Toggle SGML Header (+)


Section 1: 10-K (10-K)

12.31.12 10K MB



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

 
FORM 10-K
 
(Mark One)
 
ý
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended December 31, 2012
 
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. Yes ý No o
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o No ý
 
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.  Yes ý No o
 
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).  Yes ý No o
 
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
 

1




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 filer ý
 
Accelerated filer o
 
 
 
Non-accelerated filer o
(Do not check if a smaller reporting company)
 
Smaller reporting company o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes o No ý
 
The aggregate market value of the voting shares held by non-affiliates of the Registrant was approximately $1,137,978,512 as of June 30, 2012, 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 54,779,141 shares of the Registrant’s common stock as of February 19, 2013.
 
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 2013 Annual Meeting of Stockholders.
 
Part III


2





MB FINANCIAL, INC. AND SUBSIDIARIES
 
FORM 10-K
 
December 31, 2012
 
INDEX
 
 
 
 
Page
 
 
 
Item 1
 
Item 1A
 
Item 1B
 
Item 2
 
Item 3
 
Item 4
Mine Safety Disclosures
 
 
 
 
 
 
 
 
Item 5
 
Item 6
 
Item 7
 
Item 7A
 
Item 8
 
Item 9
 
Item 9A
 
Item 9B
 
 
 
 
 
 
 
 
Item 10
 
Item 11
 
Item 12
 
Item 13
 
Item 14
 
 
 
 
 
 
 
 
Item 15
 
 
 


3



PART I


 
Item 1.
  Business
 
Special Note Regarding Forward-Looking Statements
 
When used in this Annual Report on Form 10-K and in other documents filed or furnished 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, the Federal Reserve Board 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, any changes in capital requirements pursuant to the Dodd-Frank Act and the implementation of the Basel III capital standards, other governmental initiatives affecting the financial services industry and changes in federal and/or state tax laws or interpretations thereof by taxing authorities; (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.

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 85 banking offices through our bank subsidiary, MB Financial Bank, N.A. (MB Financial Bank). 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, leasing, retail banking and wealth management.  As of December 31, 2012, on a consolidated basis, we had total assets of $9.6 billion, deposits of $7.5 billion, stockholders’ equity of $1.3 billion, and $2.9 billion of client assets under management in our Wealth Management Group (including $1.8 billion in our trust department and $1.1 billion in our majority owned asset management firm, Cedar Hill Associates LLC).
 
MB Financial, Inc. was incorporated as a Maryland corporation in 2001 in connection with a merger of predecessor companies. We have completed a number of acquisitions in recent years, including the following recent transactions.
 

4



During 2009 and 2010, MB Financial Bank acquired certain assets and assumed certain liabilities of the following institutions in transactions facilitated by the Federal Deposit Insurance Corporation (FDIC):

Glenwood, Illinois-based Heritage Community Bank (Heritage);
Oak Forest, Illinois-based InBank;
Chicago, Illinois-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).  

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 shares in the losses on assets (generally loans and other real estate owned) covered under the agreements (referred to as “covered loans” and “covered other real estate owned”).  

On December 28, 2012, MB Financial Bank acquired Celtic Leasing Corp. (“Celtic”), a privately held, mid-ticket equipment leasing company. See Note 2 of the notes to our audited consolidated financial statements contained in Item 8 of this report for additional information.

MB Financial Bank Subsidiaries

MB Financial Bank, our largest subsidiary, has two wholly owned subsidiaries with significant operating activities: LaSalle Systems Leasing, Inc. (LaSalle) and Celtic. MB Financial Bank also has a majority owned subsidiary with significant operating activities, Cedar Hill Associates, LLC (Cedar Hill).
 
LaSalle, which we acquired in 2002, focuses on leasing technology-related equipment to middle market and larger businesses located throughout the United States.  LaSalle also specializes in selling and administering third party equipment maintenance contracts as well as technology-related equipment. Celtic focuses on leasing equipment to middle market health care, legal, technology, and manufacturing companies located throughout the United States.
 
Cedar Hill is an asset management firm located in Chicago, Illinois that we acquired in April 2008.

During the fourth quarter of 2012, MB Financial Bank's subsidiary, Vision Investment Services, Inc., a registered broker/dealer with the Securities and Exchange Commission, was dissolved.
 
Primary Lines of Business
 
Our operations are managed as one unit, and we have one reportable segment. Our chief operating decision-makers use consolidated information 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 operate four primary lines of business: commercial banking, leasing, 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, treasury management, capital markets, and international banking products to these companies. In general, our credit products are designed for companies with annual revenues between $10 million and $250 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, and checking accounts. Our capital markets products include derivatives and interest rate risk solutions, capital solutions, merger and acquisition advisory, and real estate debt placement. Our international banking services include trade services, export trade finance, and foreign exchange. We also provide a full set of credit, deposit and treasury management services for real estate operators and investors.


5




Leasing. Leasing includes lease banking as well as lease originations and related services. Lease banking serves equipment leasing companies located throughout the United States. We have provided banking services to this industry 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 elite 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. Lessees include investment grade “Fortune 1000” companies located throughout the U.S. and large middle-market companies. We also invest directly in equipment that we lease to other companies located throughout the United States (referred to as direct finance, leveraged or 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.

Retail Banking.  Retail banking has 85 banking offices and approximately 125 ATMs located throughout the Chicago metropolitan area. We also have one branch in Philadelphia, Pennsylvania. Our target customer includes individuals who live and work near our branch offices, as well as companies with annual revenues of $1 to $10 million located near our offices. Our personal checking product line offers checking options designed for all market segments--the under-served, the more affluent, the loyal customer, the very young and the senior population. These products are supported by relevant ancillary services such as “ibankmb.com,” our internet banking and bill pay service. Customers may also take advantage of the MB Debit MasterCard, our Platinum Credit Card, and our new Everyday Prepaid Card. Our retail lending division offers mortgages and other personal loan solutions.

Our business banking division offers the same business services available to our larger commercial business customers, customized to this business segment. These customers are afforded the expertise of a business banker and the personal attention of a local branch. These customers can take advantage of a corporate credit card and corporate debit card as well as many other treasury management services to meet the needs of their business.

We also offer our extensive MB Bank@Work program through which our bankers will go to enrolled employers' facilities to provide individual banking services for their employees.

Our bankers strive to provide high quality personal service. Our telephone customer service center is open 7 days a week. PAL, our automated telephone banking service, and MB.net are available 24/7 to provide a constant information source for our customers.
 
Wealth Management.  Our wealth management group provides comprehensive wealth management solutions to individuals, corporations and not-for-profits. We provide private banking, investment management, custody, personal trust, financial planning and wealth advisory services to business owners, high net worth individuals, foundations and endowments, and private banking services through our private bankers, asset management and trust advisors and Cedar Hill. Estate settlement, guardianship and retirement plan services are provided through our asset management and trust group. Our investment advisors working in our branches offer a wide variety of financial products and services to our retail customers, including non-FDIC insured investment alternatives and/or insurance products. MB Financial Bank subsidiary Cedar Hill also provides clients with non-FDIC insured investment alternatives and/or insurance products.

Lending Activities
 
General.  Our loan portfolio consists primarily of loans to businesses or for business purposes.
 
Commercial.  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.  Most commercial loans are short-term in nature, being one year or less, with the maximum term generally being five to seven years.  Our commercial loans typically range in size from $250 thousand to $20 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, and advances are usually predicated on predetermined advance rates depending

6




upon asset class.  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.  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 interest rate swap agreements 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 property value and the overall creditworthiness of the prospective borrower.  Our commercial real estate loans typically range in size from $250 thousand to $20 million.
 
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.  In addition, most 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.  Prior to 2008, we provided construction loans for the acquisition and development of land and construction of condominiums, townhomes, and one-to-four family residences.  We also provided acquisition, development and construction loans for retail and other commercial purposes, primarily in our market areas. Since 2008, we have provided construction loans primarily for owner occupied real estate.  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 on 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 a 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 value 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 lessees usually acknowledge our security interest in the leased equipment and often agrees to send lease payments directly to us.  Lessees are often companies that have an investment grade public debt rating by Moody’s or Standard & Poors or the equivalent although 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 typically have a fixed interest rate and are fully amortizing, with maturities typically ranging from three to five years. 
 
We also invest directly in equipment leased to other companies (which we refer to as direct finance, leveraged or 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.”
 

7




Residential Real Estate.  We originate fixed and adjustable rate residential real estate loans secured by one to four family homes.  Terms of first mortgages generally 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 a majority of our newly originated fixed-rate residential real estate loans and to hold in portfolio a limited number of adjustable-rate residential real estate loans with 15 and 30 year maturities.
 
