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Section 1: 10-K (MB FINANCIAL, INC. 10K 123110)

mbfi_10k123110.htm
 
 


 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
___________

FORM 10-K

(Mark One)

 x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 
For the fiscal year ended December 31, 2010

 
OR

 o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 
For the transition period from ____________ to ____________


Commission file number 0-24566-01
MB FINANCIAL, INC.
(Exact name of registrant as specified in its charter)


Maryland
 
36-4460265
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
     
800 West Madison Street, Chicago, Illinois
 
60607
(Address of Principal Executive Offices)
 
(Zip Code)


Registrant’s telephone number, including area code:  (888) 422-6562

Securities registered pursuant to Section 12(b) of the Act:

Title of Each Class
 
Name of Each Exchange on Which Registered
     
Common Stock, par value $0.01 per share
 
The NASDAQ Stock Market LLC
     
     
 
Securities registered pursuant to Section 12(g) of the Act:

None
(Title of Class)
 


 
 
 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.Yesx    Noo


Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.Yeso    Nox


Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.
Yesx                      Noo

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yeso                      Noo

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statement incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filerx                                                      Accelerated filero

Non-accelerated filero (Do not check if a smaller reporting company)                                                                           Smaller reporting companyo


Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
Yeso                      Nox


The aggregate market value of the voting shares held by non-affiliates of the Registrant was approximately $938,042,913 as of June 30, 2010, the last business day of the Registrant’s most recently completed second fiscal quarter.  Solely for the purpose of this computation, it has been assumed that executive officers and directors of the Registrant are “affiliates.”


There were issued and outstanding 53,957,336 shares of the Registrant’s common stock as of February 8, 2011.

DOCUMENTS INCORPORATED BY REFERENCE:


Document
   
Part of Form 10-K
       
Portions of the definitive Proxy Statement to
     
be used in conjunction with the Registrant’s
   
Part III
2011 Annual Meeting of Stockholders.
     
 
 
 
 

 


MB FINANCIAL, INC. AND SUBSIDIARIES

FORM 10-K

December 31, 2010

INDEX

     
Page
     
 
Business.................................................................................................................................................................................................................................................
4
 
Risk Factors...........................................................................................................................................................................................................................................
18
 
Unresolved Staff Comments................................................................................................................................................................................................................
27
 
Properties...............................................................................................................................................................................................................................................
27
 
Legal Proceedings.................................................................................................................................................................................................................................
27
 
Reserved.................................................................................................................................................................................................................................................
27
       
     
 
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities...........................................................
28
 
Selected Financial Data........................................................................................................................................................................................................................
31
 
Management’s Discussion and Analysis of Financial Condition and Results of Operations..................................................................................................
37
 
Quantitative and Qualitative Disclosures about Market Risk........................................................................................................................................................
65
 
Financial Statements and Supplementary Data................................................................................................................................................................................
68
 
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.................................................................................................
129
 
Controls and Procedures......................................................................................................................................................................................................................
129
 
Other Information..................................................................................................................................................................................................................................
129
       
     
 
Directors, Executive Officers, and Corporate Governance..............................................................................................................................................................
130
 
Executive Compensation......................................................................................................................................................................................................................
130
 
Security Ownership of Certain Beneficial Owners,  and Management and Related Stockholder Matters..............................................................................
130
 
Certain Relationships, Related Transactions and Director Independence...................................................................................................................................
131
 
Principal Accountant Fees and Services...........................................................................................................................................................................................
131
       
     
 
Exhibits and Financial Statement Schedules.....................................................................................................................................................................................
132
   
Signatures...............................................................................................................................................................................................................................................
133
       


 
 

 
 
PART I


Item 1.  Business

Special Note Regarding Forward-Looking Statements

When used in this Annual Report on Form 10-K and in other filings with the Securities and Exchange Commission, in press releases or other public shareholder communications, or in oral statements made with the approval of an authorized executive officer, the words or phrases "believe," "will," "should," "will likely result," "are expected to," "will continue," "is anticipated," "estimate," "project," "plans," or similar expressions are intended to identify "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995.  You are cautioned not to place undue reliance on any forward-looking statements, which speak only as of the date made.  These statements may relate to MB Financial, Inc.’s future financial performance, strategic plans or objectives, revenues or earnings projections, or other financial items.  By their nature, these statements are subject to numerous uncertainties that could cause actual results to differ materially from those anticipated in the statements.

Important factors that could cause actual results to differ materially from the results anticipated or projected include, but are not limited to, the following: (1) expected revenues, cost savings, synergies and other benefits from our merger and acquisition activities might not be realized within the anticipated time frames or at all, and costs or difficulties relating to integration matters, including but not limited to customer and employee retention, might be greater than expected; (2) the possibility that the expected benefits of the FDIC-assisted transactions we previously completed will not be realized; (3) the credit risks of lending activities, including changes in the level and direction of loan delinquencies and write-offs and changes in estimates of the adequacy of the allowance for loan losses, which could necessitate additional provisions for loan losses, resulting both from loans we originate and loans we acquire from other financial institutions; (4) results of examinations by the Office of Comptroller of Currency and other regulatory authorities, including the possibility that any such regulatory authority may, among other things, require us to increase our allowance for loan losses or write-down assets; (5) competitive pressures among depository institutions; (6) interest rate movements and their impact on customer behavior and net interest margin; (7) the impact of repricing and competitors’ pricing initiatives on loan and deposit products; (8) fluctuations in real estate values; (9) the ability to adapt successfully to technological changes to meet customers’ needs and developments in the market place; (10) our ability to realize the residual values of our direct finance, leveraged, and operating leases; (11) our ability to access cost-effective funding; (12) changes in financial markets; (13) changes in economic conditions in general and in the Chicago metropolitan area in particular; (14) the costs, effects and outcomes of litigation; (15) new legislation or regulatory changes, including but not limited to the Dodd-Frank Wall Street Reform and Consumer Protection Act and regulations adopted thereunder, changes in federal and/or state tax laws or interpretations thereof by taxing authorities, changes in laws, rules or regulations applicable to companies that have participated in the TARP Capital Purchase Program of the U.S. Department of the Treasury and other governmental initiatives affecting the financial services industry; (16) changes in accounting principles, policies or guidelines; (17) our future acquisitions of other depository institutions or lines of business; and (18) future goodwill impairment due to changes in our business, changes in market conditions, or other factors.

We do not undertake any obligation to update any forward-looking statement to reflect circumstances or events that occur after the date on which the forward-looking statement is made.
 
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General

MB Financial, Inc., headquartered in Chicago, Illinois, is a financial holding company with banking offices located primarily in the Chicago area.  The words "MB Financial,"  "the Company," "we," "our" and "us" refer to MB Financial, Inc. and its wholly owned subsidiaries, unless we indicate otherwise.  Our primary market is the Chicago metropolitan area, in which we operate approximately 90 banking offices through our bank subsidiary, MB Financial Bank, N.A. (MB Financial Bank), including one banking office in the city of Philadelphia, Pennsylvania.  Through MB Financial Bank, we offer a broad range of financial services primarily to small and middle market businesses and individuals in the markets that we serve.  Our primary lines of business include commercial banking, retail banking and wealth management.  As of December 31, 2010, we had total assets of $10.3 billion, deposits of $8.2 billion, stockholders’ equity of $1.3 billion, and $3.9 billion of client assets under administration in our Wealth Management Group (including $2.3 billion in our trust department, $598 million in our broker/dealer subsidiary, Vision Investment Services, Inc., and $1.0 billion in our majority owned asset management firm, Cedar Hill Associates LLC).

We have grown significantly in the past several years through a number of acquisitions, including the following most recent transactions.

In August 2006, we acquired Oak Brook Bank, based in Oak Brook, Illinois, and its parent, First Oak Brook Bancshares, Inc.

In April 2008, we purchased an 80% interest in Cedar Hill Associates LLC (Cedar Hill), an asset management firm located in Chicago, Illinois.

During 2009 and 2010, MB Financial Bank acquired certain assets and assumed certain liabilities of Glenwood, Illinois-based Heritage Community Bank (Heritage), Oak Forest, Illinois-based InBank, Chicago-based Corus Bank, N.A. (Corus), Aurora, Illinois-based Benchmark Bank (Benchmark), Chicago, Illinois-based New Century Bank (New Century) and Chicago, Illinois-based Broadway Bank (Broadway) in transactions facilitated by the Federal Deposit Insurance Corporation (FDIC).  For the Heritage, Benchmark, New Century and Broadway transactions, MB Financial Bank entered into loss-share agreements with the FDIC.  Under the loss-share agreements, MB Financial Bank will share in the losses on assets (loans and other real estate owned) covered under the agreements (referred to as “covered loans” and “covered other real estate owned”).  See Note 2 of the notes to our December 31, 2010 audited consolidated financial statements contained in Item 8 of this report for additional information.

MB Financial Bank, our largest subsidiary, has two wholly owned subsidiaries with significant operating activities: LaSalle Systems Leasing, Inc. and Vision Investment Services, Inc.; MB Financial Bank also has a majority owned subsidiary with significant operating activities, Cedar Hill Associates, LLC.

LaSalle Systems Leasing, Inc. (LaSalle) focuses primarily on leasing technology-related equipment to middle market and larger businesses located throughout the United States.  LBS specializes in selling and administering third party equipment maintenance contracts as well as technology-related equipment.  We acquired LaSalle in 2002.

Vision Investment Services, Inc. (Vision) is registered with the Securities and Exchange Commission as a broker/dealer, is a member of the Financial Industry Regulatory Authority, is a member of the Securities Investor Protection Corporation, and is a licensed insurance agency.  Vision has one wholly owned subsidiary: Vision Insurance Services, Inc.  Vision Insurance Services, Inc. is a licensed insurance agency which functions as a distribution firm for certain insurance and annuity products.  Vision provides both institutional and retail clients with investment and wealth management services.  It had $598 million in assets under administration at December 31, 2010.

As noted above, Cedar Hill is an asset management firm located in Chicago, Illinois that we acquired in April 2008, with approximately $1.0 billion in assets under management at December 31, 2010.

MBRE Holdings LLC, a Delaware limited liability company and a subsidiary of MB Financial Bank N.A., was established in August 2002 as the holding company of MB Real Estate Holdings LLC, which is also a Delaware limited liability company.  MB Real Estate Holdings LLC and MBRE Holdings LLC were established as part of an initiative to enhance our earnings by providing alternative methods of raising capital and funding.  On December 31, 2010, MBRE Holdings LLC and its subsidiary MB Real Estate Holdings LLC, were dissolved.
 
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We also own all of the issued and outstanding common securities of Coal City Capital Trust I, MB Financial Capital Trust II, MB Financial Capital Trust III, MB Financial Capital Trust IV, MB Financial Capital Trust V, MB Financial Capital Trust VI, FOBB Capital Trust I, and FOBB Capital Trust III, all statutory business trusts formed for the purpose of issuing trust preferred securities.  See Note 13 of the notes to our audited consolidated financial statements contain in Item 8 of this report for additional information.

Recent Developments

On January 28, 2011, the Company announced that it will pay a cash dividend of $0.01 per share to stockholders of record as of February 11, 2011.

Primary Lines of Business

Our operations are currently managed as one unit, and we have one reportable segment.  Our chief operating decision-makers use consolidated results to make operating and strategic decisions.

We concentrate on serving middle market businesses and their owners.  We also serve consumers who live or work near our branches.  We have established three primary lines of business: commercial banking; retail banking; and wealth management.  Each is described below.

Commercial Banking.  Commercial banking focuses on serving middle market businesses, primarily located in the Chicago metropolitan area.  We provide a full set of credit, deposit, and treasury management products to these companies.  In general, our credit products are designed for companies with annual revenues between $5 million and $150 million and credit needs of up to $35 million.  We have a broad range of credit products for our target market, including working capital loans and lines of credit; accounts receivable financing; inventory and equipment financing; industrial revenue bond financing; business acquisition loans; owner occupied real estate loans; and financial, performance and commercial letters of credit.  Our deposit and treasury management products are designed for companies with annual revenues up to $500 million and include: internet banking products, investment sweep accounts, zero balance accounts, automated tax payments, ATM access, telephone banking, lockbox, automated clearing house transactions, account reconciliation, controlled disbursement, detail and general information reporting, wire transfers, vault services for currency and coin, a variety of international banking services, and checking accounts.  We also provide a full set of credit, deposit and treasury management services for real estate operators and investors.

Commercial banking also serves small and medium size equipment leasing companies located throughout the United States.  We have provided banking services to these companies for more than three decades.  Competition in serving equipment lessors generally comes from large banks, finance companies, large industrial companies and some community banks.  We compete based upon rapid decision making and excellent service and by providing flexible financial solutions to meet our customers’ needs.  We provide full banking services to leasing companies by financing the debt portion of leveraged equipment leases (referred to as lease loans), providing short and long-term equity financing and by making working capital and bridge loans.  For lease loans, a lessee’s credit is often rated as investment grade for its public debt by Moody’s, Standard & Poors or the equivalent.  Whether or not a lessee has a public debt rating, they are subject to the same internal credit analysis as any other customer of MB Financial Bank.  We also invest directly in equipment that we lease to other companies located throughout the United States (referred to as operating leases).  Our operating lease portfolio is made up of various kinds of equipment, generally technology related, such as computer systems, satellite equipment, and general manufacturing equipment.  We seek leasing transactions where we believe the equipment leased is integral to the lessee’s business, thereby increasing the likelihood of renewal at the end of the lease term.

Additionally, our subsidiary LaSalle primarily focuses on leasing technology-related equipment and providing related services to middle market and larger businesses throughout the United States and provides us the additional ability to directly originate leases.
 
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Retail Banking.  Retail banking is made up of approximately 90 branch offices and 133 ATMs spread principally throughout the Chicago metropolitan area, with one branch in Philadelphia, PA.  Our target customer is the household looking for a complete suite of deposit and lending products and personal customer service that resembles that of a community bank.  Our full line of consumer deposit products consists of checking, savings, money market, time deposits and IRA accounts. Our lead product “MB Red Checking” is an account that rewards customers with a high interest rate for meeting specified account activity.   Retail banking also serves business customers (under $10 million in revenues) that desire a full business product set and the convenience of our branch network. Our business banking division offers the same business services available to our larger commercial businesses, the expertise of a business banker and the personal attention of the local branch.

All of our deposit products are supported by an array of ancillary products: “ibankmb.com” is our robust state of the art internet banking and bill payment service provided to our customers at no cost, allowing them to bank 24/7 from anywhere around the globe; “MB Debit MasterCard®”  and “MB Platinum” credit card offer purchasing power anywhere MasterCard is accepted; “My Bank, My Rewards” allows our customers to earn rewards points for all signature debit card purchases and credit card purchases, redeemable for merchandise, gift cards and travel; and e-statement, which conveniently provides  a paperless statement for our customers.  We also provide “Guard My Card”, a service in which the bank pays overdrafts caused by the customer's ATM or debit card use, up to $500 on a qualified checking account.

Wealth Management.  Our Wealth Management Group provides comprehensive wealth management solutions to individuals, corporations and not-for-profits.  We provide banking, investment management, custody, personal trust, financial planning and wealth advisory services to high net worth individuals through our Private Bankers, Asset Management and Trust Advisors and Cedar Hill.  Estate settlement, guardianship, tax deferred exchange services and retirement plan services are provided through the Trust Department.  Financial Advisors from Vision Investments work through our branches offering a wide variety of financial products and services to our retail customers.  MB Financial Bank subsidiaries Cedar Hill and Vision provide clients with non-FDIC insured investment alternatives and/or insurance products.

Lending Activities

General.  We are primarily a commercial lender and our loan portfolio consists primarily of loans to businesses or for business purposes.

Commercial Lending.  We make commercial loans mainly to middle market businesses, most often located in the Chicago area.  Borrowers tend to be privately owned and are generally manufacturers, wholesalers, distributors, long-term health care operators and service providers.  Loan products offered are primarily working capital and term loans and lines of credit that help our customers finance accounts receivable, inventory and equipment.  We also offer financial, performance and commercial letters of credit.  Commercial loans secured by owner occupied real estate are classified as commercial real estate loans in the loan portfolio composition table in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 6 to the audited consolidated financial statements in “Item 8. Financial Statements and Supplementary Data”.  Most commercial loans are short-term in nature, being one year or less, with the maximum term generally being five years.  Our commercial loans typically range in size from $500 thousand to $15 million.

Lines of credit for customers are typically secured, and are subject to renewal upon a satisfactory review of the borrower’s financial condition and credit history.  Secured short-term commercial business loans are usually collateralized by accounts receivable, inventory, equipment and/or real estate.  Such loans are typically, but not always, guaranteed by the owners of the business.  Collateral securing commercial loans may depreciate over time, be difficult to appraise and fluctuate in value based on the success of the business.  In addition, in the case of loans secured by accounts receivable, the availability of funds for repayment and economic conditions may impact the ability of the borrower to collect the amounts due from its customers.  Accordingly, we make our commercial loans primarily based on the historical and expected cash flow of the borrower, secondarily on underlying collateral provided by the borrower, and lastly on guarantor support.

Commercial Real Estate Lending.  We originate commercial real estate loans that are generally secured by multi-unit residential property and owner and non-owner occupied commercial and industrial property.  Longer term commercial real estate loans are generally made at fixed rates, although some have interest rates that change based on the Prime Rate or LIBOR.  Generally, terms of up to twenty-five years are offered on fully amortizing loans, but most loans are structured with a balloon payment at the end of five years or less.  For our fixed rate loans with maturities greater than five years, we may enter into an interest rate swap agreement with a third party to mitigate interest rate risk.  In deciding whether to make a commercial real estate loan, we consider, among other things, the experience and qualifications of the borrower as well as the value and cash flow of the underlying property.  Some factors considered are net operating income of the property before debt service and depreciation, the debt service coverage ratio (the ratio of the property’s net cash flow to debt service requirements), the global cash flows of the borrower, the ratio of the loan amount to the appraised value and the overall creditworthiness of the prospective borrower.  Our commercial real estate loans typically range in size from $250 thousand to $20 million.
 
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The repayment of commercial real estate loans is often dependent on the successful operations of the property securing the loan or the business conducted on the property securing the loan.  These loans may therefore be more adversely affected by conditions in real estate markets or in the economy in general.  For example, if the cash flow from the borrower’s project is reduced due to leases not being obtained or renewed, the borrower’s ability to repay a loan may be impaired.  In addition, many commercial real estate loans are not fully amortized over the loan period, but have balloon payments due at maturity.  A borrower’s ability to make a balloon payment typically will depend on their ability to either refinance the loan or complete a timely sale of the underlying property.

