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BUSE > SEC Filings for BUSE > Form 10-K on 14-Mar-2013All Recent SEC Filings

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Annual Report

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following is management's discussion and analysis of the financial condition and results of operations of First Busey and subsidiaries for the years ended December 31, 2012, 2011, and 2010. It should be read in conjunction with "Item
1. Business," "Item 6. Selected Financial Data," the Consolidated Financial Statements and the related Notes to the Consolidated Financial Statements included in this Annual Report.

Critical Accounting Estimates

Critical accounting estimates are those that are critical to the portrayal and understanding of First Busey's financial condition and results of operations and require management to make assumptions that are difficult, subjective or complex. These estimates involve judgments, estimates and uncertainties that are susceptible to change. In the event that different assumptions or conditions were to prevail, and depending on the severity of such changes, the possibility of a materially different financial condition or materially different results of operations is a reasonable likelihood.

First Busey's significant accounting policies are described in "Note 1 - Significant Accounting Policies" in the Notes to the Consolidated Financial Statements. The majority of these accounting policies do not require management to make difficult, subjective or complex judgments or estimates or the variability of the estimates is not material. However, the following policies could be deemed critical:

Fair Value of Investment Securities. Securities are classified as held-to-maturity when First Busey has the ability and management has the positive intent to hold those securities to maturity. Accordingly, they are stated at cost, adjusted for amortization of premiums and accretion of discounts. First Busey had no securities classified as held-to-maturity at December 31, 2012 or 2011. Securities are classified as available for sale when First Busey may decide to sell those securities due to changes in market interest rates, liquidity needs, changes in yields on alternative investments, and for other reasons. They are carried at fair value with unrealized gains and losses, net of taxes, reported in other comprehensive income. All of First Busey's securities are classified as available for sale. For equity securities, unadjusted quoted prices in active markets for identical assets are utilized to determine fair value at the measurement date. For all other securities, we obtain fair value measurements from an independent pricing service. 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 and the security's terms and conditions, among other things. Due to the limited nature of the market for certain securities, the fair value and potential sale proceeds could be materially different in the event of a sale.

Realized securities gains or losses are reported in securities gains (losses), net in the Consolidated Statements of Income. The cost of securities sold is based on the specific identification method. Declines in the fair value of available for sale securities below their amortized cost are evaluated to determine whether the loss is temporary or other-than-temporary. If the Company
(a) has the intent to sell a debt security or (b) will more-likely-than-not be required to sell the debt security before its anticipated recovery, then the Company recognizes the entire unrealized loss in earnings as an other-than-temporary loss. If neither of these conditions are met, the Company evaluates whether a credit loss exists. The impairment is separated into the amount of the total impairment related to the credit loss and the amount of total impairment related to all other factors. The amount of the total other-than-temporary impairment related to the credit loss is recognized in earnings and the amount related to all other factors is recognized in other comprehensive income.

The Company also evaluates whether the decline in fair value of an equity security is temporary or other-than-temporary. In determining whether an unrealized loss on an equity security is temporary or other-than-temporary, management considers various factors including the magnitude and duration of the impairment, the financial condition and near-term prospects of the issuer, and the intent and ability of the Company to hold the equity security to forecasted recovery.

Allowance for Loan Losses. First Busey has established an allowance for loan losses which represents its estimate of the probable losses inherent in the loan portfolio as of the date of the financial statements. Management has established an allowance for loan losses which reduces the total loans outstanding by an estimate of uncollectible loans. Loans deemed uncollectible are charged against and reduce the allowance. A provision for loan losses is charged to current expense. This provision acts to replenish the allowance for loan losses and to maintain the allowance at a level that management deems adequate.

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To determine the adequacy of the allowance for loan losses, a formal analysis is completed quarterly to assess the risk within the loan portfolio. This assessment is reviewed by senior management of the bank and holding company. The analysis includes review of historical performance, dollar amount and trends of past due loans, dollar amount and trends in non-performing loans, review of certain impaired loans, and review of loans identified as sensitive assets. Sensitive assets include non-accrual loans, past-due loans, loans on First Busey's watch loan reports and other loans identified as having probable potential for loss.

