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Section 1: 10-K (MB FINANCIAL FORM 10-K)

mbfi10k_123108.htm
 
 


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

FORM 10-K

(Mark One)

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

 
For the fiscal year ended December 31, 2008

 
OR

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

 
For the transition period from ____________ to ____________


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


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


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

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

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

None

(Title of Class)

 
 

 


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

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

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

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filerx    Accelerated filero
 
    Non-accelerated filer                                            o(Do not check if a smaller reporting company)                                Smaller reporting companyo

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

The aggregate market value of the voting shares held by non-affiliates of the Registrant was approximately $722,242,874 as of June 30, 2008, 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 34,934,157 shares of the Registrant’s common stock as of February 27, 2009.

DOCUMENTS INCORPORATED BY REFERENCE:

Document
   
Part of Form 10-K
       
Portions of the definitive Proxy Statement to
     
be used in conjunction with the Registrant’s
   
Part III
2009 Annual Meeting of Stockholders.
     


 
 

 


MB FINANCIAL, INC. AND SUBSIDIARIES

FORM 10-K

December 31, 2008

INDEX

     
Page
     
 
Business
4
 
Risk Factors
14
 
Unresolved Staff Comments
19
 
Properties
19
 
Legal Proceedings
21
 
Submission of Matters to a Vote of Security Holders
21
       
     
 
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
22
 
Selected Financial Data
24
 
Management’s Discussion and Analysis of Financial Condition and Results of Operations
28
 
Quantitative and Qualitative Disclosures about Market Risk
49
 
Financial Statements and Supplementary Data
53
 
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
99
 
Controls and Procedures
99
 
Other Information
99
       
     
 
Directors, Executive Officers, and Corporate Governance
100
 
Executive Compensation
100
 
Security Ownership of Certain Beneficial Owners,  and Management and Related Stockholder Matters
100
 
Certain Relationships, Related Transactions and Director Independence
101
 
Principal Accountant Fees and Services
101
       
     
 
Exhibits and Financial Statement Schedules
102
   
103
       


 
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PART I
 
Item 1.  Business

Special Note Regarding Forward-Looking Statements
 
When used in this Annual Report on Form 10-K and in other filings with the Securities and Exchange Commission, in press releases or other public shareholder communications, or in oral statements made with the approval of an authorized executive officer, the words or phrases "believe," "will," "should," "will likely result," "are expected to," "will continue," "is anticipated," "estimate," "project," "plans," or similar expressions are intended to identify "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. You are cautioned not to place undue reliance on any forward-looking statements, which speak only as of the date made.  These statements may relate to MB Financial, Inc.’s future financial performance, strategic plans or objectives, revenues or earnings projections, or other financial items.  By their nature, these statements are subject to numerous uncertainties that could cause actual results to differ materially from those anticipated in the statements.
 
Important factors that could cause actual results to differ materially from the results anticipated or projected include, but are not limited to, the following (1) 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; (2) competitive pressures among depository institutions; (3) interest rate movements and their impact on customer behavior and net interest margin; (4) the impact of repricing and competitors' pricing initiatives on loan and deposit products; (5) fluctuations in real estate values; (6) the ability to adapt successfully to technological changes to meet customers' needs and developments in the market place; (7) our ability to realize the residual values of our direct finance, leveraged, and operating leases; (8) our ability to access cost-effective funding; (9) changes and volatility in financial markets; (10) changes in economic conditions in general and in the Chicago metropolitan area in particular; (11) the costs, effects and outcomes of litigation; (12) new legislation or regulatory changes, including but not limited to changes in federal and/or state tax laws or interpretations thereof by taxing authorities and other governmental initiatives affecting the financial services industry; (13) changes in accounting principles, policies or guidelines; (14) our future acquisitions of other depository institutions or lines of business.
 
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 72 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 71 banking offices through our bank subsidiary, MB Financial Bank, N.A. (MB Financial Bank).  MB Financial Bank also has one banking office in the city of Philadelphia.  Through MB Financial Bank, we offer a broad range of financial services primarily to small and middle market businesses and individuals in the markets that we serve.  Our primary lines of business include commercial banking, retail banking and wealth management.  As of December 31, 2008, we had total assets of $8.8 billion, deposits of $6.5 billion, stockholders’ equity of $1.1 billion, an asset management and trust department with approximately $3.3 billion in assets under management, including approximately $702.1 million that represents our own investment accounts under management, and a broker/dealer subsidiary, Vision Investment Services, Inc., with $479.2 million in assets under administration.
 
We were incorporated as a Maryland corporation in 2001 as part of the merger of MB Financial, Inc., a Delaware corporation (which we sometimes refer to as Old MB Financial) and MidCity Financial Corporation (MidCity Financial).  This all-stock, merger-of-equals transaction, which we accounted for as pooling-of-interests, was completed on November 6, 2001 through the merger of Old MB Financial and MidCity Financial into our newly-formed company to create the presently existing MB Financial, Inc.
 
We have continued to grow subsequent to the Old MB Financial-MidCity Financial merger.  In April 2002, we acquired First National Bank of Lincolnwood, based in Lincolnwood, Illinois, and its parent, First Lincolnwood Corporation, for approximately $35.0 million in cash.  In August 2002, we acquired Chicago-based LaSalle Systems Leasing, Inc. and its affiliated company, LaSalle Equipment Limited Partnership (which we sometimes refer to below collectively as “LaSalle”) for consideration comprised of $5.0 million of our
 
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common stock and cash of $30.7 million paid at the time of closing, plus deferred payments of $3.5 million that were tied to LaSalle’s operating results for the four-year period subsequent to the acquisition date.  In February 2003, we acquired South Holland Trust & Savings Bank, based in South Holland, Illinois, and its parent, South Holland Bancorp, Inc., for $93.1 million in cash.  In May 2004, we acquired First Security Federal Savings Bank, based in Chicago, Illinois, and its parent, First SecurityFed Financial, Inc., for $140.2 million.  The purchase price was paid through a combination of cash and our common stock totaling $73.3 million and $66.9 million, respectively.  In August 2006, we acquired Oak Brook Bank, based in Oak Brook, Illinois, and its parent First Oak Brook Bancshares, Inc. (FOBB), for $371.0 million. The purchase price was paid through a combination of cash and our common stock totaling $74.1 million and $296.9 million, respectively.  First National Bank of Lincolnwood, South Holland Trust & Savings Bank, First Security Federal Savings Bank, and Oak Brook Bank, had assets of approximately $227.5 million, $560.3 million, $576.0 million, and $2.6 billion, respectively, as of their acquisition dates, and all were merged into MB Financial Bank.  In April 2008, we purchased an 80% interest in Cedar Hill Associates, LLC (Cedar Hill), an asset management firm located in Chicago, Illinois, with approximately $960 million in assets under management.
 
In May 2003, we sold Abrams Centre National Bank (Abrams), based in Dallas, Texas, and its parent Abrams Centre Bancshares, Inc., for $16.3 million in cash.  Abrams, a former subsidiary of MidCity Financial, had assets of approximately $98.4 million as of the sale date.
 
In November 2007, we sold Union Bank (Union), based in Oklahoma City, Oklahoma, for $76.3 million in cash.  Union, a former subsidiary of MidCity Financial, had assets of approximately $398.6 million as of the sale date.
 
MB Financial Bank, our largest subsidiary, has seven wholly owned subsidiaries with significant operating activities: MB Financial Center LLC; MB Financial Community Development Corporation; MBRE Holdings LLC; LaSalle Systems Leasing, Inc.; Vision Investment Services, Inc.; Cedar Hill Associates, LLC; and Ashland Management LLC.
 
MB Financial Center LLC is used to manage the real estate activities of our operations center located in Rosemont, Illinois (See Item 2. Properties for additional information).
 
MB Financial Community Development Corporation engages in community lending and makes equity investments to facilitate the construction and rehabilitation of housing in low-to-moderate income neighborhoods in MB Financial Bank’s market area.
 
MBRE Holdings LLC, a Delaware limited liability company, was established in August 2002 as the holding company of MB Real Estate Holdings LLC, which is also a Delaware limited liability company.  MB Real Estate Holdings LLC and MBRE Holdings LLC were established as part of an initiative to enhance our earnings by providing alternative methods of raising capital and funding.  The assets of MB Real Estate Holdings LLC consist primarily of 100% participation interests in commercial real estate loans, construction real estate loans, residential real estate loans, commercial loans and lease loans originated by MB Financial Bank and mortgage-backed securities.  MB Real Estate Holdings LLC has elected to be taxed as a Real Estate Investment Trust for federal income tax purposes.  The management of MBRE Holdings LLC consists of certain officers of MB Financial and MB Financial Bank who receive no compensation from MBRE Holdings LLC or MB Real Estate Holdings LLC.
 
LaSalle focuses primarily on leasing technology-related equipment to middle market and large “Fortune 1000” businesses located throughout the United States.  During the second quarter of 2005, LaSalle, which was the owner of 60% of LaSalle Business Solutions (LBS), purchased from the minority owners the remaining 40% of LBS.  LBS specializes in selling and administering third party equipment maintenance contracts as well as technology-related equipment.
 
Vision Investment Services, Inc. (Vision) is registered with the Securities and Exchange Commission as a broker/dealer, is a member of the National Association of Securities Dealers, is a member of the Securities Investor Protection Corporation, and is a licensed insurance agency.  Vision has two wholly owned subsidiaries; Vision Insurance Services, Inc. and Vision Asset Management, Inc.  Vision Insurance Services, Inc. is a licensed insurance agency which functions as a distribution firm for certain annuity products, whereas Vision Asset Management, Inc. is a Registered Investment Advisor with the Securities and Exchange Commission.  Vision was acquired in connection with our February 2003 acquisition of South Holland Trust & Savings Bank (South Holland).  Vision provides both institutional and retail clients with investment and wealth management services.  It had $479.2 million in assets under administration at December 31, 2008.
 
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Cedar Hill is an asset management firm located in Chicago, Illinois, with approximately $807.1 million in assets under management at December 31, 2008.
 
Ashland Management Agency, Inc. holds and/or manages certain properties purchased by the Company.
 
We also own all of the issued and outstanding common securities of Coal City Capital Trust I, MB Financial Capital Trust II, MB Financial Capital Trust III, MB Financial Capital Trust IV, MB Financial Capital Trust V, MB Financial Capital Trust VI, FOBB Capital Trust I, FOBB Capital Trust III, all statutory business trusts formed for the purpose of issuing trust preferred securities.  See Note 13 of the notes to our audited consolidated financial statements for additional information.
 
