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MBFI > SEC Filings for MBFI > Form 10-K on 21-Feb-2014All Recent SEC Filings

Show all filings for MB FINANCIAL INC /MD

Form 10-K for MB FINANCIAL INC /MD


21-Feb-2014

Annual Report


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

The following is a discussion and analysis of our financial position and results of operations and should be read in conjunction with the information set forth under Item 1A Risks Factors, Item 7A, Quantitative and Qualitative Disclosures about Market Risk, and our consolidated financial statements and notes thereto appearing under Item 8 of this report.

Overview

We had net income and net income available to common stockholders of $98.5 million for the year ended December 31, 2013 compared to net income and net income available to common stockholders of $90.4 million and $87.1 million, respectively, for the year ended December 31, 2012 and net income and net income available to common shareholders of $38.7 million and $28.3 million, respectively, for the year ended December 31, 2011. Fully diluted earnings per common share were $1.79 for the year ended December 31, 2013 compared to $1.60 per common share in 2012 and $0.52 per common share in 2011.

The increase in earnings from the year ended December 31, 2012 to the year ended December 31, 2013 was primarily due to an increase in non-interest income of $25.2 million primarily from revenues earned from our key fee initiatives (predominantly leasing revenues) and decrease of $9.4 million in non-interest expense primarily from gains recognized on other real estate owned, partially offset by a $20.5 million decrease in net interest income. Net interest income decreased as a result of a decline in average earning assets (primarily as a result of a decrease in covered loans) and a decrease of the net interest margin. The increase in earnings from the year ended December 31, 2011 to the year ended December 31, 2012 was primarily due to a $129.7 million decrease in provision for credit losses as a result of improved credit quality, partially offset by a $32.5 million decrease in net interest income as a result of a decline in average earning assets and net interest margin and a $12.7 million increase in prepayment fees on interest bearing liabilities.

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. 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 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 non-interest income and non-interest expenses. During the years ended December 31, 2013, 2012 and 2011, non-interest income included revenue from our key fee initiatives: capital markets and international banking service fees, commercial deposit and treasury management fees, net lease financing income, trust and asset management fees, and card fees. Non-interest income also included loan service fees, consumer and other deposit service fees, brokerage fees, net gain (loss) on investment securities, increase in cash surrender value of life insurance, net gain (loss) on sale of other assets, accretion of the FDIC indemnification asset, net gains on sale of loans and other operating income. During the years ended December 31, 2013, 2012 and 2011, non-interest 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, merger related expenses, branch impairment charges, other real estate owned gains or losses, other real estate expenses (net of rental income), prepayment fees on interest bearing liabilities and other operating expenses. Additionally, dividends on preferred shares reduced net income available to common stockholders.

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. Non-interest income and non-interest expenses are impacted by growth of banking and leasing operations and growth in the number of loan and deposit accounts through both acquisitions and core banking and leasing business growth. Growth in operations affects other expenses primarily as a result of additional employee, branch facility and promotional marketing expense. Growth 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. Non-performing asset levels impact salaries and benefits, legal expenses and other real estate owned expenses.


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. The allowance for loan losses is 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 appropriate 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 December 31, 2013, the aggregate residual value of the equipment leased under our direct finance, leveraged, and operating leases totaled $76.8 million. See Note 1 and Note 6 of our audited consolidated financial statements 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 December 31, 2013, the Company had $80 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 December 31, 2013, the Company had approximately $7 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 income.


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.

See Note 18 to the consolidated financial statements for a complete discussion on the Company's use of fair valuation of assets and liabilities and the related measurement techniques.

Goodwill. The excess of the cost of an acquisition over the fair value of the net assets acquired, including core deposit and client relationship intangibles, consists of goodwill. See Note 8 to the consolidated financial statements for further information regarding core deposit and client relationship intangibles. The Company reviews goodwill to determine potential impairment annually, or more frequently if events and circumstances indicate that goodwill might be impaired, by comparing the carrying value of the reporting units with the fair value of the reporting units.

The Company's annual assessment date for goodwill impairment testing is as of December 31. As of December 31, 2013, the Company had two reporting units:
banking and leasing. Based on the Company's 2013 goodwill impairment testing, the fair values of the two reporting units were in excess of their carrying value. No impairment losses were recognized during the years ended December 31, 2013, 2012 and 2011.

Recent Accounting Pronouncements. Refer to Note 1 of our consolidated financial statements for a description of recent accounting pronouncements including the respective dates of adoption and effects on results of operations and financial condition.


Net Interest Income

The following table presents, for the periods indicated, the total dollar amount of interest income from average interest earning assets and the related yields, as well as the interest expense on average interest bearing liabilities, and the related costs, expressed both in dollars and rates (dollars in thousands). The table below and the discussion that follows contain presentations of net interest income and net interest margin on a tax-equivalent basis, which is adjusted for the tax-favored status of income from certain loans and investments. Net interest margin also is presented on a tax-equivalent basis in "Item 6 Selected Financial Data." We believe this measure to be the preferred industry measurement of net interest income, as it provides a relevant comparison between taxable and non-taxable amounts.