The allowance consists of specific and general components. The specific component considers loans that are classified as impaired. For such loans that are classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying amount of that loan. The general component covers non-classified loans and classified loans not considered impaired, and is based on historical loss experience adjusted for qualitative factors. Other adjustments may be made to the allowance for pools of loans after an assessment of internal or external influences on credit quality that are not fully reflected in the historical loss experience.

A loan is considered to be impaired when, based on current information and events, it is probable First Busey will not be able to collect all principal and interest amounts due according to the contractual terms of the loan agreement. When a loan becomes impaired, management generally calculates the impairment based on the present value of expected future cash flows discounted at the loan's effective interest rate. If the loan is collateral dependent, the fair value of the collateral is used to measure the amount of impairment. The amount of impairment and any subsequent changes are recorded through a charge to earnings as an adjustment to the allowance for loan losses. When management considers a loan, or a portion thereof, as uncollectible, such amount deemed uncollectable is charged against the allowance for loan losses. Because a significant majority of First Busey's loans are collateral dependent, First Busey has determined the required allowance on these loans based upon the estimated fair value, net of selling costs, of the respective collateral. The required allowance or actual losses on these impaired loans could differ significantly if the ultimate fair value of the collateral is significantly different from the fair value estimates used by First Busey in estimating such potential losses.

Deferred Taxes. We have maintained significant net deferred tax assets for deductible temporary differences, the largest of which relates to the net operating loss carryforward and the allowance for loan losses. For income tax return purposes, only actual 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 recoverability 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 recoverability of our deferred tax assets. Positive evidence includes available tax planning strategies and the probability that taxable income will continue to be generated in future periods, as it was in 2012, 2011 and 2010, while negative evidence includes a cumulative loss in 2009 and 2008 and certain business and economic trends. We evaluated the recoverability of our net deferred tax asset and established a valuation allowance for certain state net operating loss and credit carryforwards that are not expected to be fully realized. Management believes that it is more likely than not that the other deferred tax assets included in the accompanying Consolidated Financial Statements will be fully realized. We have determined that no valuation allowance is required for any other deferred tax assets as of December 31, 2012, although there is no guarantee that those assets will be recognizable in future periods.

We must assess the likelihood that any deferred tax assets will be realized through the reduction of taxes in future periods and establish a valuation allowance for those assets for which recovery is not more likely than not. In making this assessment, we must make judgments and estimates regarding the ability to realize the asset through the future reversal of existing taxable temporary differences, future taxable income, and the possible application of future tax planning strategies. The Company's evaluation gave consideration to the fact that all net operating loss carrybacks have been utilized. Therefore, utilization of net operating loss carryforwards are dependent on implementation of tax strategies and continued profitability.

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Executive Summary

Operating Results

                                                    Year Ended December 31:
                                                   2012       2011       2010
Net income:
Consolidated                                     $ 22,357   $ 29,873   $ 23,230
Busey Bank                                         19,162     28,504     21,230
FirsTech                                              935      1,437      1,821
Busey Wealth Management                             3,363      3,095      3,283
Consolidated earnings per share, fully-diluted   $   0.22   $   0.29   $   0.27

Operating Performance

First Busey Corporation's net income for the year ended December 31, 2012 was $22.4 million and net income available to common shareholders was $18.7 million, or $0.22 per fully-diluted common share, as compared to net income of $29.9 million and net income available to common shareholders of $24.5 million, or $0.29 per fully-diluted common share, for the year ended December 31, 2011. As net interest income margins have compressed, non-interest income sources of revenue have increased. The decrease in net income from year to year is due in large part to the previously disclosed commitment to our commercial banking and fee-based businesses, which have increased certain costs. This commitment is the centerpiece of our long term strategy to build quality asset and fee growth based upon solid capital and a careful balance of risk and return.