Recent Developments
 
On February 27, 2009, we will pay a cash dividend, distributing $0.12 per share to shareholders of record as of February 13, 2009.
 
Primary Lines of Business
 
Our operations are currently managed as one unit and we have one reportable segment.  Our chief operating decision-makers use consolidated results to make operating and strategic decisions.
 
We concentrate on serving small and middle market businesses, leasing companies, and their respective owners.  We also serve consumers who live or work near our branches.  Through our acquisition program and careful selection of officers and employees, we have positioned ourselves to take a leading role in these attractive niches.  We have established three primary lines of business: commercial banking; retail banking; and wealth management.  Each is described below.
 
Commercial Banking.  Our commercial banking group focuses on serving small and middle market businesses, primarily located in the Chicago metropolitan area.  We provide a full set of credit, deposit, and treasury management products to these companies.  In general, our credit products are specifically designed for companies with annual revenues between $5 million and $100 million and credit needs of up to $25 million.  We have a broad range of credit products for our target market, including working capital loans and lines of credit; accounts receivable; 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 products for businesses, investment sweep accounts, zero balance accounts, automated tax payments, ATM access, merchant credit card processing, telephone banking, lockbox, automated clearing house transactions, account reconciliation, controlled disbursement, detail and general information reporting, wire transfers, a variety of international banking services, and checking accounts.  We also provide a full set of credit, deposit and treasury management services for real estate operators and investors.
 
Within commercial banking, we also target small and medium size equipment leasing companies located throughout the United States.  We have provided lease banking services to these companies for more than three decades.  Competition in serving this equipment leasing market generally comes from large banks, finance companies, large industrial companies and some community banks.  We compete based upon rapid decision making and excellent service and by providing flexible financial solutions to meet our customers’ needs.  We provide full banking services to leasing companies by financing the debt portion of leveraged equipment leases (referred to as lease loans), providing short and long-term equity financing and by making working capital and bridge loans.  For lease loans, a lessee’s credit is often rated as investment grade for its public debt by Moody’s, Standard & Poors or the equivalent.  If a lessee does not have a public debt rating, they are subject to the same internal credit analysis as any other customer of MB Financial Bank.  We also invest directly in equipment that we lease to other companies located throughout the United States (referred to as operating leases).  Our operating lease portfolio is made up of various kinds of equipment, generally technology related, such as computer systems, satellite equipment, and general manufacturing equipment.  We seek leasing transactions where we believe the equipment leased is integral to the lessee’s business, thereby increasing the likelihood of renewal at the end of the lease term.
 
Additionally, LaSalle, a subsidiary of MB Financial Bank, primarily focuses on leasing technology-related equipment to middle market and large “Fortune 1000” businesses throughout the United States and provides us the additional ability to directly originate leases.  LaSalle is a 28-year old organization that banked with MB Financial Bank since its inception, prior to being acquired by us in 2002.  LaSalle’s experienced leasing personnel enhance our ability to originate leases, and expand the products that we offer our commercial banking customers.
 
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Retail Banking.  The target market for our retail banking group is individuals who live or work near our banking offices.  We offer a full set of personal banking products to these individuals, including checking accounts, savings accounts, NOW and money market accounts, time deposit accounts, secured and unsecured consumer loans, residential mortgage loans, Internet banking and a variety of fee for service products, such as money orders and travelers’ checks.  As our customers’ needs change, we adjust our product offerings accordingly, and develop new products to differentiate ourselves from our competitors.  To offer our customers additional convenience, beginning in 2005, we expanded our banking hours (including Sundays in some locations), provided a 7:00 PM cut-off time for deposits to accelerate cash availability for our customers, and introduced our ATM Freedom product that allows free ATM transactions anytime and anywhere in the world.  In 2008, we opened a limited number of supermarket branches in the Chicago metropolitan area.
 
Wealth Management.  Our Wealth Management Group provides coordinated and integrated delivery of investment management, trust, brokerage and private banking services.  Our asset management and trust department offers a wide range of financial services, including personal trust, investment management, custody, estate settlement, guardianship, tax-deferred exchange and retirement plan services.  Our private banking department provides qualified clients with personalized, “high touch” banking products and services, including a private banker as a single point of contact for all their financial needs.  MB Financial Bank subsidiaries Cedar Hill Associates and Vision Investment Services provide clients with non-FDIC insured investment alternatives and insurance products.
 
Lending Activities
 
General.  We are primarily a commercial lender and our loan portfolio consists primarily of loans to businesses or for business purposes.
 
Commercial Lending.  We make commercial loans to small and middle market businesses most often located in the Chicago area.  Borrowers tend to be privately owned and are generally manufacturers, wholesalers, distributors, long-term health care operators and service providers.  Loan products offered are primarily working capital and term loans and lines of credit that help our customers finance accounts receivable, inventory and equipment.  We also offer financial, performance and commercial letters of credit.  Commercial loans secured by owner occupied real estate are classified as commercial real estate loans in the loan portfolio composition table in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 6 to the audited consolidated financial statements in “Item 8. Financial Statements and Supplementary Data”.  Most commercial loans are short-term in nature, being one year or less, with the maximum term generally being five years.  Our commercial loans typically range in size from $500 thousand to $15 million.
 
Lines of credit for customers are typically secured, established for one year or less, and are subject to renewal upon a satisfactory review of the borrower’s financial statements and credit history.  Secured short-term commercial business loans are usually collateralized by accounts receivable, inventory, equipment and/or real estate.  Such loans are typically, but not always, guaranteed by the owners of the business.  Collateral securing commercial loans may depreciate over time, be difficult to appraise and fluctuate in value based on the success of the business.  In addition, in the case of loans secured by accounts receivable, the availability of funds for 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.
 
Commercial Real Estate Lending.  We originate commercial real estate loans that are generally secured by multi-unit residential property and owner and non-owner occupied commercial and industrial property.  We also make loans to finance the acquisition and development of land for residential, retail, and industrial uses.  Longer term commercial real estate loans are generally made at fixed rates, although some have interest rates that change based on our Reference 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.  For our fixed rate loans with maturities greater than five years, we may enter into an interest rate swap agreement with a third party to mitigate interest rate risk.  In deciding whether to make a commercial real estate loan, we consider, among other things, the experience and qualifications of the borrower as well as the value and cash flow of the underlying property.  Some factors considered are net operating income of the property before debt service and depreciation, the debt service coverage ratio (the ratio of the property’s net cash flow to debt service requirements), the global cash flows of the borrower, the ratio of the loan amount to the appraised value and the overall creditworthiness of the prospective borrower.  Our commercial real estate loans typically range in size from $250 thousand to $20 million.
 
Commercial real estate lending typically involves higher principal amounts than other types of loans and the repayment of such a loan is often dependent on the successful operations of the property securing the loan or the business conducted on the property securing the loan.  These loans may therefore be more adversely affected by conditions in real
 
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estate markets or in the economy in general.  For example, if the cash flow from the borrower’s project is reduced due to leases not being obtained, renewed or modified from their original terms, the borrower’s ability to repay a loan may be impaired.  In addition, many commercial real estate loans are not fully amortized over the loan period, but have balloon payments due at maturity.  A borrower’s ability to make a balloon payment typically will depend on their ability to either refinance the loan or complete a timely sale of the underlying property.
 
Construction Real Estate.  We provide construction loans for the acquisition and development of land for further improvement of condominiums, townhomes, and one-to-four family residences.  We also provide acquisition, development and construction loans for retail and other commercial purposes, primarily in our market areas.  With regard to construction lending, there were fewer new loans made during 2008 compared to prior years due to the economic environment.  Construction lending can involve a higher level of risk than other types of lending because funds are advanced partially based upon the value of the project, which is uncertain prior to the project’s completion.  Because of the uncertainties inherent in estimating construction costs as well as the market value of a completed project and the effects of governmental regulation of real property, our estimates with regards to the total funds required to complete a project and the related loan-to-value ratio may vary from actual results.  As a result, construction loans often involve the disbursement of substantial funds with repayment dependent, in part, on the success of the ultimate project and the ability of the borrower to sell or lease the property or refinance the indebtedness.  If our estimate of the value of a project at completion proves to be overstated, we may have inadequate security for repayment of the loan and we may incur a loss.
 
Lease Loans.  We lend money to small and mid-size 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.  Lease loans generally are non-recourse to the leasing company, and, consequently, our recourse is limited to the lessee and the leased equipment.  For this reason, we underwrite lease loans by examining the creditworthiness of the lessee rather than the lessor.  Generally, lease loans are secured by an assignment of lease payments and a security interest in the equipment being leased.  As with commercial loans secured by equipment, equipment securing our lease loans may depreciate over time, may be difficult to appraise and may fluctuate in value.  We rely on the lessee’s continuing financial stability, rather than the value of the leased equipment, for repayment of all required amounts under lease loans.  In the event of default, it is unlikely that the proceeds from the sale of leased equipment will be sufficient to satisfy the outstanding unpaid amounts under terms of the lease loan.
 
The lessee acknowledges the bank’s security interest in the leased equipment and normally agrees to send lease payments directly to us.  Lessees tend to be Fortune 1000 companies and have an investment grade public debt rating by Moody’s or Standard & Poors or the equivalent, though, we also provided credit to below investment grade and non-rated companies as well.  If the lessee does not have a public debt rating, they are subject to the same internal credit analysis as any other customer.  Lease loans almost always are fully amortizing, with maturities typically ranging from three to five years.  Loan interest rates are fixed.
 
We also invest directly in equipment leased to other companies (which we refer to as operating leases).  The profitability of these investments depends, to a great degree, upon our ability to realize the residual values of this equipment.  See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations-Critical Accounting Policies-Residual Value of Our Direct Finance, Leveraged and Operating Leases.”
 
Residential Real Estate.  We also originate fixed and adjustable rate residential real estate loans secured by one to four family homes.  Terms of first mortgages range from five to thirty years.  Terms for second mortgages range from five to ten years.  In deciding whether to make a residential real estate loan, we consider the qualifications of the borrower as well as the value of the underlying property.  Our general practice is to sell the majority of our newly originated fixed-rate residential real estate loans shortly after they are funded, and to hold in portfolio the majority of adjustable rate residential real estate loans.
 