Consumer.  Our consumer loan portfolio is primarily focused on home equity lines of credit, fixed-rate second mortgage loans and indirect motorcycle loans, and to a lesser extent, secured and unsecured consumer loans, as well as personal and business credit cards.  Home equity lines of credit are generally extended up to 80% of the value of the property, less existing liens.  Terms for second mortgages typically range from five to ten years.  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.  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 in the event of default.
 
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 and expertise to our customers, ease of access to our facilities, convenient hours and competitive pricing (including competitive interest rates paid on deposits, interest rates charged on loans and fees charged for other non-interest related services).
 
Personnel
 
As of December 31, 2012, we and our subsidiaries employed a total of 1,758 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”), the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), enacted on July 21, 2010, and other legislation.  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, the Dodd-Frank Act and Federal Reserve Board regulations, a bank holding company must serve as a source of strength for its subsidiary banks.  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.
 
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

8




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: finance leasing and 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. 
 
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 (collectively, the federal banking agencies) have issued substantially similar risk-based and leverage capital regulations applicable to bank holding companies and banks.  In addition, these 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 regulations 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, 2012 were 14.73% and 16.62%, respectively.
 
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, 2012, we had a leverage ratio of 10.50%.
 
The federal banking agencies’ risk-based capital rules 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

9




a much greater extent than permitted in existing risk-based capital guidelines.  Basel II also addresses capital requirements for operational risk and refines the existing capital requirements for market risk exposures.
 
A final rule implementing the advanced approaches of Basel II in the United States, which applies 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 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.

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.
 
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 considered by United States banking regulators in developing new regulations applicable to other banks and bank holding companies.
 
For banks in the United States, among the most significant provisions of Basel III concerning capital are the following:

minimum capital ratios, including a minimum ratio of common equity to risk-weighted assets;
an additional countercyclical capital buffer to be imposed by banking regulators periodically at their discretion, with advance notice;
restrictions on capital distributions and discretionary bonuses 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 over the counter (OTC) derivatives, repos and securities financing activities; and
for capital instruments issued on or after January 13, 2013 (other than common equity), a loss-absorbency requirement.

The federal banking agencies have proposed regulations to implement the provisions of the Dodd-Frank Act and Basel III on capital. These are described below under “-Proposed Capital Regulations.”
 
The Basel III provisions on liquidity include complex criteria establishing a liquidity coverage ratio (“LCR”) and a net stable funding ratio (“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.  In June 2011, the federal banking agencies adopted a rule applicable to only large, internationally active banks requiring their risk-based capital to meet the higher of the minimum requirements under the advanced approaches or under the risk-based capital rules generally applicable to United States banks.
 

10




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.
 
As of December 31, 2012, our subsidiary bank met the requirements to be classified as “well-capitalized.”

In connection with proposed new capital rules, certain changes to the prompt corrective action rules have also been proposed. See “--Proposed Capital Regulations” below.

Proposed Capital Regulations
The federal banking agencies have proposed regulations that would substantially amend the capital regulations currently applicable to us. The proposed regulations would implement the “Basel III” regulatory capital reforms and changes required by the Dodd-Frank Act. “Basel III” refers to various documents released by the Basel Committee on Banking Supervision. As published, the proposed regulations contemplated a general effective date of January 1, 2013, and, for certain provisions, various phase-in periods and later effective dates. However, the federal banking agencies have announced that the proposed regulations will not be effective on January 1, 2013. The agencies have not adopted final rules or published any modifications to the proposed regulations. The proposed regulations as published are summarized below. It is not possible to predict when or in what form final regulations may be adopted.
The proposed regulations include new minimum capital ratios, to be phased in until fully effective on January 1, 2015, and would refine the definitions of what constitutes “capital” for purposes of calculating those ratios. The proposed new minimum capital ratios would be: (i) a new common equity Tier 1 capital ratio of 4.5%; (ii) a Tier 1 capital ratio of 6% (increased from 4%); (iii) a total capital ratio of 8% (unchanged from current rules); and (iv) a Tier 1 leverage ratio of 4%. The proposed regulations would also establish a “capital conservation buffer” requirement of 2.5% above each of the new regulatory minimum capital ratios to be phased in starting on January 1, 2016 and fully effective on January 1, 2019. An institution would be subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if any of its capital levels fell below the buffer amount.
The proposed regulations also implement other revisions to the current capital rules, such as recognition of all unrealized gains and losses on available for sale debt and equity securities, and provide that instruments that will no longer qualify as capital would be phased out over time.

11




The federal banking agencies also proposed revisions, effective January 1, 2015, to the prompt corrective action framework, which is designed to place restrictions on insured depository institutions if their capital levels show signs of weakness. Under the prompt corrective action requirements, insured depository institutions would be required to meet the following in order to qualify as “well capitalized:” (i) a common equity Tier 1 risk-based capital ratio of 6.5%; (ii) a Tier 1 risk-based capital ratio of 8% (increased from 6%); (iii) a total risk-based capital ratio of 10% (unchanged from current rules); and (iv) a Tier 1 leverage ratio of 5% (unchanged from the current rules).
The proposed regulations set forth certain changes for the calculation of risk-weighted assets, effective January 1, 2015. In particular, the proposed regulations would establish risk-weighting categories generally ranging from 0% for U.S. government and agency securities to 600% for certain equity exposures. Specifics include, among others:
For residential mortgage exposures, changing the current 50% risk weight for high-quality seasoned mortgages and 100% risk-weight for all other mortgages to risk weights between 35% and 200% depending upon the LTV ratio and other factors (but VA and FHA guaranteed loans would have 0% risk weight).
Applying a 150% risk weight instead of a 100% risk weight for certain high volatility commercial real estate acquisition, development and construction loans.
Assigning a 150% risk weight to exposures (other than residential mortgage exposures) that are 90 days past due.
Providing for a 20% credit conversion factor for the unused portion of a commitment with an original maturity of one year or less that is not unconditionally cancellable (currently set at 0%).
Certain increased capital requirements for counterparty credit risk relating to over-the-counter derivatives, repos and securities financing transactions.

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.

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.
 
Federal Deposit Insurance Reform.  The FDIC maintains the Deposit Insurance Fund (the “DIF”).  The deposit accounts of our subsidiary bank are insured by the DIF to the maximum amount provided by law.  The general insurance limit is $250 thousand, but for non-interest bearing transaction accounts, there was unlimited insurance coverage until January 1, 2013.  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.
 
The FDIC assesses deposit insurance premiums on each insured institution quarterly based on annualized rates for one of four risk categories. Each institution is assigned to one of four risk categories based on its capital, supervisory ratings and other factors.  Well capitalized institutions that are financially sound with only a few minor weaknesses are assigned to Risk Category I.  Risk Categories II, III and IV present progressively greater risks to the DIF. 
 
As required by the Dodd-Frank Act, the FDIC has adopted rules, under which insurance premium assessments are based on an institution’s total assets minus its tangible equity (defined as Tier 1 capital) instead of its deposits.  Under these rules, an institution with total assets of less than $10 billion will be assigned to a Risk Category as described above, and a range of initial base assessment rates will apply to each category, subject to adjustment downward based on unsecured debt issued by the institution and, except for an institution in Risk Category I, adjustment upward if the institution’s brokered deposits exceed 10% of its domestic deposits, to produce total base assessment rates.  Total base assessment rates range from 2.5 to 9 basis points for Risk Category I, 9 to 24 basis points for Risk Category II, 18 to 33 basis points for Risk Category III, and 30 to 45 basis points for Risk Category IV, all subject to further adjustment upward if the institution holds more than a de minimis amount of unsecured debt issued by another FDIC-insured institution. The FDIC may increase or decrease its rates by 2.0 basis points without further rulemaking.  In an emergency, the FDIC may also impose a special assessment.
 

12




For a bank that has had total assets of $10 billion or more for four consecutive quarters, effective for assessments for the second quarter of 2011 and payable at the end of September 2011, FDIC regulations require the bank to 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 ratings. 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 is 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.”

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.
 
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

13




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.
 
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 certain compliance and due diligence obligations, defines certain 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:
 
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 and its affiliates, and the power to prohibit unfair, deceptive or abusive acts or practices.
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 to establish a risk committee responsible for enterprise-wide risk management practices, comprised of independent directors including one risk management expert.
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.