Reconciliations of net interest income and net interest margin on a tax-equivalent basis to net interest income and net interest margin in accordance with accounting principles generally accepted in the United States of America are provided in the table.

                                                                              Year Ended December 31,
(dollars in thousands)                         2013                                    2012                                    2011
                                  Average                    Yield/       Average                    Yield/       Average                    Yield/
                                  Balance       Interest      Rate        Balance       Interest      Rate        Balance       Interest      Rate
Interest Earning Assets:
Loans (1) (2) (3)              $ 5,282,072     $ 228,931      4.33 %   $ 5,412,373     $ 263,079      4.86 %   $ 5,867,533     $ 317,566      5.41 %
Loans exempt from federal
income taxes (4)                   326,426        14,786      4.47         278,925        13,275      4.68         231,505        11,118      4.74
Taxable investment
securities                       1,393,341        26,084      1.87       1,542,814        33,424      2.17       1,669,971        41,349      2.48
Investment securities exempt
from federal income taxes
(4)                                933,840        50,098      5.36         815,500        45,094      5.53         460,971        26,562      5.76
Federal funds sold                   4,510            15      0.33               -             -         -               -             -         -
Other interest bearing
deposits                           283,854           690      0.24         337,325           867      0.26         442,190         1,153      0.26
Total interest earning
assets                           8,224,043     $ 320,604      3.90       8,386,937     $ 355,739      4.24       8,672,170     $ 397,748      4.59
Non-interest earning assets      1,167,834                               1,161,048                               1,283,963
Total assets                   $ 9,391,877                             $ 9,547,985                             $ 9,956,133
Interest Bearing
Liabilities:
Deposits:
NOW and money market deposit   $ 2,698,226     $   3,483      0.13 %   $ 2,646,299     $   4,286      0.16 %   $ 2,678,049     $   7,637      0.29 %
Savings deposit                    839,025           546      0.07         789,595           786      0.10         732,731         1,379      0.19
Time deposits                    1,639,054        15,211      0.93       2,132,370        25,186      1.18       2,610,436        35,865      1.37
Short-term borrowings              264,381           622      0.24         231,872         1,204      0.52         244,594           849      0.35
Long-term borrowings and
junior subordinated notes          223,266         5,697      2.52         362,255        11,060      3.00         439,054        13,557      3.05
Total interest bearing
liabilities                      5,663,952     $  25,559      0.45       6,162,391     $  42,522      0.69       6,704,864     $  59,287      0.88
Non-interest bearing
deposits                         2,234,537                               1,973,666                               1,771,918
Other non-interest bearing
liabilities                        195,397                                 137,302                                 120,647
Stockholders' equity             1,297,991                               1,274,626                               1,358,704
Total liabilities and
stockholders' equity           $ 9,391,877                             $ 9,547,985                             $ 9,956,133
Net interest income/interest
rate spread (5)                                $ 295,045      3.45 %                   $ 313,217      3.55 %                   $ 338,461      3.71 %
Less: taxable equivalent
adjustment                                        22,709                                  20,429                                  13,188
Net interest income, as
reported                                       $ 272,336                               $ 292,788                               $ 325,273
Net interest margin (6)                                       3.31 %                                  3.49 %                                  3.75 %
Tax equivalent effect                                         0.28 %                                  0.24 %                                  0.15 %
Net interest margin on a
fully tax equivalent basis
(6)                                                           3.59 %                                  3.73 %                                  3.90 %

(1) Non-accrual loans are included in average loans.
(2) Interest income includes amortization of deferred loan origination fees of $3.6 million, $3.5 million and $4.7 million for the years ended December 31, 2013, 2012 and 2011, respectively.
(3) Loans held for sale are included in the average loan balance listed. Related interest income is included in loan interest income.
(4) Non-taxable loan and investment income is presented on a fully tax equivalent basis assuming a 35% tax rate.
(5) Interest rate spread represents the difference between the average yield on interest earning assets and the average cost of interest bearing liabilities and is presented on a fully tax equivalent basis.
(6) Net interest margin represents net interest income as a percentage of average interest earning assets.

Net interest income on a fully tax equivalent basis decreased $18.2 million during the year ended December 31, 2013 compared to the year ended December 31, 2012. The decrease from the year ended December 31, 2012 was due to a $162.9 million decrease in average earning asset balances (primarily as a result of a decrease in covered loans) as well as a 14 basis point decline in net interest margin on a fully tax equivalent basis. The net interest margin, expressed on a fully tax equivalent basis, was 3.59% for 2013 and 3.73% for 2012. The decrease in the margin during 2013 was primarily due to a decrease in yields on loans, as a result of tighter credit spreads and lower covered loan yields, and a decrease in yields on investment securities, partially offset by a lower cost of funds.


Net interest income on a fully tax equivalent basis decreased $25.2 million during the year ended December 31, 2012 compared to the year ended December 31, 2011, primarily due to a $285.2 million decrease in average interest earning assets and a 17 basis point decline in our net interest margin on a fully tax equivalent basis. The decrease in average interest earning assets was primarily due to a decrease in loan balances (primarily covered and real estate related loans). The net interest margin, expressed on a fully tax equivalent basis, was 3.73% for 2012 and 3.90% for 2011. The decline in the margin was primarily due to lower covered loan yields (negatively impacted the margin by 12 basis points), and tighter credit spreads, partially offset by a lower costs of funds.