Consumer Lending.  Our consumer loan portfolio is primarily focused on home equity lines of credit, fixed-rate second mortgage loans, indirect vehicle loans, and to a lesser extent, direct motorcycle loans and secured and unsecured consumer loans.  Home equity lines of credit are generally extended up to 80% of the appraised value of the property, less existing liens.  Indirect vehicle loans represent consumer loans made primarily through a network of Harley Davidson motorcycle dealers in 44 states. To a lesser extent we originate consumer loans for other motorcycle dealers and a few local auto dealerships.  Consumer loans typically have shorter terms and lower balances with higher yields as compared to residential real estate loans, but carry a higher risk of default.  Terms for second mortgages typically range from five to ten years.  Consumer loan collections are dependent on the
 
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borrower’s continuing financial stability, and thus, are more likely to be affected by adverse personal circumstances.  Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount which can be recovered on these loans.
 
Foreign Operations
 
MB Financial Bank holds certain commercial real estate loans, residential real estate loans, other loans and mortgage-backed investment securities in a real estate investment trust through its wholly owned subsidiary MBRE Holdings LLC headquartered and domiciled in Freeport, The Bahamas.  MBRE Holdings LLC and its subsidiary, MB Real Estate Holdings LLC, were established in August 2002 to provide us with alternative methods for raising capital and funding.  We do not engage in operations in any other foreign countries.
 
Competition
 
We face substantial competition in all phases of our operations, including deposit gathering and loan origination, from a variety of competitors.  Commercial banks, savings institutions, brokerage firms, credit unions, mutual fund companies, insurance companies and specialty finance companies all compete with us for new and existing customers.  Several national financial institutions have commenced aggressive de novo branching plans that have heightened competitive pressures in our market areas.  Our bank competes by providing quality services to our customers, ease of access to our facilities, convenient hours and competitive pricing of services (including interest rates paid on deposits, interest rates charged on loans and fees charged for other non-interest related services).
 
Personnel
 
As of December 31, 2008, we and our subsidiaries employed a total of 1,342 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 banking and securities 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.  We must file reports with the Federal Reserve Board and such additional information as the Federal Reserve Board may require, and our holding company and non-banking affiliates are subject to examination by the Federal Reserve Board.  Under Federal Reserve Board policy, a bank holding company must serve as a source of strength for its subsidiary banks.  Under this policy, the Federal Reserve Board may require, and has required in the past, a holding company to contribute additional capital to an undercapitalized subsidiary bank.  The Bank Holding Company Act provides that a bank holding company must obtain Federal Reserve Board approval before:
 
Acquiring, directly or indirectly, ownership or control of any voting shares of another bank or bank
 
holding company if, after such acquisition, it would own or control more than 5% of such shares
 
(unless it already owns or controls the majority of such shares);
   
Acquiring all or substantially all of the assets of another bank or bank holding company; or
   
Merging or consolidating with another bank holding company.
 
The Bank Holding Company Act generally prohibits a bank holding company from acquiring direct or indirect ownership or control of more than 5% of the voting shares of any company which is not a bank or bank holding company, or from engaging directly or indirectly in activities other than those of banking, managing or controlling banks, or providing services for its subsidiaries.  The principal exceptions to these prohibitions involve certain non-bank activities which, by statute or by Federal Reserve Board regulation or order, have been identified as activities closely related to the business of banking or managing or controlling banks.  The list of activities permitted by the Federal Reserve Board includes, among other things: lending; operating a savings institution, mortgage company, finance company, credit card company or factoring company; performing certain data processing operations; providing certain investment and financial advice; underwriting and acting as an insurance agent for certain types of credit-related insurance; leasing property on a full-payout, non-
 
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operating basis; selling money orders, travelers’ checks and United States Savings Bonds; real estate and personal property appraising; providing tax planning and preparation services; and, subject to certain limitations, providing securities brokerage services for customers.  These activities may also be affected by federal legislation.
 
In November 1999, the Gramm-Leach-Bliley Act became law.  The Gramm-Leach-Bliley Act is intended to, among other things; facilitate affiliations among banks, securities firms, insurance firms and other financial companies.  To further this goal, the Gramm-Leach-Bliley Act amended portions of the Bank Holding Company Act of 1956 to authorize bank holding companies, such as us, directly or through non-bank subsidiaries to engage in securities, insurance and other activities that are financial in nature or incidental to a financial activity.  In order to undertake these activities, a bank holding company must become a "financial holding company" by submitting to the appropriate Federal Reserve Bank a declaration that the company elects to be a financial holding company and a certification that all of the depository institutions controlled by the company are well capitalized and well managed.  We submitted the declaration of our election to become a financial holding company with the Federal Reserve Bank of Chicago in June 2002, and our election became effective in July 2002.
 
Depository Institution Regulation. Our bank subsidiary is subject to regulation by the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation.  This regulatory structure includes:
 
 
Real estate lending standards, which provide guidelines concerning loan-to-value ratios for various types of real estate loans;

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

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

 
Rules restricting types and amounts of equity investments; and

 
Rules addressing various safety and soundness issues, including operations and managerial standards, standards for asset quality, earnings and compensation standards.
 
Capital Adequacy.  The Federal Reserve Board, Office of the Comptroller of the Currency and Federal Deposit Insurance Corporation have issued substantially similar risk-based and leverage capital guidelines applicable to bank holding companies and banks.  In addition, these regulatory agencies may from time to time require that a bank holding company or bank maintain capital above the minimum levels, based on its financial condition or actual or anticipated growth.
 
The Federal Reserve Board's risk-based guidelines establish a two-tier capital framework.  Tier 1 capital generally consists of common stockholders' equity, retained earnings, a limited amount of qualifying perpetual preferred stock, qualifying trust preferred securities and minority 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.  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, 2008 were 12.07% and 14.08%, 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, 2008, we had a leverage ratio of 9.85%.
 
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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 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 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, 2008, our subsidiary bank met the requirements to be classified as “well-capitalized.”
 
Dividends.  The Federal Reserve Board's policy is that a bank holding company should pay cash dividends only to the extent that its net income for the past year is sufficient to cover both the cash dividends and a rate of earnings retention that is consistent with the holding company's capital needs, asset quality and overall financial condition, and that it is inappropriate for a bank holding company experiencing serious financial problems to borrow funds to pay dividends.  Furthermore, a bank that is classified under the prompt corrective action regulations as "undercapitalized" will be prohibited from paying any dividends.
 
On December 5, 2008, as part of the Troubled Asset Relief Program (“TARP”) Capital Purchase Program of the United States Department of the Treasury (“Treasury”), the Company sold to Treasury 196,000 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A (the “Series A Preferred Stock”), having a liquidation preference amount of $1,000 per share, for a purchase price of $196.0 million in cash and (ii) issued to Treasury a ten-year warrant to purchase 1,012,048 shares of the Company’s common stock  at an exercise price of $29.05 per share.
 
The securities purchase agreement between us and Treasury provides that prior to the earlier of (i) December 5, 2011 and (ii) the date on which all of the shares of the Series A Preferred Stock have been redeemed by us or transferred by Treasury to third parties, we may not, without the consent of Treasury, (a) pay a quarterly cash dividend on our common stock of more than $0.18 per share or (b) subject to limited exceptions, redeem, repurchase or otherwise acquire shares of our common stock or preferred stock, other than the Series A Preferred Stock, or trust preferred securities.  In addition, under the terms of the Series A Preferred Stock, we may not pay dividends on our common stock at any time we are in arrears on the dividends payable on the Series A Preferred Stock.  Dividends on the Series A Preferred Stock are payable quarterly at a rate of 5% per annum for the first five years and a rate of 9% per annum thereafter if not redeemed prior to that time.
 
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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 currently maintains the Deposit Insurance Fund (the “DIF”), which was created in 2006 in the merger of the Bank Insurance Fund and the Savings Association Insurance Fund.   The deposit accounts of our subsidiary bank are insured by the DIF to the maximum amount provided by law.  This insurance is backed by the full faith and credit of the United States Government.
 
As insurer, the FDIC is authorized to conduct examinations of and to require reporting by DIF-insured institutions. It also may prohibit any DIF-insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious threat to the DIF. The FDIC also has the authority to take enforcement actions against insured institutions.
 
The FDIC’s regulations for risk-based deposit insurance assessments establish four Risk Categories. The FDIC regards well-capitalized institutions that are financially sound with only a few minor weaknesses, including MB Financial Bank, as Risk Category I.  Risk Categories II, III and IV present progressively greater risks to the DIF and pay progressively higher rates.  For the first quarter of 2009, Risk Category I institutions will pay quarterly assessments for deposit insurance at annual rates of 12 to 14 basis points.  With advance notice to insured institutions, rates are subject to change.  Within Risk Category I, the precise rate for an individual institution with less than $10 billion in assets is generally determined by a formula using CAMELS ratings, which are assigned in examinations, and financial ratios.  A different method applies for larger institutions.  The rate for an individual institution is applied to its assessment base, consisting generally of its deposit liabilities subject to certain adjustments.
 
In an effort to restore capitalization levels and to ensure the DIF will adequately cover projected losses from future bank failures, the FDIC, in October 2008, proposed a rule to alter the way in which it differentiates for risk in the risk-based assessment system and to revise deposit insurance assessment rates, including base assessment rates. For Risk Category I institutions, the FDIC proposes (i) to determine the initial base assessment rate using a combination of weighted-average CAMELS component ratings and the financial ratios method assessment rate (as defined), each equally weighted and (ii) to revise the uniform amount and the pricing multipliers. The FDIC also proposes to introduce three adjustments that could be made to an institution’s initial base assessment rate, including (i) a potential decrease of up to 2 basis points for long-term unsecured debt, including senior and subordinated debt, (ii) a potential increase for secured liabilities in excess of 15% of domestic deposits and (iii) for non-Risk Category I institutions, a potential increase for brokered deposits in excess of 10% of domestic deposits.  The FDIC also proposes, effective April 1, 2009, initial base assessment rates for Risk Category I institutions of 10 to 14 basis points. After the effect of potential base-rate adjustments, the annualized assessment rate for Risk Category I institutions would range from 8 to 21 basis points. A final rule related to this proposal is expected to be issued during the first quarter of 2009. The Company cannot provide any assurance as to the amount of any proposed increase in its deposit insurance premium rate, should such an increase occur, as such changes are dependent upon a variety of factors beyond the Company’s control.
 