Significant operating performance items were:

Net interest income for the year ended December 31, 2012 was $102.1 million compared to $110.4 million for the same period of 2011. Year-over-year net interest income declines were driven by decreases in average loan volumes and yields, which have prompted initiatives to foster quality asset growth. Additional liquidity generated by our growing deposit base has primarily been deployed into our investment portfolio over the past year which has a lower average yield than our loan portfolio.

Net interest margin for the year ended December 31, 2012 decreased to 3.24% compared to 3.52% for the same period of 2011. The Company continued to experience downward pressure on its yield on interest-earning assets resulting from a protracted period of historically low rates and heightened competition for assets, which has been experienced throughout the banking industry.

The efficiency ratio for the year ended December 31, 2012 was 68.54%, as compared to 59.03% for the same period of 2011. Efficiency ratios have been influenced throughout the year by a number of events (such as our core conversion and branch closures which are discussed in more detail in the Other Expense section below).

FirsTech's net income for the year ended December 31, 2012 was $0.9 million as compared to $1.4 million for the year ended December 31, 2011 due to decreased volume of online bill payments and increased investments in talent to support future growth.

Busey Wealth Management's net income for the year ended December 31, 2012 was $3.4 million as compared to $3.1 million for the year ended December 31, 2011.

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Asset Quality

While much internal focus has been directed toward organic growth, our commitment to credit quality remains strong. We continue to expect gradual improvement in our overall asset quality during 2013; however, this remains dependent upon market-specific economic conditions, and specific measures may fluctuate from quarter to quarter. The key metrics are as follows:

Non-performing loans decreased to $25.4 million at December 31, 2012 from $38.5 million at December 31, 2011.

Illinois/Indiana non-performing loans decreased to $17.8 million at December 31, 2012 from $27.7 million at December 31, 2011.

Florida non-performing loans decreased to $7.6 million at December 31, 2012 from $10.8 million at December 31, 2011.

Loans 30-89 days past due decreased to $2.3 million at December 31, 2012 from $4.7 million at December 31, 2011.

Other non-performing assets, primarily consisting of other real estate owned, decreased to $3.5 million at December 31, 2012 from $8.5 million at December 31, 2011.

The ratio of non-performing assets to total loans plus other non-performing assets at December 31, 2012 decreased to 1.39% from 2.28% at December 31, 2011.

The allowance for loan losses to non-performing loans ratio increased to 189.32% at December 31, 2012 from 151.91% at December 31, 2011.

The allowance for loan losses to total loans ratio decreased to 2.32% at December 31, 2012 from 2.85% at December 31, 2011.

Net charge-offs of $27.0 million recorded for the year ended December 31, 2012 were lower than the $37.5 million recorded for the year ended December 31, 2011.

Provision expense of $16.5 million for the year ended December 31, 2012 decreased from the $20.0 million recorded for the year ended December 31, 2011.

Overview and Strategy

The Company takes great pride in the extensive organizational transformation successfully executed by our associates during 2012. From launching a new sales model in our commercial banking division which we believe has turned the corner on loan growth, to continued strides in strengthening credit, we believe we have positioned ourselves for greater opportunities in the future. With the creation of Trevett Capital Partners, we have expanded our wealth services capabilities in Florida, while also investing in talent to promote our fee-based wealth, payment processing and cash management business in the Midwest. We also completed a core data processing system conversion to support the developing product needs of our customers and the profitability metrics needed to dynamically manage a growing business.

Following an extensive analysis, we closed two limited service branches and one full service branch at the end of the fourth quarter of 2012. We also finalized plans to close four more branches in strategic markets spread across Illinois during the second quarter of 2013. To support a steady earnings flow to our shareholders, we elected to offset some of the related exit costs with securities gains. Our research indicated customer usage patterns at targeted facilities were duplicated by other nearby branches, enabling us to deploy our resources more efficiently through consolidation of our network. In addition, the Company is expanding its toll-free customer support hours and continually monitors avenues of development for innovative mobile channels of delivery. The process of understanding and optimizing best avenues for service distribution will be an ongoing exercise.