14




Make permanent the $250 thousand limit for federal deposit insurance and provided unlimited federal deposit insurance until January 1, 2013 for non-interest bearing demand transaction accounts at all insured depository institutions (later legislation extended this unlimited coverage to IOLTA accounts until January 1, 2013).
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.
Give the Federal Reserve Board the authority to establish rules regarding interchange fees charged for electronic debit transactions by a payment card issuer that, together with its affiliates, has assets of $10 billion or more 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 rules under this provision that limit the swipe fees that a debit card issuer can charge a merchant for a transaction to the sum of 21 cents and five basis points times the value of the transaction, plus up to one cent for fraud prevention costs.
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.
Require annual stress testing by banks with more than $10 billion in assets and impose certain reporting and disclosure requirements.
 
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.

Incentive Compensation.  The Dodd-Frank Act requires the federal banking regulators and other agencies, including the Securities and Exchange Commission, to issue regulations or guidelines requiring disclosure to the regulators of incentive-based compensation arrangements and to prohibit incentive-based compensation arrangements for directors, officers or employees that encourage inappropriate risks by providing excessive compensation, fees or benefits or that could lead to material financial loss to a financial institution.  Proposed regulations for this purpose have been published, which are based upon the key principles that 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 and appropriate policies, procedures and monitoring.  The proposed regulations are consistent with the Guidance on Sound Incentive Compensation Policies issued by regulators in 2010.
 
As part of the regular, risk-focused examination process, the incentive compensation arrangements of banking organizations will be reviewed, and the regulator’s findings 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 any deficiencies.
 
The scope and content of the U.S. banking regulations and 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.  From time to time, various other 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

15




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.
 
A substantial portion of our loan portfolio is secured by real estate. Deterioration in the real estate markets or other segments of our loan portfolio could lead to losses, which could have a material negative effect on our financial condition and results of operations.
 
As of December 31, 2012, 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 42% of our total loan portfolio was secured by real estate (compared to approximately 45% as of December 31, 2011), a majority of which is commercial real estate. 
 
Our commercial real estate loans make up approximately 30% of the loan portfolio and underlying weakness in the real estate market result in additional risk in the portfolio.
 
Our commercial real estate portfolio consists of health care, industrial, multifamily, office, retail and church and schools loans.  Our concentration in commercial real estate loans involves additional risk as the values of the properties securing the loans have declined over the past several years.  Vacancy rates have increased over the past several years, resulting in lower cash flows on the underlying properties and stress on our customer's ability to repay their loans.
 
At December 31, 2012, 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 commercial real estate loans totaled $1.8 billion, or 30% of our total loan portfolio. This loan type represented approximately 51% of our total non-performing loans as of December 31, 2012.
 
The deterioration in the quality of our commercial real estate portfolio has been a significant factor behind the higher than normal charge-offs and provisions for loan losses we have experienced in recent years.  A weak real estate market 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.
 

16




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. At December 31, 2012, our commercial loans totaled $1.2 billion, or 21% of our total loan portfolio. This loan type represented approximately 20.6% of our total non-performing loans as of December 31, 2012.
 
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. At December 31, 2012, our lease loans totaled $1.3 billion, or 23% of our total loan portfolio. This loan type represented approximately 1.2% of our total non-performing loans as of December 31, 2012.

We have recently been negatively affected by credit risk associated with residential real estate.

We originate fixed and adjustable rate loans secured by one- to four-family residential real estate.  Our general practice is to sell a majority of our newly originated fixed-rate residential real estate loans and to hold in portfolio a limited number of adjustable-rate residential real estate loans with 15 and 30 year maturities. Our portfolio also includes home equity lines of credit and fixed-rate second mortgage loans.  Home equity lines of credit are generally extended up to 80% of the value of the property, less existing liens.  Terms for second mortgages typically range from five to ten years.

This type of real estate lending is generally sensitive to regional and local economic conditions that significantly impact the ability of borrowers to meet their loan payment obligations, making loss levels difficult to predict. The decline in residential real estate values as a result of the downturn in the Chicago-area housing markets has reduced the value of the real estate collateral securing these types of loans and increased the risk that we will incur losses if borrowers default on their loans. Residential loans with high combined loan-to-value ratios generally will be more sensitive to declining property values than those with lower combined loan-to-value ratios and therefore may experience a higher incidence of default and severity of losses. In addition, if the borrowers sell their homes, the borrowers may be unable to repay their loans in full from the sale proceeds. As a result, these loans may experience higher rates of delinquencies, defaults and losses, which could in turn adversely affect our financial condition and results of operations.

Our non-performing consumer related loans increased from $14.7 million, or 11.4% of our total non-performing loans, as of December 31, 2011 to $30.9 million, or 26% of our total non-performing loans, as of December 31, 2012, primarily due to increases in non-performing home equity and residential real estate loans. These two categories combined accounted for 95% of the consumer related non-performing loans as of December 31, 2012.
 
 Changes in economic conditions, particularly an 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. 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
the net worth and liquidity of loan guarantors may decline, impairing their ability to honor commitments to us.
 

17




Except for our leasing and lease loan 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.
 
Negative developments in the financial industry have adversely affected our industry and our business.
 
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.

The downgrade of the U.S. credit rating and Europe’s debt crisis could have a material adverse effect on our business, financial condition and liquidity.
 
Standard & Poor’s lowered its long term sovereign credit rating on the United States of America from AAA to AA+ on August 5, 2011. A further downgrade or a downgrade by other rating agencies could have a material adverse impact on financial markets and economic conditions in the United States and worldwide. Any such adverse impact could have a material adverse effect on our liquidity, financial condition and results of operations. Many of our investment securities are issued by and some of our loans are made to the U.S. government and government agencies and sponsored entities.
 
In addition, the possibility that certain European Union (“EU”) member states will default on their debt obligations have negatively impacted economic conditions and global markets. The continued uncertainty over the outcome of international and the EU’s financial support programs and the possibility that other EU member states may experience similar financial troubles could further disrupt global markets. The negative impact on economic conditions and global markets could also have a material adverse effect on our liquidity, financial condition and results of operations.
 
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;
changes and uncertainties as to the future value of the collateral, in the case of a collateralized loan;
credit experience of a particular borrower;
changes in economic and industry conditions; and
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 as well as current macroeconomic factors; and
our specific reserve, based on our evaluation of non-performing loans and their underlying collateral.
 
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. 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

18




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 may need additional provisions to replenish the allowance for loan losses. Any increases in the allowance for loan losses will result in a decrease in net income and, most likely, capital, and may have a material negative effect on our financial condition and results of operations.
 
The fair value of our investment securities can fluctuate due to market conditions out of our control.
 
As of December 31, 2012, our investment securities portfolio contained 117 securities in an unrealized loss position (with total unrealized losses of $6.4 million as of that date), compared to 39 securities in an unrealized loss position as of December 31, 2011 (with total unrealized losses of $2.3 million as of that date). Factors beyond our control can significantly influence the fair value of securities in our investment securities portfolio and can cause potential adverse changes to the fair value of these securities. These factors include but are not limited to rating agency downgrades of the securities, defaults by the issuer or with respect to the underlying securities, changes in market interest rates and instability in the credit markets. Any of these mentioned factors could cause an-other-than-temporary impairment or permanent impairment of these assets, which would lead to accounting charges which could have a material negative effect on our financial condition and results of operations. In addition, we have a large longer term municipal security portfolio that would decline substantially in value if interest rates increase materially.

Higher FDIC deposit insurance premiums and assessments could significantly increase our non-interest expense.
 
FDIC insurance rates 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.
 
Changes in interest rates may reduce our net interest income, and may result in higher defaults in a rising rate environment.
 
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, among other things.
 
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.

If the interest rates paid on deposits and other interest bearing liabilities increase at a faster rate than the interest rates received on loans and other interest earning assets, our net interest income, and therefore earnings, could be adversely affected.  As a result of the relatively low interest rate environment, an increasing percentage of our deposits have been comprised of deposits bearing no or a relatively low rate of interest. We would incur a higher cost of funds to retain these deposits in a rising interest rate environment. In addition, a substantial portion of our loans (approximately 40% of our total loan portfolio as of December 31, 2012) have adjustable interest rates.  While the higher payment amounts we would receive on these loans in a rising interest rate environment may increase our interest income, some borrowers may be unable to afford the higher payment amounts, which may result in a higher rate of default. Rising interest rates also may reduce the demand for loans and the value of our fixed-rate investment securities.
 

19




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 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, and the terms of certain loans may exceed the coverage periods under the loss-share agreements.
 
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. In addition, the loss-share agreements protect MB Financial Bank against losses for limited periods of time (generally ten years for single family residential real estate loans and five years for commercial loans). To the extent MB Financial Bank continues to hold any of the covered loans following the expiration of the applicable loss-share period, it will absorb 100% of any losses. The loss-share agreements begin to expire as follows: Heritage in March 2014, Benchmark in December 2014, and Broadway and New Century in June 2015.
 