FDIC insurance expense totaled $1.9 million and $664.0 thousand in 2008 and 2007, respectively. FDIC insurance expense includes deposit insurance assessments and Financing Corporation (“FICO”) assessments related to outstanding FICO bonds. The FICO is a mixed-ownership government corporation established by the Competitive Equality Banking Act of 1987 whose sole purpose was to function as a financing vehicle for the now defunct Federal Savings & Loan Insurance Corporation. Under the Federal Deposit Insurance Reform Act of 2005, which became law in 2006, MB Financial Bank received a one-time assessment credit of $5.3 million to be applied against future deposit insurance assessments, subject to certain limitations. This credit was utilized to offset $2.1 million of deposit insurance assessments during 2007 and $3.1 million of assessments during 2008. The assessment credits were utilized as of December 31, 2008.

Temporary Liquidity Guarantee Program.  On November 21, 2008, the Board of Directors of the FDIC adopted a final rule relating to the Temporary Liquidity Guarantee Program (“TLG Program”). The TLG Program was announced by the FDIC on October 14, 2008, preceded by the determination of systemic risk by the Secretary of the Department of Treasury (after consultation with the President), as an initiative to counter the system-wide crisis in the nation’s financial sector. Under the TLG Program the FDIC will (i) guarantee, through the earlier
 
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of maturity or June 30, 2012, certain newly issued senior unsecured debt issued by participating institutions on or after October 14, 2008, and before June 30, 2009 and (ii) provide full FDIC deposit insurance coverage for non-interest bearing transaction deposit accounts, Negotiable Order of Withdrawal (“NOW”) accounts paying less than 0.5% interest per annum and Interest on Lawyers Trust Accounts held at participating FDIC insured institutions through December 31, 2009. Coverage under the TLG Program was available for the first 30 days without charge. The fee assessment for coverage of senior unsecured debt ranges from 50 basis points to 100 basis points per annum, depending on the initial maturity of the debt. The fee assessment for the Transaction Account Guarantee Program is 10 basis points per quarter on amounts in covered accounts exceeding $250,000.  On December 5, 2008, the Company elected not to opt-out of either guarantee program.  The FDIC has announced that for an additional premium, it will extend the TLG Program through October 2009, but no regulations have been published in proposed or final form.
 
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 Federal Deposit Insurance Corporation-insured institution is obligated, consistent with safe and sound banking practices, to help meet the credit needs of its entire community, including low and moderate income neighborhoods.  The Community Reinvestment Act requires the appropriate federal banking regulator, in connection with the examination of an insured institution, to assess the institution’s record of meeting the credit needs of its community and to consider this record in its evaluation of certain applications, such as a merger or the establishment of a branch.  An unsatisfactory rating may be used as the basis for the denial of an application and will prevent a bank holding company of the institution from making an election to become a financial holding company.
 
As of its last examination, MB Financial Bank received a Community Reinvestment Act rating of “outstanding.”
 
Interstate Banking and Branching.  The Federal Reserve Board may approve an application of a bank holding company to acquire control of, or acquire all or substantially all of the assets of, a bank located in a state other than the bank holding company's home state, without regard to whether the transaction is prohibited by the laws of any state.  The Federal Reserve Board may not approve the acquisition of a bank that has not been in existence for the minimum time period (not exceeding five years) specified by the law of the target bank’s home state.  The Federal Reserve Board also may not approve an application if the bank holding company (and its bank affiliates) controls or would control more than ten percent of the insured deposits in the United States or, generally, 30% or more of the deposits in the target bank's home state or in any state in which the target bank maintains a branch.  Individual states may waive the 30% statewide concentration limit.  Each state may limit the percentage of total insured deposits in the state that may be held or controlled by a bank or bank holding company to the extent the limitation does not discriminate against out-of-state banks or bank holding companies.
 
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 new compliance and due diligence obligations, creates new crimes and penalties, compels the production of documents located both inside and outside the United States, including those of foreign institutions that have a correspondent relationship in the United States, and clarifies the safe harbor from civil liability to customers. The U.S. Treasury Department has issued a number of regulations implementing the USA Patriot Act that apply certain of its requirements to
 
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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.
 
Future Legislation and Changes in Regulations.  Proposals to change the laws and regulations governing the banking industry are frequently introduced in Congress, in the state legislatures and by the various bank regulatory agencies.  New legislation and/or changes in regulations could affect us in substantial and unpredictable ways, and increase or decrease the cost of doing business, limit or expand permissible activities or affect the competitive balance among banks and other financial institutions.  The likelihood and timing of any proposed legislation or changes in regulations and the impact they might have on us cannot be determined at this time.
 
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 common stock 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 common stock could decline due to any of these identified or other risks, and you could lose all or part of your investment.
 
Changes in economic conditions, particularly a further economic slowdown in the Chicago area, could hurt our business.

Our business is directly affected by market conditions, trends in industry and finance, legislative and regulatory changes, and changes in governmental monetary and fiscal policies and inflation, all of which are beyond our control.  In 2007, the housing and real estate sectors experienced an economic slowdown that has continued into 2009.  Further deterioration in economic conditions, particularly within the Chicago area, could result in the following consequences, among others, any of which could hurt our business materially:
 
·  
loan delinquencies may increase;
 
·  
problem assets and foreclosures may increase;
 
·  
demand for our products and services may decline; and
 
·  
collateral for our loans may decline in value, in turn reducing a customer’s borrowing power and reducing the value of assets and collateral securing our loans.

Negative developments in the financial industry and credit markets may continue to adversely impact our financial condition and results of operations.

Negative developments beginning in the latter half of 2007 in the sub-prime mortgage market and the securitization markets for such loans, together with other factors, have resulted in uncertainty in the financial markets in general and a related general economic downturn, which have continued into 2009.  In addition, as a consequence of the recession that the United
 
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States now finds itself in, business activity across a wide range of industries face serious difficulties due to the lack of consumer spending and the extreme lack of liquidity in the global credit markets. Unemployment has also increased significantly.

As a result of these economic crises, many lending institutions, including us, have experienced declines in the performance of their loans, including construction loans and commercial real estate loans.  In addition, the values of real estate collateral supporting many loans have declined and may continue to decline.  Bank and bank holding company stock prices have been negatively affected, as has the ability of banks and bank holding companies to raise capital or borrow in the debt markets compared to recent years.  These conditions may have a material adverse effect on our financial condition and results of operations.  In addition, as a result of the foregoing factors, there is a potential for new laws and regulations regarding lending and funding practices and liquidity standards, and bank regulatory agencies are expected to be very aggressive in responding to concerns and trends identified in examinations.  Negative developments in the financial industry and the impact of new legislation and regulations in response to those developments could restrict our business operations, including our ability to originate loans, and adversely impact our results of operations and financial condition.  Overall, during the past year, the general business environment has had an adverse effect on our business, and there can be no assurance that the environment will improve in the near term. Until conditions improve, we expect our business, financial condition and results of operations to be adversely affected.

Recent legislative and regulatory initiatives to address difficult market and economic conditions may not stabilize the U.S. banking system.

The recently enacted Emergency Economic Stabilization Act of 2008 (the “EESA”) authorizes the U.S. Treasury Department (the “Treasury”) to purchase from financial institutions and their holding companies up to $700 billion in mortgage loans, mortgage-related securities and certain other financial instruments, including debt and equity securities issued by financial institutions and their holding companies, under a Troubled Asset Relief Program (“TARP”).  The purpose of TARP is to restore confidence and stability to the U.S. banking system and to encourage financial institutions to increase their lending to customers and to each other.  The Treasury has allocated $250 billion towards the TARP Capital Purchase Program (“CPP”).  Under the CPP, Treasury has purchased preferred equity securities from participating institutions, including $196.0 million of our preferred stock.  The EESA also increased federal deposit insurance on most deposit accounts from $100,000 to $250,000.  This increase is in place until the end of 2009.

The EESA followed, and has been followed by, numerous actions by the Board of Governors of the Federal Reserve System, the U.S. Congress, Treasury, the FDIC, the SEC and others to address the current liquidity and credit crisis that has followed the sub-prime meltdown that commenced in 2007.  These measures include homeowner relief that encourage loan restructuring and modification; the establishment of significant liquidity and credit facilities for financial institutions and investment banks; the lowering of the federal funds rate; emergency action against short selling practices; a temporary guaranty program for money market funds; the establishment of a commercial paper funding facility to provide back-stop liquidity to commercial paper issuers; and coordinated international efforts to address illiquidity and other weaknesses in the banking sector.  In addition, Treasury recently announced its Financial Stability Plan to attack the current credit crisis, and President Obama has signed into law the American Recovery and Reinvestment Act (the “ARRA”).  The purpose of these legislative and regulatory actions is to stabilize the U.S. banking system, improve the flow of credit and foster an economic recovery.  The regulatory and legislative initiatives described above may not have their desired effects, however.  If the volatility in the markets continues and economic conditions fail to improve or worsen, our business, financial condition and results of operations could be materially and adversely affected.
 
Current levels of market volatility are unprecedented.
 
The capital and credit markets have been experiencing volatility and disruption for more than a year. In recent months, the volatility and disruption has reached unprecedented levels. In some cases, the markets have produced downward pressure on stock prices and credit availability for certain issuers without regard to those issuers’ underlying financial strength. If current levels of market disruption and volatility continue or worsen, there can be no assurance that we will not experience an adverse effect, which may be material, on our ability to access capital, if needed or desired, and on our business, financial condition and results of operations.

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Our allowance for loan losses may prove to be insufficient to absorb losses in our loan portfolio.
 
Lending money is a substantial part of our business. Every loan carries a certain risk that it will not be repaid in accordance with its terms or that any underlying collateral will not be sufficient to assure repayment. This risk is affected by, among other things:
 
• cash flow of the borrower and/or the project being financed;

 the changes and uncertainties as to the future value of the collateral, in the case of a collateralized loan;

the credit history of a particular borrower;

changes in economic and industry conditions; and

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

 our specific reserve, based on our evaluation of non-performing loans and their underlying collerateral; and

current macroeconomic factors and model imprecision factors.
 
The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and requires us to make significant estimates of current credit risks and future trends, all of which may undergo material changes. Continuing deterioration in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of our control, may require an increase in the allowance for loan losses. In addition, bank regulatory agencies periodically review our allowance for loan losses and may require an increase in the provision for possible loan losses or the recognition of further loan charge-offs, based on judgments different than those of management. In addition, if charge-offs in future periods exceed the allowance for loan losses, we will need additional provisions to increase the allowance for loan losses. Any increases in the allowance for loan losses will result in a decrease in net income and, possibly, capital, and may have a material adverse effect on our financial condition and results of operations.
 