Construction Real Estate.  Historically we have provided construction loans for the acquisition and development of land and construction of condominiums, townhomes, and one-to-four family residences.  We have also provided acquisition, development and construction loans for retail and other commercial purposes, primarily in our market areas.  With regard to construction lending, there were fewer new loans made during 2010, 2009 and 2008 compared to prior years due to the unfavorable economic environment for new home sales and commercial properties.  Construction lending can involve a higher level of risk than other types of lending because funds are advanced partially based upon the value of the project, which is uncertain prior to the project’s completion.  Because of the uncertainties inherent in estimating construction costs as well as the market value of a completed project and the effects of governmental regulation of real property, our estimates with regards to the total funds required to complete a project and the related loan-to-value ratio may vary from actual results.  As a result, construction loans often involve the disbursement of substantial funds with repayment dependent, in part, on the success of the ultimate project and the ability of the borrower to sell or lease the property or refinance the indebtedness.  If our estimate of the value of a project at completion proves to be overstated or market values have declined since we originated our loan, we may have inadequate security for repayment of the loan and we may incur a loss.

Lease Loans.  We lend money to leasing companies to finance the debt portion of leases (which we refer to as lease loans).  A lease loan arises when a leasing company discounts the equipment rental revenue stream owed to the leasing company by a lessee.  Lease loans generally are non-recourse to the leasing company, and, consequently, our recourse is limited to the lessee and the leased equipment.  For this reason, we underwrite lease loans by examining the creditworthiness of the lessee rather than the lessor.  Generally, lease loans are secured by an assignment of lease payments and a security interest in the equipment being leased.  As with commercial loans secured by equipment, equipment securing our lease loans may depreciate over time, may be difficult to appraise and may fluctuate in value.  We rely on the lessee’s continuing financial stability, rather than the value of the leased equipment, for repayment of all required amounts under lease loans.  In the event of default, it is unlikely that the proceeds from the sale of leased equipment will be sufficient to satisfy the outstanding unpaid amounts under terms of the lease loan.

The lessee acknowledges our security interest in the leased equipment and normally agrees to send lease payments directly to us.  Lessees tend to be companies that have an investment grade public debt rating by Moody’s or Standard & Poors or the equivalent, though, we also provide credit to below investment grade and non-rated companies.  Whether or not a lessee has a public debt rating, they are subject to the same internal credit analysis as any other customer.  Lease loans almost always are fully amortizing, with maturities typically ranging from three to five years.  Loan interest rates are fixed.

We also invest directly in equipment leased to other companies (which we refer to as operating leases).  The profitability of these investments depends, to a great degree, upon our ability to realize the expected residual values of this equipment.  See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations-Critical Accounting Policies-Residual Value of Our Direct Finance, Leveraged and Operating Leases.”
 
Residential Real Estate.  We originate fixed and adjustable rate residential real estate loans secured by one to four family homes.  Terms of first mortgages range from five to thirty years.  In deciding whether to make a residential real estate loan, we consider the qualifications of the borrower as well as the value of the underlying property.  Our general practice is to sell the majority of our newly originated fixed-rate residential real estate loans and to hold in portfolio some adjustable rate residential real estate loans.  On a limited basis we hold loans with 15 and 30 year maturities.
 
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Consumer Lending.  Our consumer loan portfolio is primarily focused on home equity lines of credit, fixed-rate second mortgage loans, indirect vehicle loans, and to a lesser extent, secured and unsecured consumer loans.  Home equity lines of credit are generally extended up to 80% of the appraised value of the property, less existing liens.  Indirect vehicle loans represent consumer loans made primarily through a network of motorcycle dealers in 46 states.  Consumer loans typically have shorter terms and lower balances with higher yields as compared to residential real estate loans, but carry a higher risk of default.  Terms for second mortgages typically range from five to ten years.  Consumer loan collections are dependent on the borrower’s continuing financial stability, and thus, are more likely to be affected by adverse personal circumstances.  Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount which can be recovered on these loans.

Foreign Operations

MB Financial Bank held certain commercial real estate loans, residential real estate loans, other loans and mortgage-backed investment securities in a real estate investment trust through a wholly owned subsidiary MBRE Holdings LLC, headquartered and domiciled in Freeport, The Bahamas.  MBRE Holdings LLC and its subsidiary, MB Real Estate Holdings LLC, were both dissolved effective December 31, 2010 and their assets were absorbed by MB Financial Bank.  We have not engaged in operations in any other foreign countries.

Competition

We face substantial competition in all phases of our operations, including deposit gathering and loan origination, from a variety of competitors.  Commercial banks, savings institutions, brokerage firms, credit unions, mutual fund companies, asset management firms,  insurance companies and specialty finance companies all compete with us for new and existing customers.  Our bank competes by providing quality services to our customers, ease of access to our facilities, convenient hours and competitive pricing of services (including interest rates paid on deposits, interest rates charged on loans and fees charged for other non-interest related services).

Personnel

As of December 31, 2010, we and our subsidiaries employed a total of 1,703 full-time equivalent employees.  We consider our relationship with our employees to be good.

Supervision and Regulation

We, our subsidiary bank, and its subsidiaries, are subject to an extensive system of laws and regulations that are intended primarily for the protection of customers and depositors and not for the protection of security holders.  These laws and regulations govern such areas as capital, permissible activities, allowance for loan losses, loans and investments, and rates of interest that can be charged on loans.  Described below are elements of selected laws and regulations.  The descriptions are not intended to be complete and are qualified in their entirety by reference to the full text of the statutes and regulations described.

Holding Company Regulation. As a bank holding company and financial holding company, we are subject to comprehensive regulation by the Board of Governors of the Federal Reserve System, frequently referred to as the Federal Reserve Board, under the Bank Holding Company Act of 1956, as amended by the Gramm-Leach-Bliley Act of 1999 (the “Gramm-Leach-Bliley Act”), and by the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), enacted on July 21, 2010.  We must file reports with the Federal Reserve Board and such additional information as the Federal Reserve Board may require, and our holding company and non-banking affiliates are subject to examination by the Federal Reserve Board.  Under Federal Reserve Board policy, a bank holding company must serve as a source of strength for its subsidiary banks.  Under this policy, the Federal Reserve Board may require, and has required in the past, a holding company to contribute additional capital to an undercapitalized subsidiary bank.  The Bank Holding Company Act provides that a bank holding company must obtain Federal Reserve Board approval before:

·  
Acquiring directly or indirectly, ownership or control of any voting shares of another bank or bank holding company if, after such acquisition, it would own or control more than 5% of such shares (unless it already owns or controls the majority of such shares);

·  
Acquiring all or substantially all of the assets of another bank or bank holding company, or

·  
Merging or consolidating with another bank holding company.
 
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The Bank Holding Company Act generally prohibits a bank holding company from acquiring direct or indirect ownership or control of more than 5% of the voting shares of any company which is not a bank or bank holding company, or from engaging directly or indirectly in activities other than those of banking, managing or controlling banks, or providing services for its subsidiaries.  The principal exceptions to these prohibitions involve certain non-bank activities which, by statute or by Federal Reserve Board regulation or order, have been identified as activities closely related to the business of banking or managing or controlling banks.  The list of activities permitted by the Federal Reserve Board includes, among other things: lending; operating a savings institution, mortgage company, finance company, credit card company or factoring company; performing certain data processing operations; providing certain investment and financial advice; underwriting and acting as an insurance agent for certain types of credit-related insurance; leasing property on a full-payout, non-operating basis; selling money orders, travelers’ checks and United States Savings Bonds; real estate and personal property appraising; providing tax planning and preparation services; and, subject to certain limitations, providing securities brokerage services for customers.  These activities may also be affected by federal legislation.

The Gramm-Leach-Bliley Act amended portions of the Bank Holding Company Act of 1956 to authorize bank holding companies, such as us, directly or through non-bank subsidiaries to engage in securities, insurance and other activities that are financial in nature or incidental to a financial activity.  In order to undertake these activities, a bank holding company must become a "financial holding company" by submitting to the appropriate Federal Reserve Bank a declaration that the company elects to be a financial holding company and a certification that all of the depository institutions controlled by the company are well capitalized and well managed.  We submitted the declaration of our election to become a financial holding company with the Federal Reserve Bank of Chicago in June 2002, and our election became effective in July 2002.

Depository Institution Regulation. Our bank subsidiary is subject to regulation by the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation.  This regulatory structure includes:

·  
Real estate lending standards, which provide guidelines concerning loan-to-value ratios for various types of real estate loans;

·  
Risk-based capital rules, including accounting for interest rate risk, concentration of credit risk and the risks posed by non-traditional activities;

·  
Rules requiring depository institutions to develop and implement internal procedures to evaluate and control credit and settlement exposure to their correspondent banks;

·  
Rules restricting types and amounts of equity investments; and

·  
Rules addressing various safety and soundness issues, including operations and managerial standards, standards for asset quality, earnings and compensation standards.

Capital Adequacy.  The Federal Reserve Board, Office of the Comptroller of the Currency and Federal Deposit Insurance Corporation have issued substantially similar risk-based and leverage capital guidelines applicable to bank holding companies and banks.  In addition, these regulatory agencies may from time to time require that a bank holding company or bank maintain capital above the minimum levels, based on its financial condition or actual or anticipated growth.

The Federal Reserve Board's risk-based guidelines establish a two-tier capital framework.  Tier 1 capital generally consists of common stockholders' equity, retained earnings, a limited amount of qualifying perpetual preferred stock, qualifying trust preferred securities and noncontrolling interests in the equity accounts of consolidated subsidiaries, less goodwill and certain intangibles.  Tier 2 capital generally consists of certain hybrid capital instruments and perpetual debt, mandatory convertible debt securities and a limited amount of subordinated debt, qualifying preferred stock, loan loss allowance, and unrealized holding gains on certain equity securities.  The sum of Tier 1 and Tier 2 capital represents qualifying total capital, at least 50% of which must consist of Tier 1 capital.
 
Risk-based capital ratios are calculated by dividing Tier 1 and total capital by risk-weighted assets.  Assets and off-balance sheet exposures are assigned to one of four categories of risk-weights, based primarily on relative credit risk.  For bank holding companies, generally the minimum Tier 1 risk-based capital ratio is 4% and the minimum total risk-based capital ratio is 8%.  Our Tier 1 and total risk-based capital ratios under these guidelines at December 31, 2010 were 15.75% and 17.75%, respectively.
 
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The Federal Reserve Board’s leverage capital guidelines establish a minimum leverage ratio determined by dividing Tier 1 capital by adjusted average total assets.  The minimum leverage ratio is 3% for bank holding companies that meet certain specified criteria, including having the highest regulatory rating.  All other bank holding companies generally are required to maintain a leverage ratio of at least 4%.  At December 31, 2010, we had a leverage ratio of 10.66%.

The federal regulatory authorities’ risk-based capital guidelines are based upon the 1988 capital accord (“Basel I”) of the Basel Committee on Banking Supervision (the “Basel Committee”).  The Basel Committee is a committee of central banks and bank supervisors/regulators from the major industrialized countries that develops broad policy guidelines for use by each country’s supervisors in determining the supervisory policies and regulations to which they apply.  Actions of the Committee have no direct effect on banks in participating countries.  In 2004, the Basel Committee published a new capital accord (“Basel II”) to replace Basel I.  Basel II provides two approaches for setting capital standards for credit risk – an internal ratings-based approach tailored to individual institutions’ circumstances and a standardized approach that bases risk weightings on external credit assessments to a much greater extent than permitted in existing risk-based capital guidelines.  Basel II also would set capital requirements for operational risk and refine the existing capital requirements for market risk exposures.

A final rule implementing the advanced approaches of Basel II in the United States would apply only to certain large or internationally active banking organizations, or “core banks” – defined as those with consolidated total assets of $250 billion or more or consolidated on-balance sheet foreign exposures of $10 billion or more, became effective as of April 1, 2008.  Certain other U.S. banking organizations would have the option to adopt the requirements of this rule.  The Company is not required to comply with the advanced approaches of Basel II.

In July 2008, the agencies issued a proposed rule that would give banking organizations that do not use the advanced approaches the option to implement a new risk-based capital framework that generally parallels the relevant approaches under Basel II, but recognizes that United States markets have unique characteristics and risk profiles, most notably with respect to risk weighting residential mortgage exposures. To date, no final rule has been adopted.

In 2009, the United States Treasury Department issued a policy statement (the “Treasury Policy Statement”) entitled “Principles for Reforming the U.S. and International Regulatory Capital Framework for Banking Firms,” which contemplates changes to the existing regulatory capital regime involving substantial revisions to major parts of the Basel I and Basel II capital frameworks and affecting all regulated banking organizations and other systemically important institutions.  The Treasury Policy Statement calls for, among other things, higher and stronger capital requirements for all banking firms, with changes to the regulatory capital framework to be phased in over a period of several years.

On December 17, 2009, the Basel Committee issued a set of proposals (the “2009 Capital Proposals”) that would significantly revise the definitions of Tier 1 capital and Tier 2 capital.  Among other things, the 2009 Capital Proposals would re-emphasize that common equity is the predominant component of Tier 1 capital.  Concurrently with the release of the 2009 Capital Proposals, the Basel Committee also released a set of proposals related to liquidity risk exposure (the “2009 Liquidity Proposals”).  The 2009 Liquidity Proposals include the implementation of (i) a “liquidity coverage ratio” or LCR, designed to ensure that a bank maintains an adequate level of unencumbered, high-quality assets sufficient to meet the bank’s liquidity needs over a 30-day time horizon under an acute liquidity stress scenario and (ii) a “net stable funding ratio” or NSFR, designed to promote more medium and long-term funding of the assets and activities of banks over a one-year time horizon.

The Dodd-Frank Act includes certain provisions concerning the capital regulations of the United States banking regulators, which are often referred to as the “Collins Amendment.”  These provisions are intended to subject bank holding companies to the same capital requirements as their bank subsidiaries and to eliminate or significantly reduce the use of hybrid capital instruments, especially trust preferred securities, as regulatory capital. Under the Collins Amendment, trust preferred securities issued by a company, such as our company, with total consolidated assets of less than $15 billion before May 19, 2010 and treated as regulatory capital are grandfathered, but any such securities issued later are not eligible as regulatory capital.  The banking regulators must develop regulations setting minimum risk-based and leverage capital requirements for holding companies and banks on a consolidated basis that are no less stringent than the generally applicable requirements in effect for depository institutions under the prompt corrective action regulations discussed below.  The banking regulators also must seek to make capital standards countercyclical so that the required levels of capital increase in times of economic expansion and decrease in times of economic contraction.  The Act requires these new capital regulations to be adopted by the Federal Reserve in final form 18 months after the date of enactment of the Dodd-Frank Act (July 21, 2010).  To date, no proposed regulations have been issued.
 
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In December 2010 and January 2011, the Basel Committee published the final texts of reforms on capital and liquidity generally referred to as “Basel III.”  Although Basel III is intended to be implemented by participating countries for large, internationally active banks, its provisions are likely to be considered by United States banking regulators in developing new regulations applicable to other banks in the United States, including MB Financial Bank.

For banks in the United States, among the most significant provisions of Basel III concerning capital are the following:

·  
A minimum ratio of common equity to risk-weighted assets reaching 4.5%, plus an additional 2.5% as a capital conservation buffer, by 2019 after a phase-in period.
·  
A minimum ratio of Tier 1 capital to risk-weighted assets reaching 6.0% by 2019 after a phase-in period.
·  
A minimum ratio of total capital to risk-weighted assets, plus the additional 2.5% capital conservation buffer, reaching 10.5% by 2019 after a phase -in period.
·  
An additional countercyclical capital buffer to be imposed by applicable national banking regulators periodically at their discretion, with advance notice.
·  
Restrictions on capital distributions and discretionary bonuses applicable when capital ratios fall within the buffer zone.
·  
Deduction from common equity of deferred tax assets that depend on future profitability to be realized.
·  
Increased capital requirements for counterparty credit risk relating to OTC derivatives, repos and securities financing activities.
·  
For capital instruments issued on or after January 13, 2013 (other than common equity), a loss-absorbency requirement such that the instrument must be written off or converted to common equity if a trigger event occurs, either pursuant to applicable law or at the direction of the banking regulator.  A trigger event is an event under which the banking entity would become nonviable without the write-off or conversion, or without an injection of capital from the public sector.   The issuer must maintain authorization to issue the requisite shares of common equity if conversion were required.

The Basel III provisions on liquidity include complex criteria establishing the LCR and NSFR.  The purpose of the LCR is to ensure that a bank maintains adequate unencumbered, high quality liquid assets to meet its liquidity needs for 30 days under a severe liquidity stress scenario.  The purpose of the NSFR is to promote more medium and long-term funding of assets and activities, using a one-year horizon.  Although Basel III is described as a “final text,” it is subject to the resolution of certain issues and to further guidance and modification, as well as to adoption by United States banking regulators, including decisions as to whether and to what extent it will apply to United States banks that are not large, internationally active banks.

Prompt Corrective Action.  The Federal Deposit Insurance Corporation Improvement Act of 1991, among other things, identifies five capital categories for insured depository institutions (well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized) and requires the respective federal bank regulatory agencies to implement systems for "prompt corrective action" for insured depository institutions that do not meet minimum capital requirements within these categories.  This act imposes progressively more restrictive constraints on operations, management and capital distributions, depending on the category in which an institution is classified.  Failure to meet the capital guidelines could also subject a banking institution to capital raising requirements.  An "undercapitalized" bank must develop a capital restoration plan and its parent holding company must guarantee that bank's compliance with the plan.  The liability of the parent holding company under any such guarantee is limited to the lesser of five percent of the bank's assets at the time it became "undercapitalized" or the amount needed to comply with the plan.  Furthermore, in the event of the bankruptcy of the parent holding company, such guarantee would take priority over the parent's general unsecured creditors.  In addition, the Federal Deposit Insurance Corporation Improvement Act requires the various regulatory agencies to prescribe certain non-capital standards for safety and soundness relating generally to operations and management, asset quality and executive compensation and permits regulatory action against a financial institution that does not meet these standards.