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 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

20




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.
 
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.

Prepaid card products and services are subject to extensive supervision and regulations are costly to maintain and maybe subject to fraud.
 
We recently introduced several prepaid card products for our retail banking customers and are the issuing bank for a sponsorship general purpose reloadable program. Prepaid cards are highly regulated by federal and state regulatory authorities.  Some of the laws and related regulations in this area include consumer protection laws, escheat laws, privacy laws, anti-money laundering laws and data protection laws.  Compliance with these laws and regulations is costly and requires significant personnel resources.

Issuers of prepaid cards have suffered significant losses in recent years with respect to the theft of cardholder data that has been illegally exploited for personal gain. Criminals are using increasingly sophisticated methods to engage in illegal activities involving

21




cards and cardholder information, such as counterfeiting, fraudulent payment or refund schemes and identity theft. We rely upon third parties for some transaction processing services, which subjects us and our cardholders to risks related to the vulnerabilities of those third parties.  Theft or fraud-related losses involving our prepaid cards and other products and services could result in reputational damage to us and adversely affect our operating results.

 
Financial reform legislation will, among other things, tighten capital standards 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 law significantly changes the current bank regulatory structure and affects 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.  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.  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. See “Item 1. Business-Supervision and Regulation-Proposed Capital Regulations.”
 
The Dodd-Frank Act also broadened the base for FDIC insurance assessments. Assessments are now 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. The Dodd-Frank Act also permanently increased the maximum amount of deposit insurance for banks, savings institutions and credit unions to $250,000 per depositor.
 
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 an electronic debit transaction by a payment card issuer that, together with its affiliates, has assets of $10 billion or more, and to enforce a new statutory requirement that such fees be reasonable and proportional to the actual cost of a transaction to the issuer.  By regulation, the Federal Reserve Board has limited the fees for such a transaction to the sum of 21 cents plus five basis points times the value of the transaction, plus up to one cent for fraud prevention costs.  The Dodd-Frank Act also restricts 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 created a Bureau of Consumer Financial Protection with broad powers to supervise and enforce consumer protection laws. The Bureau has 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 has examination and enforcement authority over all banks with more than $10 billion in assets.
 
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 law and its implementing regulations has resulted, and will continue to result, in additional operating costs that could have a material adverse effect on our future financial condition and results of operations.  For additional discussion of the Dodd-Frank Act, see “Item 1. Business—Supervision and Regulation-Regulatory Reform.”
 
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,

22




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.
 
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.
 
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, 2012, 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 flow estimates assume a similar economic environment to what we have seen in 2012.  If this does not happen, our future cash flows would be negatively impacted.  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.

Our operations rely on numerous external vendors.
We rely on numerous external vendors to provide us with products and services necessary to maintain our day-to-day operations. Accordingly, our operations are exposed to risk that these vendors will not perform in accordance with the contracted arrangements under service level agreements. The failure of an external vendor to perform in accordance with the contracted arrangements under service level agreements, because of changes in the vendor's organizational structure, financial condition, support for existing products and services or strategic focus or for any other reason, could be disruptive to our operations, which in turn could have a material negative impact on our financial condition and results of operations. We also could be adversely affected to the extent such an agreement is not renewed by the third party vendor or is renewed on terms less favorable to us.




23






 We are subject to certain risks in connection with our use of technology.
Our security measures may not be sufficient to mitigate the risk of a cyber attack.
Communications and information systems are essential to the conduct of our business, as we use such systems to manage our customer relationships, our general ledger and virtually all other aspects of our business. Our operations rely on the secure processing, storage, and transmission of confidential and other information in our computer systems and networks. Although we take protective measures and endeavor to modify them as circumstances warrant, the security of our computer systems, software, and networks may be vulnerable to breaches, unauthorized access, misuse, computer viruses, or other malicious code and cyber attacks that could have a security impact. If one or more of these events occur, this could jeopardize our or our customers' confidential and other information processed and stored in, and transmitted through, our computer systems and networks, or otherwise cause interruptions or malfunctions in our operations or the operations of our customers or counterparties. We may be required to expend significant additional resources to modify our protective measures or to investigate and remediate vulnerabilities or other exposures, and we may be subject to litigation and financial losses that are either not insured against or not fully covered through any insurance maintained by us. We could also suffer significant reputational damage.
Security breaches in our internet banking activities could further 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, which could result in significant legal liability and significant damage to our reputation and our business.
Our security measures may not protect us from systems failures or interruptions.
While we have established policies and procedures to prevent or limit the impact of systems failures and interruptions, there can be no assurance that such events will not occur or that they will be adequately addressed if they do. In addition, we outsource certain aspects of our data processing and other operational functions to certain third-party providers. If our third-party providers encounter difficulties, or if we have difficulty in communicating with them, our ability to adequately process and account for transactions could be affected, and our business operations could be adversely impacted. Threats to information security also exist in the processing of customer information through various other vendors and their personnel.
The occurrence of any systems failure or interruption could damage our reputation and result in a loss of customers and business, could subject us to additional regulatory scrutiny, or could expose us to legal liability. Any of these occurrences could have a material adverse effect on our financial condition and results of operations.

New lines of business or new products and services may subject us to additional risks.
 
From time to time, we may seek to implement new lines of business or offer new products and services within existing lines of business. There are substantial risks and uncertainties associated with these efforts, particularly in instances where the markets are not fully developed.  In developing and marketing new lines of business and/or new products and services, we may invest significant time and resources. Initial timetables for the introduction and development of new lines of business and/or new products or services may not be achieved and price and profitability targets may not prove feasible, which could in turn have a material negative effect on our operating results.

Item 1B.
  Unresolved Staff Comments
 
None.
 
Item 2.
  Properties
 
We conduct our business at 85 banking offices located in the Chicago metropolitan area and one banking office in Philadelphia, Pennsylvania.  We own a majority of our banking center facilities.  The remaining facilities are leased.  We have approximately 125 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 7 of the notes to our consolidated financial statements for additional information regarding our premises and equipment.
 

24




We also have non-bank office locations in Chicago and Forest Park, Illinois; Paramus, New Jersey; Birmingham and Troy, Michigan; Columbus, Ohio; and Irvine, LaJolla and Newport Beach, California.  These offices are used by our lease banking personnel and our Cedar Hill, LaSalle and Celtic 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.
  Mine Safety Disclosures
     
Not applicable.
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 1,406 holders of record of our common stock as of December 31, 2012.
 
The following table presents quarterly market price information and cash dividends paid per share for our common stock for 2012 and 2011:
 
 
 
Market Price Range
 
 
High
 
Low
 
Dividends
Paid
2012
 
 

 
 

 
 

Quarter ended December 31, 2012
 
$
20.66

 
$
17.00

 
$
0.10

Quarter ended September 30, 2012
 
$
22.46

 
$
19.71

 
$
0.01

Quarter ended June 30, 2012
 
$
22.21

 
$
18.88

 
$
0.01

Quarter ended March 31, 2012
 
$
22.26

 
$
17.11

 
$
0.01

2011
 
 

 
 

 
 

Quarter ended December 31, 2011
 
$
17.97

 
$
14.01

 
$
0.01

Quarter ended September 30, 2011
 
$
21.25

 
$
13.86

 
$
0.01

Quarter ended June 30, 2011
 
$
22.49

 
$
17.38

 
$
0.01

Quarter ended March 31, 2011
 
$
21.52

 
$
17.09

 
$
0.01

 
The timing and amount of cash dividends paid depends on our earnings, capital requirements, financial condition and other relevant factors.  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 17 of notes to consolidated financial statements contained in Item 8 of this report.
 

25




The following table sets forth information for the three months ended December 31, 2012 with respect to our repurchases of our outstanding common shares:
 
 
 
Total Number of
Shares Purchased (1)
 
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, 2012 — October 31, 2012
 

 
$

 

 
1,000,000

November 1, 2012 — November 30, 2012
 

 

 

 
1,000,000

December 1, 2012 — December 31, 2012
 
3,730

 
19.15

 

 
1,000,000

Total
 
3,730

 
$
19.15

 

 
 

 
(1)          Represents shares withheld to satisfy tax withholding obligations upon the exercise of stock options and vesting of restricted stock awards.
 
In the fourth quarter of 2012, the Company's board of directors authorized the Company to purchase up to one million shares of common stock from time to time over the next two years, subject to market conditions and other factors.