As of December 31, 2008, approximately 85% of our loan portfolio consisted of commercial-related credits, consisting of commercial loans, commercial loans collateralized by the assignment of lease payments, commercial real estate loans and construction loans.  See “Item 1. Business—Lending Activities.”
 
Changes in interest rates may reduce our net interest income.
 
Like other financial institutions, 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, and prepayments on our loans and investments.
 
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 result in differing spreads on interest earning assets and interest bearing liabilities.  While we take measures intended to manage the risks from changes in market interest rates, we cannot control or accurately predict changes in market rates of interest or be sure our protective measures are adequate.
 
We pursue acquisitions to supplement internal growth.
 
We pursue a strategy of supplementing internal growth by acquiring other financial institutions that will help us fulfill our strategic objectives and enhance our earnings.  There are risks associated with this strategy, however, including the following:
 
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 We may be exposed to potential asset quality issues or unknown or contingent liabilities of the banks or businesses we acquire.  If these issues or liabilities exceed our estimates, our earnings and financial condition may be adversely 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 our management considered acceptable and expect that we will experience this condition in the future in one or more markets;

 The acquisition of other entities generally requires integration of systems, procedures and personnel of the acquired entity in order to make the transaction economically feasible.  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 borrow funds to finance an acquisition, thereby increasing our leverage and diminishing our liquidity; and

 We have completed various acquisitions and opened additional banking offices in the past few years that enhanced our rate of growth.  We may not be able to continue to sustain our past rate of growth or to grow at all in the future.

Our growth or future losses may require us to raise additional capital in the future, but that capital may not be available when it is needed or the cost of that capital may be very high.
 
We are required by federal and state regulatory authorities to maintain adequate levels of capital to support our operations.  We anticipate that our existing 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.
 
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 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.
 
Our wholesale funding sources may prove insufficient to replace deposits or support our future growth.
 
We must maintain sufficient funds to respond to the needs of depositors and borrowers.  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.  As we continue to grow, we may become more dependent on these sources, which include brokered certificates of deposit, repurchase agreements, federal funds purchased, Federal Reserve term auction funds and Federal Home Loan Bank advances.  Adverse operating results or changes in industry conditions could lead to an inability to replace these additional funding sources at maturity.  Our financial flexibility will be severely 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 operating margins and profitability would be adversely affected.
 
Since our business is concentrated in the Chicago metropolitan area, a further decline in the economy of this area may adversely affect our business.
 
Except for our lease banking activities which are nationwide, our lending and deposit gathering activities are concentrated primarily 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.  Continued deterioration in the real estate markets where collateral for a mortgage loan is located could adversely 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.
 
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Adverse 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.
 
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.  To the extent our market capitalization (market value of total common shares outstanding) is less than the book value of our total stockholders’ equity (which it was not as of December 31, 2008 but was as of February 27, 2009), this will be considered, along with other pertinent factors, in determining whether goodwill is impaired.  If our estimates of future cash flows or other components of our fair value calculations are inaccurate, the fair value of goodwill reflected in our financial statements could be inaccurate and we could be required to take asset impairment charges, which could have a material adverse effect on our results of operations and financial condition.

Non-compliance with 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 Department’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.
 
New or changes in existing 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 financial company’s shareholders.  These regulations may sometimes impose significant limitations on operations.  The significant federal and state banking regulations that affect us are described in this report under the heading “Item 1. Business-Supervision and Regulation.”  These regulations, along with the currently existing tax, accounting, securities, insurance, and monetary laws, regulations, rules, standards, policies, and interpretations control the methods by which financial institutions conduct business, implement strategic initiatives and tax compliance, and govern financial reporting and disclosures.  These laws, regulations, rules, standards, policies, and interpretations are constantly evolving and may change significantly over time.
 
Significant legal actions could subject us to substantial liabilities.
 
We are from time to time subject to claims related to our operations.  These claims and legal actions, including supervisory actions by our regulators, could involve large monetary claims and significant defense costs.  As a result, we may be exposed to substantial liabilities, which could adversely affect our results of operations and financial condition.
 
The loss of certain key personnel could adversely affect our operations.
 
Our success depends in large part on the retention of a limited number of key management, lending 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 lending officers and on their relationships with the customers and communities they serve.  The loss of these key persons could negatively impact the affected banking operations.
 
 
Because of our participation in the CPP under the EESA, we are subject to several restrictions, including restrictions on compensation paid to our executive officers and other key employees.
 
Our ability to retain key officers and employees may be further impacted by legislation and regulation affecting the financial services industry. On February 17, 2009, the American Recovery and Reinvestment Act of 2009 was signed into law. Section 7001 of the ARRA amended Section 111 of the EESA in its entirety. While the U.S. Treasury must promulgate regulations to implement the restrictions and standards set forth in Section 7001, the ARRA, among other things, significantly expands the executive compensation restrictions previously imposed by the EESA. Such restrictions apply to any entity that has received or will receive financial assistance under the Troubled Asset Recovery Program, and will generally continue to apply for as long as any obligation arising from financial assistance provided under TARP, including preferred stock issued under the Capital Purchase Program, remains outstanding. These ARRA restrictions will not apply to any Troubled Asset Recovery Program recipient during such time when the federal government (i) only holds any warrants to purchase common stock of such recipient or (ii) does not hold any preferred stock or warrants to purchase common stock of such recipient. As a result of our participation in the Capital Purchase Program, the restrictions and standards set forth in Section 7001 of the ARRA shall be applicable to us, subject to regulations promulgated by the U.S. Treasury. Such restrictions and standards may further impact management's ability to compete with financial institutions that are not subject to the same limitations as us under Section 7001 of the ARRA.
 
    Our business, financial condition or results of operations could be materially adversely affected by the loss of any of its key employees, or our inability to attract and retain skilled employees.
 
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 in our geographic markets 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.  As a result, these nonbank competitors have certain advantages over us in accessing funding and in providing various services.
 
We are subject to security and operational risks relating to our use of technology that could damage our reputation and our business.
 
Security breaches in our internet banking activities could expose us to possible liability and damage our reputation.  Any compromise of our security also could deter customers from using our internet banking services that involve the transmission of confidential information.  We rely on standard internet security systems to provide the security and authentication necessary to effect secure transmission of data.  These precautions may not protect our systems from compromises or breaches of our security measures that could result in damage to our reputation and our business.  Additionally, we outsource our data processing to a third party.  If our third party provider encounters difficulties or if we have difficulty in communicating with such third party, it will significantly affect our ability to adequately process and account for customer transactions, which would significantly affect our business operations.
 
Item 1B.  Unresolved Staff Comments
 
None.
 
Item 2.  Properties
 
We conduct our business at 72 retail banking center locations, with 71 in the Chicago metropolitan area and one in Philadelphia, Pennsylvania.  We own 37 of our banking center facilities.  The other facilities are leased for various terms.  All of our branches have ATMs, and we have 10 additional ATMs at other locations in the Chicago metropolitan area.  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.
 
Set forth below is information relating to each of our offices as of December 31, 2008.  The total net book value of our premises and equipment (including land and land improvements, buildings, furniture and equipment, and buildings and leasehold improvements) at December 31, 2008 was $186.5 million.
 
19

 
Principal Business Office:
800 West Madison Street, Chicago, Illinois
 
Banking Office Locations:

Chicago (Central)
1200 North Ashland Avenue, Chicago, Illinois (1)
936 North Western, Chicago, Illinois
820 North Western, Chicago, Illinois
2 South LaSalle Street, Chicago, Illinois (1)
303 East Wacker Drive, Chicago, Illinois (1)
One East Wacker Drive, Chicago, Illinois (1)
One South Wacker Drive, Chicago, Illinois (1)
33 W. Huron St., Chicago, Illinois (1)
557 S. State St., Chicago, Illinois (1)
1420 West Madison Street, Chicago, Illinois (2)

Chicago (North)
2965 North Milwaukee, Chicago, Illinois
5670 North Milwaukee, Chicago, Illinois
6443 North Sheridan Road, Chicago, Illinois (1)

Chicago (South)
5100 South Damen Avenue, Chicago, Illinois
1618 West 18th Street, Chicago, Illinois
3030 East 92nd Street, Chicago, Illinois

Chicago (West)
6422 West Archer Avenue, Chicago, Illinois (2)
8300 West Belmont, Chicago, Illinois

Chicago (Suburban)
777 Army Trail Rd., Addison, Illinois
2992 Indian Trail Rd., Aurora, Illinois
1050 Busse Hwy., Bensenville, Illinois (1)
455 S. Weber Rd., Bolingbrook, Illinois
1500 Roosevelt Rd., Broadview, Illinois
5750 West 87th Street, Burbank, Illinois
7000 County Line Road, Burr Ridge, Illinois
8300 S. Madison St., Burr Ridge, Illinois
600 W. Plainfield Rd., Countryside, Illinois
1100 E. Exchange Ave., Crete, Illinois (1)
2401 75th St. Darien, Illinois
14121 Chicago Road, Dolton, Illinois
1218 Sheffield Ave., Dyer Indiana (1)
990 North York Road, Elmhurst, Illinois
685 N. Lagrange Rd., Frankfort, Illinois (1)
356 Park Ave., Glencoe, Illinois (1)
2823 Pfingsten Rd., Glenview, Illinois (1)
2200 N. Waukegan Rd., Glenview, Illinois (1)
581 Elm Pl., Highland Park, Illinois (1)
2345 West 183rd St., Homewood, Illinois (1)
13900 S. Bell Rd., Homer Glen, Illinois
326 W. Burlington Ave., LaGrange Park, Illinois
401 North LaGrange Road, LaGrange Park, Illinois (1)
1151 State Street, Lemont, Illinois
6401 North Lincoln Avenue, Lincolnwood, Illinois
4010 West Touhy Avenue, Lincolnwood, Illinois
6444 S. College Rd., Lisle, Illinois (1)
1145 S. Main St., Lombard, Illinois (2)
6201 West Dempster Street, Morton Grove, Illinois
9147 Waukekgan Road, Morton Grove, Illinois
 
20

 
15 East Prospect Avenue, Mount Prospect, Illinois (1)
380 W. Diehl Rd., Naperville, Illinois
7557 West Oakton Street, Niles, Illinois (1)
1161 Church St., Northbrook, Illinois (1)
7222 West Cermak Road, North Riverside, Illinois (1)
1400 Sixteenth St., Oak Brook, Illinois (1)
3824 York Rd., Oak Brook, Illinois (1)
9701 S. Cicero Ave., Oak Lawn, Illinois
6621 West North Ave., Oak Park, Illinois
2251 Plum Grove Road, Palatine, Illinois
1014 Busse Highway, Park Ridge, Illinois (1)
6111 North River Road, Rosemont, Illinois (3)
200 West Higgins Road, Schaumburg, Illinois (1)
475 East 162nd Street, South Holland, Illinois
16340 South Park Avenue, South Holland, Illinois
16145 South State St., South Holland, Illinois (1)
2607 Lincoln Hwy., St. Charles, Illinois
16255 South Harlem Avenue, Tinley Park, Illinois
18299 South Harlem Avenue, Tinley Park, Illinois
16039 South Harlem Avenue, Tinley Park, Illinois (1)
28W571 Batavia Rd., Warrenville, Illinois (1)
212 S. West St., Wheaton, Illinois

Pennsylvania
7918 Bustleton Avenue, Philadelphia, Pennsylvania
 
(1)  
Leased facilities.
(2)  
Land under building site is leased; other land and buildings are owned.
(3)  
The Company owns the building.  However, the first floor is under a master lease agreement to a third party.  The branch leases the space from the third party.
 