The various federal bank regulatory agencies have adopted substantially similar regulations that define the five capital categories identified by the Federal Deposit Insurance Corporation Improvement Act, using the total risk-based capital, Tier 1 risk-based capital and leverage capital ratios as the relevant capital measures.  These regulations establish various degrees of corrective action to be taken when an institution is considered undercapitalized.  Under the regulations, a "well capitalized" institution must have a Tier 1 risk-based capital ratio of at least 6%, a total risk-based capital ratio of at least 10% and a leverage ratio of at least 5% and not be subject to a capital directive or order.  An institution is "adequately capitalized" if it has a Tier 1 risk-based capital ratio of at least 4%, a total risk-based capital ratio of at least 8% and a leverage ratio of at least 4% (3% in certain circumstances).  An institution is “undercapitalized” if it has a Tier 1 risk-based capital ratio of less than 4%, a total risk-based capital ratio of less than 8% or a leverage ratio of less than 4% (3% in certain circumstances).  An institution is "significantly undercapitalized" if it has a Tier 1 risk-based capital ratio of less than 3%, a total risk-based capital ratio of less than 6% or a leverage ratio of less than 3%.  An institution is "critically undercapitalized" if its tangible equity is equal to or less than 2% of total assets.  Generally, an institution may be reclassified in a lower capitalization category if it is determined that the institution is in an unsafe or unsound condition or engaged in an unsafe or unsound practice.

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As of December 31, 2010, our subsidiary bank met the requirements to be classified as “well-capitalized.”

Dividends.  The Federal Reserve Board's policy is that a bank holding company should pay cash dividends only to the extent that its net income for the past year is sufficient to cover both the cash dividends and a rate of earnings retention that is consistent with the holding company's capital needs, asset quality and overall financial condition, and that it is inappropriate for a bank holding company experiencing serious financial problems to borrow funds to pay dividends.  Furthermore, a bank that is classified under the prompt corrective action regulations as "undercapitalized" will be prohibited from paying any dividends.

On December 5, 2008, as part of the Troubled Asset Relief Program (TARP) Capital Purchase Program of the United States Department of the Treasury (Treasury), the Company sold to Treasury 196,000 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A (the “Series A Preferred Stock”), having a liquidation preference amount of $1,000 per share, for a purchase price of $196.0 million in cash and (ii) issued to Treasury a ten-year warrant to purchase 1,012,048 shares (which was subsequently reduced to 506,024 shares, as explained below) of the Company’s common stock  at an exercise price of $29.05 per share (the “Warrant”).

The Company may redeem the Series A Preferred Stock at any time by repaying Treasury, without penalty, subject to Treasury’s consultation with the Company’s appropriate regulatory agency.  Additionally, upon redemption of the Series A Preferred Stock, the Warrant may be repurchased from the Treasury at its fair market value as agreed-upon by the Company and Treasury.

On September 17, 2009, the Company completed a public offering of its common stock by issuing 12,578,125 shares of common stock for aggregate gross proceeds of $201.3 million.  The net proceeds to the Company after deducting underwriting discounts and commissions and offering expenses were $190.9 million.  With the proceeds from this offering and the proceeds received by the Company from issuances pursuant to its Dividend Reinvestment and Stock Purchase Plan, the Company has received aggregate gross proceeds from “Qualified Equity Offerings” in excess of the $196.0 million aggregate liquidation preference amount of the Series A Preferred Stock.  As a result, the number of shares of the Company’s common stock underlying the Warrant has been reduced by 50%, from 1,012,048 shares to 506,024 shares.

The securities purchase agreement between us and Treasury provides that prior to the earlier of (i) December 5, 2011 and (ii) the date on which all of the shares of the Series A Preferred Stock have been redeemed by us or transferred by Treasury to third parties, we may not, without the consent of Treasury, (a) pay a quarterly cash dividend on our common stock of more than $0.18 per share or (b) subject to limited exceptions, redeem, repurchase or otherwise acquire shares of our common stock, preferred stock (other than the Series A Preferred Stock) or trust preferred securities.  In addition, under the terms of the Series A Preferred Stock, we may not pay dividends on our common stock at any time we are in arrears on the dividends payable on the Series A Preferred Stock.  Dividends on the Series A Preferred Stock are payable quarterly at a rate of 5% per annum for the first five years and a rate of 9% per annum thereafter if not redeemed prior to that time.

Our primary source for cash dividends is the dividends we receive from our subsidiary bank.  Our bank is subject to various regulatory policies and requirements relating to the payment of dividends, including requirements to maintain capital above regulatory minimums.  A national bank must obtain the approval of the Office of the Comptroller of the Currency prior to paying a dividend if the total of all dividends declared by the national bank in any calendar year will exceed the sum of the bank’s net profits for that year and its retained net profits for the preceding two calendar years, less any required transfers to surplus.
 
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Federal Deposit Insurance Reform.  The FDIC currently maintains the Deposit Insurance Fund (the “DIF”), which was created in 2006 in the merger of the Bank Insurance Fund and the Savings Association Insurance Fund.  The deposit accounts of our subsidiary bank are insured by the DIF to the maximum amount provided by law.  This insurance is backed by the full faith and credit of the United States Government.

As insurer, the FDIC is authorized to conduct examinations of and to require reporting by DIF-insured institutions.  It also may prohibit any DIF-insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious threat to the DIF.  The FDIC also has the authority to take enforcement actions against insured institutions.

Under its current regulations, the FDIC imposes assessments for deposit insurance on an insured institution quarterly according to its ranking in one of four risk categories based upon supervisory and capital evaluations. The assessment rate for an individual institution is determined according to a formula based on a weighted average of the institution’s individual CAMELS component ratings plus either six financial ratios or, in the case of an institution with assets of $10.0 billion or more, the average ratings of its long-term debt. Well-capitalized institutions (generally those with CAMELS composite ratings of 1 or 2) are grouped in Risk Category I and their initial base assessment rate for deposit insurance is set at an annual rate of between 12 and 16 basis points. The initial base assessment rate for institutions in Risk Categories II, III and IV is set at annual rates of 22, 32 and 50 basis points, respectively. These initial base assessment rates are adjusted to determine an institution’s final assessment rate based on its brokered deposits, secured liabilities and unsecured debt. The adjustments include higher premiums for institutions that rely significantly on excessive amounts of brokered deposits, including CDARS, higher premiums for excessive use of secured liabilities, including Federal Home Loan Bank advances and adding financial ratios and debt issuer ratings to the premium calculations for banks with over $10 billion in assets, while providing a reduction for all institutions for their unsecured debt.  Total base assessment rates after adjustments range from 7 to 24 basis points for Risk Category I, 17 to 43 basis points for Risk Category II, 27 to 58 basis points for Risk Category III, and 40 to 77.5 basis points for Risk Category IV.

In addition, all institutions with deposits insured by the FDIC are required to pay assessments to fund interest payments on bonds issued by the Financing Corporation, a mixed-ownership government corporation established to recapitalize a predecessor to the Deposit Insurance Fund.  These assessments will continue until the Financing Corporation bonds mature in 2019.

Insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged or is engaging in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC or written agreement entered into with the FDIC. The management of the Bank does not know of any practice, condition or violation that might lead to termination of deposit insurance.

On November 12, 2009, the FDIC adopted regulations that required insured depository institutions to prepay on December 30, 2009, their estimated quarterly risk-based assessments for the fourth quarter of 2009 and all of 2010, 2011 and 2012, along with their quarterly risk-based assessment for the fourth quarter of 2009. The FDIC collected MB Financial Bank’s pre-paid assessments amounting to $45.0 million on December 30, 2009.

Pursuant to the Dodd-Frank Act, the FDIC has established 2.0% as the designated reserve ratio (DRR), that is, the ratio of the DIF to insured deposits. The FDIC has adopted a plan under which it will meet the statutory minimum DRR of 1.35% by September 30, 2020, the deadline imposed by the Dodd-Frank Act.  The Dodd-Frank requires the FDIC to offset the effect on institutions with assets less than $10 billion of the increase in the statutory minimum DRR to 1.35% from the former statutory minimum of 1.15%.  The FDIC has not yet announced how it will implement this offset or how larger institutions will be affected by it.

The Dodd-Frank Act requires the FDIC to establish rules setting insurance premium assessments based on an institution's total assets minus its tangible equity instead of its deposits. The FDIC has adopted regulations under which, effective for assessments for the second quarter of 2011 and payable at the end of September 2011, a bank that has had total assets of $10 billion or more for four consecutive quarters will be assessed quarterly for deposit insurance under a scorecard method. The scorecard method uses a performance score and a loss severity score, which are combined and converted into an initial base assessment rate.  The performance score is based on measures of the bank's ability to withstand asset-related stress and funding-related stress and weighted CAMELS rating. The loss severity score is a measure of potential losses to the FDIC in the event of the bank's failure. Under a formula, the performance score and loss severity score are combined and converted to a total score that determines the bank's initial base assessment rate. The FDIC has the discretion to alter the total score based on factors not captured by the scorecard.  The resulting initial base assessment rate would be subject to adjustments downward based on long term unsecured debt issued by the bank, to adjustment upward based on long term unsecured debt held by the bank that is issued by other FDIC-insured institutions, and to further adjustment upward if the bank's brokered deposits exceed 10% of its domestic deposits.  Modifications to the scorecard method may apply to certain "highly complex institutions."  MB Financial Bank will not be regarded as a "highly complex institution."
 
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On November 9, 2010 and January 18, 2011, the FDIC (as mandated by Section 343 of the “Dodd-Frank Wall Street Reform and Consumer Protection Act,” as described below) adopted rules providing for unlimited deposit insurance for traditional noninterest-bearing transaction accounts and IOLTA accounts for two years starting December 31, 2010.  This coverage applies to all insured deposit institutions, and there is no separate FDIC assessment for the insurance.  Furthermore, this unlimited coverage is separate from, and in addition to, the coverage provided to depositors with respect to other accounts held at an insured depository institution.

Transactions with Affiliates.  We and our subsidiary bank are affiliates within the meaning of the Federal Reserve Act.  The Federal Reserve Act imposes limitations on a bank with respect to extensions of credit to, investments in, and certain other transactions with, its parent bank holding company and the holding company’s other subsidiaries.  Furthermore, bank loans and extensions of credit to affiliates also are subject to various collateral requirements.

Community Reinvestment Act.  Under the Community Reinvestment Act, every FDIC-insured institution is obligated, consistent with safe and sound banking practices, to help meet the credit needs of its entire community, including low and moderate income neighborhoods.  The Community Reinvestment Act requires the appropriate federal banking regulator, in connection with the examination of an insured institution, to assess the institution’s record of meeting the credit needs of its community and to consider this record in its evaluation of certain applications, such as a merger or the establishment of a branch.  An unsatisfactory rating may be used as the basis for the denial of an application and will prevent a bank holding company of the institution from making an election to become a financial holding company.

As of its last examination, MB Financial Bank received a Community Reinvestment Act rating of “outstanding.”

Interstate Banking and Branching.  The Federal Reserve Board may approve an application of a bank holding company to acquire control of, or acquire all or substantially all of the assets of, a bank located in a state other than the bank holding company's home state, without regard to whether the transaction is prohibited by the laws of any state.  The Federal Reserve Board may not approve the acquisition of a bank that has not been in existence for the minimum time period (not exceeding five years) specified by the law of the target bank’s home state.  The Federal Reserve Board also may not approve an application if the bank holding company (and its bank affiliates) controls or would control more than ten percent of the insured deposits in the United States or, generally, 30% or more of the deposits in the target bank's home state or in any state in which the target bank maintains a branch.  Individual states may waive the 30% statewide concentration limit.  Each state may limit the percentage of total insured deposits in the state that may be held or controlled by a bank or bank holding company to the extent the limitation does not discriminate against out-of-state banks or bank holding companies.  Under the Dodd-Frank Act, the OCC may generally approve de novo branching by a national bank outside its home state.

The federal banking agencies are authorized to approve interstate bank merger transactions without regard to whether these transactions are prohibited by the law of any state, unless the home state of one of the banks opted out of interstate mergers prior to June 1, 1997.  Interstate acquisitions of branches are permitted only if the law of the state in which the branch is located permits these acquisitions.  Interstate mergers and branch acquisitions are subject to the nationwide and statewide-insured deposit concentration limits described above.

Privacy Rules.  Federal banking regulators, as required under the Gramm-Leach-Bliley Act, have adopted rules limiting the ability of banks and other financial institutions to disclose nonpublic information about consumers to non-affiliated third parties.  The rules require disclosure of privacy policies to consumers and, in some circumstances, allow consumers to prevent disclosure of certain personal information to non-affiliated third parties.  The privacy provisions of the Gramm-Leach-Bliley Act affect how consumer information is transmitted through diversified financial services companies and conveyed to outside vendors.
 
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International Money Laundering Abatement and Financial Anti-Terrorism Act of 2001.  The President signed the USA Patriot Act of 2001 into law in October 2001.  This act contains the International Money Laundering Abatement and Financial Anti-Terrorism Act of 2001 (the “IMLAFA”).  The IMLAFA substantially broadens existing anti-money laundering legislation and the extraterritorial jurisdiction of the United States, imposes new compliance and due diligence obligations, creates new crimes and penalties, compels the production of documents located both inside and outside the United States, including those of foreign institutions that have a correspondent relationship in the United States, and clarifies the safe harbor from civil liability to customers.  The U.S. Treasury Department has issued a number of regulations implementing the USA Patriot Act that apply certain of its requirements to financial institutions such as our banking and broker-dealer subsidiaries.  The regulations impose obligations on financial institutions to maintain appropriate policies, procedures and controls to detect, prevent and report money laundering and terrorist financing.  The increased obligations of financial institutions, including us, to identify their customers, watch for and report suspicious transactions, respond to requests for information by regulatory authorities and law enforcement agencies, and share information with other financial institutions, requires the implementation and maintenance of internal procedures, practices and controls which have increased, and may continue to increase, our costs and may subject us to liability.

As noted above, enforcement and compliance-related activity by government agencies has increased. Money laundering and anti-terrorism compliance is among the areas receiving a high level of focus in the present environment.

Regulatory Reform.  On July 21 2010, the Dodd-Frank Act was signed into law. The Dodd-Frank Act (as amended) implements far-reaching changes across the financial regulatory landscape, including provisions that, among other things, will:

·  
Centralize responsibility for consumer financial protection by creating a new agency, the Bureau of Consumer Financial Protection, with broad rulemaking, supervision and enforcement authority for a wide range of consumer protection laws that would apply to all banks and certain others, including the examination and enforcement powers with respect to any bank with more than $10 billion in assets, such as MB Financial Bank, and its affiliates.
·  
Restrict the preemption of state consumer financial protection law by federal law and disallow subsidiaries and affiliates of national banks, such as MB Financial Bank, from availing themselves of such preemption.
·  
Require new capital rules and apply the same leverage and risk-based capital requirements that apply to insured depository institutions to most bank holding companies.
·  
Require the Office of the Comptroller of the Currency to seek to make its capital requirements for national banks, such as MB Financial Bank, countercyclical so that capital requirements increase in times of economic expansion and decrease in times of economic contraction.
·  
Require publicly-traded bank holding companies with assets of $10 billion or more, such as the Company, to establish a risk committee responsible for enterprise-wide risk management practices.
·  
Change the assessment base for federal deposit insurance from the amount of insured deposits to consolidated average assets less tangible capital.
·  
Increase the minimum ratio of net worth to insured deposits of the Deposit Insurance Fund from 1.15% to 1.35% and require the FDIC, in setting assessments, to offset the effect of the increase on institutions with assets of less than $10 billion.  As a result, this increase is generally expected to impose more deposit insurance cost on institutions with assets of $10 billion or more.
·  
Provide for new disclosure and other requirements relating to executive compensation and corporate governance, including guidelines or regulations on incentive-based compensation and a prohibition on compensation arrangements that encourage inappropriate risks or that could provide excessive compensation.
·  
Make permanent the $250 thousand limit for federal deposit insurance and provide unlimited federal deposit insurance until January 1, 2013 for non-interest bearing demand transaction accounts and IOLTA accounts at all insured depository institutions.
·  
Repeal the federal prohibitions on the payment of interest on demand deposits, thereby permitting depository institutions to pay interest on business transaction and other accounts.
·  
Allow de novo interstate branching by banks.
 
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·  
Give the Federal Reserve Board the authority to establish rules regarding interchange fees charged for electronic debit transactions by payment card issuers, such as MB Financial Bank, having assets over $10 billion and to enforce a new statutory requirement that such fees be reasonable and proportional to the actual cost of a transaction to the issuer.  The Federal Reserve Board has proposed rules under this provision that would limit the swipe fees that a debit card issuer can charge merchants to seven to 12 cents per transaction, subject to an undetermined adjustment for fraud prevention costs.  Final regulations are due nine months after enactment of the Dodd-Frank Act.
·  
Increase the authority of the Federal Reserve Board to examine the Company and its non-bank subsidiaries.
·  
Require all bank holding companies to serve as a source of financial strength to their depository institution subsidiaries in the event such subsidiaries suffer from financial distress.
·  
Restrict proprietary trading by banks, bank holding companies and others, and their acquisition and retention of ownership interests in and sponsorship of hedge funds and private equity funds.  This restriction is commonly referred to as the “Volcker Rule.”  There is an exception in the Volcker Rule to allow a bank to organize and offer hedge funds and private equity funds to customers if certain conditions are met.  These conditions include, among others, requirements that the bank provides bona fide investment advisory services; the funds are organized only in connection with such services and to customers of such services; the bank does not have more than a de minimis interest in the funds, limited to a 3% ownership interest in any single fund and an aggregated investment in all funds of 3% of Tier 1 capital; the bank does not guarantee the obligations or performance of the funds; and no director or employee of the bank has an ownership interest in the fund unless he or she provides services directly to the funds.  Further details on the scope of the Volcker Rule and its exceptions are expected to be defined in regulations due to be issued later in 2011.

Many aspects of the Dodd-Frank Act are subject to rulemaking and will take effect over several years, making it difficult to anticipate the overall financial impact on the Company and the financial services industry more generally. Provisions in the legislation that affect deposit insurance assessments, and payment of interest on demand deposits could increase the costs associated with deposits. Provisions in the legislation that require revisions to the capital requirements of the Company and MB Financial Bank could require the Company and MB Financial Bank to seek additional sources of capital in the future.

TARP-Related Compensation and Corporate Governance Requirements. The Emergency Economic Stabilization Act of 2008 (“EESA”) was signed into law on October 3, 2008 and authorized the U.S. Treasury to provide funds to be used to restore liquidity and stability to the U.S. financial system pursuant to the TARP.  Under the authority of EESA, Treasury instituted the TARP Capital Purchase Program to encourage U.S. financial institutions to build capital to increase the flow of financing to U.S. businesses and consumers and to support the U.S. economy.  As noted above, on December 5, 2008, the Company participated in this program by issuing 196,000 shares of the Company’s Series A Preferred Stock to Treasury for a purchase price of $196.0 million in cash and issued the Warrant to Treasury.