Stock Performance Presentation
 
In addition to showing the cumulative returns for the Company's common stock and the NASDAQ Composite Index, the stock performance graph contained in the Company's Annual Report on Form 10-K for the year ended December 31, 2011 included the NASDAQ Bank Index and an index of peer companies selected by the Company. The Company believes that a better industry comparison would be provided by using the SNL Mid Cap Bank Index instead of the NASDAQ Bank Index, as the performance of the latter is skewed by companies with market capitalizations much larger and smaller than the Company's. The peer index will be removed as the number of companies currently comprising the group has made that index less meaningful than it was in the past.

In accordance with Item 201(e) of Regulation S-K of the Securities and Exchange Commission, which requires the inclusion of all new indexes and all indexes used in the immediately preceding year, the following line graph shows a comparison of the cumulative returns for the period beginning December 31, 2007 and ending December 31, 2012 of the Company's common stock, the NASDAQ Composite Index, the SNL Mid Cap Bank Index, the NASDAQ Bank Index and an index of peer companies selected by the Company. The information assumes that $100 was invested at the closing price on December 31, 2007 in the Company's common stock and each index, and that all dividends were reinvested.


26





 
COMPARISON OF 5-YEAR CUMULATIVE TOTAL RETURN
FOR MB FINANCIAL, INC., NASDAQ COMPOSITE INDEX, NASDAQ BANK INDEX,
SNL MID CAP BANK INDEX, AND PEER GROUP INDEX
  
 
 
Period Ending
Index
 
12/31/2007
 
12/31/2008
 
12/31/2009
 
12/31/2010
 
12/31/2011
 
12/31/2012
MB Financial, Inc.
 
$
100.00

 
$
93.01

 
$
66.26

 
$
58.35

 
$
57.74

 
$
67.14

NASDAQ Composite Index
 
100.00

 
60.02

 
87.24

 
103.08

 
102.26

 
120.42

NASDAQ Bank Index
 
100.00

 
78.46

 
65.67

 
74.97

 
67.10

 
79.64

SNL Mid Cap Bank Index
 
100.00

 
52.25

 
44.30

 
51.51

 
45.28

 
50.74

Peer Group Index
 
100.00

 
71.16

 
42.92

 
50.76

 
42.04

 
57.52

 
The Peer Group is made up of the common stock of the following companies:
First Midwest Bancorp, Inc.
Old Second Bancorp, Inc.
PrivateBancorp, Inc.
Taylor Capital Group, Inc.
Wintrust Financial Corporation

27





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.
 
For purposes of the following discussion, balances, average rate, income and expenses associated with the Company’s merchant card processing business have been excluded from continuing operations.
 
Our summary consolidated financial information and other financial data contain information determined by methods other than in accordance with GAAP.  These measures include net interest income on a fully tax equivalent basis and net interest margin on a fully tax equivalent basis.
 
The tax equivalent adjustment to net interest income and net interest margin 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 do not pertain to our most central business operations, making the measure more meaningful when comparing our operating results from period to period.
  
A reconciliation of net interest margin on a fully tax equivalent basis to net interest margin is contained in the “Selected Financial Data” discussed below.


28




Selected Financial Data:
 
 
 
As of or for the Year Ended December 31,
(Dollars in thousands, except per share data)
 
2012
 
2011
 
2010 (1)
 
2009 (2)
 
2008
Statement of Income Data:
 
 

 
 

 
 

 
 

 
 

Interest income
 
$
335,310

 
$
384,560

 
$
429,640

 
$
393,538

 
$
413,788

Interest expense
 
42,522

 
59,287

 
89,868

 
142,986

 
192,900

Net interest income
 
292,788

 
325,273

 
339,772

 
250,552

 
220,888

Provision for credit losses
 
(8,900
)
 
120,750

 
246,200

 
231,800

 
125,721

Net interest income after provision for credit losses
 
301,688

 
204,523

 
93,572

 
18,752

 
95,167

Other income
 
111,599

 
109,106

 
185,756

 
127,154

 
80,393

Other expenses
 
286,436

 
269,633

 
258,776

 
223,750

 
183,390

Income (loss) before income taxes
 
126,851

 
43,996

 
20,552

 
(77,844
)
 
(7,830
)
Applicable income tax expense (benefit)
 
36,477

 
5,268

 
24

 
(45,265
)
 
(23,555
)
Income (loss) from continuing operations
 
90,374

 
38,728

 
20,528

 
(32,579
)
 
15,725

Income from discontinued operations, net of income tax
 

 

 

 
6,453

 
439

Net income (loss)
 
90,374

 
38,728

 
20,528

 
(26,126
)
 
16,164

Dividends and discount accretion on preferred shares
 
3,269

 
10,414

 
10,382

 
10,298

 
789

Net income (loss) available to common stockholders
 
$
87,105

 
$
28,314

 
$
10,146

 
$
(36,424
)
 
$
15,375

Common Share Data:
 
 

 
 

 
 

 
 

 
 

Basic earnings (loss) per common share from continuing operations
 
$
1.67

 
$
0.71

 
$
0.39

 
$
(0.81
)
 
$
0.45

Basic earnings per common share from discontinued operations
 

 

 

 
0.16

 
0.01

Basic earnings (loss) per common share
 
1.61

 
0.52

 
0.19

 
(0.91
)
 
0.44

Diluted earnings (loss) per common share from continuing operations
 
1.66

 
0.71

 
0.39

 
(0.81
)
 
0.45

Diluted earnings per common share from discontinued operations
 

 

 

 
0.16

 
0.01

Diluted earnings (loss) per common share
 
1.60

 
0.52

 
0.19

 
(0.91
)
 
0.44

Common book value per common share
 
23.29

 
21.92

 
21.14

 
20.75

 
25.17

Weighted average common shares outstanding:
 
 

 
 

 
 

 
 

 
 

Basic
 
54,270,297

 
54,057,158

 
52,724,715

 
40,042,655

 
34,706,092

Diluted
 
54,505,976

 
54,337,280

 
53,035,047

 
40,042,655

 
35,061,712

Dividend payout ratio (3) 
 
8.13
%
 
7.69
%
 
21.05
%
 
NM

 
163.64
%
Cash dividends per common share
 
$
0.13

 
$
0.04

 
$
0.04

 
$
0.15

 
$
0.72

 
(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.
(3)
Not meaningful for 2009 due to our net loss for that year.


29




Selected Financial Data (continued):
 
 
 
As of or for the Year Ended December 31,
(Dollars in thousands)
 
2012
 
2011
 
2010
 
2009
 
2008
Balance Sheet Data:
 
 

 
 

 
 

 
 

 
 

Cash and due from banks
 
$
176,010

 
$
144,228

 
$
106,726

 
$
136,763

 
$
79,824

Investment securities
 
2,416,977

 
2,509,412

 
1,677,929

 
2,913,594

 
1,400,376

Loans, gross
 
5,766,930

 
5,950,995

 
6,617,811

 
6,524,547

 
6,228,563

Allowance for loan losses
 
124,204

 
126,798

 
192,217

 
177,072

 
144,001

Loans held for sale
 
7,492

 
4,727

 

 

 

Total assets
 
9,571,805

 
9,833,072

 
10,320,364

 
10,865,393

 
8,819,763

Deposits
 
7,542,697

 
7,647,607

 
8,152,958

 
8,683,276

 
6,495,571

Short-term and long-term borrowings
 
336,652

 
486,218

 
553,917

 
655,266

 
960,085

Junior subordinated notes issued to capital trusts
 
152,065

 
158,538

 
158,571

 
158,677

 
158,824

Stockholders’ equity
 
1,275,770

 
1,393,027

 
1,344,786

 
1,251,180

 
1,068,824

Performance Ratios:
 
 

 
 

 
 

 
 

 
 

Return on average assets
 
0.95
%
 
0.39
%
 
0.20
%
 
(0.27
)%
 
0.20
%
Return on average equity
 
6.83

 
2.85

 
1.54

 
(2.32
)
 
1.80

Return on average common equity
 
7.05

 
2.43

 
0.89

 
(3.91
)
 
1.74

Net interest margin (1)
 
3.49

 
3.75

 
3.72

 
2.85

 
3.03

Tax equivalent effect
 
0.24

 
0.15

 
0.11

 
0.12

 
0.13

Net interest margin — fully tax equivalent basis (1) 
 
3.73

 
3.90

 
3.83

 
2.97

 
3.16

Loans to deposits
 
76.46

 
77.82

 
81.17

 
75.14

 
95.89

Asset Quality Ratios:
 
 

 
 

 
 

 
 

 
 

Non-performing loans to total loans (2)
 
