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MBFI > SEC Filings for MBFI > Form 10-Q on 6-May-2014All Recent SEC Filings

Show all filings for MB FINANCIAL INC /MD

Form 10-Q for MB FINANCIAL INC /MD


6-May-2014

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 non-interest income and non-interest expenses. During the periods under report, 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 assets, accretion of the FDIC indemnification asset, net gains on sale of loans and other operating income. During the periods under report, 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, net loss on other real estate owned, other real estate expenses (net of rental income) and other operating expenses.

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.

The Company had net income of $20.0 million for the three months ended March 31, 2014 compared to net income of $24.9 million for the three months ended March 31, 2013. Fully diluted earnings per common share were $0.36 for the three months ended March 31, 2014 compared to $0.46 per common share for the three months ended March 31, 2013.


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 Compliance and 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 March 31, 2014, the aggregate residual value of the equipment leased under our direct finance, leveraged, and operating leases totaled $75.1 million. See Note 1 and Note 6 of our December 31, 2013 audited consolidated financial statements contained in our Annual Report Form 10-K for the year ended December 31, 2013 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 March 31, 2014, the Company had $81 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 March 31, 2014, the Company had approximately $8 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 13 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 consists of goodwill, and core deposit and client relationship intangibles. See Note 8 of our December 31, 2013 audited consolidated financial statements contained in our Annual Report Form 10-K for the year ended December 31, 2013 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. Goodwill is tested for impairment at the reporting unit level. The Company has two reporting units: banking and leasing. No impairment losses were recognized during the three months ended March 31, 2014 and 2013. We are not aware of any events or circumstances subsequent to our annual goodwill impairment testing date of December 31, 2013 that would indicate impairment of goodwill at March 31, 2014.

Recent Accounting Pronouncements. Refer to Note 2 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 tables present, 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 tables 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. 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.


                                                                Three Months Ended March 31,
(dollars in thousands)                                  2014                                    2013
                                           Average                    Yield/       Average                    Yield/
                                           Balance       Interest      Rate        Balance       Interest      Rate
Interest Earning Assets:
Loans (1) (2) (3)                       $ 5,283,645     $  53,946      4.14 %   $ 5,361,881     $  58,536      4.43 %
Loans exempt from federal income
taxes (4)                                   323,526         3,536      4.37         311,509         3,472      4.46
Taxable investment securities             1,384,371         8,146      2.35       1,484,300         6,140      1.65
Investment securities exempt from
federal income taxes (4)                    935,863        12,410      5.30         911,742        12,400      5.44
Federal funds sold                            5,889             5      0.34               -             -         -
Other interest earning deposits             187,049           113      0.25         197,057           135      0.28
Total interest earning assets             8,120,343     $  78,156      3.90       8,266,489     $  80,683      3.96
Non-interest earning assets               1,247,599                               1,183,099
Total assets                            $ 9,367,942                             $ 9,449,588
Interest Bearing Liabilities:
Deposits:
NOW and money market deposit            $ 2,727,620     $     848      0.13 %   $ 2,737,494     $     927      0.14 %
Savings deposit                             862,197           109      0.05         822,214           136      0.07
Time deposits                             1,434,114         2,812      0.80       1,806,895         4,646      1.04
Short-term borrowings                       200,578           100      0.20         191,902           167      0.35
Long-term borrowings and junior
subordinated notes                          221,694         1,378      2.49         248,891         1,567      2.52
Total interest bearing liabilities        5,446,203     $   5,247      0.39       5,807,396     $   7,443      0.52
Non-interest bearing deposits             2,372,866                               2,145,058
Other non-interest bearing
liabilities                                 213,650                                 216,213
Stockholders' equity                      1,335,223                               1,280,921
Total liabilities and stockholders'
equity                                  $ 9,367,942                             $ 9,449,588
Net interest income/interest rate
spread (5)                                              $  72,909      3.51 %                   $  73,240      3.44 %
Less: taxable equivalent adjustment                         5,581                                   5,555
Net interest income, as reported                        $  67,328                               $  67,685
Net interest margin (6)                                                3.36 %                                  3.32 %
Tax equivalent effect                                                  0.28 %                                  0.27 %
Net interest margin on a fully tax
equivalent basis (6)                                                   3.64 %                                  3.59 %