Volume and Rate Analysis of Net Interest Income

The following table presents the extent to which changes in volume and interest rates of interest earning assets and interest bearing liabilities have affected our interest income and interest expense during the periods indicated. Information is provided in each category with respect to (i) changes attributable to changes in volume (changes in volume multiplied by prior period rate), (ii) changes attributable to changes in rates (changes in rates multiplied by prior period volume) and (iii) change attributable to a combination of changes in rate and volume (change in rates multiplied by the changes in volume) (in thousands). Changes attributable to the combined impact of volume and rate have been allocated proportionately to the changes due to volume and the changes due to rate (dollars in thousands).

                                                               Year Ended December 31,
                                           2013 Compared to 2012                     2012 Compared to 2011
                                     Change       Change                      Change        Change
                                     Due to       Due to         Total        Due to        Due to         Total
                                     Volume        Rate         Change        Volume         Rate         Change
Interest Earning Assets:
Loans                              $ (6,208 )   $ (27,940 )   $ (34,148 )   $ (23,549 )   $ (30,938 )   $ (54,487 )
Loans exempt from federal income
taxes (1)                             2,176          (665 )       1,511         2,258          (101 )       2,157
Taxable investment securities        (3,055 )      (4,285 )      (7,340 )      (2,999 )      (4,926 )      (7,925 )
Investment securities exempt
from federal income taxes (1)         6,382        (1,378 )       5,004        19,645        (1,113 )      18,532
Federal funds sold                       15             -            15             -             -             -
Other interest bearing deposits        (132 )         (45 )        (177 )        (270 )         (16 )        (286 )
Total decrease in interest
income                                 (822 )     (34,313 )     (35,135 )      (4,915 )     (37,094 )     (42,009 )
Interest Bearing Liabilities:
Deposits
NOW and money market deposit
accounts                                 83          (886 )        (803 )         (90 )      (3,261 )      (3,351 )
Savings deposits                         46          (286 )        (240 )         100          (693 )        (593 )
Time deposits                        (5,179 )      (4,796 )      (9,975 )      (6,047 )      (4,632 )     (10,679 )
Short-term borrowings                   149          (731 )        (582 )         (46 )         401           355
Long-term borrowings and junior
subordinated notes                   (3,756 )      (1,607 )      (5,363 )      (2,347 )        (150 )      (2,497 )
Total decrease in interest
expense                              (8,657 )      (8,306 )     (16,963 )      (8,430 )      (8,335 )     (16,765 )
Total increase (decrease) in net
interest income                    $  7,835     $ (26,007 )   $ (18,172 )   $   3,515     $ (28,759 )   $ (25,244 )

(1) Non-taxable loan and investment income is presented on a fully tax equivalent basis assuming a 35% rate.


Non-interest Income

                                                    Year Ended
                                                                                   Increase/      Percentage
                                      December 31, 2013     December 31, 2012     (Decrease)        Change
Non-interest income (in
thousands):
Capital markets and international
banking fees                         $           3,560     $           5,086     $    (1,526 )        (30.0 )%
Commercial deposit and treasury
management fees                                 24,867                23,636           1,231            5.2
Lease financing, net                            61,243                36,382          24,861           68.3
Trust and asset management fees                 19,142                17,990           1,152            6.4
Card fees                                       11,013                 9,368           1,645           17.6
Loan service fees                                5,563                 5,845            (282 )         (4.8 )
Consumer and other deposit service
fees                                            13,968                14,428            (460 )         (3.2 )
Brokerage fees                                   4,907                 4,792             115            2.4
Net (loss) gain on investment
securities                                          (1 )                 555            (556 )       (100.2 )
Increase in cash surrender value
of life insurance                                3,385                 3,570            (185 )         (5.2 )
Net loss on sale of assets                        (323 )                (942 )           619          (65.7 )
Accretion of FDIC indemnification
asset                                              342                 1,055            (713 )        (67.6 )
Net gain on sale of loans                        1,664                 2,325            (661 )        (28.4 )
Other operating income                           5,064                 5,103             (39 )         (0.8 )
Total non-interest income            $         154,394     $         129,193     $    25,201           19.5  %

Non-interest income increased by $25.2 million, or 19.5%, for the year ended December 31, 2013 compared to the year ended December 31, 2012, driven by revenue from our key fee initiatives.

Net lease financing income increased as a result of leasing revenues attributable to the addition of Celtic ($25.9 million).

Card fee income increased due to higher revenues on prepaid, debit and credit cards.

Commercial deposit and treasury management fees increased as a result of the addition of new treasury management services customers.

Trust and asset management fees increased due to strong equity market performance and the addition of new clients.

Capital markets and international banking service fees decreased due to lower swap, syndication, and merger and acquisition advisory revenues.

Accretion of FDIC indemnification asset decreased, consistent with the decrease in the related asset balance.

. . .

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