In 2013 we will continue to monitor our investments and revenue growth with the greatest of care as we strive to deliver optimal value to our shareholders. With a healthy capital foundation, consistent earnings and dividend history, strong credit quality, and a reinforced sales model, we believe we remain well positioned to explore potential external growth opportunities to enhance and complement our mission to achieve positive organic growth. We take pride in our past and look confidently towards our future.

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Results of Operation - Three Years Ended December 31, 2012

Net Interest Income

Net interest income is the difference between interest income and fees earned on earning assets and interest expense incurred on interest-bearing liabilities. Interest rate levels and volume fluctuations within earning assets and interest-bearing liabilities impact net interest income. Net interest margin is tax-equivalent net interest income as a percent of average earning assets.

Certain assets with tax favorable treatment are evaluated on a tax-equivalent basis. Tax-equivalent basis assumes a federal income tax rate of 35%. Tax favorable assets generally have lower contractual pre-tax yields than fully taxable assets. A tax-equivalent analysis is performed by adding the tax savings to the earnings on tax favorable assets. After factoring in the tax favorable effects of these assets, the yields may be more appropriately evaluated against alternative earning assets. In addition to yield, various other risks are factored into the evaluation process.

The following table shows the consolidated average balance sheets, detailing the major categories of assets and liabilities, the interest income earned on interest-earning assets, the interest expense paid for the interest-bearing liabilities, and the related interest rates for the periods, or as of the dates, shown. All average information is provided on a daily average basis.

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                   Average Balance Sheets and Interest Rates

                                                                     Years Ended December 31,
                                          2012                                 2011                                 2010
                              Average      Income/    Yield/       Average      Income/    Yield/       Average      Income/    Yield/
                              Balance      Expense     Rate        Balance      Expense     Rate        Balance      Expense     Rate
                                                                      (dollars in thousands)
Interest-bearing bank
deposits                    $   263,017   $     666      0.25 %  $   282,634   $     722      0.26 %  $   155,132   $     391      0.25 %

Investment securities:
U.S. Treasuries and
Agencies                        447,720       7,776      1.74 %      387,137       9,173      2.37 %      355,654       9,678      2.72 %
Obligations of states and
political subdivisions(1)       222,931       6,735      3.02 %      107,746       4,363      4.05 %       80,975       4,583      5.66 %
Other securities                273,099       5,104      1.87 %      236,031       5,297      2.24 %      126,579       4,275      3.38 %
Loans(1), (2), (3)            2,014,797      98,963      4.91 %    2,173,408     115,157      5.30 %    2,609,337     139,231      5.34 %
Total interest-earning
assets(1)                   $ 3,221,564   $ 119,244      3.70 %  $ 3,186,956   $ 134,712      4.23 %  $ 3,327,677   $ 158,158      4.75 %

Cash and due from banks          77,482                               76,651                               80,174
Premises and equipment           70,748                               71,446                               75,597
Allowance for loan losses       (52,243 )                            (71,031 )                            (92,792 )
Other assets                    186,125                              209,389                              258,175
Total assets                $ 3,503,676                          $ 3,473,411                          $ 3,648,831

Liabilities and
Stockholders' Equity
transaction deposits        $    42,532   $      66      0.16 %  $    39,900   $      91      0.23 %  $    40,260   $     118      0.29 %
Savings deposits                196,592         223      0.11 %      188,539         318      0.17 %      176,518         386      0.22 %
Money market deposits         1,366,068       2,952      0.22 %    1,236,225       3,858      0.31 %    1,160,790       5,607      0.48 %
Time deposits                   741,038       9,255      1.25 %      877,011      14,393      1.64 %    1,199,114      26,603      2.22 %
Short-term borrowings:
Federal funds purchased               -           -         - %            -           -         - %            5           -         - %
Repurchase agreements           132,150         279      0.21 %      127,095         367      0.29 %      134,207         554      0.41 %
Other                                 -          35         - %            -          38         - %        2,016          86      4.26 %
Long-term debt                   13,531         648      4.79 %       29,024       1,442      4.97 %       63,860       2,930      4.59 %
Junior subordinated debt
issued to unconsolidated
trusts                           55,000       1,312      2.39 %       55,000       1,919      3.49 %       55,000       2,748      5.00 %
Total interest-bearing
liabilities                 $ 2,546,911   $  14,770      0.58 %  $ 2,552,794   $  22,426      0.88 %  $ 2,831,769   $  39,032      1.38 %