(1) Non-accrual loans are included in average loans.
(2) Interest income includes amortization of net deferred loan origination costs of $55 thousand for the three months ended March 31, 2014 compared to net deferred loan origination fees of $981 thousand for the three months ended March 31, 2013.
(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 $331 thousand during the three months ended March 31, 2014 compared to the three months ended March 31, 2013, primarily due to lower yields on loans. The net interest margin, expressed on a fully tax equivalent basis, was 3.64% for the first quarter of 2014 and 3.59% for the first quarter of 2013. This five basis point increase was primarily due to a lower cost of funds and improved taxable investment securities yields, partially offset by lower loan yields.


Non-interest Income

                                              Three Months Ended
                                                  March 31,
                                                                          Increase/     Percentage
                                             2014            2013        (Decrease)       Change
Non-interest income (in thousands):
Capital markets and international
banking fees                             $       978     $      808     $       170         21.0  %
Commercial deposit and treasury
management fees                                7,144          5,966           1,178         19.7  %
Lease financing, net                          13,196         16,263          (3,067 )      (18.9 )%
Trust and asset management fees                5,207          4,494             713         15.9  %
Card fees                                      2,701          2,695               6          0.2  %
Loan service fees                                965          1,011             (46 )       (4.5 )%
Consumer and other deposit service
fees                                           2,935          3,246            (311 )       (9.6 )%
Brokerage fees                                 1,325          1,157             168         14.5  %
Net gain on investment securities                317             (1 )           318           NM
Increase in cash surrender value of
life insurance                                   827            844             (17 )       (2.0 )%
Net loss on sale of assets                         7              -               7        100.0  %
Accretion of FDIC indemnification
asset                                             31            143            (112 )      (78.3 )%
Net gain on sale of loans                         59            639            (580 )      (90.8 )%
Other operating income                           920          1,438            (518 )      (36.0 )%
Total non-interest income                $    36,612     $   38,703     $    (2,091 )       (5.4 )%

NM - not meaningful

Non-interest income decreased by $2.1 million, or 5.4%, for the three months ended March 31, 2014 compared to the three months ended March 31, 2013.

Leasing revenues declined due to lower equipment remarketing gains and lower fees from the sale of third-party equipment maintenance contracts.

Commercial deposit and treasury management fees increased in the first quarter due to robust new customer activity.

Trust and asset management fees increased due to the growth in investment management fees as a result of new customers added and the impact of higher equity values on assets under management and related fee revenue.


Non-interest Expenses

                                              Three Months Ended
                                                  March 31,
                                                                          Increase/     Percentage
                                             2014            2013        (Decrease)       Change
Non-interest expenses (in thousands):
Salaries and employee benefits           $    44,377     $   43,514     $       863          2.0  %
Occupancy and equipment expense                9,592          9,404             188          2.0  %
Computer services and
telecommunication expense                      5,084          3,887           1,197         30.8  %
Advertising and marketing expense              2,081          2,103             (22 )       (1.0 )%
Professional and legal expense                 1,779          1,295             484         37.4  %
Other intangibles amortization expense         1,240          1,544            (304 )      (19.7 )%
Net loss recognized on other real
estate owned                                     187            330            (143 )      (43.3 )%
Other real estate expense, net                   396            139             257        184.9  %
Other operating expenses                      11,311          9,213           2,098         22.8  %
Total non-interest expenses              $    76,047     $   71,429     $     4,618          6.5  %

Non-interest expenses increased by $4.6 million, or 6.5%, for the three months ended March 31, 2014 from the three months ended March 31, 2013. Non-interest expenses include $680 thousand expenses related to the pending merger with Taylor Capital Group, Inc. ("Taylor Capital"), mainly for professional and legal services.

Other operating expenses increased due to a write-off of an investment in low-income housing funds that invested in real estate projects. This investment was made in 2006 as a community development initiative. The extended slow real estate recovery in some low income areas of Chicago negatively impacted this investment.

Computer services and telecommunication expenses increased due primarily to an increase in spending on IT security, data warehouse, investments in our key fee initiatives, as well as higher transaction volumes in leasing, treasury management and card areas.