In addition to the restrictions on the Company’s ability to pay dividends on and repurchase its stock, as described above under “Dividends,” participation in the TARP Capital Purchase Program also includes certain requirements and restrictions regarding compensation that were expanded significantly by the American Recovery and Reinvestment Act of 2009 (“ARRA”), as implemented by Treasury’s Interim Final Rule on TARP Standards for Compensation and Corporate Governance.  These requirements and restrictions include, among others, the following: (i) a prohibition on paying or accruing bonuses, retention awards and incentive compensation, other than qualifying long-term restricted stock or pursuant to certain preexisting employment contracts, to the Company’s five most highly-compensated employees; (ii) a general prohibition on providing severance benefits, or other benefits due to a change in control of the Company, to the Company’s senior executive officers (“SEOs”) and next five most highly compensated employees; (iii) a requirement to make subject to clawback any bonus, retention award, or incentive compensation paid to any of the SEOs and any of the next twenty most highly compensated employees if such compensation was based on materially inaccurate financial statements or any other materially inaccurate performance metric criteria; (iv) a requirement to establish a policy on luxury or excessive expenditures; (v) a requirement to annually provide shareholders with a non-binding advisory “say on pay” vote on executive compensation; (vi) a prohibition on deducting more than $500,000 in annual compensation, including performance-based compensation, to the executives covered under Internal Revenue Code Section 162(m); (vii) a requirement that the compensation committee of the board of directors evaluate and review on a semi-annual basis the risks involved in employee compensation plans; and (viii) a prohibition on providing tax “gross-ups” to the Company’s SEOs and the next 20 most highly compensated employees.  These requirements and restrictions will remain applicable to the Company until it has redeemed the Series A Preferred Stock in full.
 
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Incentive Compensation.  On October 22, 2009, the Federal Reserve issued a comprehensive proposal on incentive compensation policies (the “Incentive Compensation Proposal”) intended to ensure that the incentive compensation policies of banking organizations do not undermine the safety and soundness of such organizations by encouraging excessive risk-taking. The Incentive Compensation Proposal, which covers all employees that have the ability to materially affect the risk profile of an organization, either individually or as part of a group, is based upon the key principles that a banking organization’s incentive compensation arrangements should (i) provide incentives that do not encourage risk-taking beyond the organization’s ability to effectively identify and manage risks, (ii) be compatible with effective internal controls and risk management, and (iii) be supported by strong corporate governance, including active and effective oversight by the organization’s board of directors. Banking organizations are instructed to begin an immediate review of their incentive compensation policies to ensure that they do not encourage excessive risk-taking and implement corrective programs as needed. Where there are deficiencies in the incentive compensation arrangements, they must be immediately addressed.

Additionally, the Incentive Compensation Proposal will require the Federal Reserve to review, as part of the regular, risk-focused examination process, the incentive compensation arrangements of banking organizations, such as us, that are not “large, complex banking organizations.” These reviews will be tailored to each organization based on the scope and complexity of the organization’s activities and the prevalence of incentive compensation arrangements. The findings of the supervisory initiatives will be included in reports of examination. Deficiencies will be incorporated into the organization’s supervisory ratings, which can affect the organization’s ability to make acquisitions and take other actions. Enforcement actions may be taken against a banking organization if its incentive compensation arrangements, or related risk-management control or governance processes, pose a risk to the organization’s safety and soundness and the organization is not taking prompt and effective measures to correct the deficiencies.

The scope and content of the U.S. banking regulators’ policies on executive compensation are continuing to develop and are likely to continue evolving in the near future. It cannot be determined at this time whether compliance with such policies will adversely affect the Company’s ability to hire, retain and motivate its key employees.

Other Future Legislation and Changes in Regulations.  In addition to the specific proposals described above, from time to time, various legislative and regulatory initiatives are introduced in Congress and state legislatures, as well as by regulatory agencies. Such initiatives may include proposals to expand or contract the powers of bank holding companies and depository institutions or proposals to substantially change the financial institution regulatory system. Such legislation could change banking statutes and the operating environment of the Company in substantial and unpredictable ways. If enacted, such legislation could increase or decrease the cost of doing business, limit or expand permissible activities or affect the competitive balance among banks, savings associations, credit unions, and other financial institutions. The Company cannot predict whether any such legislation will be enacted, and, if enacted, the effect that it, or any implementing regulations, would have on the financial condition or results of operations of the Company. A change in statutes, regulations or regulatory policies applicable to the MB Financial or any of its subsidiaries could have a material effect on the business of the Company.

Internet Website

We maintain a website with the address www.mbfinancial.com.  The information contained on our website is not included as a part of, or incorporated by reference into, this Annual Report on Form 10-K.  Other than an investor's own Internet access charges, we make available free of charge through our website our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, and amendments to these reports, as soon as reasonably practicable after we have electronically filed such material with, or furnished such material to, the Securities and Exchange Commission.

Item 1A.  Risk Factors

An investment in our securities is subject to risks inherent in our business.  Before making an investment decision, you should carefully consider the risks and uncertainties described below together with all of the other information included in this report.  In addition to the risks and uncertainties described below, other risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially and adversely affect our business, financial condition and results of operations.  The value or market price of our securities could decline due to any of these identified or other risks, and you could lose all or part of your investment.
 
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A large percentage of our loan portfolio is secured by real estate, in particular commercial real estate. Continued deterioration in the real estate markets or other segments of our loan portfolio could lead to additional losses, which could have a material negative effect on our financial condition and results of operations.

As of December 31, 2010, excluding loans acquired in the Heritage, Benchmark, Broadway and New Century FDIC-assisted transactions and covered by our loss-sharing agreements with the FDIC for those transactions, approximately 50% of our total loan portfolio was secured by real estate (compared to 57% as of December 31, 2009), the majority of which is commercial real estate.  The commercial real estate market continues to experience a variety of difficulties.  In particular, market conditions in the Chicago metropolitan area, in which a majority of our commercial real estate loans are concentrated, have declined significantly over the past two years.  As a result of increased levels of commercial and consumer delinquencies and declining real estate values, which reduce the customer's borrowing power and the value of the collateral securing the loan, we have experienced increasing levels of charge-offs and provisions for loan losses. Continued increases in delinquency levels or continued declines in real estate values, which cause our borrowers’ loan-to-value ratios to increase, could result in additional charge-offs and provisions for loan losses. This could have a material negative effect on our business and results of operations.

Our construction loans make up approximately 6% of the loan portfolio and a substantial portion of our construction loans were non-performing at December 31, 2010.   Our commercial real estate loans make up approximately 33% of the loan portfolio and underlying weakness in the real estate market result in additional risk in the portfolio.

We provide loans for the acquisition and development of land and for the acquisition, development, and construction of condominiums, townhomes, and one-to-four family residences. We also provide acquisition, development and construction loans for retail and other commercial properties, primarily in our market areas.  Our commercial real estate portfolio consists of healthcare, industrial, multifamily, office, retail and church and schools loans.

Construction lending can involve a higher level of risk than other types of lending because funds are often advanced based upon the value of the project, which is uncertain prior to the project's completion. Because of the uncertainties inherent in estimating construction costs and the timing of project completion as well as the market value of a completed project and the effects of governmental regulation of real property, our estimates with regard to the total funds required to complete a project, the proceeds from a project’s sale or refinance, and the related loan-to-value ratio may vary from actual results. Construction loans of for sale properties (residential or commercial) often involve the disbursement of substantial funds with repayment dependent, in part, on the success of the ultimate project and the ability of the borrower to sell or lease the property or refinance the indebtedness. If our estimate of the value of a project at completion proves to be overstated, we may have inadequate security for repayment of the loan and we may incur a loss.

Our concentration in commercial real estate loans involves additional risk as the values of the properties securing the loans have declined.  Vacancy rates have increased, resulting in lower cash flows on the underlying properties and stress on our customers to repay their loans.

At December 31, 2010, excluding loans acquired in the Heritage, Benchmark, Broadway and New Century FDIC-assisted transactions and covered by our loss-sharing agreements with the FDIC for those transactions, our construction loans totaled approximately $423.3 million, or 6% of our total loan portfolio and commercial real estate loans totaled $2.2 billion, or 33% of our total loan portfolio. These loan types represented approximately 78% of our total non-performing loans as of December 31, 2010.

The deterioration in the quality of our construction loan portfolio and commercial real estate portfolio has been a significant factor behind the substantial increases in charge-offs and provisions for loan losses we have experienced over the last two years.  Our provisions for loan losses and net charge offs for 2010 were $246.2 million and $231.1 million, respectively, compared with $231.8 million and $198.7 million, respectively, for 2009.  The Chicago area real estate market remains weak, and we believe that further deterioration in the quality of our construction loan and commercial real estate portfolio is a possibility.  This could result in additional charge-offs and provisions for loan losses, which could have a material negative effect on our financial condition and results of operations.
 
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Repayment of our commercial loans and lease loans is often dependent on the cash flows of the borrower or lessee, which may be unpredictable, and the collateral securing these loans may fluctuate in value.

We make our commercial loans primarily based on the identified cash flow of the borrower and secondarily on the underlying collateral provided by the borrower. Collateral securing commercial loans may depreciate over time, be difficult to appraise and fluctuate in value. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect the amounts due from its customers. Accordingly, we make our commercial loans primarily based on the historical and expected cash flow of the borrower and secondarily on underlying collateral provided by the borrower.

We lend money to small and mid-sized independent leasing companies to finance the debt portion of leases (which we refer to as lease loans). A lease loan arises when a leasing company discounts the equipment rental revenue stream owed to the leasing company by a lessee. Our lease loans entail many of the same types of risks as our commercial loans. Lease loans generally are non-recourse to the leasing company, and, consequently, our recourse is limited to the lessee and the leased equipment. As with commercial loans secured by equipment, the equipment securing our lease loans may depreciate over time, may be difficult to appraise and may fluctuate in value. We rely on the lessee's continuing financial stability, rather than the value of the leased equipment, for the repayment of all required amounts under lease loans. In the event of a default on a lease loan, it is unlikely that the proceeds from the sale of the leased equipment will be sufficient to satisfy the outstanding unpaid amounts under the terms of the loan.

Changes in economic conditions, particularly a further economic slowdown in the Chicago area, could hurt our business.

Our business is directly affected by market conditions, trends in industry and finance, legislative and regulatory changes, and changes in governmental monetary and fiscal policies and inflation, all of which are beyond our control. In 2007, the housing and real estate sectors experienced an economic slowdown that continued through 2010. Further deterioration in economic conditions, particularly within the Chicago area, could result in the following consequences, among others, any of which could hurt our business materially:

·  
loan delinquencies may increase;
·  
problem assets and foreclosures may increase;
·  
demand for our products and services may decline;
·  
collateral for our loans may decline in value, in turn reducing a customer's borrowing power and reducing the value of collateral securing our loans; and
·  
the net worth and liquidity of loan guarantors may decline, impairing their ability to honor commitments to us.

Difficult market conditions and economic trends have adversely affected our industry and our business.

The United States has experienced an economic downturn beginning in 2008 and continuing through 2010.  While economic growth may have resumed recently, the rate of this growth has been very low and unemployment remains at high levels.  Many lending institutions, including us, have experienced declines in the performance of their loans, especially construction and commercial real estate loans. In addition, the values of real estate collateral supporting many loans have declined and may continue to decline. Bank and bank holding company stock prices have been negatively affected, as has the ability of banks and bank holding companies to raise capital or borrow in the debt markets compared to recent years. These conditions may have a material negative effect on our financial condition and results of operations. In addition, as a result of the foregoing factors, there is a potential for new laws and regulations regarding lending and funding practices, regulations requiring higher capital levels and liquidity standards are expected, and bank regulatory agencies have been and are expected to continue to be very aggressive in responding to concerns and trends identified in examinations.

Negative developments in the financial industry and the impact of new legislation and regulations in response to those developments could restrict our business operations, including our ability to originate loans, and negatively impact our results of operations and financial condition. Overall, during the past few years, the general business environment has had a negative effect on our business. Until there is a sustained improvement in economic conditions, we expect our business, financial condition and results of operations to be negatively affected.
 
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Our allowance for loan losses may prove to be insufficient to absorb losses in our loan portfolio.

Lending money is a substantial part of our business. Every loan carries a certain risk that it will not be repaid in accordance with its terms or that any underlying collateral will not be sufficient to assure repayment. This risk is affected by, among other things:

·  
cash flow of the borrower and/or the project being financed;
·  
the changes and uncertainties as to the future value of the collateral, in the case of a collateralized loan;
·  
the credit experience of a particular borrower;
·  
changes in economic and industry conditions; and
·  
the duration of the loan.

We maintain an allowance for loan losses, a reserve established through a provision for loan losses charged to expense, which we believe is appropriate to provide for probable losses in our loan portfolio. The amount of this allowance is determined by our management through a periodic review and consideration of several factors, including, but not limited to:

·  
our general reserve, based on our historical default and loss experience;
·  
our specific reserve, based on our evaluation of non-performing loans and their underlying collateral; and
·  
current macroeconomic factors and model imprecision factors.

The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and requires us to make significant estimates of current credit risks and future trends, all of which may undergo material changes. Continuing deterioration in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of our control, may require an increase in the allowance for loan losses. In addition, bank regulatory agencies periodically review our allowance for loan losses and may require an increase in the provision for possible loan losses or the recognition of further loan charge-offs, based on judgments different than those of management. In addition, if charge-offs in future periods exceed the allowance for loan losses, we will need additional provisions to increase the allowance for loan losses. Any increases in the allowance for loan losses will result in a decrease in net income and, possibly, capital, and may have a material negative effect on our financial condition and results of operations.

The value of the securities in our investment securities portfolio may be negatively affected by continued disruptions in securities markets.

Due to heightened credit and liquidity risks and the volatile economy, making the determination of the value of a securities portfolio is less certain.  There can be no assurance that decline in market value associated with these disruptions will not result in other-than-temporary or permanent impairments of these assets, which would lead to accounting charges that could have a material negative effect on our financial condition and results of operations.

Higher FDIC deposit insurance premiums and assessments could significantly increase our non-interest expense.

FDIC insurance premiums increased significantly in 2009 and we may pay higher FDIC premiums in the future.

The Dodd-Frank Act established 1.35% as the minimum DRR. The FDIC has determined that the DRR should be 2.0% and has adopted a plan under which it will meet the statutory minimum DRR of 1.35% by the statutory deadline of September 30, 2020. The Dodd-Frank requires the FDIC to offset the effect on institutions with assets less than $10 billion of the increase in the statutory minimum DRR to 1.35% from the former statutory minimum of 1.15%.  The FDIC has not announced how it will implement this offset or how larger institutions will be affected by it.

The Dodd-Frank Act also requires the FDIC to base insurance premium on an institution's total assets minus its tangible equity instead of its deposits. The FDIC has adopted regulations under which, effective for assessments for the second quarter of 2011 and payable at the end of September 2011, a bank that has had total assets of $10 billion or more for four consecutive quarters is assessed quarterly for deposit insurance under a scorecard method, using a performance score and a loss severity score, which are combined and converted into an initial base assessment rate which is subject to certain adjustments.   It is possible that our insurance premiums will increase under these final regulations.
 
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Changes in interest rates may reduce our net interest income.

Our consolidated operating results are largely dependent on our net interest income. Net interest income is the difference between interest earned on loans and investments and interest expense incurred on deposits and other borrowings. Our net interest income is impacted by changes in market rates of interest, changes in credit spreads, changes in the shape of the yield curve, the interest rate sensitivity of our assets and liabilities, prepayments on our loans and investments, and the mix of our funding sources and assets.

Our interest earning assets and interest bearing liabilities may react in different degrees to changes in market interest rates. Interest rates on some types of assets and liabilities may fluctuate prior to changes in broader market interest rates, while rates on other types may lag behind. The result of these changes to rates may cause differing spreads on interest earning assets and interest bearing liabilities. While we take measures intended to manage the risks from changes in market interest rates, we cannot control or accurately predict changes in market rates of interest or be sure our protective measures are adequate.

We pursue a strategy of supplementing internal growth by acquiring other financial companies or their assets and liabilities that we believe will help us fulfill our strategic objectives and enhance our earnings. There are risks associated with this strategy, including the following:

·  
We may be exposed to potential asset quality issues or unknown or contingent liabilities of the banks, businesses, assets, and liabilities we acquire. If these issues or liabilities exceed our estimates, our results of operations and financial condition may be materially negatively affected;
·  
Prices at which acquisitions can be made fluctuate with market conditions. We have experienced times during which acquisitions could not be made in specific markets at prices we considered acceptable and expect that we will experience this condition in the future;
·  
The acquisition of other entities generally requires integration of systems, procedures and personnel of the acquired entity into our company to make the transaction economically successful. This integration process is complicated and time consuming and can also be disruptive to the customers of the acquired business. If the integration process is not conducted successfully and with minimal effect on the acquired business and its customers, we may not realize the anticipated economic benefits of particular acquisitions within the expected time frame, and we may lose customers or employees of the acquired business. We may also experience greater than anticipated customer losses even if the integration process is successful.
·  
To the extent our costs of an acquisition exceed the fair value of the net assets acquired, the acquisition will generate goodwill.  As discussed below, we are required to assess our goodwill for impairment at least annually, and any goodwill impairment charge could have a material adverse effect on our results of operations and financial condition;
·  
To finance an acquisition, we may borrow funds, thereby increasing our leverage and diminishing our liquidity, or raise additional capital, which could dilute the interests of our existing stockholders; and
·  
We have completed various acquisitions and opened additional banking offices in the past few years that enhanced our rate of growth.  We may not be able to continue to sustain our past rate of growth or to grow at all in the future.

Our participation in the loss-share agreements with the FDIC requires that we follow certain servicing procedures.

MB Financial Bank entered into loss-share agreements with the FDIC as part of the Heritage, Benchmark, Broadway and New Century transactions. These loss-share agreements require that MB Financial Bank follow certain servicing procedures as specified in the agreement.  A failure to follow these procedures or any other breach of the agreement by MB Financial Bank could result in the loss of FDIC reimbursement of losses on covered loans and other real estate owned, which could have a material negative effect on our financial condition and results of operations;

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Our growth or future losses may require us to raise additional capital in the future, but that capital may not be available when it is needed or the cost of that capital may be very high.

We are required by federal and state regulatory authorities to maintain adequate levels of capital to support our operations. We anticipate that our capital resources will satisfy our capital requirements for the foreseeable future. We may at some point need to raise additional capital to support continued growth or losses, both internally and through acquisitions. Any capital we obtain may result in the dilution of the interests of existing holders of our common stock.

Our ability to raise additional capital, if needed, will depend on conditions in the capital markets at that time (which are outside our control) and on our financial condition and performance. Accordingly, we cannot make assurances of our ability to raise additional capital if needed, or if the terms will be acceptable to us. If we cannot raise additional capital when needed, our ability to further expand our operations through internal growth and acquisitions could be materially impaired and our financial condition and liquidity could be materially and negatively affected.