We also have non-bank office locations in Chicago, Illinois, Paramus, New Jersey, Troy, Michigan, Columbus, Ohio, and Freeport, The Bahamas.  The Chicago office is used as the headquarters for Cedar Hill.  The Paramus location is used as part of our lease banking services.  The Troy and Columbus locations are used only as part of LaSalle’s business.  The Freeport office houses the headquarters for MBRE Holdings LLC.  None of these locations provide banking services to our customers.
 
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.  Submission of Matters to a Vote of Security Holders
 
No matter was submitted to a vote of security holders, through the solicitation of proxies or otherwise, during the quarter ended December 31, 2008.
 
21

 
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 1,650 holders of record of our common stock as of December 31, 2008.
 
The following table presents quarterly market price information and cash dividends paid per share for our common stock for 2008 and 2007:
 
 
Market Price Range
   
High
 
Low
 
Dividends Paid
2008
           
Quarter ended December 31, 2008
 
 $34.59
 
 $20.43
 
 $0.18
Quarter ended September 30, 2008
 
 $44.29
 
 $18.76
 
 $0.18
Quarter ended June 30, 2008
 
 $32.59
 
 $22.47
 
 $0.18
Quarter ended March 31, 2008
 
 $33.30
 
 $25.41
 
 $0.18
2007
           
Quarter ended December 31, 2007
 
 $36.52
 
 $29.13
 
 $0.18
Quarter ended September 30, 2007
 
 $37.88
 
 $31.15
 
 $0.18
Quarter ended June 30, 2007
 
 $36.53
 
 $33.18
 
 $0.18
Quarter ended March 31, 2007
 
 $37.89
 
 $34.50
 
 $0.18
 
The timing and amount of cash dividends paid depends on our earnings, capital requirements, financial condition and other relevant factors.  In this regard, we reduced our dividend for the first quarter of 2009 to $0.12 per share after reviewing these factors and giving consideration to the current economic environment.  The primary source for dividends paid to stockholders is dividends paid to us from MB Financial Bank.  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 11%, 8% and 7%, respectively.  The minimum ratios required for a bank to be considered “well capitalized” for regulatory purposes are 10%, 6% and 5%, respectively.  In addition to adhering to our internal policy, there are regulatory restrictions on the ability of national banks to pay dividends.  See “Item 1. Business - Supervision and Regulation - Dividends” above and Note 18 of notes to consolidated financial statements contained in Item 8 of this report.
 
The following table sets forth information for the three months ended December 31, 2008 with respect to 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, 2008 – October 31, 2008
 172
 
 $29.67
 
 -
 
 -
November 1, 2008 – November 30, 2008
 160
 
 29.71
 
 -
 
 -
December 1, 2008 – December 31, 2008
 38,660
 (2)
 26.09
 (2)
 -
 
 -
Total
 38,992
 
 $26.12
 
 -
   

(1)  
Represents shares of stock withheld upon vesting of restricted shares or exercise of stock options to satisfy tax withholding obligations.
(2)  
Includes 36,817 shares surrendered to the Company in payment of the exercise price of stock options exercised, and to satisfy tax withholding obligations.
 
On December 5, 2008, as part of the Troubled Asset Relief Program (“TARP”) Capital Purchase Program of the United States Department of the Treasury (“Treasury”), the Company sold to Treasury 196,000 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A (the “Series A Preferred Stock”), having a liquidation preference
 
22

 
amount of $1,000 per share, for a purchase price of $196.0 million in cash and (ii) issued to Treasury a ten-year warrant to purchase 1,012,048 shares of the Company’s common stock at an exercise price of $29.05 per share.
 
The securities purchase agreement between us and Treasury provides that prior to the earlier of (i) December 5, 2011 and (ii) the date on which all of the shares of the Series A Preferred Stock have been redeemed by us or transferred by Treasury to third parties, we may not, without the consent of Treasury, (a) pay a cash dividend on our common stock of more than $0.18 per share or (b) subject to limited exceptions, redeem, repurchase or otherwise acquire shares of our common stock or preferred stock, other than the Series A Preferred Stock, or trust preferred securities.  In addition, under the terms of the Series A Preferred Stock, we may not pay dividends on our common stock unless we are current in our dividend payments on the Series A Preferred Stock.  Dividends on the Series A Preferred Stock are payable quarterly at a rate of 5% per annum for the first five years and a rate of 9% per annum thereafter if not redeemed prior to that time.
 
Stock Performance Presentation
 
The following line graph shows a comparison of the cumulative returns for the Company, the NASDAQ Market Bank Index and an index of peer corporations selected by the Company, for the period beginning December 31, 2003 and ending December 31, 2008.  The information assumes that $100 was invested at the closing price on December 31, 2003 in the Common Stock and each index, and that all dividends were reinvested.
 
COMPARISON OF 5-YEAR CUMULATIVE TOTAL RETURN
AMONG MB FINANCIAL, INC.,
NASDAQ BANK INDEX AND PEER GROUP INDEX

Comparison of 5 yr Cumulative Total Return
 
 
Fiscal Year Ending
COMPANY/INDEX/MARKET
12/31/2003
12/31/2004
12/31/2005
12/31/2006
12/31/2007
12/31/2008
             
MB Financial, Inc.
 100.00
 117.37
 100.01
 108.23
 90.56
 84.23
NASDAQ Banks
 100.00
 110.99
 106.18
 117.87
 91.85
 69.88
Peer Group
 100.00
 121.82
 123.52
 129.14
 96.12
 58.73
 
23

 
 
The Peer Group is made up of the common stocks of the following companies:
 
AMCORE FINANCIAL INC
FIRST MIDWEST BANCORP INC
MIDWEST BANC HOLDINGS INC
OLD SECOND BANCORP INC
PRIVATEBANCORP INC
TAYLOR CAPITAL GROUP INC
WINTRUST FINANCIAL CORPORATION
 
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 November 28, 2007, the Company sold its Union Bank subsidiary.  In accordance with accounting principles generally accepted in the United States, the assets, liabilities, earnings, and cash flows of the business conducted by Union Bank have been shown separately as discontinued operations in the consolidated balance sheets, consolidated statements of income, and consolidated statements of cash flows for all periods presented.
 
For purposes of the following discussion, balances, average rate, income and expenses associated with Union Bank have been excluded from continuing operations.  See Note 3 in the notes to consolidated financial statements contained under Item 8. Financial Statements and Supplementary Data.
 
Our summary consolidated financial information and other financial data contain information determined by methods other than in accordance with accounting principles generally accepted in the United States of America (GAAP).  These measures include net interest income on a fully tax equivalent basis, net interest margin on a fully tax equivalent basis, tangible equity to assets ratio, tangible common equity to assets ratio, tangible common book value per share, and annualized cash return on average tangible common equity.  Our management uses these non-GAAP measures in its analysis of our performance.  The tax equivalent adjustment to net interest income recognizes the income tax savings when comparing taxable and tax-exempt assets and assumes a 35% tax rate.  Management believes that it is a standard practice in the banking industry to present net interest income and net interest margin on a fully tax equivalent basis, and accordingly believes that providing these measures may be useful for peer comparison purposes.  The other measures exclude goodwill and other intangible assets, net of tax benefit, in determining tangible stockholders’ equity.  Management believes the presentation of these other financial measures excluding the impact of such items provides useful supplemental information that is helpful in understanding our financial results, as they provide a method to assess management’s success in utilizing our tangible capital.  These disclosures should not be viewed as substitutes for the results determined to be in accordance with GAAP, nor are they necessarily comparable to non-GAAP performance measures that may be presented by other companies.
 
24

 
Reconciliations of net interest margin on a fully tax equivalent basis to net interest margin and tangible common book value per common share to common book value per common share are contained in the “Selected Financial Data” discussed below.
 
