.

Income Tax Accounting. ASC Topic 740 provides guidance on accounting for income taxes by prescribing the minimum recognition threshold that a tax position must meet to be recognized in the financial statements. ASC Topic 740 also provides guidance on measurement, recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. As of September 30, 2012, the Company had $93 thousand of uncertain tax positions. The Company elects to treat interest and penalties recognized for the underpayment of income taxes as income tax expense. However, interest and penalties imposed by taxing authorities on issues specifically addressed in ASC Topic 740 will be taken out of the tax reserves up to the amount allocated to interest and penalties. The amount of interest and penalties exceeding the amount allocated in the tax reserves will be treated as income tax expense. As of September 30, 2012, the Company had $10 thousand of accrued interest related to tax reserves. The application of income tax law is inherently complex. Laws and regulations in this area are voluminous and are often ambiguous. As such, we are required to make many subjective assumptions and judgments regarding our income tax exposures. Interpretations of and guidance surrounding income tax laws and regulations change over time. As such, changes in our subjective assumptions and judgments can materially affect amounts recognized in the consolidated balance sheets and statements of operations.


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Fair Value of Assets and Liabilities. ASC Topic 820 defines fair value as the price that would be received to sell a financial asset or paid to transfer a financial liability in an orderly transaction between market participants at the measurement date.

The degree of management judgment involved in determining the fair value of assets and liabilities is dependent upon the availability of quoted market prices or observable market parameters. For financial instruments that trade actively and have quoted market prices or observable market parameters, there is minimal subjectivity involved in measuring fair value. When observable market prices and parameters are not fully available, management judgment is necessary to estimate fair value. In addition, changes in market conditions may reduce the availability of quoted prices or observable data. For example, reduced liquidity in the capital markets or changes in secondary market activities could result in observable market inputs becoming unavailable. Therefore, when market data is not available, the Company would use valuation techniques requiring more management judgment to estimate the appropriate fair value measurement.

Goodwill. The excess of the cost of an acquisition over the fair value of the net assets acquired consists of goodwill, and core deposit and client relationship intangibles. See Note 9 of the notes to our audited consolidated financial statements contained in our Annual Report Form 10-K for the year ended December 31, 2011 for additional information regarding core deposit and client relationship intangibles. The Company reviews goodwill and other intangible assets to determine potential impairment annually, or more frequently if events and circumstances indicate that the asset might be impaired, by comparing the carrying value of the asset with the anticipated future cash flows.

The Company's annual assessment date is December 31. No impairment losses were recognized during the nine months ended September 30, 2012 and 2011.

Goodwill is tested for impairment at the reporting unit level. All of our goodwill is allocated to MB Financial, Inc., which is the Company's only applicable reporting unit for purposes of testing goodwill impairment. Fair value was computed by estimating the future cash flows of the Company and present valuing those cash flows at an interest rate equal to our cost of capital. In addition, we compared our fair value calculation with our stock price adjusted for a control premium for reasonableness relative to our fair value calculation. Key assumptions used in estimating future cash flows included loan and deposit growth, the interest rate environment, credit spreads on new and renewed loans, future deposit pricing, loan charge-offs, provision for loan losses, fee income growth and operating expense growth. Our future cash flows estimates assumed similar credit performance to what we experienced in the last two quarters of 2011.

Results of Operations

Third Quarter Results

The Company had net income and net income available to common stockholders of $23.1 million for the third quarter of 2012 compared to net income of $19.7 million and a net income available to common stockholders of $17.1 million for the third quarter of 2011. The results for the third quarter of 2012 generated an annualized return on average assets of 0.97% and an annualized return on average common equity of 7.38% compared to 0.80% and 5.86%, respectively, for the same period in 2011.

Net interest income on a tax equivalent basis was $77.3 million for the three months ended September 30, 2012, a decrease of $6.4 million, or 7.6%, from $83.7 million for the comparable period in 2011. The decrease was primarily due to a decline in the level of interest earning assets of $138.5 million and a 23 basis point decline in the net interest margin on a fully tax equivalent basis. See "Net Interest Margin" section below for further analysis.

Gross recoveries of $14.7 million were recorded in the third quarter of 2012, prompting a negative provision for credit losses of $13.0 million. The provision for credit losses for the third quarter of 2011 was $11.5 million. See "Asset Quality" below for further analysis of the allowance for loan losses.

The Company also recorded prepayment fees on the early retirement of several interest bearing liabilities during the third quarter of 2012. See "Overview" above.