Conditions in the financial markets may limit our access to additional funding to meet our liquidity needs.

Liquidity is essential to our business, as we must maintain sufficient funds to respond to the needs of depositors and borrowers. An inability to raise funds through deposits, borrowings, the sale or pledging as collateral of loans and other assets could have a substantial negative effect on our liquidity. Our access to funding sources in amounts adequate to finance our activities could be impaired by factors that affect us specifically or the financial services industry in general. Factors that could negatively affect our access to liquidity sources include a decrease in the level of our business activity due to a market downturn or negative regulatory action against us. Our ability to borrow could also be impaired by factors that are not specific to us, such as severe disruption of the financial markets or negative news and expectations about the prospects for the financial services industry as a whole, as evidenced by recent turmoil in the domestic and worldwide credit markets.

Our wholesale funding sources may prove insufficient to replace deposits or support our future growth.

As a part of our liquidity management, we use a number of funding sources in addition to core deposit growth and repayments and maturities of loans and investments. These sources include brokered certificates of deposit, repurchase agreements, federal funds purchased and Federal Home Loan Bank advances. Negative operating results or changes in industry conditions could lead to an inability to replace these additional funding sources at maturity. Our financial flexibility could be constrained if we are unable to maintain our access to funding or if adequate financing is not available to accommodate future growth at acceptable interest rates. Finally, if we are required to rely more heavily on more expensive funding sources to support future growth, our revenues may not increase proportionately to cover our costs. In this case, our results of operations and financial condition would be negatively affected.

Since our business is concentrated in the Chicago metropolitan area, a further decline in the economy of this area may negatively affect our business.

Except for our leasing activities and certain treasury management services, which are nationwide, our lending and deposit gathering activities are concentrated in the Chicago metropolitan area. Our success depends on the general economic conditions of this metropolitan area and its surrounding areas.

Many of the loans in our portfolio are secured by real estate. Most of these loans are secured by properties located in the Chicago metropolitan area. Deterioration in the real estate markets where collateral for a mortgage loan is located could negatively affect the borrower's ability to repay the loan and the value of the collateral securing the loan. Real estate values are affected by various other factors, including changes in general or regional economic conditions, governmental rules or policies and natural disasters such as tornados.

Negative changes in the regional and general economy could reduce our growth rate, impair our ability to collect loans and generally have a negative effect on our financial condition and results of operations.
 
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The soundness of other financial institutions could negatively affect us.

Our ability to engage in routine funding and other transactions could be negatively affected by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships. Defaults by, or even rumors or questions about, one or more financial services institutions, or the financial services industry generally, have led to market-wide liquidity problems and losses of depositor, creditor and counterparty confidence and could lead to losses or defaults by us or by other institutions. We could experience increases in deposits and assets as a result of the difficulties or failures of other banks, which would increase the capital we need to support our growth.

Non-compliance with the USA PATRIOT Act, Bank Secrecy Act, or other laws and regulations could result in fines or sanctions.

The USA PATRIOT and Bank Secrecy Acts require financial institutions to develop programs to prevent financial institutions from being used for money laundering and terrorist activities. If such activities are detected, financial institutions are obligated to file suspicious activity reports with the U.S. Treasury's Office of Financial Crimes Enforcement Network. These rules require financial institutions to establish procedures for identifying and verifying the identity of customers seeking to open new financial accounts. Failure to comply with these regulations could result in fines or sanctions. During the last year, several banking institutions have received large fines for non-compliance with these laws and regulations. Although we have developed policies and procedures designed to assist in compliance with these laws and regulations, no assurance can be given that these policies and procedures will be effective in preventing violations of these laws and regulations.

We provide treasury management services to money services businesses, which include: check cashers, issuers/sellers of traveler’s checks, money orders and stored value cards, and money transmitters.  Money services businesses pose risk of compliance with regulatory guidance.

We provide treasury management services to the check cashing industry, offering: check clearing, monetary instrument, depository, and credit services.   We also provide treasury management services to money transmitters.  Financial institutions that open and maintain accounts for money services businesses are expected to apply the requirements of the USA PATRIOT Act and Bank Secrecy Act, as they do with all accountholders, on a risk-assessed basis.  As with any category of accountholder, there will be money services businesses that pose little risk of money laundering or lack of compliance with other laws and regulations and those that pose a significant risk.    Providing treasury management services to money services businesses represent a significant compliance and regulatory risk, and failure to comply with all statutory and regulatory requirements could result in fines or sanctions.

Recently enacted financial reform legislation will, among other things, tighten capital standards, create a new Consumer Financial Protection Bureau and result in new regulations that are expected to increase our costs of operations.

On July 21, 2010, President Obama signed the Dodd-Frank Act into law.  This new law will significantly change the current bank regulatory structure and affect the lending, deposit, investment, trading and operating activities of financial institutions and their holding companies. The Dodd-Frank Act requires various federal agencies to adopt a broad range of new implementing rules and regulations, and to prepare numerous studies and reports for Congress. The federal agencies are given significant discretion in drafting the implementing rules and regulations, and consequently, many of the details and much of the impact of the Dodd-Frank Act may not be known for many months or years.

Among the many requirements in the Dodd-Frank Act for new banking regulations is a requirement for new capital regulations to be adopted within 18 months.  These regulations must be at least as stringent as, and may call for higher levels of capital than, current regulations.  Generally, trust preferred securities will no longer be eligible as Tier 1 capital, but the Company’s currently outstanding trust preferred securities will be grandfathered and its currently outstanding TARP preferred securities will continue to qualify as Tier 1 capital.  In addition, the Office of the Comptroller of the Currency is required to seek to make its capital requirements for national banks, such as MB Financial Bank, countercyclical so that capital requirements increase in times of economic expansion and decrease in times of economic contraction.
 
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Certain provisions of the Dodd-Frank Act are expected to have a near term impact on us.  For example, one year after the date of its enactment, the Dodd-Frank Act eliminates the federal prohibitions on paying interest on demand deposits, thus allowing businesses to have interest bearing checking accounts. Depending on competitive responses, this significant change to existing law could have an adverse impact on our interest expense.

The Dodd-Frank Act also broadens the base for FDIC insurance assessments. Assessments will now be based on the average consolidated total assets less tangible equity capital of a financial institution and are generally expected to increase for institutions having total assets in excess of $10 billion, including MB Financial Bank. The Dodd-Frank Act also permanently increases the maximum amount of deposit insurance for banks, savings institutions and credit unions to $250,000 per depositor, retroactive to January 1, 2008, and non-interest bearing transaction accounts and IOLTA accounts have unlimited deposit insurance through December 31, 2013.

In addition, the Dodd-Frank Act increased the authority of the Federal Reserve Board to examine the Company and its non-bank subsidiaries and gave the Federal Reserve Board the authority to establish rules regarding interchange fees charged for electronic debit transactions by payment card issuers, such as MB Financial Bank, having assets over $10 billion and to enforce a new statutory requirement that such fees be reasonable and proportional to the actual cost of a transaction to the issuer.  The Federal Reserve Board recently proposed capping such fees at seven to 12 cents, subject to adjustment for fraud prevention costs.  The Dodd-Frank Act also will restrict proprietary trading by banks, bank holding companies and others, and their acquisition and retention of ownership interests in and sponsorship of hedge funds and private equity funds, subject to an exception allowing a bank to organize and offer hedge funds and private equity funds to customers if certain conditions are met, including, among others, a requirement that the bank limit its ownership interest in any single fund to 3% and its aggregate investment in all funds to 3% of Tier 1 capital, with no director or employee of the bank holding an ownership interest in the fund unless he or she provides services directly to the funds.

The Dodd-Frank Act requires publicly traded companies to give stockholders a non-binding vote on executive compensation and so-called "golden parachute" payments, and authorizes the Securities and Exchange Commission to promulgate rules that would allow stockholders to nominate their own candidates using a company's proxy materials. The legislation also directs the federal banking regulators to issue rules prohibiting incentive compensation that encourages inappropriate risks.

The Dodd-Frank Act creates a new Bureau of Consumer Financial Protection with broad powers to supervise and enforce consumer protection laws. The Bureau will have broad rule-making authority for a wide range of consumer protection laws that apply to all banks, including the authority to prohibit "unfair, deceptive or abusive" acts and practices. The Bureau will have examination and enforcement authority over all banks with more than $10 billion in assets, including MB Financial Bank.

Many aspects of the Dodd-Frank Act are subject to rulemaking and will take effect over several years, making it difficult to anticipate the overall financial impact on the Company.  However, compliance with this new law and its implementing regulations will result in additional operating costs that could have a material adverse effect on our financial condition and results of operations.

New or changing tax, accounting, and regulatory rules and interpretations could significantly impact strategic initiatives, results of operations, cash flows, and financial condition.

The financial services industry is extensively regulated. Federal and state banking regulations are designed primarily to protect the deposit insurance funds and consumers, not to benefit a company's stockholders. These regulations may sometimes impose significant limitations on operations. The significant federal and state banking regulations that affect us are described in this report under the heading “Item 1. Business-Supervision and Regulation”. These regulations, along with the currently existing tax, accounting, securities, insurance, and monetary laws, regulations, rules, standards, policies, and interpretations control the methods by which financial institutions conduct business, implement strategic initiatives and tax compliance, and govern financial reporting and disclosures. These laws, regulations, rules, standards, policies, and interpretations are constantly evolving and may change significantly over time.

Significant legal actions could subject us to substantial liabilities.

We are from time to time subject to claims related to our operations. These claims and legal actions, including supervisory actions by our regulators, could involve large monetary claims and significant defense costs. As a result, we may be exposed to substantial liabilities, which could negatively affect our results of operations and financial condition.
 
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The loss of certain key personnel could negatively affect our operations.

Our success depends in large part on the retention of a limited number of key management and other banking personnel. We could undergo a difficult transition period if we were to lose the services of any of these individuals. Our success also depends on the experience of our banking facilities' managers and bankers and on their relationships with the customers and communities they serve. The loss of these key persons could negatively impact the affected banking operations.

As a result of our participation in the TARP Capital Purchase Program, we are subject to significant restrictions on compensation payable to our executive officers and other key employees.

Our ability to attract and retain key officers and employees may be impacted by legislation and regulation affecting the financial services industry. In 2009, the American Recovery and Reinvestment Act (the “ARRA”) became law. The ARRA, through the implementing regulations of the U.S. Treasury, significantly expanded the executive compensation restrictions originally imposed on TARP participants, including us. Among other things, these restrictions limit our ability to pay bonuses and other incentive compensation and make severance payments. These restrictions will continue to apply to us for as long as the preferred stock we issued pursuant to the TARP Capital Purchase Program remains outstanding. These restrictions may negatively affect our ability to compete with financial institutions that are not subject to the same limitations.

We may experience future goodwill impairment.

If our estimates of the fair value of our goodwill change as a result of changes in our business or other factors, we may determine that an impairment charge is necessary. Estimates of fair value are based on a complex model using, among other things, cash flows and company comparisons.  As of December 31, 2010, our market capitalization was less than the book value of our total common stockholders’ equity.  Should this condition continue to exist for an extended period of time, the Company will consider this and other factors, including the Company’s anticipated cash flows, to determine whether goodwill is impaired. Our future cash flows estimates assume that credit performance returns to our historic performance over the next two years.  If this does not happen, our future cash flows would be negatively impacted.  Given the weak economy and our recent credit performance, there is a high degree of uncertainty regarding this assumption.  No assurance can be given that the Company will not record an impairment loss on goodwill in the future and any such impairment loss could have a material adverse effect on our results of operations and financial condition.

Our future success is dependent on our ability to compete effectively in the highly competitive banking industry.

We face substantial competition in all phases of our operations from a variety of different competitors. Our future growth and success will depend on our ability to compete effectively in this highly competitive environment. To date, we have grown our business successfully by focusing on our business lines and emphasizing the high level of service and responsiveness desired by our customers. We compete for loans, deposits and other financial services with other commercial banks, thrifts, credit unions, brokerage houses, mutual funds, insurance companies and specialized finance companies. Many of our competitors offer products and services which we do not offer, and many have substantially greater resources and lending limits, name recognition and market presence that benefit them in attracting business. In addition, larger competitors may be able to price loans and deposits more aggressively than we do, and smaller newer competitors may also be more aggressive in terms of pricing loan and deposit products than we are in order to obtain a share of the market. Some of the financial institutions and financial services organizations with which we compete are not subject to the same degree of regulation as is imposed on bank holding companies, federally insured state-chartered banks and national banks and federal savings banks. In addition, increased competition among financial services companies due to the recent consolidation of certain competing financial institutions and the conversion of certain investment banks to bank holding companies may negatively affect our ability to successfully market our products and services. As a result, these competitors have certain advantages over us in accessing funding and in providing various services.
 
26

 
 
We are subject to security and operational risks relating to our use of technology that could damage our reputation and our business.

Security breaches in our internet banking activities could expose us to possible liability and damage our reputation. Any compromise of our security also could deter customers from using our internet banking services that involve the transmission of confidential information. We rely on standard internet security systems to provide the security and authentication necessary to effect secure transmission of data. These precautions may not protect our systems from compromises or breaches of our security measures that could result in damage to our reputation and our business. Additionally, we outsource our data processing to a third party. If our third party provider encounters difficulties or if we have difficulty in communicating with such third party, it will significantly affect our ability to adequately process and account for customer transactions, which would significantly affect our business operations.

Item 1B.  Unresolved Staff Comments

None.

Item 2.  Properties

We conduct our business at approximately 90 retail banking center locations.  Except for one banking facility in Philadelphia, Pennsylvania, all of our branches are located in the Chicago metropolitan area.  We own 58 of our banking center facilities.  The other facilities are leased for various terms.  We have 133 ATMs at our branches and at other locations.  We believe that all of our properties and equipment are well maintained, in good operating condition and adequate for all of our present and anticipated needs.  See Note 8 of the notes to our consolidated financial statements for additional information regarding our premises and equipment.

We also have non-bank office locations in Chicago, Illinois, Paramus, New Jersey, Troy, Michigan, and Columbus, Ohio.  These offices are used by our lease banking personnel and our Cedar Hill and LaSalle subsidiaries.

We believe our facilities in the aggregate are suitable and adequate to operate our banking and related business.

Item 3.  Legal Proceedings

We are involved from time to time as plaintiff or defendant in various legal actions arising in the normal course of our businesses.  While the ultimate outcome of pending proceedings cannot be predicted with certainty, it is the opinion of management, after consultation with counsel representing us in such proceedings, that the resolution of these proceedings should not have a material adverse effect on our consolidated financial position or results of operation.

Item 4.  (Removed and Reserved)

27

 
 
PART II

Item 5.  Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Our common stock is traded on the NASDAQ Global Select Market under the symbol “MBFI.”  There were approximately 1,578 holders of record of our common stock as of December 31, 2010.

The following table presents quarterly market price information and cash dividends paid per share for our common stock for 2010 and 2009:

 
Market Price Range
   
High
 
Low
 
Dividends Paid
2010
           
Quarter ended December 31, 2010
 
 $   17.70
 
 $   13.93
 
 $   0.01
Quarter ended September 30, 2010
 
 $   19.97
 
 $   14.68
 
 $   0.01
Quarter ended June 30, 2010
 
 $   28.18
 
 $   18.32
 
 $   0.01
Quarter ended March 31, 2010
 
 $   24.17
 
 $   19.00
 
 $   0.01
2009
           
Quarter ended December 31, 2009
 
 $   21.77
 
 $   16.67
 
 $   0.01
Quarter ended September 30, 2009
 
 $   21.45
 
 $     9.95
 
 $   0.01
Quarter ended June 30, 2009
 
 $   17.44
 
 $     9.25
 
 $   0.01
Quarter ended March 31, 2009
 
 $   28.04
 
 $     9.77
 
 $   0.12

The timing and amount of cash dividends paid depends on our earnings, capital requirements, financial condition and other relevant factors.  In this regard, after reviewing these factors and giving consideration to the economic environment, we reduced our quarterly common stock cash dividend to $0.12 per share in the first quarter of 2009 and to $0.01 per share in the second quarter of 2009.  The primary source for dividends paid to stockholders is dividends paid to us from MB Financial Bank and cash on hand.  We have an internal policy which provides that dividends paid to us by MB Financial Bank cannot exceed an amount that would cause the bank’s total risk-based capital, Tier 1 risk-based capital and Tier 1 leverage capital ratios to fall below 12%, 9% and 8%, respectively.  These ratios are in excess of the minimum ratios required for a bank to be considered “well capitalized” for regulatory purposes (10%, 6% and 5%, respectively).  In addition to adhering to our internal policy, there are regulatory restrictions on the ability of national banks to pay dividends.  See “Item 1. Business - Supervision and Regulation - Dividends” above and Note 18 of notes to consolidated financial statements contained in Item 8 of this report.

As indicated in the following table, there were no repurchases of our outstanding common shares during  the three months ended December 31, 2010:

 
Total Number of Shares Purchased
 
Average Price Paid per Share
 
Number of Shares Purchased as Part  Publicly Announced Plans or Programs
 
Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs
October 1, 2010 – October 31, 2010
 -
 
 $     -
 
 -
 
 -
November 1, 2010 – November 30, 2010
 -
 
 -
 
 -
 
 -
December 1, 2010 – December 31, 2010
 -
 
 -
 
 -
 
 -
Total
 -
 
 $     -
 
 -
   
 
28

 

On December 5, 2008, as part of the Troubled Asset Relief Program (“TARP”) Capital Purchase Program of the United States Department of the Treasury (“Treasury”), the Company sold to Treasury 196,000 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A (the “Series A Preferred Stock”), having a liquidation preference amount of $1,000 per share, for a purchase price of $196.0 million in cash and issued to Treasury a ten-year warrant to purchase 1,012,048 shares of the Company’s common stock at an exercise price of $29.05 per share (the “Warrant”).  As explained below, the number of shares underlying the Warrant has been reduced to 506,024.

The Company may redeem the Series A Preferred Stock at any time by repaying Treasury, without penalty, subject to Treasury’s consultation with the Company’s appropriate regulatory agency.  Additionally, upon redemption of the Series A Preferred Stock, the Warrant may be repurchased from Treasury at its fair market value as agreed-upon by the Company and Treasury.