2.03
%
 
2.17
%
 
5.48
%
 
4.16
 %
 
2.34
%
Non-performing assets to total assets (3)
 
1.62

 
2.12

 
4.21

 
2.84

 
1.71

Allowance for loan losses to total loans
 
2.15

 
2.13

 
2.90

 
2.71

 
2.31

Allowance for loan losses to non-performing loans (2)
 
106.17

 
98.00

 
53.03

 
65.26

 
98.67

Net loan charge-offs to average loans
 
(0.02
)
 
2.90

 
3.42

 
3.09

 
0.79

Liquidity and Capital Ratios:
 
 

 
 

 
 

 
 

 
 

Tier 1 capital to risk-weighted assets
 
14.73
%
 
17.34
%
 
15.75
%
 
13.51
 %
 
12.07
%
Total capital to risk-weighted assets
 
16.62

 
19.39

 
17.75

 
15.45

 
14.08

Tier 1 capital to average assets
 
10.50

 
11.73

 
10.66

 
8.71

 
9.85

Average equity to average assets
 
13.35

 
13.65

 
12.65

 
11.51

 
10.90

Other:
 
 

 
 

 
 

 
 

 
 

Banking facilities
 
86

 
88

 
90

 
87

 
72

Full time equivalent employees
 
1,758

 
1,684

 
1,703

 
1,638

 
1,342

 
(1)
Net interest margin represents net interest income from continuing operations as a percentage of average interest earning assets.
(2)
Non-performing loans include loans accounted for on a non-accrual basis and accruing loans contractually past due 90 days or more as to interest or principal.  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 5 in the notes to consolidated financial statements contained under Item 8. Financial Statements and Supplementary Data.
(3)
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 5 in the notes to consolidated financial statements contained under Item 8. Financial Statements and Supplementary Data.


30




Selected Financial Data (continued):

The following table sets forth our selected quarterly financial data (in thousands, except common share data):
 
 
 
Three Months Ended 2012
 
Three Months Ended 2011
 
 
December
 
September
 
June
 
March
 
December
 
September
 
June
 
March
Statement of Income Data:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Interest income
 
$
77,614

 
$
82,663

 
$
85,593

 
$
89,440

 
$
93,433

 
$
94,288

 
$
98,105

 
$
98,734

Interest expense
 
8,098

 
10,588

 
11,489

 
12,347

 
13,188

 
13,872

 
15,698

 
16,529

Net interest income
 
69,516

 
72,075

 
74,104

 
77,093

 
80,245

 
80,416

 
82,407

 
82,205

Provision for credit losses
 
1,000

 
(13,000
)
 

 
3,100

 
8,000

 
11,500

 
61,250

 
40,000

Net interest income after provision for credit losses
 
68,516

 
85,075

 
74,104

 
73,993

 
72,245

 
68,916

 
21,157

 
42,205

Other income
 
36,285

 
28,553

 
23,907

 
22,854

 
24,451

 
26,367

 
29,145

 
29,143

Other expenses
 
71,106

 
81,165

 
66,834

 
67,331

 
69,433

 
66,608

 
66,728

 
66,864

Income (loss) before income taxes
 
33,695

 
32,463

 
31,177

 
29,516

 
27,263

 
28,675

 
(16,426
)
 
4,484

Income tax expense (benefit)
 
9,683

 
9,330

 
9,034

 
8,430

 
7,810

 
8,978

 
(9,060
)
 
(2,460
)
Net income (loss)
 
$
24,012

 
$
23,133

 
$
22,143

 
$
21,086

 
$
19,453

 
$
19,697

 
$
(7,366
)
 
$
6,944

Dividends and discount accretion on preferred shares
 

 

 

 
3,269

 
2,606

 
2,605

 
2,602

 
2,601

Net income (loss) available to common stockholders
 
$
24,012

 
$
23,133

 
$
22,143

 
$
17,817

 
$
16,847

 
$
17,092

 
$
(9,968
)
 
$
4,343

Net interest margin
 
3.31
%
 
3.42
%
 
3.59
%
 
3.64
%
 
3.71
%
 
3.74
%
 
3.79
%
 
3.76
%
Tax equivalent effect
 
0.26

 
0.25

 
0.24

 
0.23

 
0.20

 
0.16

 
0.13

 
0.12

Net interest margin on a fully tax equivalent basis
 
3.57
%
 
3.67
%
 
3.83
%
 
3.87
%
 
3.91
%
 
3.90
%
 
3.92
%
 
3.88
%
Common Share Data:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Basic earnings (loss) per common share
 
$
0.44

 
$
0.43

 
$
0.41

 
$
0.33

 
$
0.31

 
$
0.32

 
$
(0.18
)
 
$
0.08

Diluted earnings (loss) per common share
 
0.44

 
0.42

 
0.41

 
0.33

 
0.31

 
0.31

 
(0.18
)
 
0.08

Weighted average common shares outstanding
 
54,401,504

 
54,346,827

 
54,174,717

 
54,155,856

 
54,140,646

 
54,121,156

 
54,002,979

 
53,961,176

Diluted weighted average common shares outstanding
 
54,597,737

 
54,556,517

 
54,448,709

 
54,411,916

 
54,360,178

 
54,323,320

 
54,002,979

 
54,254,876



31




Fourth Quarter Results
 
We had net income available to common stockholders of $24.0 million for the fourth quarter of 2012 compared to net income available to common stockholders of $16.8 million for the fourth quarter of 2011.  The results for the fourth quarter of 2012 generated an annualized return on average assets of 1.01% and an annualized return on average common equity of 7.55% compared to 0.78% and 5.66%, respectively, for the same period in 2011.
 
Net interest income on a fully tax equivalent basis decreased $9.8 million during the fourth quarter of 2012 compared to the fourth quarter of 2011, primarily due to a $241.2 million decrease in average interest earning assets and a 34 basis point decline in our net interest margin on a fully tax equivalent basis. The decrease in average interest earning assets was primarily due to a decrease in covered loans and taxable investment securities. The decline in the margin was primarily due to lower covered loan yields, and tighter credit spreads, partially offset by lower costs of funds.
 
The provision for credit losses was $1.0 million in the fourth quarter of 2012 and $8.0 million in the fourth quarter of 2011.  Net recoveries were $2.4 million in the fourth quarter of 2012 compared to net charge-offs of $13.9 million in the fourth quarter of 2011.  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 $36.3 million during the fourth quarter of 2012, an increase of $11.8 million, or 48.4%, compared to $24.5 million for the fourth quarter of 2011. This growth was driven by revenue from our key fee initiatives:
Net lease financing income increased as a result of an increase in equipment remarketing gains and fees from the sale of equipment maintenance contracts.
Capital markets and international banking service fees increased primarily due to an increase in merger and acquisition advisory and interest rate swap fees.
Card fee income increased primarily due to fees earned on prepaid and credit cards.
Loan service fees increased due to an increase in prepayment fees.
Other income was also impacted by lower losses recognized on OREO.
 
Other expenses increased $1.7 million, or 2.4%, to $71.1 million for the fourth quarter of 2012 from $69.4 million for the fourth quarter of 2011.
Salaries and employee benefits expense increased primarily due to annual salary increases, an increase in incentives, commissions on higher lease revenues, and higher health insurance claims.
Other real estate expense decreased as a result of fewer properties in other real estate owned throughout the fourth quarter of 2012 compared to the fourth quarter of 2011.
Other operating expenses were down partially due to the decrease in FDIC insurance premiums as a result of a change in the assessment computation during the second quarter of 2012 and the impact of improved credit quality on the computation.
Other operating expenses were also favorably impacted in the fourth quarter of 2012 by a decrease in the clawback liability related to our loss share agreements with the FDIC recorded during the period.

Income tax expense for the fourth quarter of 2012 increased to $9.7 million from $7.8 million for the fourth quarter of 2011 due to higher pre-tax income. 



32





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 and net income available to common stockholders of $87.1 million for the year ended December 31, 2012 compared to net income and net income available to common stockholders of $38.7 million and $28.3 million, respectively, for the year ended December 31, 2011 and net income and net income available to common shareholders of $20.5 million and $10.1 million, respectively, for the year ended December 31, 2010. Fully diluted earnings per common share were $1.60 for the year ended December 31, 2012 compared to $0.52 per common share in 2011 and $0.19 per common share in 2010.

The increase in earnings from the year ended December 31, 2011 to the year ended December 31, 2012 was primarily due to a $129.7 million decrease in provision for credit losses as a result of improved credit quality, partially offset by a $32.5 million decrease in net interest income as a result of a decline in average earning assets and net interest margin and a $12.7 million increase in prepayment fees on interest bearing liabilities.  The increase in earnings from the year ended December 31, 2010 to the year ended December 31, 2011 was primarily due to a $125.5 million decrease in provision for credit losses of as a result of improved credit quality, partially offset by a $62.6 million decrease in acquisition related gains and a $18.0 million decrease in gains from the sale of investment securities.   