Selected Financial Data:

 
As of or for the Year Ended December 31,
   
2008
 
2007
 
2006 (1)
 
2005
 
2004 (2)
Statement of Income Data:
                   
Interest income
 
 $413,788
 
 $457,266
 
 $374,371
 
 $274,522
 
 $213,788
Interest expense
 
 192,900
 
 244,960
 
 186,192
 
 105,689
 
 65,083
Net interest income
 
 220,888
 
 212,306
 
 188,179
 
 168,833
 
 148,705
Provision for loan losses
 
 125,721
 
 19,313
 
 10,100
 
 8,150
 
 7,800
Net interest income after provision for loan losses
 
 95,167
 
 192,993
 
 178,079
 
 160,683
 
 140,905
Other income
 
 98,466
 
 99,904
 
 71,321
 
 60,080
 
 63,288
Other expenses
 
 200,787
 
 206,836
 
 159,075
 
 133,511
 
 119,518
Income (loss) before income taxes
 
 (7,154)
 
 86,061
 
 90,325
 
 87,252
 
 84,675
Applicable income tax expense (benefit)
 
 (23,318)
 
 24,036
 
 27,269
 
 26,607
 
 25,697
Income from continuing operations
 
 16,164
 
 62,025
 
 63,056
 
 60,645
 
 58,978
Discontinued operations
                   
Income from discontinued operations before income taxes
 
 -
 
 50,475
 
 6,213
 
 6,281
 
 6,091
Income taxes
 
 -
 
 18,637
 
 2,155
 
 2,172
 
 1,941
Income from discontinued operations
 
 -
 
 31,838
 
 4,058
 
 4,109
 
 4,150
Net income
 
 16,164
 
 93,863
 
 67,114
 
 64,754
 
 63,128
Dividends on preferred shares
 
 789
 
 -
 
 -
 
 -
 
 -
Net income available to common shareholders
 
 $  15,375
 
 $  93,863
 
 $  67,114
 
 $  64,754
 
 $  63,128
                     
Common Share Data:
                   
Basic earnings per common share from continuing operations
 
 $      0.44
 
 $      1.73
 
 $      2.02
 
 $      2.13
 
 $      2.11
Basic earnings per common share from discontinued operations
 
 $            -
 
 $      0.88
 
 $      0.13
 
 $      0.14
 
 $      0.15
Basic earnings per common share
 
 $      0.44
 
 $      2.61
 
 $      2.15
 
 $      2.27
 
 $      2.26
Diluted earnings per common share from continuing operations
 
 $      0.44
 
 $      1.70
 
 $      1.99
 
 $      2.10
 
 $      2.07
Diluted earnings per common share from discontinued operations
 
 $            -
 
 $      0.88
 
 $      0.13
 
 $      0.14
 
 $      0.14
Diluted earnings per common share
 
 $      0.44
 
 $      2.58
 
 $      2.12
 
 $      2.24
 
 $      2.21
Common book value per common share
 
 $    25.17
 
 $    24.91
 
 $    23.10
 
 $    17.81
 
 $    16.90
Less: goodwill and other tangible assets, net of tax benefit, per common share
 
 $    11.56
 
 $    11.43
 
 $    10.85
 
 $      4.66
 
 $      4.63
Tangible common book value per common share
 
 $    13.61
 
 $    13.48
 
 $    12.25
 
 $    13.15
 
 $    12.27
Weighted average common shares outstanding:
                   
Basic
 
 34,706,092
 
 35,919,900
 
 31,156,887
 
 28,480,909
 
 27,886,191
Diluted
 
 35,061,712
 
 36,439,561
 
 31,687,220
 
 28,895,042
 
 28,537,111
Dividend payout ratio
 
163.64%
 
27.59%
 
30.70%
 
24.63%
 
22.09%
Cash dividends per common share
 
 $      0.72
 
 $      0.72
 
 $      0.66
 
 $      0.56
 
 $      0.50

(1)
In 2006 we acquired First Oak Brook Bancshares, Inc.
(2)
In 2004 we acquired First SecurityFed Financial, Inc.

25

Selected Financial Data (continued):
   
As of or for the Year Ended December 31,
(Dollars in thousands)
 
2008
 
2007
 
2006
 
2005
 
2004
Balance Sheet Data:
                   
Cash and due from banks
 
 $  79,824
 
 $141,248
 
 $142,207
 
 $  82,751
 
 $  81,059
Investment securities
 
 1,400,376
 
 1,241,385
 
 1,628,348
 
 1,316,149
 
 1,256,526
Loans, gross
 
 6,228,563
 
 5,615,627
 
 4,971,494
 
 3,480,447
 
 3,180,820
Allowance for loan losses
 
 144,001
 
 65,103
 
 58,983
 
 42,290
 
 42,255
Assets held for sale
 
 -
 
 -
 
 393,608
 
 370,103
 
 320,190
Total assets
 
 8,819,763
 
 7,834,703
 
 7,978,298
 
 5,719,065
 
 5,253,975
Deposits
 
 6,495,571
 
 5,513,783
 
 5,580,553
 
 3,906,212
 
 3,698,540
Short-term and long-term borrowings
 
 960,085
 
 1,186,586
 
 934,384
 
 771,088
 
 633,616
Junior subordinated notes issued to capital trusts
 
 158,824
 
 159,016
 
 179,162
 
 123,526
 
 87,443
Liabilities held for sale
 
 -
 
 -
 
 361,008
 
 341,988
 
 293,110
Stockholders’ equity
 
 1,066,195
 
 862,369
 
 846,952
 
 506,986
 
 484,537
Plus: minority interest
 
 2,629
 
 -
 
 -
 
 -
 
 -
      Less: goodwill
 
 387,069
 
 379,047
 
 379,047
 
 125,010
 
 123,628
      Less: other intangible assets, net of tax benefit
 
 16,754
 
 16,479
 
 18,756
 
 8,186
 
 8,832
Tangible equity
 
 665,001
 
 466,843
 
 449,149
 
 373,790
 
 352,077
      Less: preferred stock
 
 193,025
 
 -
 
 -
 
 -
 
 -
Tangible common equity
 
 $471,976
 
 $466,843
 
 $449,149
 
 $373,790
 
 $352,077
Performance Ratios (continuing operations):
                   
Return on average assets
 
0.20%
 
0.78%
 
0.96%
 
1.10%
 
1.23%
Return on average common equity
 
1.74%
 
7.29%
 
10.06%
 
12.31%
 
13.55%
Net interest margin (1)
 
3.03%
 
3.20%
 
3.40%
 
3.62%
 
3.67%
Tax equivalent effect
 
0.13%
 
0.12%
 
0.11%
 
0.12%
 
0.10%
Net interest margin – fully tax equivalent basis (1)
 
3.16%
 
3.32%
 
3.51%
 
3.74%
 
3.77%
Efficiency ratio (2)
 
61.19%
 
63.90%
 
59.77%
 
56.53%
 
54.18%
Cash return on average tangible common equity (3)
 
3.65%
 
14.14%
 
16.03%
 
17.02%
 
18.26%
Loans to deposits
 
95.89%
 
101.85%
 
89.09%
 
89.10%
 
86.00%
Performance Ratios (total):
                   
Return on average assets
 
0.20%
 
1.19%
 
1.02%
 
1.17%
 
1.31%
Return on average common equity
 
1.74%
 
11.03%
 
10.70%
 
13.15%
 
14.50%
Net interest margin (1)
 
3.03%
 
3.22%
 
3.41%
 
3.63%
 
3.69%
Tax equivalent effect
 
0.13%
 
0.11%
 
0.11%
 
0.11%
 
0.10%
Net interest margin – fully tax equivalent basis (1)
 
3.16%
 
3.33%
 
3.52%
 
3.74%
 
3.79%
Efficiency ratio (2)
 
61.19%
 
55.90%
 
59.61%
 
56.47%
 
55.16%
Cash return on average tangible common equity (3)
 
3.65%
 
21.14%
 
17.04%
 
18.16%
 
19.53%
Loans to deposits
 
95.89%
 
101.85%
 
89.10%
 
89.16%
 
84.44%
Asset Quality Ratios:
                   
Non-performing loans to total loans (4)
 
2.34%
 
0.44%
 
0.43%
 
0.58%
 
0.71%
Non-performing assets to total assets (5)
 
1.71%
 
0.33%
 
0.31%
 
0.36%
 
0.44%
Allowance for loan losses to total loans
 
2.31%
 
1.16%
 
1.19%
 
1.22%
 
1.33%
Allowance for loan losses to non-performing loans (4)
 
98.67%
 
266.17%
 
274.75%
 
209.66%
 
187.21%
Net loan charge-offs to average loans
 
0.79%
 
0.25%
 
0.24%
 
0.24%
 
0.23%
Liquidity and Capital Ratios:
                   
Tier 1 capital to risk weighted assets
 
12.07%
 
9.75%
 
10.49%
 
11.70%
 
11.38%
Total capital to risk weighted assets
 
14.08%
 
11.58%
 
11.80%
 
12.91%
 
12.54%
Tier 1 capital to average assets
 
9.85%
 
8.18%
 
8.39%
 
9.08%
 
8.62%
Average equity to average assets
 
10.90%
 
10.76%
 
9.50%
 
8.93%
 
9.07%
Tangible equity to assets (6)
 
7.90%
 
6.28%
 
5.93%
 
6.69%
 
6.87%
Tangible common equity to assets (7)
 
5.61%
 
6.28%
 
5.93%
 
6.69%
 
6.87%
Other:
                   
Banking facilities
 
72
 
73
 
70
 
45
 
45
Full time equivalent employees (8)
 
1,342
 
1,282
 
1,380
 
1,123
 
1,030
 
(1)  
Net interest margin represents net interest income as a percentage of average interest earning assets.
(2)  
Equals total other expense divided by the sum of net interest income on a fully tax equivalent basis and total other income less net gains (losses) on securities available for sale.
(3)  
Net cash flow available to common stockholders (net income plus other intangibles amortization expense, net of tax benefit) / Average tangible common equity (average common equity less average goodwill and average other intangibles, net of tax benefit).
(4)  
Non-performing loans include loans accounted for on a non-accrual basis, accruing loans contractually past due 90 days or more as to interest or principal and loans the terms of which have been renegotiated to provide reduction or deferral of interest or principal because of a deterioration in the financial position of the borrower.
(5)  
Non-performing assets include non-performing loans, other real estate owned and other repossessed assets.
(6)  
Equals total ending shareholders’ equity plus minority interest less goodwill and other intangibles, net of tax benefit, divided by total assets less goodwill and other intangibles, net of tax benefit.
(7)  
Equals total ending shareholders’ equity plus minority interest less preferred stock, goodwill and other intangibles, net of tax benefit, divided by total assets less goodwill and other intangibles, net of tax benefit.
(8)  
Includes Union Bank employees.