On September 17, 2009, the Company completed a public offering of its common stock by issuing 12,578,125 shares of common stock for aggregate gross proceeds of $201.3 million.  The net proceeds to the Company after deducting underwriting discounts and commissions and offering expenses were approximately $190.9 million.  With the proceeds from this offering and the proceeds received by the Company from issuances pursuant to its Dividend Reinvestment and Stock Purchase Plan, the Company received aggregate gross proceeds from “Qualified Equity Offerings” in excess of the $196.0 million aggregate liquidation preference amount of the Series A Preferred Stock.  As a result, the number of shares of the Company’s common stock underlying the Warrant was reduced by 50%, from 1,012,048 shares to 506,024 shares.

The securities purchase agreement between us and Treasury provides that prior to the earlier of (i) December 5, 2011 and (ii) the date on which all of the shares of the Series A Preferred Stock have been redeemed by us or transferred by Treasury to third parties, we may not, without the consent of Treasury, (a) pay a cash dividend on our common stock of more than $0.18 per share or (b) subject to limited exceptions, redeem, repurchase or otherwise acquire shares of our common stock or preferred stock (other than the Series A Preferred Stock) or trust preferred securities.  In addition, under the terms of the Series A Preferred Stock, we may not pay dividends on our common stock unless we are current in our dividend payments on the Series A Preferred Stock.   Dividends on the Series A Preferred Stock are payable quarterly at a rate of 5% per annum for the first five years and a rate of 9% per annum thereafter if not redeemed prior to that time.

29

 

Stock Performance Presentation

The following line graph shows a comparison of the cumulative returns for the Company, the NASDAQ Market Bank Index, an index of peer corporations selected by the Company and the NASDAQ Composite Index, for the period beginning December 31, 2005 and ending December 31, 2010.  The information assumes that $100 was invested at the closing price on December 31, 2005 in the Common Stock and each index, and that all dividends were reinvested.
 
COMPARISON OF 5-YEAR CUMULATIVE TOTAL RETURN
AMONG MB FINANCIAL, INC.,
NASDAQ BANK INDEX, PEER GROUP INDEX AND NASDAQ COMPOSITE INDEX
 
total return performance 
 

   
Period Ending
 
Index
12/31/05
12/31/06
12/31/07
12/31/08
12/31/09
12/31/10
MB Financial, Inc.
100.00
108.22
90.56
84.23
60.01
52.84
NASDAQ Bank Index
100.00
113.82
91.16
71.52
59.87
68.34
NASDAQ Composite
100.00
110.39
122.15
73.32
106.57
125.91
Peer Group Index 2010
100.00
103.18
79.86
56.81
34.26
40.52

The Peer Group is made up of the common stocks of the following companies:

FIRST MIDWEST BANCORP INC
OLD SECOND BANCORP INC
PRIVATEBANCORP INC
TAYLOR CAPITAL GROUP INC
WINTRUST FINANCIAL CORPORATION
 
30

 
 
Item 6.  Selected Financial Data

Set forth below and on the following page is our summary consolidated financial information and other financial data.  This information should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included herein in response to Item 7 and the consolidated financial statements and notes thereto included herein in response to Item 8 (in thousands, except common share data).

On August 10, 2009, the Company sold its merchant card processing business.  In accordance with accounting principles generally accepted in the United States of America (GAAP), the assets, liabilities, results of operations, including a pre-tax gain of $10.2 million and cash flows of the Company’s merchant card processing business have been shown separately as discontinued operations in the consolidated balance sheets, consolidated statements of operations, and consolidated statements of cash flows for all periods presented.

On November 28, 2007, the Company sold its Union Bank (“Union”) subsidiary.  In accordance with U.S. GAAP, the assets, liabilities, results of operations, and cash flows of the business conducted by Union Bank have been shown separately as discontinued operations in the consolidated balance sheets, consolidated statements of operations, and consolidated statements of cash flows for all periods presented.

For purposes of the following discussion, balances, average rate, income and expenses associated with Union and the Company’s merchant card processing business have been excluded from continuing operations.  See Note 3 in the notes to consolidated financial statements contained under Item 8 Financial Statements and Supplementary Data.

Our summary consolidated financial information and other financial data contain information determined by methods other than in accordance with GAAP.  These measures include core pre-tax, pre-provision earnings, net interest income on a fully tax equivalent basis, net interest margin on a fully tax equivalent basis; efficiency ratio, with net gains and losses on other real estate owned, net gains and losses on securities available for sale, net gains and losses on sale of other assets,  acquisition related gains and increase (decrease) in market value of assets held in trust for deferred compensation excluded from  the non-interest income component of this ratio and the FDIC special assessment expense, contributions to MB Financial Charitable Foundation, executive separation agreement expense, unamortized issuance costs related to redemption of trust preferred securities, impairment charges and increase (decrease) in market value of assets held in trust for deferred compensation excluded from the non-interest expense component of this ratio; ratios of tangible equity to tangible assets, tangible common equity to tangible assets, and tangible common equity to risk-weighted assets; and tangible book value per common share.

Our management uses these non-GAAP measures in its analysis of our performance.  Management believes that core pre-tax, pre-provision earnings are a useful measure in assessing our core operating performance, particularly during times of economic stress.  The tax equivalent adjustment to net interest income recognizes the income tax savings when comparing taxable and tax-exempt assets and assumes a 35% tax rate.  Management believes that it is a standard practice in the banking industry to present net interest income and net interest margin on a fully tax equivalent basis, and accordingly believes that providing these measures may be useful for peer comparison purposes.  Management also believes that by excluding net gains and losses on other real estate owned, net gains and losses on securities available for sale, net gains and losses on sale of other assets, acquisition related gains and increase (decrease) in market value of assets held in trust for deferred compensation from the non-interest income component and the FDIC special assessment expense, contributions to MB Financial Charitable Foundation, executive separation agreement expense, unamortized issuance costs related to redemption of trust preferred securities,  impairment charges and increase (decrease) in market value of assets held in trust for deferred compensation from other non-interest expense component of the efficiency ratio, this ratio better reflects our operating performance.

The other measures exclude the ending balances of acquisition-related goodwill and other intangible assets, net of tax benefit, in determining tangible assets, tangible equity and tangible common equity.  Management believes the presentation of these other financial measures excluding the impact of such items provides useful supplemental information that is helpful in understanding our financial results, as they provide a method to assess management’s success in utilizing our tangible capital.  These disclosures should not be viewed as substitutes for the results determined to be in accordance with GAAP, nor are they necessarily comparable to non-GAAP performance measures that may be presented by other companies.
 
31

 
 
Reconciliations of net interest margin on a fully tax equivalent basis to net interest margin, efficiency ratio as adjusted to efficiency ratio, tangible assets to total assets, tangible  equity to stockholders’ equity and tangible common book value per common share to common book value per common share are contained in the “Selected Financial Data” discussed below.

Selected Financial Data:

 
As of or for the Year Ended December 31,
   
2010 (1)
 
2009 (2)
 
2008
 
2007
 
2006 (3)
Statement of Income Data:
                   
Interest income
 
 $    429,640
 
 $     393,538
 
 $    413,788
 
 $   457,266
 
 $   374,371
Interest expense
 
 89,868
 
 142,986
 
 192,900
 
 244,960
 
 186,192
Net interest income
 
 339,772
 
 250,552
 
 220,888
 
 212,306
 
 188,179
Provision for loan losses
 
 246,200
 
 231,800
 
 125,721
 
 19,313
 
 10,100
Net interest income after provision for loan losses
 
 93,572
 
 18,752
 
 95,167
 
 192,993
 
 178,079
Other income
 
 185,756
 
 127,154
 
 80,393
 
 83,528
 
 64,376
Other expenses
 
 258,776
 
 223,750
 
 183,390
 
 191,506
 
 152,218
Income (loss) before income taxes
 
 20,552
 
 (77,844)
 
 (7,830)
 
 85,015
 
 90,237
Applicable income tax expense (benefit)
 
 24
 
 (45,265)
 
 (23,555)
 
 23,670
 
 27,238
Income (loss) from continuing operations
 
 20,528
 
 (32,579)
 
 15,725
 
 61,345
 
 62,999
Income from discontinued operations, net of income tax
 
 -
 
 6,453
 
 439
 
 32,518
 
 4,115
Net income (loss)
 
 20,528
 
 (26,126)
 
 16,164
 
 93,863
 
 67,114
Dividends on preferred shares
 
 10,382
 
 10,298
 
 789
 
 -
 
 -
Net income (loss) available to common stockholders
 
 $      10,146
 
 $     (36,424)
 
 $      15,375
 
 $     93,863
 
 $      67,114
                     
Core pre-tax, pre-provision earnings
 
 $    194,109
 
 $     119,672
 
 $    117,410
 
 $   110,229
 
 $      99,700
                     
Common Share Data:
                   
Basic earnings (loss) per common share from continuing operations
 
 $          0.39
 
 $         (0.81)
 
 $          0.45
 
 $         1.70
 
 $          2.02
Basic earnings per common share from discontinued operations
 
 -
 
 0.16
 
 0.01
 
 0.91
 
 0.13
Impact of preferred stock dividends on basic earnings (loss) per common share
 
 (0.20)
 
 (0.26)
 
 (0.02)
 
 -
 
 -
Basic earnings (loss) per common share
 
 0.19
 
 (0.91)
 
 0.44
 
 2.61
 
 2.15
Diluted earnings (loss) per common share from continuing operations
 
 0.39
 
 (0.81)
 
 0.45
 
 1.68
 
 1.99
Diluted earnings per common share from discontinued operations
 
 -
 
 0.16
 
 0.01
 
 0.89
 
 0.13
Impact of preferred stock dividends on diluted earnings (loss) per common share
 
 (0.20)
 
 (0.26)
 
 (0.02)
 
 -
 
 -
Diluted earnings (loss) per common share
 
 0.19
 
 (0.91)
 
 0.44
 
 2.57
 
 2.12
Common book value per common share
 
 21.14
 
 20.75
 
 25.17
 
 24.91
 
 23.10
Less: goodwill and other tangible assets, net of tax benefit, per common share
 
 7.53
 
 8.07
 
 11.56
 
 11.43
 
 10.85
Tangible common book value per common share
 
 13.60
 
 12.68
 
 13.61
 
 13.48
 
 12.25
Weighted average common shares outstanding:
                   
Basic
 
 52,724,715
 
 40,042,655
 
 34,706,092
 
 35,919,900
 
 31,156,887
Diluted
 
 53,035,047
 
 40,042,655
 
 35,061,712
 
 36,439,561
 
 31,687,220
Dividend payout ratio (4)
 
21.05%
 
NM
 
163.64%
 
27.59%
 
30.70%
Cash dividends per common share
 
 $0.04
 
 $0.15
 
 $0.72
 
 $0.72
 
 $0.66

(1)  
In 2010, we completed two FDIC-assisted transactions.  See Note 2 in the notes to consolidated financial statements contained under Item 8. Financial Statements and Supplementary Data.
(2)  
In 2009, we completed four FDIC-assisted transactions.  See Note 2 in the notes to consolidated financial statements contained under Item 8. Financial Statements and Supplementary Data.
(3)  
In 2006, we acquired First Oak Brook Bancshares, Inc.
(4)  
Not meaningful for 2009 due to our net loss for that year.
 
32

 
 
Selected Financial Data (continued):

   
As of or for the Year Ended December 31,
(Dollars in thousands)
 
2010
 
2009
 
2008
 
2007
 
2006
                     
Balance Sheet Data:
                   
Cash and due from banks
 
 $   106,726
 
 $   136,763
 
 $     79,824
 
 $   141,248
 
 $   142,207
Investment securities
 
 1,677,929
 
 2,913,594
 
 1,400,376
 
 1,241,385
 
 1,628,348
Loans, gross
 
 6,617,811
 
 6,524,547
 
 6,228,563
 
 5,615,627
 
 4,971,494
Allowance for loan losses
 
 192,217
 
 177,072
 
 144,001
 
 65,103
 
 58,983
Assets held for sale
 
 -
 
 -
 
 -
 
 -
 
 393,608
Total assets
 
 10,320,364
 
 10,865,393
 
 8,819,763
 
 7,834,703
 
 7,978,298
      Less: goodwill
 
 387,069
 
 387,069
 
 387,069
 
 379,047
 
 379,047
      Less: other intangible assets, net of tax benefit
 
 22,853
 
 24,510
 
 16,754
 
 16,479
 
 18,756
Tangible assets
 
 9,910,442
 
 10,453,814
 
 8,415,940
 
 466,843
 
 449,149
Deposits
 
 8,152,958
 
 8,683,276
 
 6,495,571
 
 5,513,783
 
 5,580,553
Short-term and long-term borrowings
 
 553,917
 
 655,266
 
 960,085
 
 1,186,586
 
 934,384
Junior subordinated notes issued to capital trusts
 
 158,571
 
 158,677
 
 158,824
 
 159,016
 
 179,162
Liabilities held for sale
 
 -
 
 -
 
 -
 
 -
 
 361,008
Stockholders’ equity
 
 1,344,786
 
 1,251,180
 
 1,068,824
 
 862,369
 
 846,952
      Less: goodwill
 
 387,069
 
 387,069
 
 387,069
 
 379,047
 
 379,047
      Less: other intangible assets, net of tax benefit
 
 22,853
 
 24,510
 
 16,754
 
 16,479
 
 18,756
Tangible equity
 
 934,864
 
 839,601
 
 665,001
 
 466,843
 
 449,149
      Less: preferred stock
 
 194,104
 
 193,522
 
 193,025
 
 -
 
 -
Tangible common equity
 
 740,760
 
 646,079
 
 471,976
 
 466,843
 
 449,149
                     
Performance Ratios:
                   
Return on average assets
 
0.20%
 
(0.27%)
 
0.20%
 
1.19%
 
1.02%
Return on average equity
 
1.54%
 
(2.32%)
 
1.80%
 
11.03%
 
10.70%
Return on average common equity
 
0.89%
 
(3.91%)
 
1.74%
 
11.03%
 
10.70%
Core pre-tax, pre-provision earnings to average assets
 
1.85%
 
1.22%
 
1.42%
 
1.39%
 
1.51%
Net interest margin (1)
 
3.72%
 
2.85%
 
3.03%
 
3.22%
 
3.41%
Tax equivalent effect
 
0.11%
 
0.12%
 
0.13%
 
0.11%
 
0.11%
Net interest margin – fully tax equivalent basis (1)
 
3.83%
 
2.97%
 
3.16%
 
3.33%
 
3.52%
Efficiency ratio (2)
 
55.80%
 
62.29%
 
59.24%
 
60.24%
 
58.90%
Loans to deposits
 
81.17%
 
75.14%
 
95.89%
 
101.85%
 
89.09%
                     
Asset Quality Ratios:
                   
Non-performing loans to total loans (3)
 
5.48%
 
4.16%
 
2.34%
 
0.44%
 
0.43%
Non-performing assets to total assets (4)
 
4.21%
 
2.84%
 
1.71%
 
0.33%
 
0.31%
Allowance for loan losses to total loans
 
2.90%
 
2.71%
 
2.31%
 
1.16%
 
1.19%
Allowance for loan losses to non-performing loans (3)
 
53.03%
 
65.26%
 
98.67%
 
266.17%
 
274.75%
Net loan charge-offs to average loans
 
3.42%
 
3.09%
 
0.79%
 
0.25%
 
0.24%
                     
Liquidity and Capital Ratios:
                   
Tier 1 capital to risk-weighted assets
 
15.75%
 
13.51%
 
12.07%
 
9.75%
 
10.49%
Total capital to risk-weighted assets
 
17.75%
 
15.45%
 
14.08%
 
11.58%
 
11.80%
Tier 1 capital to average assets
 
10.66%
 
8.71%
 
9.85%
 
8.18%
 
8.39%
Average equity to average assets
 
12.65%
 
11.51%
 
10.90%
 
10.76%
 
9.50%
Tangible equity to tangible assets (5)
 
9.43%
 
8.03%
 
7.90%
 
6.28%
 
5.93%
Tangible common equity to tangible assets (6)
 
7.47%
 
6.18%
 
5.61%
 
6.28%
 
5.93%
Tangible common equity to risk-weighted assets (7)
 
10.94%
 
8.83%
 
7.10%
 
7.40%
 
7.47%
                     
Other:
                   
Banking facilities
 
90
 
87
 
72
 
73
 
70
Full time equivalent employees (8)
 
1,703
 
1,638
 
1,342
 
1,282
 
1,380
 
(1)  
Net interest margin represents net interest income from continuing operations as a percentage of average interest earning assets.
(2)  
Equals total other expense excluding non-core items divided by the sum of net interest income on a fully tax equivalent basis and total other income less non-core items.
(3)  
Non-performing loans include loans accounted for on a non-accrual basis, accruing loans contractually past due 90 days or more as to interest or principal and loans the terms of which have been renegotiated to provide reduction or deferral of interest or principal because of a deterioration in the financial position of the borrower.  Non-performing loans excludes purchased credit-impaired loans that were acquired as part of the Heritage, InBank, Corus, Benchmark, Broadway, and New Century FDIC-assisted transactions.  See Note 6 in the notes to consolidated financial statements contained under Item 8. Financial Statements and Supplementary Data.
(4)  
Non-performing assets include non-performing loans, other real estate owned and other repossessed assets.  Non-performing assets exclude other real estate owned that is related to the Heritage, InBank, Benchmark, Broadway, and New Century FDIC-assisted transactions.  See Note 2 in the notes to consolidated financial statements contained under Item 8. Financial Statements and Supplementary Data.
(5)  
Equals total ending stockholders’ equity less goodwill and other intangibles, net of tax benefit, divided by total assets less goodwill and other intangibles, net of tax benefit.
(6)  
Equals total ending stockholders’ equity less preferred stock, goodwill and other intangibles, net of tax benefit, divided by total assets less goodwill and other intangibles, net of tax benefit.
(7)  
Equals total ending stockholders’ equity less preferred stock, goodwill and other intangibles, net of tax benefit, divided by risk-weighted assets.
(8)  
Includes Union Bank employees for 2006 and employees of our merchant card processing business for all years shown, except 2010.
 