Net interest spread                                      3.12 %                               3.35 %                               3.37 %

Noninterest- bearing
deposits                        515,934                              472,516                              450,106
Other liabilities                26,982                               29,228                               33,716
Stockholders' equity            413,849                              418,873                              333,240
Total liabilities and
stockholders' equity        $ 3,503,676                          $ 3,473,411                          $ 3,648,831

Interest income/earning
assets(1)                   $ 3,221,564   $ 119,244      3.70 %  $ 3,186,956   $ 134,712      4.23 %  $ 3,327,677   $ 158,158      4.75 %
Interest expense/earning
assets                      $ 3,221,564   $  14,770      0.46 %  $ 3,186,956   $  22,426      0.71 %  $ 3,327,677   $  39,032      1.17 %
Net interest margin(1)                    $ 104,474      3.24 %                $ 112,286      3.52 %                $ 119,126      3.58 %

(1)On a tax-equivalent basis, assuming a federal income tax rate of 35%.

(2)Non-accrual loans have been included in average loans, net of unearned discount.

(3)Includes loan fee income of $2.0 million, $1.4 million and $1.0 million for 2012, 2011 and 2010, respectively.

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             Average Balance Sheets and Interest Rates (continued)

Changes in Net Interest Income:

                                                     Years Ended December 31, 2012, 2011, and 2010
                                 Year 2012 vs. 2011 Change due to(1)              Year 2011 vs. 2010 Change due to(1)
                               Average          Average         Total          Average         Average
                                Volume        Yield/Rate        Change         Volume         Yield/Rate      Total Change
                                                                 (dollars in thousands)
Increase (decrease) in
interest income:
Interest-bearing bank
deposits                     $        (50 )  $          (6 )  $      (56 )  $         326    $          5    $          331
Investment securities:
U.S. Treasuries and
agencies                            1,294           (2,691 )      (1,397 )            812          (1,317 )            (505 )
Obligations of state and
political subdivisions(2)           3,707           (1,335 )       2,372            1,283          (1,503 )            (220 )
Other securities                      765             (958 )        (193 )          2,803          (1,781 )           1,022
Loans(2)                           (8,097 )         (8,097 )     (16,194 )        (23,104 )          (970 )         (24,074 )
Change in interest
income(2)                    $     (2,381 )  $     (13,087 )  $  (15,468 )  $     (17,880 )  $     (5,566 )  $      (23,446 )

Increase (decrease) in
interest expense:
transaction deposits         $          6    $         (31 )  $      (25 )  $          (1 )  $        (26 )  $          (27 )
Savings deposits                       13             (108 )         (95 )             25             (93 )             (68 )
Money market deposits                 374           (1,280 )        (906 )            344          (2,093 )          (1,749 )
Time deposits                      (2,022 )         (3,116 )      (5,138 )         (6,201 )        (6,009 )         (12,210 )
Federal funds purchased                 -                -             -                -               -                 -
Repurchase agreements                  14             (102 )         (88 )            (28 )          (159 )            (187 )
Other short-term
borrowings                              -               (3 )          (3 )            (24 )           (24 )             (48 )
Long-term debt                       (744 )            (50 )        (794 )         (1,713 )           225            (1,488 )
Junior subordinated debt
owed to unconsolidated
trusts                                  -             (607 )        (607 )              -            (829 )            (829 )
Change in interest
expense                      $     (2,359 )  $      (5,297 )  $   (7,656 )  $      (7,598 )  $     (9,008 )  $      (16,606 )
Increase (decrease) in
net interest income(2)       $        (22 )  $      (7,790 )  $   (7,812 )  $     (10,282 )  $      3,442    $       (6,840 )

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