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Net income available to common stockholders was also impacted by the repurchase in the first quarter of 2012 of all $196 million of preferred stock issued in 2008 to the U.S. Department of Treasury as part of TARP. As a result, there were no dividends and discount accretion on preferred shares in the third quarter of 2012 compared to $2.6 million in the third quarter of 2011.

Other Income (in thousands):



                                            Three Months Ended
                                               September 30,          Increase/     Percentage
                                             2012          2011      (Decrease)       Change
Other income:
Capital markets and international
banking fees                              $     1,344    $    605    $       739           122 %
Commercial deposit and treasury
management fees                                 5,860       6,157           (297 )          (5 )%
Lease financing, net                            9,671       6,494          3,177            49 %
Trust and asset management fees                 4,428       4,272            156             4 %
Card fees                                       2,385       2,071            314            15 %
Loan service fees                               1,125       1,706           (581 )         (34 )%
Retail and other deposit service fees           3,792       4,123           (331 )          (8 )%
Brokerage fees                                  1,185       1,273            (88 )          (7 )%
Net gain on investment securities                 281           -            281            NM
Increase in cash surrender value of
life insurance                                    890       1,014           (124 )         (12 )%
Net loss on sale of assets                        (12 )         -            (12 )          NM
Accretion of FDIC indemnification
asset                                             204         985           (781 )         (79 )%
Net loss recognized on other real
estate owned                                   (3,938 )    (3,118 )         (820 )          26 %
Net gain on sale of loans                         575         190            385           203 %
Other operating income                            763         595            168            28 %
Total other income                        $    28,553    $ 26,367    $     2,186             8 %

NM - Not meaningful

Other income increased by $2.2 million for the third quarter of 2012 compared to the third quarter of 2011. Net lease financing income increased as a result of higher promotional and remarketing income as well as increased sales of equipment maintenance contracts. Capital markets and international banking fees increased due to an increase in interest rate swap fees. These increases were partly offset by the decreases in accretion of FDIC indemnification asset and loan service fees as well as an increase in the net loss recognized on other real estate. Accretion of FDIC indemnification asset decreased as accretion is recorded based on the FDIC indemnification asset balance, which has declined as we have received loss-share payments. Loan service fees decreased due to a decrease in prepayment and exit fees. Net loss recognized on other real estate owned increased due to updated appraisals with lower valuations on land and construction projects.


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Other Expenses (in thousands):



                                        Three Months Ended
                                           September 30,           Increase /      Percentage
                                        2012           2011        (Decrease)        Change

Other expense:
Salaries and employee benefits       $    42,083    $   38,422    $       3,661            10 %
Occupancy and equipment expense            8,274         9,092             (818 )          (9 )%
Computer services and
telecommunication expense                  3,777         3,488              289             8 %
Advertising and marketing expense          2,025         1,740              285            16 %
Professional and legal expense             1,554         1,647              (93 )          (6 )%
Other intangibles amortization
expense                                    1,251         1,414             (163 )         (12 )%
FDIC insurance premiums                    1,545         2,272             (727 )         (32 )%
Branch impairment charges                    758             -              758            NM
Other real estate expense, net               874         1,181             (307 )         (26 )%
Prepayment fees on interest
bearing liabilities                       12,682             -           12,682            NM
Other operating expenses                   6,342         7,352           (1,010 )         (14 )%
Total other expense                  $    81,165    $   66,608    $      14,557            22 %

NM - Not meaningful

Other expense increased by $14.6 million for the third quarter of 2012 compared to the third quarter of 2011. The Company recorded $12.7 million in prepayment fees on interest bearing liabilities as a result of the prepayment of certain brokered certificates of deposit and an FHLB advance in efforts to lower our future funding costs and improve our funding mix. Salaries and employee benefits expense increased due to annual salary increases and an increase in incentive compensation. An impairment charge of $758 thousand was recorded in third quarter of 2012 due to our decision to close a branch. Occupancy and equipment expense decreased due to decreases in real estate taxes and equipment maintenance costs. FDIC insurance premiums decreased due to a change in the assessment computation during the second quarter of 2012 and the impact of improved credit quality on the computation. Other real estate expense decreased as a result of decreased holding costs related to other real estate owned given we have fewer properties. The decrease in other operating expenses was primarily due to a decrease in the clawback liability related to our loss share agreements with the FDIC.

Income Taxes

The Company had income tax expense of $9.3 million for the three months ended September 30, 2012 compared to income tax expense of $9.0 million for the same period in 2011 due to the Company's primarily due to improvement in pre-tax income.