On March 14, 2012, we repurchased all $196.0 million of preferred stock issued in 2008 to the U.S. Department of Treasury as part of the Troubled Asset Relief Program (“TARP”) Capital Purchase Program. The repurchase resulted in a one-time, non-cash after-tax charge of approximately $1.2 million or $0.02 per common share in the first quarter of 2012, related to unaccreted discount recorded at the date of issuance.

The profitability of our operations depends primarily on our net interest income after provision for credit losses, which is the difference between interest earned on interest earning assets and interest paid on interest bearing liabilities less provision for credit losses.  The provision for credit losses is dependent on changes in our loan portfolio and management’s assessment of the collectability of our loan portfolio as well as prevailing economic and market conditions.  

Our net income is also affected by other income and other expenses.  During the years ended December 31, 2012, 2011 and 2010, other income included revenue from our key fee initiatives: capital markets and international banking service fees, commercial deposit and treasury management fees, net lease financing income, trust and asset management fees, and card fees. Other income also included loan service fees, consumer and other deposit service fees, brokerage fees, net gain (loss) on investment securities, increase in cash surrender value of life insurance, net gain (loss) on sale of other assets, acquisition related gains, accretion of the FDIC indemnification asset, other real estate owned gains or losses, net gains on sale of loans and other operating income.  During the years ended December 31, 2012, 2011 and 2010, other expenses included salaries and employee benefits, occupancy and equipment expense, computer services and telecommunication expense, advertising and marketing expense, professional and legal expense, other intangibles amortization expense, branch impairment charges, other real estate expenses (net of rental income), prepayment fees on interest bearing liabilities and other operating expenses.  Additionally, dividends on preferred shares reduced net income available to common stockholders.
 
Net interest income is affected by changes in the volume and mix of interest earning assets, interest earned on those assets, the volume and mix of interest bearing liabilities and interest paid on interest bearing liabilities.  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 employee, branch facility and promotional marketing expense.  Growth in the number of loan and deposit accounts affects other income, including service fees as well as other expenses such as computer services, supplies, postage, telecommunications and other miscellaneous expenses.  Non-performing asset levels impact salaries and benefits, legal expenses and other real estate owned expenses.
 

33




Critical Accounting Policies
 
Our consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of America and follow general practices within the industries in which we operate.  This preparation requires management to make estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes.  These estimates, assumptions, and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, actual results could differ from the estimates, assumptions, and judgments reflected in the financial statements.  Certain policies inherently have a greater reliance on the use of estimates, assumptions, and judgments and, as such, have a greater possibility of producing results that could be materially different than originally reported.  Management believes the following policies are both important to the portrayal of our financial condition and results of operations and require subjective or complex judgments; therefore, management considers the following to be critical accounting policies.  Management has reviewed the application of these polices with the Audit Committee of our Board of Directors.
 
Allowance for Loan Losses.  Subject to the use of estimates, assumptions, and judgments in management's evaluation process used to determine the adequacy of the allowance for loan losses, which combines several factors: management's ongoing review and grading of the loan portfolio, consideration of past loan loss experience, trends in past due and nonperforming loans, risk characteristics of the various classifications of loans, existing economic conditions, the fair value of underlying collateral, and other qualitative and quantitative factors which could affect probable credit losses. Because current economic conditions can change and future events are inherently difficult to predict, the anticipated amount of estimated loan losses, and therefore the adequacy of the allowance, could change significantly. As an integral part of their examination process, various regulatory agencies also review the allowance for loan losses. Such agencies may require that certain loan balances be charged off when their credit evaluations differ from those of management or require that adjustments be made to the allowance for loan losses, based on their judgments about information available to them at the time of their examination. We believe the allowance for loan losses is adequate and properly recorded in the financial statements.  See “Allowance for Loan Losses” section below for further analysis.
 
Residual Value of Our Direct Finance, Leveraged, and Operating Leases.  Lease residual value represents the present value of the estimated fair value of the leased equipment at the termination date of the lease.  Realization of these residual values depends on many factors, including management’s use of estimates, assumptions, and judgment to determine such values.  Several other factors outside of management’s control may reduce the residual values realized, including general market conditions at the time of expiration of the lease, whether there has been technological or economic obsolescence or unusual wear and tear on, or use of, the equipment and the cost of comparable equipment.  If, upon the expiration of a lease, we sell the equipment and the amount realized is less than the recorded value of the residual interest in the equipment, we will recognize a loss reflecting the difference.  On a quarterly basis, management reviews the lease residuals for potential impairment.  If we fail to realize our aggregate recorded residual values, our financial condition and profitability could be adversely affected.  At December 31, 2012, the aggregate residual value of the equipment leased under our direct finance, leveraged, and operating leases totaled $74.9 million.  See Note 1 and Note 6 of our audited consolidated financial statements for additional information.

Income Tax Accounting.  ASC Topic 740 provides guidance on accounting for income taxes by prescribing the minimum recognition threshold that a tax position must meet to be recognized in the financial statements.  ASC Topic 740 also provides guidance on measurement, recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.  As of December 31, 2012, the Company had $104 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, 2012, the Company had approximately $9 thousand of accrued interest related to tax reserves.  The application of income tax law is inherently complex.  Laws and regulations in this area are voluminous and are often ambiguous.  As such, we are required to make many subjective assumptions and judgments regarding our income tax exposures.  Interpretations of, and guidance surrounding income tax laws and regulations change over time.  As such, changes in our subjective assumptions and judgments can materially affect amounts recognized in the consolidated balance sheets and statements of income.
 
Fair Value of Assets and Liabilities.  ASC Topic 820 defines fair value as the price that would be received to sell a financial asset or paid to transfer a financial liability in an orderly transaction between market participants at the measurement date.
 
The degree of management judgment involved in determining the fair value of assets and liabilities is dependent upon the availability of quoted market prices or observable market parameters. For financial instruments that trade actively and have quoted market prices or observable market parameters, there is minimal subjectivity involved in measuring fair value. When observable market prices and parameters are not fully available, management judgment is necessary to estimate fair value. In addition, changes in market conditions may reduce the availability of quoted prices or observable data. For example, reduced

34




liquidity in the capital markets or changes in secondary market activities could result in observable market inputs becoming unavailable. Therefore, when market data is not available, the Company would use valuation techniques requiring more management judgment to estimate the appropriate fair value measurement.
 
See Note 18 to the consolidated financial statements for a complete discussion on the Company’s use of fair valuation of assets and liabilities and the related measurement techniques.
 
Goodwill.  The excess of the cost of an acquisition over the fair value of the net assets acquired consists of goodwill, and core deposit and client relationship intangibles.  See Note 8 to the consolidated financial statements for further information regarding core deposit and client relationship intangibles.  The Company reviews goodwill to determine potential impairment annually, or more frequently if events and circumstances indicate that goodwill might be impaired, by comparing the carrying value of the reporting unit with the fair value of the reporting unit.
 
The Company’s annual assessment date for goodwill impairment testing is as of December 31.  No impairment losses were recognized during the years ended December 31, 2012, 2011 and 2010.
 
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 credit losses, fee income growth and operating expense growth. Our future cash flow estimates assumed a similar economic environment to what we experienced in 2012.
 
Recent Accounting Pronouncements.  Refer to Note 1 of our consolidated financial statements for a description of recent accounting pronouncements including the respective dates of adoption and effects on results of operations and financial condition.
 
Net Interest Income
 
The following table presents, for the periods indicated, the total dollar amount of interest income from average interest earning assets and the related yields, as well as the interest expense on average interest bearing liabilities, and the related costs, expressed both in dollars and rates (dollars in thousands).  The table below and the discussion that follows contain presentations of net interest income and net interest margin on a tax-equivalent basis, which is adjusted for the tax-favored status of income from certain loans and investments.  Net interest margin also is presented on a tax-equivalent basis in “Item 6 Selected Financial Data.”  We believe this measure to be the preferred industry measurement of net interest income, as it provides a relevant comparison between taxable and non-taxable amounts.
 
Reconciliations of net interest income and net interest margin on a tax-equivalent basis to net interest income and net interest margin in accordance with accounting principles generally accepted in the United States of America are provided in the table.
 