33

 
 
Selected Financial Data (continued):

Core Pre-Tax, Pre-Provision Earnings (Dollars in Thousands)

   
2010
2009
2008
2007
2006
Income (loss) before income taxes
 $       20,552
 $     (77,844)
 $     (7,830)
 $     85,015
 $     90,237
Provision for loan losses
 246,200
 231,800
 125,721
 19,313
 10,100
 
Pre-tax, pre-provision earnings
 266,752
 153,956
 117,891
 104,328
 100,337
             
Non-core other income
         
 
Net gains (losses) on other real estate owned
 (9,284)
 (429)
 455
 140
 222
 
Net gains (losses) on securities available for sale
 18,648
 14,029
 1,130
 (3,744)
 (445)
 
Net gain (loss) on sale of other assets
 630
 (13)
 (1,104)
 10,097
 860
 
Acquisition related gains
 62,649
 28,547
 -
 -
 -
 
Increase (decrease) in market value of assets held in
       
 
     trust for deferred compensation
 562
 710
 (1,657)
 609
 493
Total non-core other income
 73,205
 42,844
 (1,176)
 7,102
 1,130
             
Non-core other expense
         
 
FDIC special assessment
 -
 3,850
 -
 -
 -
 
Contributions to MB Financial Charitable Foundation
 -
 -
 -
 4,500
 -
 
Executive separation agreement expense
 -
 -
 -
 5,980
 -
 
Unamortized issuance costs related to
         
 
     redemption of trust preferred securities
 -
 -
 -
 1,914
 -
 
Impairment charges
 -
 4,000
 -
 -
 -
 
Increase (decrease) in market value of assets held in
       
 
     trust for deferred compensation
 562
 710
 (1,657)
 609
 493
Total non-core other expense
 562
 8,560
 (1,657)
 13,003
 493
Core pre-tax, pre-provision earnings
 $     194,109
 $     119,672
 $    117,410
 $   110,229
 $     99,700
             
Average assets
 10,506,028
 9,777,288
 8,240,344
 7,910,610
 6,602,070
             
Core pre-tax, pre-provision earnings
         
 
to average assets
1.85%
1.22%
1.42%
1.39%
1.51%
 
34

 
 
Efficiency Ratio Calculation (Dollars in Thousands)

     
2010
2009
2008
2007
2006
Non-interest expense
 $   258,776
 $   223,750
 $   183,390
 $   191,506
 $   152,218
Less FDIC special assessment
 -
 3,850
 -
 -
 -
Less contributions to MB Financial Charitable Foundation
 -
 -
 -
 4,500
 -
Less executive separation agreement expense
 -
 -
 -
 5,908
 -
Less unamortized issuance costs related to redemption
         
 
of trust preferred securities
 -
 -
 -
 1,914
 -
Less impairment charges
 -
 4,000
 -
 -
 -
Less increase (decrease) in market value of assets held in
         
 
trust for deferred compensation
 562
 710
 (1,657)
 609
 493
 
Non-interest expense - as adjusted
 $   258,214
 $   215,190
 $   185,047
 $   178,575
 $   151,725
               
Net interest income
 $   339,772
 $   250,552
 $   220,888
 $   212,306
 $   188,179
Tax equivalent adjustment
 10,458
 10,625
 9,890
 7,728
 6,191
Net interest income on a fully tax equivalent basis
 350,230
 261,177
 230,778
 220,034
 194,370
Plus other income
 185,756
 127,154
 80,393
 83,528
 64,376
Less net gains (losses) on other real estate owned
 (9,284)
 (429)
 455
 140
 222
Less net gains (losses) on securities available for sale
 18,648
 14,029
 1,130
 (3,744)
 (445)
Less net gains (losses) on sale of other assets
 630
 (13)
 (1,104)
 10,097
 860
Less acquisition related gains
 62,649
 28,547
 -
 -
 -
Less increase (decrease) in market value of assets held in
         
 
trust for deferred compensation
 562
 710
 (1,657)
 609
 493
Net interest income plus non-interest income -
         
 
as adjusted
 $   462,781
 $   345,487
 $   312,347
 $   296,460
 $   257,616
               
Efficiency ratio
55.80%
62.29%
59.24%
60.24%
58.90%
               
Efficiency ratio (without adjustments)
49.24%
59.24%
60.87%
64.73%
60.27%

 
The following table sets forth our selected quarterly financial data (in thousands, except common share data):

 
Three Months Ended 2010
Three Months Ended 2009
Statement of Income Data:
December
September
June
March
December
September
June
March
Interest income
$   103,573
$    109,752
$   110,441
$   105,874
$    110,250
$     93,609
$     93,864
$      95,815
Interest expense
18,918
22,134
23,760
25,056
36,049
32,675
34,475
39,787
                 
Net interest income
84,655
87,618
86,681
80,818
74,201
60,934
59,389
56,028
Provision for loan losses
49,000
65,000
85,000
47,200
70,000
45,000
27,100
89,700
                 
Net interest income (loss) after provision for loan losses
35,655
22,618
1,681
33,618
4,201
15,934
32,289
(33,672)
                 
Other income
30,795
35,798
92,706
26,457
42,927
30,900
24,925
28,402
Other expenses
64,615
66,478
66,032
61,651
61,072
59,158
54,508
49,012
Income (loss) before income taxes
1,835
(8,062)
28,355
(1,576)
(13,944)
(12,324)
2,706
(54,282)
Income tax expense (benefit)
(1,358)
(5,253)
9,158
(2,523)
(4,164)
(13,596)
(1,480)
(26,025)
Income (loss) from continuing operations
3,193
(2,809)
19,197
947
(9,780)
1,272
4,186
(28,257)
Income from discontinued operations, net of income tax
-
-
-
-
-
6,172
129
152
Net income (loss)
$       3,193
$     (2,809)
$     19,197
$          947
$      (9,780)
$       7,444
$       4,315
$   (28,105)
Preferred stock dividends and discount accretion
2,598
2,597
2,594
2,593
2,591
2,589
2,587
2,531
Net income (loss) available to common stockholders
$          595
$     (5,406)
$     16,603
$    (1,646)
$    (12,371)
$       4,855
$       1,728
$   (30,636)
                 
Net interest margin
3.72%
3.81%
3.79%
3.55%
2.74%
2.74%
3.05%
2.88%
Tax equivalent effect
0.11%
0.11%
0.12%
0.12%
0.12%
0.11%
0.13%
0.13%
Net interest margin on a fully tax equivalent basis
3.83%
3.92%
3.91%
3.67%
2.86%
2.85%
3.18%
3.01%
                 
Common Share Data :
               
Basic earnings (loss) per common share from continuing operations
$       0.06
$   (0.05)
$       0.36
$       0.02
$   (0.19)
$       0.03
$      0.12
$   (0.81)
Basic earnings per common share from discontinued operations
$             -
$            -
$             -
$             -
$            -
$       0.16
$      0.00
$      0.00
Impact of preferred stock dividends on basic earnings (loss) per common share
$    (0.05)
$   (0.05)
$    (0.05)
$     (0.05)
$   (0.05)
$    (0.07)
$   (0.07)
$   (0.07)
Basic earnings (loss) per common share
$       0.01
$   (0.10)
$       0.31
$     (0.03)
$   (0.25)
$       0.12
$      0.05
$   (0.88)
Diluted earnings (loss) per common share from continuing operations
$       0.06
$   (0.05)
$       0.36
$        0.02
$   (0.19)
$       0.03
$      0.12
$   (0.81)
Diluted earnings per common share from discontinued operations
$             -
$            -
$             -
$             -
$            -
$       0.16
$      0.00
$      0.00
Impact of preferred stock dividends on diluted earnings (loss) per common share
$    (0.05)
$   (0.05)
$    (0.05)
$     (0.05)
$   (0.05)
$    (0.07)
$   (0.07)
$   (0.07)
Diluted earnings (loss) per common share
$       0.01
$   (0.10)
$       0.31
$     (0.03)
$   (0.25)
$       0.12
$      0.05
$   (0.88)
                 
Weighted average common shares outstanding
53,572,157
53,327,219
52,702,779
51,264,727
50,279,008
39,104,894
35,726,879
34,914,012
Diluted weighted average common shares outstanding
53,790,047
53,327,219
53,034,426
51,264,727
50,279,008
39,299,168
35,876,483
34,914,012
 
35

 
 
Fourth Quarter Results

We had net income available to common stockholders of $595 thousand for the fourth quarter of 2010, compared to a net loss available to common stockholders of $12.4 million for the fourth quarter of 2009.  The results for the fourth quarter of 2010 generated annualized return on average assets of 0.12%, and an annualized return on average common equity of 0.21%, compared to (0.33%) and (4.54%), respectively, for the same period in 2009.

Net interest income increased 14.1% to $84.7 million in the fourth quarter of 2010, compared to $74.2 million for fourth quarter of 2009 primarily due to an increase in our net interest margin which on a fully tax equivalent basis increased by 97 basis points to 3.83% for the fourth quarter of 2010 compared to the same period in 2009.  The margin increase from the fourth quarter of 2009 was due to an improved average loan yield as a result of an improved loan mix, an improved asset mix with loans representing a greater fraction of assets, and a decrease in our average cost of funds as a result of an improved deposit mix and downward repricing of certificates of deposit.

The provision for loan losses was $49.0 million in the fourth quarter of 2010 and $70.0 million in the fourth quarter of 2009.  Net charge-offs were $50.7 million in the fourth quarter of 2010 compared to $82.2 million in the fourth quarter of 2009.  See “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Asset Quality” in Item 7 below for further analysis of the allowance for loan losses.

Other income was $30.8 million during the fourth quarter of 2010, a decrease of $12.1 million, or 28.3% compared to $42.9 million for the fourth quarter of 2009.  During the fourth quarter of 2009, we recorded an $18.3 million gain relating to our Benchmark FDIC-assisted transaction.   Deposit service fees increased from $9.3 million in the fourth quarter of 2009 to $9.9 million in the fourth quarter of 2010, primarily due to an increase in commercial deposit fees related to deposits assumed in our FDIC-assisted transactions and an increase in NSF and overdraft fees.  Net lease financing income increased mainly as a result of an increase in the sales of third party equipment maintenance contracts. The Broadway and New Century FDIC-assisted transactions resulted in accretion on the corresponding indemnification assets of approximately $3 million during the fourth quarter of 2010.  Prior year accretion related to the Heritage Bank transaction and was not significant.  Trust and asset management fees increased primarily due to an increase in assets under management as a result of organic growth and an increase in the market value of assets under management.

Other expense increased $3.5 million, or 5.8%, to $64.6 million for the fourth quarter of 2010 from $61.1 million for the fourth quarter of 2009.  Our Broadway and New Century transactions increased total other expense by approximately $1.2 million for the fourth quarter of 2010.

Income tax benefit from continuing operations for the fourth quarter of 2010 was $1.4 million compared to an income tax benefit from continuing operations of $4.2 million for the three months ended December 31, 2009.  See Note 16 of notes to consolidated financial statements contained in Item 8 of this report for further analysis of income taxes.

36

 

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,” “General” in 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 available to common stockholders of $10.1 million for the year ended December 31, 2010 compared to a net loss available to common stockholders of $36.4 million for the year ended December 31, 2009.  The increase in earnings was primarily due to an $89.2 million increase in net interest income and a $58.6 million increase in other income, partially offset by an increase in other expense of $35 million and higher provision for loan losses of $14.4 million.  Fully diluted earnings (loss) per common share was $0.19 for the year ended December 31, 2010, compared to ($0.91) per common share in 2009.

Overall, the business environment has been adverse for an extended period of time for many households and businesses in the United States, including those in the Chicago metropolitan area.  The business environment began to significantly deteriorate in 2008 and has remained in a depressed state through and including 2010.  Unemployment remains at elevated levels and real estate prices continue to be significantly lower than the peak of the market several years ago.  As a result of economic conditions, many borrowers’ cash flows have declined due to higher vacancy rates and lower product demand.  Additionally, the values of real estate securing our loans have declined over this extended period.  These factors have caused us to experience higher loan charge-off rates and to increase our reserves for losses on impaired and potential problem loans.

The profitability of our operations depends primarily on our net interest income after provision for loan losses, which is the difference between interest earned on interest earning assets and interest paid on interest bearing liabilities less provision for loan losses.  The provision for loan losses is dependent on changes in our loan portfolio and management’s assessment of the collectability of our loan portfolio as well as prevailing economic and market conditions.  Our net income is also affected by other income and other expenses.  Non-interest income or other income consists of loan service fees, deposit service fees, net lease financing income, brokerage fees, trust and asset management fees, net gains on the sale of investment securities available for sale, increase in cash surrender value of life insurance, net gain (loss) on sale of other assets, acquisition related gains, accretion of the indemnification asset and other operating income.  Other expenses include salaries and employee benefits, occupancy and equipment expense, computer services expense, advertising and marketing expense, professional and legal expense, brokerage fee expense, telecommunication expense, other intangibles amortization expense, FDIC insurance premiums, other real estate expenses (net of rental income), impairment charges and other operating expenses.  Additionally, dividends on preferred shares reduce 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.  Other income and other expenses are impacted by growth of operations and growth in the number of loan and deposit accounts through both acquisitions and core banking business growth.  Growth in operations affects other expenses primarily as a result of additional employees, branch facilities 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.  Higher levels of non-performing assets increase salaries and benefits because of the need to hire additional problem loan remediation staff, legal expenses and other real estate owned expenses.

As noted under “Item 6 Selected Financial Data,” on August 10, 2009, the Company sold its merchant card processing business, resulting in a pre-tax gain of $10.2 million.

For purposes of the following discussion, income and expenses associated with the Company’s merchant card processing business, including the gains recognized on the sale, have been excluded from continuing operations.  See Note 3 of the notes to our consolidated financial statements for additional information on discontinued operations.
 
37

 
 
The Financial Accounting Standards Board’s (FASB) Accounting Standards Codification (ASC) became effective on July 1, 2009. At that date, the ASC became FASB’s officially recognized source of authoritative U.S. GAAP applicable to all public and non-public non-governmental entities, superseding existing FASB, American Institute of Certified Public Accountants (AICPA), Emerging Issues Task Force (EITF) and related literature. Rules and interpretive releases of the SEC under the authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. All other accounting literature is considered non-authoritative. The switch to the ASC affects the way companies refer to U.S. GAAP in financial statements and accounting policies. Citing particular content in the ASC involves specifying the unique numeric path to the content through the Topic, Subtopic, Section and Paragraph structure.

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 is 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 December 31, 2010, the aggregate residual value of the equipment leased under our direct finance, leveraged, and operating leases totaled $53.4 million.  See Note 1 and Note 7 of our audited consolidated financial statements for additional information.
 
38

 

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, 2010, the Company had $55 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, 2010, the Company had approximately $3 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 the financial asset or paid to transfer the 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.

During the year ended December 31, 2010, the Company completed two FDIC-assisted transactions and completed four FDIC-assisted transactions in 2009.  The Company recorded assets and liabilities at the estimated fair value as of the acquisition dates.  See Note 2 below to the consolidated financial statements for additional information.

See Note 19 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 9 to the consolidated financial statements for further 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 stock price has historically traded above its book value.  However, as of December 31, 2010, our market capitalization was less than our common stockholders’ equity.  Should this situation continue to exist for an extended period of time, the Company will consider this and other factors, including the Company’s anticipated future cash flows, to determine whether goodwill is impaired.  No assurance can be given that the Company will not record an impairment loss on goodwill in the future.

The Company’s annual assessment date is as of December 31.  No impairment losses were recognized during the years ended December 31, 2010, 2009 and 2008.
 
39

 
 
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 assume that credit performance returns to our historic experience over the next two years.  If this does not happen, our future cash flows would be negatively impacted.  Given the weak economy and our recent credit performance, there is a high degree of uncertainty regarding this assumption.

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.

40

 

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,
 
2010
 
2009
 
2008
 
Average
 
Yield/
 
Average
 
Yield/
 
Average
 
Yield/
 
Balance
Interest
Rate
 
Balance
Interest
Rate
 
Balance
Interest
Rate
Interest Earning Assets:
                     
Loans (1) (2) (3)
 $     6,635,701
 $   358,648
5.40%
 
 $   6,339,229
 $   326,293
5.15%
 
 $   5,892,845
 $   354,210
6.01%
Loans exempt from federal income taxes (4)
 123,075
 8,978
7.19
 
 82,019
 7,658
9.21
 
 59,746
 4,408
7.26
Taxable investment securities
 1,635,544
 50,542
3.09
 
 1,444,552
 45,777
3.17
 
 868,700
 40,468
4.66
Investment securities exempt from federal income taxes (4)
 356,496
 20,900
5.86
 
 391,071
 22,698
5.72
 
 414,234
 23,849
5.66
Federal funds sold
 352
 2
0.56
 
 -
 -
 -
 
 12,849
 276
2.11
Other interest bearing deposits
 386,521
 1,028
0.27
 
 545,314
 1,737
0.32
 
 52,497
 467
0.89
     Total interest earning assets
 9,137,689
 $   440,098
4.82
 
 8,802,185
 $   404,163
4.59
 
 7,300,871
 $   423,678
5.80
Non-interest earning assets
 1,368,339
     
 975,103
     
 939,473
   
     Total assets
 $   10,506,028
     
 $   9,777,288
     
 $   8,240,344
   
                       
Interest Bearing Liabilities:
                     
Deposits:
                     
  NOW and money market deposit
 $     2,767,044
 $     14,965
0.54%
 
 $   2,098,530
 $     17,773
0.85%
 
 $   1,292,407
 $     23,176
1.79%
  Savings deposit
 619,304
 1,911
0.31
 
 473,477
 1,717
0.36
 
 383,534
 1,239
0.32
  Time deposits
 3,335,457
 58,974
1.77
 
 3,725,326
 102,124
2.74
 
 3,426,332
 126,955
3.71
Short-term borrowings
 268,251
 1,145
0.43
 
 449,548
 5,166
1.15
 
 681,074
 17,590
2.58
Long-term borrowings and  junior subordinated notes
 465,387
 12,873
2.73
 
 512,267
 16,206
3.12
 
 581,026
 23,940
4.05
     Total interest bearing liabilities
 7,455,443
 $     89,868
1.21
 
 7,259,148
 $   142,986
1.97
 
 6,364,373
 $   192,900
3.03
Non-interest bearing deposits
 1,594,504
     
 1,307,021
     
 891,072
   
Other non-interest bearing liabilities
 127,099
     
 85,890
     
 85,368
   
Stockholders’ equity
 1,328,982
     
 1,125,229
     
 899,531
   
     Total liabilities and stockholders’ equity
 $   10,506,028
     
 $   9,777,288
     
 $   8,240,344
   
     Net interest income/interest rate spread (5)
 
 $   350,230
3.61%
   
 $   261,177
2.62%
   
 $   230,778
2.77%
     Taxable equivalent adjustment
 
 (10,458)
     
 (10,625)
     
 (9,890)
 
     Net interest income, as reported
 
 $   339,772
     
 $   250,552
     
 $   220,888
 
     Net interest margin  (6)
   
3.72%
     
2.85%
     
3.03%
     Tax equivalent effect
   
0.11%
     
0.12%
     
0.13%
     Net interest margin on a fully tax equivalent basis (6)
   
3.83%
     
2.97%
     
3.16%

(1)  
Non-accrual loans are included in average loans.
(2)  
Interest income includes amortization of deferred loan origination fees of $4.6 million, $5.1 million and $7.0 million for the years ended December 31, 2010, 2009, and 2008, 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.
 