Year-To-Date Results

The Company had net income of $66.4 million and net income available to common stockholders of $63.1 million in the nine months ended September 30, 2012 compared to net income of $19.3 and net income available to common stockholders of $11.5 million in the nine months ended September 30, 2011. The results for the nine months ended September 30, 2012 generated an annualized return on average assets of 0.93% and an annualized return on average common equity of 6.87% compared to 0.26% and 1.32%, respectively, for the same period in 2011. The results for the nine months ended September 30, 2011 included a provision for credit losses of approximately $50 million in connection with the sale during the second quarter of 2011 of loans with an aggregate carrying amount of $281.6 million prior to the transfer to loans held for sale, including $156.3 million in non-performing loans. The remaining decrease in provision for credit losses was primarily due to the decrease in non-performing and potential problem loan inflows as well as more recoveries in 2012.

Net interest income on a tax equivalent basis was $238.3 million for the nine months ended September 30, 2012, a decrease of $15.4 million, or 6.1%, from $253.7 million for the comparable period in 2011. The decrease was primarily due to a decline in the level of interest earning assets of $300.1 million and an 11 basis point decline in the net interest margin on a fully tax equivalent basis. See "Net Interest Margin" section below for further analysis.


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The Company recorded a negative provision for credit losses of $9.9 million in the nine months ended September 30, 2012 compared to a provision for credit losses of $112.8 million in the nine months ended September 30, 2011. Net charge-offs were $1.1 million in the nine months ended September 30, 2012 compared to $163.1 million in the nine months ended September 30, 2011. Our provision for credit losses and net charge-offs for the nine months ended September 30, 2011 were impacted by the loan sale in the second quarter of 2011 noted earlier. See "Asset Quality" below for further analysis of the allowance for loan losses.

Net income available to common stockholders was also impacted by the repurchase in the first quarter of 2012 of all $196 million of preferred stock issued in 2008 to the U.S. Department of Treasury as part of the TARP. As a result, dividends and discount accretion on preferred shares decreased to $3.3 million in the nine months ended September 30, 2012 from $7.8 million in the nine months ended September 30, 2011.

Other Income (in thousands):



                                           Nine Months Ended
                                             September 30,          Increase/     Percentage
                                           2012          2011      (Decrease)       Change
Other income:
Capital markets and international
banking fees                            $     2,631    $  1,107    $     1,524           138 %
Commercial deposit and treasury
management fees                              17,545      17,643            (98 )          (1 )%
Lease financing, net                         23,963      19,138          4,825            25 %
Trust and asset management fees              13,367      13,158            209             2 %
Card fees                                     6,858       5,921            937            16 %
Loan service fees                             3,459       5,286         (1,827 )         (35 )%
Retail and other deposit service
fees                                         10,790      12,373         (1,583 )         (13 )%
Brokerage fees                                3,704       4,307           (603 )         (14 )%
Net gain on investment securities               244         229             15             7 %
Increase in cash surrender value of
life insurance                                2,677       3,433           (756 )         (22 )%
Net (loss) gain on sale of assets               (37 )       370           (407 )        (110 )%
Accretion of FDIC indemnification
asset                                           901       4,155         (3,254 )         (78 )%
Net loss recognized on other real
estate owned                                (15,968 )    (8,135 )       (7,833 )          96 %
Net gain on sale of loans                     1,503       2,241           (738 )         (33 )%
Other operating income                        3,677       3,429            248             7 %
Total other income                      $    75,314    $ 84,655    $    (9,341 )         (11 )%

Other income decreased by $9.3 million for the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011. Other income was primarily impacted by higher losses recognized on other real estate owned and a decrease in accretion of the FDIC indemnification asset, loan service fees and retail and other deposit service fees. Net loss recognized on other real estate owned increased due to updated appraisals with lower valuations on land and construction projects. Accretion of the FDIC indemnification asset is recorded based on the FDIC indemnification asset balance which has declined as we have received loss-share payments. Loan service fees decreased in the nine months ended September 30, 2012 compared to the same period in 2011 due to a decrease in loan prepayment and exit fees. Retail and other deposit service fees decreased due to a decrease in NSF fees. Net gain on sale of loans decreased due to the gain recognized during the nine months ended September 30, 2011 on several commercial real estate loans held for sale. Cash surrender value of life insurance decreased as a result of a death benefit recorded in the nine months ended September 30, 2011. These decreases were offset by increases in net lease financing, capital markets and international banking fees and card fee income. Net lease financing income increased primarily due to an increase in promotional and remarketing income as well as increased sales of equipment maintenance contracts. Capital markets and international banking fees increased due to an increase in interest rate swap fees. Card fee income increased due primarily to fees earned on prepaid cards and credit cards.


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