Salaries and employee benefits increased due to annual salary increases, long-term incentive expense, taxes and temporary staffing needs.

Income Taxes

Income tax expense for the three months ended March 31, 2014 was $6.8 million compared to $10.1 million for the three months ended March 31, 2013. The decrease was primarily due to a decrease in our pre-tax income during the three months ended March 31, 2014.

Balance Sheet

Total assets decreased $204.1 million, or 2.1%, from $9.6 billion at December 31, 2013 to $9.4 billion at March 31, 2014.

Cash and cash equivalents increased $40.2 million, or 8.5% from $473.5 million at December 31, 2013 to $513.6 million at March 31, 2014 primarily due to the increase in deposit balances.

Investment securities decreased $30.7 million, or 1.3%, from December 31, 2013 to March 31, 2014 mostly as a result of the principal payments received on mortgage-backed securities that were not reinvested in the portfolio.

Gross loans, excluding covered loans, decreased by $82.2 million to $5.4 billion at March 31, 2014 from December 31, 2013. Average loans, excluding covered loans, increased $70.7 million from the fourth quarter of 2013 to the first quarter of 2014.


Total liabilities decreased by $221.2 million, or 2.7%, from $8.3 billion at December 31, 2013 to $8.1 billion at March 31, 2014.

Total deposits increased by $104.5 million, or 1.4%, to $7.5 billion at March 31, 2014 from December 31, 2013 due to the increase in low cost deposits (noninterest bearing deposits, money market and NOW accounts and savings accounts). Average deposits increased $30.1 million from the fourth quarter of 2013 to the first quarter of 2014.

Over the past year and quarter, our deposit mix improved as low cost deposits increased by $395.1 million, or 7.0%, compared to March 31, 2013 and by $160.9 million, or 2.7%, compared to December 31, 2013. This improvement was driven by the growth in noninterest bearing deposits.

Noninterest bearing deposits increased by 17.8% and 2.5% compared to March 31, 2013 and December 31, 2013, respectively.

Total borrowings decreased by $300.0 million, or 42.4%, to $407.6 million at March 31, 2014. The decrease in total borrowings was primarily due to the repayment of the $300.0 million FHLB advance entered into the fourth quarter of 2013 to increase our balance sheet liquidity in preparation for an adverse market reaction to the Federal government shutdown and potential breach of the debt ceiling.

Total stockholders' equity increased $17.1 million to $1.3 billion at March 31, 2014 compared to December 31, 2013 primarily as a result of our earnings for the three months ended March 31, 2014 partly offset by dividends.

Investment Securities

The following table sets forth the amortized cost and fair value of our
investment securities, by type of security as indicated (in thousands):

                                March 31, 2014                 December 31, 2013                March 31, 2013
                           Amortized         Fair          Amortized         Fair          Amortized         Fair
                             Cost            Value           Cost            Value           Cost            Value
Available for sale
U.S. Government
sponsored agencies and
enterprises              $    50,291     $    51,836     $    50,486     $    52,068     $    38,478     $    40,949
States and political
subdivisions                  19,285          19,350          19,398          19,143         680,978         719,761
Residential
mortgage-backed
securities                   666,707         673,515         696,415         701,233         776,336         788,768
Commercial
mortgage-backed
securities                    50,841          52,924          50,891          52,941          51,048          53,837
Corporate bonds              272,490         273,853         284,083         283,070         197,162         197,675
Equity securities             10,703          10,572          10,649          10,457          10,820          11,179
Total Available for
Sale                       1,070,317       1,082,050       1,111,922       1,118,912       1,754,822       1,812,169
Held to maturity
States and political
subdivisions                 940,610         961,630         932,955         936,173         262,310         279,857
Residential
mortgage-backed
securities                   248,082         261,841         249,578         262,756         255,475         274,744
Total Held to Maturity     1,188,692       1,223,471       1,182,533       1,198,929         517,785         554,601
Total                    $ 2,259,009     $ 2,305,521     $ 2,294,455     $ 2,317,841     $ 2,272,607     $ 2,366,770

Securities of states and political subdivisions with a fair value of $656.6 million were transferred from available for sale to held to maturity during the . . .

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