41

 
 
Net interest income on a tax equivalent basis was $350.2 million for the year ended December 31, 2010, an increase of $89.1 million, or 34.1%, from $261.2 million for the comparable period in 2009.  The growth in net interest income reflects a $335.5 million increase in average interest earning assets, an increase of $287.5 million in average non-interest bearing deposits and a $196.3 million increase in average interest bearing liabilities.  The increase in net interest income was due to a higher level of interest earning assets and a significant improvement in our net interest margin.  Interest earning assets increased largely due to our FDIC-assisted transactions completed within the last two years.  See Note 2 in the notes to consolidated financial statements contained under Item 8. Financial Statements and Supplementary Data for additional information.  The margin increase from the prior year was due to an improved loan mix and a decrease in our average cost of funds as a result of an improved deposit mix and downward repricing of certificates of deposit.  The deposit mix shifted as certificates of deposits for a majority of rate sensitive customers were not renewed and our low cost deposits (non-interest bearing deposits, money market accounts, NOW and savings) increased.  The net interest margin, expressed on a fully tax equivalent basis, was 3.83% for 2010 and 2.97% for 2009.  Our non-performing loans negatively impacted the net interest margin during 2010 and 2009 by approximately 21 basis points and 15 basis points, respectively.

Net interest income on a tax equivalent basis was $261.2 million for the year ended December 31, 2009, an increase of $30.4 million, or 13.2% from $230.8 million for the comparable period in 2008.  The growth in net interest income reflects a $1.5 billion, or 20.6%, increase in average interest earning assets, an increase of $415.9 million in average non-interest bearing deposits and an $894.8 million, or 14.1%, increase in average interest bearing liabilities.  This was partially offset by approximately 19 basis points of margin compression on a fully tax equivalent basis.  The increase in average interest earning assets and the increase in average non-interest bearing deposits and interest bearing liabilities was primarily due to interest earning assets acquired and  non-interest bearing deposits and interest bearing liabilities assumed in four FDIC-assisted transactions during 2009.  See Note 2 in the notes to consolidated financial statements contained under Item 8. Financial Statements and Supplementary Data.  The net interest margin, expressed on a fully tax equivalent basis, was 2.97% for 2009 and 3.16% for 2008.  Our non-performing loans negatively impacted the net interest margin during 2009 and 2008 by approximately 15 basis points, and 9 basis points, respectively.

The recently enacted Dodd-Frank Wall Street Reform and Consumer Protection Act repealed the federal prohibitions on the payment of interest on demand deposits for commercial accounts, thereby permitting depository institutions to pay interest on business transaction and other accounts beginning July 21, 2011.  Although the ultimate impact of this legislation on the Company has not yet been determined, the Company expects interest costs associated with demand deposits to increase as a result of competitor responses to this change.

42

 

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.

   
Year Ended December 31,
   
2010 Compared to 2009
 
2009 Compared to 2008
   
Change
 
Change
     
Change
 
Change
   
   
Due to
 
Due to
 
Total
 
Due to
 
Due to
 
Total
   
Volume
 
Rate
 
Change
 
Volume
 
Rate
 
Change
Interest Earning Assets:
                       
Loans
 
 $   15,629
 
 $   16,726
 
 $   32,355
 
 $   27,016
 
 $   (54,933)
 
 $   (27,917)
Loans exempt from federal income taxes (1)
 
 3,250
 
 (1,930)
 
 1,320
 
 1,899
 
 1,351
 
 3,250
Taxable investment securities
 
 5,926
 
 (1,161)
 
 4,765
 
 21,039
 
 (15,730)
 
 5,309
Investment securities exempt from federal income taxes (1)
 
 (2,025)
 
 227
 
 (1,798)
 
 (1,343)
 
 192
 
 (1,151)
Federal funds sold
 
 2
 
 -
 
 2
 
 (138)
 
 (138)
 
 (276)
Other interest bearing deposits
 
 (452)
 
 (257)
 
 (709)
 
 1,750
 
 (480)
 
 1,270
Total increase (decrease) in interest income
 
 22,330
 
 13,605
 
 35,935
 
 50,223
 
 (69,738)
 
 (19,515)
                         
Interest Bearing Liabilities:
                       
Deposits
                       
   NOW and money market deposit accounts
 
 4,703
 
 (7,511)
 
 (2,808)
 
 10,323
 
 (15,726)
 
 (5,403)
   Savings deposits
 
 476
 
 (282)
 
 194
 
 314
 
 164
 
 478
   Time deposits
 
 (9,823)
 
 (33,327)
 
 (43,150)
 
 10,354
 
 (35,185)
 
 (24,831)
Short-term borrowings
 
 (1,572)
 
 (2,449)
 
 (4,021)
 
 (4,719)
 
 (7,705)
 
 (12,424)
Long-term borrowings and junior subordinated notes
 
 (1,405)
 
 (1,928)
 
 (3,333)
 
 (2,611)
 
 (5,123)
 
 (7,734)
Total (decrease) increase in interest expense
 
 (7,621)
 
 (45,497)
 
 (53,118)
 
 13,661
 
 (63,575)
 
 (49,914)
Total increase (decrease) in net interest income
 
 $   29,951
 
 $   59,102
 
 $   89,053
 
 $   36,562
 
 $     (6,163)
 
 $      30,399

(1)  
Non-taxable loan and investment income is presented on a fully tax equivalent basis assuming a 35% rate.
 
43

 
 
Other Income


     
Year Ended
     
     
December 31,
December 31,
 
Increase/
Percentage
     
2010
2009
 
(Decrease)
Change
Other income (in thousands):
         
 
Loan service fees
 $       6,517
 $       6,913
 
 $     (396)
(6%)
 
Deposit service fees
38,934
30,600
 
8,334
27%
 
Lease financing, net
21,853
18,528
 
3,325
18%
 
Brokerage fees
5,012
4,606
 
406
9%
 
Trust and asset management fees
15,037
12,593
 
2,444
19%
 
Net gain on sale of investment securities
18,648
14,029
 
4,619
33%
 
Increase in cash surrender value of life insurance
3,516
2,459
 
1,057
43%
 
Net loss on sale of other assets
630
(13)
 
643
4,946%
 
Acquisition related gains
62,649
28,547
 
34,102
119%
 
Accretion of indemnification income
9,678
 -
 
9,678
NM
 
Other operating income
3,282
8,892
 
(5,610)
(63%)
Total other income
 $   185,756
 $   127,154
 
 $   58,602
46%

(NM – not meaningful)
 
 
Other income increased for the year ended December 31, 2010 compared to the year ended December 31, 2009, primarily due to gains recognized on the Broadway and New Century FDIC-assisted transactions during the year ended December 31, 2010, totaling $62.6 million, while acquisition related gains in 2009 were $28.5 million.  See Note 2 in the notes to consolidated financial statements contained under Item 8 Financial Statements and Supplementary Data for additional information.  Deposit service fees increased primarily due to an increase in commercial deposit fees related to the treasury management business acquired in the Corus transaction during the second half of 2009, additional treasury management customers added through our marketing efforts, an increase in NSF and overdraft fees related to the FDIC-assisted transactions completed in 2009 and 2010, and organic growth in existing branches.  Net lease financing increased primarily due to an increase in the sales of third party equipment maintenance contracts.  Trust and asset management fees increased primarily due to an increase in assets under management, as a result of organic growth and an increase in the market value of assets under management.  Other income was also impacted by a net gain on sale of investment securities of $18.6 million for the year ended December 31, 2010, compared with a net gain on sale of investment securities of $14.0 million for the year ended December 31, 2009.  The Broadway Bank and New Century Bank FDIC-assisted transactions resulted in accretion on the corresponding indemnification asset.  Prior year accretion related to the Heritage Bank transaction and was not significant.  Other operating income decreased as a result of net losses recognized on other real estate owned of $9.3 million during the year ended December 31, 2010 compared with $429 thousand for the year ended December 31, 2009.
 
44

 

     
Year Ended
     
     
December 31,
December 31,
 
Increase/
Percentage
     
2009
2008
 
(Decrease)
Change
Other income (in thousands):
         
 
Loan service fees
 $       6,913
 $     9,180
 
 $    (2,267)
(25%)
 
Deposit service fees
30,600
28,225
 
2,375
8%
 
Lease financing, net
18,528
16,973
 
1,555
9%
 
Brokerage fees
4,606
4,317
 
289
7%
 
Trust and asset management fees
12,593
11,869
 
724
6%
 
Net gain on sale of investment securities
14,029
1,130
 
12,899
1,142%
 
Increase in cash surrender value of life insurance
2,459
5,299
 
(2,840)
(54%)
 
Net loss on sale of other assets
(13)
(1,104)
 
1,091
99%
 
Acquisition related gains
28,547
 -
 
28,547
NM
 
Other operating income
8,892
4,504
 
4,388
97%
Total other income
 $   127,154
 $   80,393
 
 $     46,761
58%

(NM – not meaningful)
 
 
Other income increased from the year ended December 31, 2008 to the year ended December 31, 2009 primarily due to gains recognized on the FDIC-assisted transactions during 2009, totaling $28.5 million, as well as a net gain on sale of investment securities of $14.0 million compared with a net gain on sale of investment securities of $1.1 million during the year ended December 31, 2008.  Loan service fees decreased, primarily due to a decrease in letter of credit and prepayment fees.  Deposit service fees increased primarily due to an increase in commercial deposit fees related to the treasury management business acquired in the Corus transaction during the second half of 2009.  The decrease in cash surrender value of life insurance was primarily due to a decrease in overall interest rates from the year ended December 31, 2008 to the year ended December 31, 2009, and $1.4 million of death benefits on bank owned life insurance policies that we recognized during the year ended December 31, 2008.  Other operating income increased primarily due to an increase in gains recognized on the sale of loans, and an increase in market value of assets held in trust for deferred compensation during the year ended December 31, 2009.

45

 

Other Expenses


     
Year Ended
     
     
December 31,
December 31,
 
Increase/
Percentage
     
2010
2009
 
(Decrease)
Change
Other expense (in thousands):
         
 
Salaries and employee benefits
 $   144,349
 $   120,654
 
 $   23,695
20%
 
Occupancy and equipment expense
 34,845
 31,521
 
 3,324
11%
 
Computer services expense
 10,949
 10,011
 
 938
9%
 
Advertising and marketing expense
 6,465
 4,185
 
 2,280
54%
 
Professional and legal expense
 5,803
 4,680
 
 1,123
24%
 
Brokerage fee expense
 1,926
 1,999
 
 (73)
(4%)
 
Telecommunication expense
 3,666
 3,433
 
 233
7%
 
Other intangibles amortization expense
 6,214
 4,491
 
 1,723
38%
 
FDIC insurance premiums
 15,600
 16,762
 
 (1,162)
(7%)
 
Impairment charges
 -
 4,000
 
 (4,000)
(100%)
 
Other real estate expenses, net
 2,694
 871
 
 1,823
209%
 
Other operating expenses
 26,265
 21,143
 
 5,122
24%
Total other expense
 $   258,776
 $   223,750
 
 $   35,026
16%


Other expense increased from the year ended December 31, 2009 to the year ended December 31, 2010, primarily due to the FDIC-assisted transactions completed during 2009 and 2010.  See Note 2 in the notes to consolidated financial statements contained under Item 8 Financial Statements and Supplementary Data for additional information.  We completed six FDIC-assisted transactions in 2009 and 2010.  Operating expenses related to the FDIC-assisted transactions were approximately $37.5 million in 2010, and approximately $14.5 million in 2009, resulting in a year over year increase of approximately $23 million.  Salaries and employee benefits expense also increased due to problem loan remediation staff added throughout 2010.  FDIC insurance premiums decreased during the twelve months ended December 31, 2010, as a $3.9 million special premium was assessed by the FDIC during the twelve months ended December 31, 2009.  Impairment charges decreased from the year ended December 31, 2009 by $4.0 million.  During the year ended December 31, 2009, the Company conducted an impairment review of branch office locations to be consolidated due to the Company’s FDIC-assisted transactions. As a result, the Company recognized a $4.0 million impairment charge related to three branches in the third quarter of 2009.  Other real estate expense increased as a result of an increase in OREO activity during 2010.  Other operating expenses increased due to an increase of $1.4 million in debit card expenses due to increased activity.  Other operating expenses also increased due to expenses related to our FDIC-assisted transactions.

46

 

     
Year Ended
     
     
December 31,
December 31,
 
Increase/
Percentage
     
2009
2008
 
(Decrease)
Change
Other expense (in thousands):
         
 
Salaries and employee benefits
$   120,654
$   108,835
 
$   11,819
11%
 
Occupancy and equipment expense
31,521
28,872
 
2,649
9%
 
Computer services expense
10,011
7,392
 
2,619
35%
 
Advertising and marketing expense
4,185
5,089
 
(904)
(18%)
 
Professional and legal expense
4,680
3,110
 
1,570
50%
 
Brokerage fee expense
1,999
1,929
 
70
4%
 
Telecommunication expense
3,433
2,818
 
615
22%
 
Other intangibles amortization expense
4,491
3,554
 
937
26%
 
FDIC insurance premiums
16,762
1,877
 
14,885
793%
 
Impairment charges on branch facilities
4,000
-
 
4,000
NM
 
Other real estate expenses, net
871
388
 
483
124%
 
Other operating expenses
21,143
19,526
 
1,617
8%
Total other expense
$   223,750
$   183,390
 
$   40,360
22%

(NM – not meaningful)
 
 
       We completed four FDIC-assisted during the year ended December 31, 2009.  The FDIC-assisted transactions increased operating expenses by approximately $14.5 million.  Salaries and employee benefits expense also increased due to problem loan remediation staff hired in 2009.  FDIC insurance premium expense increased as general insurance assessment rates increased and the FDIC imposed a special premium on all insured depository institutions based on assets as of June 30, 2009, which for the Bank amounted to $3.9 million.  During 2009, the Company conducted an impairment review of branch office locations to be consolidated due to the Company’s recent acquisitions.  As a result, the Company recognized a $4.0 million impairment charge related to three branches in 2009.  See Note 2 to the Consolidated Financial Statements for further information regarding the Heritage, InBank, Corus, and Benchmark transactions.  Other operating expenses increased primarily due to an increase in debit card expenses due to increased activity from the year ended December 31, 2008 to the year ended December 31, 2009.  Other operating expenses also increased due to expenses related to our FDIC-assisted transactions.

Income Taxes

Income tax expense from continuing operations for the year ended December 31, 2010 was $24 thousand compared to income tax benefit from continuing operations of $45.3 million for the year ended December 31, 2009.   The decrease was primarily due to an increase in our pre-tax income during the year ended December 31, 2010.  Additionally, during 2009, the Company increased the amount of benefit recognized with respect to certain previously identified uncertain tax positions as a result of developments in tax audits.  The increase in recognized tax benefit resulted in a $7.7 million increase in income tax benefit in 2009.

Income tax benefit from continuing operations for the year ended December 31, 2009 was $45.3 million, compared to income tax benefit from continuing operations of $23.6 million for the year ended December 31, 2008.   The increase was primarily due to an increase in our taxable loss for the year ended December 31, 2009.  Additionally, as mentioned above, in 2009 the Company increased the amount of benefit recognized with respect to certain previously identified uncertain tax positions.

For the years ended December 31, 2009 and 2008, the Company had $4.1 million and $236 thousand, respectively, of income tax expense from discontinued operations.

As previously stated in the “Critical Accounting Policies” section above, income tax expense recorded in the consolidated income statement involves interpretation and application of certain accounting pronouncements and federal and state tax codes, and is, therefore, considered a critical accounting policy.  See Note 1 and Note 16 of the notes to our audited consolidated financial statements for our income tax accounting policy and additional income tax information.
 
47

 
 
Balance Sheet

Total assets decreased $545.0 million or 5.0% from $10.9 billion at December 31, 2009 to $10.3 billion at December 31, 2010.  Investment securities available for sale decreased $1.2 billion from December 31, 2009 to December 31, 2010, primarily due to securities sales during 2010, the proceeds of which were used to fund our Broadway FDIC-assisted transaction and rate sensitive certificate of deposit run-off.  Security sales in the third quarter of 2010 were also done to lock in unrealized gains and shorten the overall duration of the securities portfolio.  Net loans increased by $78.1 million to $6.4 billion at December 31, 2010 primarily as a result of our FDIC-assisted transactions, offset by principal reductions on loans and net charge-offs.  See “Loan Portfolio” section below for further analysis.  The FDIC indemnification asset and other real estate owned related to FDIC-assisted transactions increased by $173.2 million and $26.0 million, respectively, from December 31, 2009 to December 31, 2010, primarily due to our Broadway and New Century FDIC-assisted transactions.  Other assets decreased primarily due to receipt of prior year income tax receivables.  Premises and equipment increased due to the purchase of several properties related to our FDIC-assisted transactions.  See Note 2 in the notes to consolidated financial statements contained under Item 8 Financial Statements and Supplementary Data for additional information.

Total liabilities decreased by $638.6 million, or 6.6%, to $9.0 billion at December 31, 2010 from $9.6 billion at December 31, 2009.  Total deposits decreased by $530.3 million, or 6.1%, to $8.2 billion at December 31, 2010 from $8.7 billion at December 31, 2009 as a result of the rate sensitive certificate of deposit run-off.  Noninterest bearing deposits increased by $139.4 million, or 9.0%, to $1.7 billion at December 31, 2010 compared to December 31, 2009.

Total stockholders’ equity increased $93.6 million to $1.3 billion at December 31, 2010 compared to December 31, 2009.  This increase was primarily due to additional paid-in capital from stock issuances pursuant to the Company’s Dividend Reinvestment and Stock Purchase Plan and an increase in accumulated other comprehensive income related to unrealized securities gains.

Investment Securities Available for Sale

The primary purpose of the investment portfolio is to provide a source of earnings, be a source of liquidity, and serve as a tool for managing interest rate risk.  In managing the portfolio, we seek to balance safety of principal and liquidity, and diversification considerations with maximum return.  See “Liquidity” and “Capital Resources” in this Item 7 and “Quantitative and Qualitative Disclosures About Market Risk - Asset Liability Management” under Item 7A.

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

 
Year Ended December 31,
 
2010
2009
2008
   
Amortized
 
Fair
 
Amortized
 
Fair
 
Amortized
 
Fair
   
Cost
 
Value
 
Cost
 
Value
 
Cost
 
Value
                         
U.S. government sponsored agencies and enterprises
 
 $         18,766
 
 $        19,434
 
 $        69,120
 
 $         70,239
 
 $      171,385