35




 
 
Year Ended December 31,
(dollars in thousands)
 
2012
 
2011
 
2010
 
 
Average
 
 
 
Yield/
 
Average
 
 
 
Yield/
 
Average
 
 
 
Yield/
 
 
Balance
 
Interest
 
Rate
 
Balance
 
Interest
 
Rate
 
Balance
 
Interest
 
Rate
Interest Earning Assets:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Loans (1) (2) (3)
 
$
5,412,373

 
$
263,079

 
4.86
%
 
$
5,867,533

 
$
317,566

 
5.41
%
 
$
6,581,528

 
$
358,648

 
5.45
%
Loans exempt from federal income taxes (4)
 
278,925

 
13,275

 
4.68

 
231,505

 
11,118

 
4.74

 
177,248

 
8,978

 
5.00

Taxable investment securities
 
1,542,814

 
33,424

 
2.17

 
1,669,971

 
41,349

 
2.48

 
1,635,544

 
50,542

 
3.09

Investment securities exempt from federal income taxes (4)
 
815,500

 
45,094

 
5.53

 
460,971

 
26,562

 
5.76

 
356,496

 
20,900

 
5.86

Federal funds sold
 

 

 

 

 

 

 
352

 
2

 
0.56

Other interest bearing deposits
 
337,325

 
867

 
0.26

 
442,190

 
1,153

 
0.26

 
386,521

 
1,028

 
0.27

Total interest earning assets
 
8,386,937

 
$
355,739

 
4.24

 
8,672,170

 
$
397,748

 
4.59

 
9,137,689

 
$
440,098

 
4.82

Non-interest earning assets
 
1,161,048

 
 

 
 

 
1,283,963

 
 

 
 

 
1,368,339

 
 

 
 

Total assets
 
$
9,547,985

 
 

 
 

 
$
9,956,133

 
 

 
 

 
$
10,506,028

 
 

 
 

Interest Bearing Liabilities:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Deposits:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

NOW and money market deposit
 
$
2,646,299

 
$
4,286

 
0.16
%
 
$
2,678,049

 
$
7,637

 
0.29
%
 
$
2,767,044

 
$
14,965

 
0.54
%
Savings deposit
 
789,595

 
786

 
0.10

 
732,731

 
1,379

 
0.19

 
619,304

 
1,911

 
0.31

Time deposits
 
2,132,370

 
25,186

 
1.18

 
2,610,436

 
35,865

 
1.37

 
3,335,457

 
58,974

 
1.77

Short-term borrowings
 
231,872

 
1,204

 
0.52

 
244,594

 
849

 
0.35

 
268,251

 
1,145

 
0.43

Long-term borrowings and junior subordinated notes
 
362,255

 
11,060

 
3.00

 
439,054

 
13,557

 
3.05

 
465,387

 
12,873

 
2.73

Total interest bearing liabilities
 
6,162,391

 
$
42,522

 
0.69

 
6,704,864

 
$
59,287

 
0.88

 
7,455,443

 
$
89,868

 
1.21

Non-interest bearing deposits
 
1,973,666

 
 

 
 

 
1,771,918

 
 

 
 

 
1,594,504

 
 

 
 

Other non-interest bearing liabilities
 
137,302

 
 

 
 

 
120,647

 
 

 
 

 
127,099

 
 

 
 

Stockholders’ equity
 
1,274,626

 
 

 
 

 
1,358,704

 
 

 
 

 
1,328,982

 
 

 
 

Total liabilities and stockholders’ equity
 
$
9,547,985

 
 

 
 

 
$
9,956,133

 
 

 
 

 
$
10,506,028

 
 

 
 

Net interest income/interest rate spread (5)
 
 

 
$
313,217

 
3.55
%
 
 

 
$
338,461

 
3.71
%
 
 

 
$
350,230

 
3.61
%
Less: taxable equivalent adjustment
 
 

 
20,429

 
 

 
 

 
13,188

 
 

 
 

 
10,458

 
 

Net interest income, as reported
 
 

 
$
292,788

 
 

 
 

 
$
325,273

 
 

 
 

 
$
339,772

 
 

Net interest margin (6)
 
 

 
 

 
3.49
%
 
 

 
 

 
3.75
%
 
 

 
 

 
3.72
%
Tax equivalent effect
 
 

 
 

 
0.24
%
 
 

 
 

 
0.15
%
 
 

 
 

 
0.11
%
Net interest margin on a fully tax equivalent basis (6)
 
 

 
 

 
3.73
%
 
 

 
 

 
3.90
%
 
 

 
 

 
3.83
%
 
(1)       Non-accrual loans are included in average loans.
(2)       Interest income includes amortization of deferred loan origination fees of $3.5 million, $4.7 million and $4.6 million for the years ended December 31, 2012, 2011 and 2010, respectively.
(3)       Loans held for sale are included in the average loan balance listed.  Related interest income is included in loan interest income.
(4)       Non-taxable loan and investment income is presented on a fully tax equivalent basis assuming a 35% tax rate.
(5)       Interest rate spread represents the difference between the average yield on interest earning assets and the average cost of interest bearing liabilities and is presented on a fully tax equivalent basis.
(6)       Net interest margin represents net interest income as a percentage of average interest earning assets.

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

Net interest income on a fully tax equivalent basis decreased $11.8 million during the year ended December 31, 2011 compared to the year ended December 31, 2010, a result of a lower level of interest earning assets partially offset by an increase in net interest margin on a fully tax equivalent basis.  The net interest margin, expressed on a fully tax equivalent basis, was 3.90% for 2011 and 3.83% for 2010.  The margin increase from the prior year was due to a decrease in our average cost of funds as a result of an improved deposit mix and downward repricing of interest bearing deposits, as well as a lower level of non-performing loans.  The deposit mix shifted as certificates of deposits for rate sensitive customers were not renewed and non-interest bearing deposits increased. 
 

36




Volume and Rate Analysis of Net Interest Income
 
The following table presents the extent to which changes in volume and interest rates of interest earning assets and interest bearing liabilities have affected our interest income and interest expense during the periods indicated.  Information is provided in each category with respect to (i) changes attributable to changes in volume (changes in volume multiplied by prior period rate), (ii) changes attributable to changes in rates (changes in rates multiplied by prior period volume) and (iii) change attributable to a combination of changes in rate and volume (change in rates multiplied by the changes in volume) (in thousands).  Changes attributable to the combined impact of volume and rate have been allocated proportionately to the changes due to volume and the changes due to rate (dollars in thousands).
 
 
 
Year Ended December 31,

 
2012 Compared to 2011
 
2011 Compared to 2010
 
 
Change
Due to
Volume
 
Change
Due to
Rate
 
Total
Change
 
Change
Due to
Volume
 
Change
Due to
Rate
 
Total
Change
Interest Earning Assets:
 
 

 
 

 
 

 
 

 
 

 
 

Loans
 
$
(23,549
)
 
$
(30,938
)
 
$
(54,487
)
 
$
(38,662
)
 
$
(2,420
)
 
$
(41,082
)
Loans exempt from federal income taxes (1)
 
2,258

 
(101
)
 
2,157

 
2,627

 
(487
)
 
2,140

Taxable investment securities
 
(2,999
)
 
(4,926
)
 
(7,925
)
 
1,043

 
(10,236
)
 
(9,193
)
Investment securities exempt from federal income taxes (1)
 
19,645

 
(1,113
)
 
18,532

 
6,028

 
(366
)
 
5,662

Federal funds sold
 

 

 

 
(2
)
 

 
(2
)
Other interest bearing deposits
 
(270
)
 
(16
)
 
(286
)
 
145

 
(20
)
 
125

Total decrease in interest income
 
(4,915
)
 
(37,094
)
 
(42,009
)
 
(28,821
)
 
(13,529
)
 
(42,350
)
Interest Bearing Liabilities:
 
 

 
 

 
 

 
 

 
 

 
 

Deposits
 
 

 
 

 
 

 
 

 
 

 
 

NOW and money market deposit accounts
 
(90
)
 
(3,261
)
 
(3,351
)
 
(467
)
 
(6,861
)
 
(7,328
)
Savings deposits
 
100

 
(693
)
 
(593
)
 
306

 
(838
)
 
(532
)
Time deposits
 
(6,047
)
 
(4,632
)
 
(10,679
)
 
(11,408
)
 
(11,701
)
 
(23,109
)
Short-term borrowings
 
(46
)
 
401

 
355

 
(95
)
 
(201
)
 
(296
)
Long-term borrowings and junior subordinated notes
 
(2,347
)
 
(150
)
 
(2,497
)
 
(756
)
 
1,440

 
684

Total decrease in interest expense
 
(8,430
)
 
(8,335
)
 
(16,765
)
 
(12,420