26


Selected Financial Data (continued):
 
The following table presents a reconciliation of cash return on average common tangible equity (in thousands):
   
2008
2007
2006
2005
2004
Net Income available to common shareholders from continuing
           
operations - as reported
 
 $  15,375
 $  62,025
 $  63,056
 $  60,645
 $  58,978
Plus:  Intangible amortization, net of tax benefit
 
 2,310
 2,278
 1,281
 645
 660
Net cash flow available to common shareholders from continuing operations
 
 $  17,685
 $  64,303
 $  64,337
 $  61,290
 $  59,638
             
Net Income available to common shareholders
 
 $  15,375
 $  93,863
 $  67,114
 $  64,754
 $  63,128
Plus:  Intangible amortization, net of tax benefit
 
 2,310
 2,278
 1,281
 645
 660
Net cash flow available to common  shareholders
 
 $  17,685
 $  96,141
 $  68,395
 $  65,399
 $  63,788
             
Average common stockholder’s equity
 
 $884,032
 $851,324
 $627,069
 $492,513
 $435,419
    Plus:  Average minority interest
 
 1,516
 -
 -
 -
 -
    Less:  Average goodwill
 
 383,737
 379,047
 213,874
 123,879
 101,314
    Less:  Average other intangible assets net of tax benefit
 
 16,788
 17,524
 11,901
 8,496
 7,453
Average tangible common equity
 
 $485,023
 $454,753
 $401,294
 $360,138
 $326,652
 
The following table sets forth our selected quarterly financial data (in thousands, except common share data):
 
Three Months Ended 2008
Three Months Ended 2007
Statement of Income Data:
December
September
June
March
December
September
June
March
Interest income
$101,535
$103,061
$101,390
$107,802
$114,829
$117,172
$113,397
$111,868
Interest expense
46,789
46,455
45,317
54,339
60,857
63,089
61,043
59,971
                 
Net interest income
54,746
56,606
56,073
53,463
53,972
54,083
52,354
51,897
Provision for loan losses
72,581
18,400
12,200
22,540
8,000
4,500
3,000
3,813
                 
Net interest income (loss) after provision for loan losses
(17,835)
38,206
43,873
30,923
45,972
49,583
49,354
48,084
                 
Other income
21,937
26,425
25,567
24,537
22,981
23,259
30,720
22,944
Other expenses
48,271
52,166
52,126
48,224
59,130
48,827
52,073
46,806
Income (loss) before income taxes
(44,169)
12,465
17,314
7,236
9,823
24,015
28,001
24,222
Income tax expense (benefit)
(19,348)
(689)
(4,693)
1,412
1,890
6,709
8,394
7,043
Income (loss) from continuing operations
(24,821)
13,154
22,007
5,824
7,933
17,306
19,607
17,179
Discontinued operations
               
Income from discontinued operations before income taxes
-
-
-
-
45,744
1,499
1,803
1,429
Income taxes
-
-
-
-
17,281
500
369
487
Income from discontinued operations
-
-
-
-
28,463
999
1,434
942
Net income (loss)
$(24,821)
$  13,154
$  22,007
$    5,824
$  36,396
$  18,305
$  21,041
$  18,121
Dividends on preferred shares
789
-
-
-
-
-
-
-
Net income (loss) available to common shareholders
$(25,610)
$  13,154
$  22,007
$    5,824
$  36,396
$  18,305
$  21,041
$  18,121
                 
Net Interest Margin
2.86%
3.04%
3.11%
3.10%
3.16%
3.22%
3.20%
3.21%
Tax equivalent effect
0.14%
0.14%
0.14%
0.12%
0.12%
0.12%
0.11%
0.12%
Net interest margin on a fully tax equivalent basis
3.00%
3.18%
3.25%
3.22%
3.28%
3.34%
3.31%
3.33%
                 
Common Share Data :
               
Basic earnings (loss) per common share from continuing operations
$    (0.74)
$      0.38
$      0.63
$      0.17
$      0.23
$      0.48
$      0.54
$      0.47
Basic earnings per common share from discontinued operations
$             -
$            -
$            -
$            -
$      0.81
$      0.03
$      0.04
$      0.02
Basic earnings (loss) per common share
$    (0.74)
$      0.38
$      0.63
$      0.17
$      1.04
$      0.51
$      0.58
$      0.49
Diluted earnings (loss) per common share from continuing operations
$    (0.74)
$      0.38
$      0.63
$      0.17
$      0.22
$      0.48
$      0.53
$      0.46
Diluted earnings per common share from discontinued operations
$             -
$            -
$            -
$            -
$      0.80
$      0.03
$      0.04
$      0.03
Diluted earnings (loss) per common share
$    (0.74)
$      0.38
$      0.63
$      0.17
$      1.02
$      0.51
$      0.57
$      0.49
Weighted average common shares outstanding
34,777,651
34,732,633
34,692,571
34,620,435
35,095,301
35,733,165
36,239,731
36,630,323
Diluted weighted average common shares outstanding
35,164,585
35,074,297
35,047,596
34,994,731
35,536,449
36,213,532
36,744,473
37,180,928
 
Fourth Quarter Results
 
We had a net loss from continuing operations available to common shareholders of $25.6 million for the fourth quarter of 2008, compared to net income from continuing operations available to common shareholders of $7.9 million for the fourth quarter of 2007.  The results for the fourth quarter of 2008 generated an annualized return on average assets of (1.15%), an annualized return on average common equity of (11.38%) and an annualized cash return on average tangible common equity of (20.14%), compared to 0.40%, 3.68% and 7.32%, respectively, for the same period in 2007.
 
27

 
Net interest income remained stable in the fourth quarter of 2008 compared to the fourth quarter of 2007.  Our average interest earning assets increased by $837.6 million from the fourth quarter of 2007 to the fourth quarter of 2008.  The increase in average interest earning assets was offset by a 28 basis point decrease in our net interest margin, on a fully tax equivalent basis.  Average interest bearing assets increased primarily due to organic growth.  There were three primary reasons for the decline in our net interest margin.  First, much of the decline in the margin was due to the timing of asset and liability repricing.  Our interest earning assets tend to reprice faster than our interest bearing liabilities.  There was a dramatic decrease in Fed funds and LIBOR rates during the fourth quarter of 2008.  As a result, our overall loan yields declined significantly more than our funding costs during the fourth quarter of 2008, as it typically takes more time for our funding liabilities to adjust.  Second, we experienced very strong core funding growth, and as a result of this growth along with the receipt of $196.0 million from the issuance of preferred securities pursuant to the TARP Capital Purchase Program, we built significant excess liquidity during the fourth quarter of 2008.  Third, our non-performing loans increased from $24.5 million at December 31, 2007 to $145.9 million at December 31, 2008.  See “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Asset Quality” in Item 7 below for further analysis of non-performing loans.
 
The provision for loan losses was $72.6 million in the fourth quarter of 2008 and $8.0 million in the fourth quarter of 2007.   The increase in our provision from 2007 to 2008 was primarily due to increases in non-performing and potential problem loans as a result of declining real estate values and the continued deterioration in economic conditions.  Net charge-offs were $17.4 million in the quarter ended December 31, 2008 compared to $4.0 million in the quarter ended December 31, 2007.  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 $21.9 million for the quarter ended December 31, 2008, a decrease of $1.0 million, or 4.5% compared to $23.0 million for the quarter ended December 31, 2007.  Deposit service fees increased from $6.6 million in the fourth quarter of 2007 to $7.5 million in the fourth quarter of 2008, primarily due to an increase in commercial deposit and treasury management fees during 2008, as a result of a lower earnings credit rate.  Trust and asset management fees increased from $2.1 million in fourth quarter of 2007 to $2.8 million in the fourth quarter of 2008, primarily due to our Cedar Hill acquisition during the second quarter of 2008.  Net gains recognized on securities sold totaled $24 thousand in the fourth quarter of 2008, compared to a net loss of $1.5 million on securities sold for the quarter ended December 31, 2007.  These increases were offset by decreases in brokerage fees, net gain on sale of assets, and other operating income of $878 thousand, $1.6 million, and $1.2 million, respectively.  Brokerage fees decreased primarily due to a $447 thousand gain on the sale of our third party brokerage business recognized in the fourth quarter of 2007, and lower sales activity during the fourth quarter of 2008 compared to the fourth quarter of 2007.  Net losses recognized on assets sold totaled $874 thousand in the fourth quarter of 2008, compared to net gains recognized of $723 thousand during the same period in 2007.  Other operating income decreased primarily due to a decrease in market value of assets held in trust for deferred compensation.
 
Other expense decreased $10.9 million or 18.4% to $48.3 million for the quarter ended December 31, 2008 from $59.1 million for the quarter ended December 31, 2007.  Salaries and employee benefits expense decreased by $8.4 million, primarily due to an executive separation agreement expense of $5.9 million incurred in the fourth quarter of 2007, and a decrease in employee bonus expense during the fourth quarter of 2008.  Professional and legal expense decreased by $1.7 million, primarily due to $1.9 million of unamortized issuance costs recognized in the fourth quarter of 2007, as a result of the redemption of trust preferred securities in October 2007.  Charitable contributions decreased $1.5 million, due to a $1.5 million contribution made in the fourth quarter of 2007 to the MB Financial Charitable Foundation, which is dedicated to strengthening the communities where MB Financial Bank operates.  Other operating expenses increased by $1.1 million, primarily due to an increase in FDIC insurance premiums, as our FDIC credits were fully utilized during the fourth quarter of 2008.
 
Income tax benefit from continuing operations for the three months ended December 31, 2008 was $19.3 million, compared to income tax expense from continuing operations of $1.9 million for the three months ended December 31, 2007.  See Note 16 of notes to consolidated financial statements contained in Item 8 of this report for further analysis of income taxes.
 
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 from continuing operations available to common shareholders of $15.4 million for the year ended December 31, 2008 compared to $62.0 million for the year ended December 31, 2007.  Fully diluted earnings per share from continuing operations available to common shareholders for 2008 were $0.44 compared to $1.70 per share in 2007.
 
28

 
The profitability of our operations depends primarily on our net interest income after provision for loan losses, which is the difference between interest earned on interest earning assets and interest paid on interest bearing liabilities less provision for loan losses.  The provision for loan losses is dependent on changes in our loan portfolio and management’s assessment of the collectability of our loan portfolio as well as prevailing economic and market conditions.  Additionally, our net income is affected by other income and other expenses.  The provision for loan losses reflects the amount, when added to the existing balance of the allowance for loan losses, that we believe is adequate to cover potential credit losses in our loan portfolio.  Non-interest income or other income consists of loan service fees, deposit service fees, net lease financing income, brokerage fees, asset management and trust fees, net gains on the sale of investment securities available for sale, increase in cash surrender value of life insurance, net gains on sale of other assets, merchant card processing fees and other operating income.  Other expenses include salaries and employee benefits, occupancy and equipment expense, computer services expense, advertising and marketing expense, professional and legal expense, brokerage fee expense, telecommunication expense, other intangibles amortization expense, merchant card processing expense, charitable contributions, and other operating expenses.  Additionally, dividends on preferred shares reduce net income available to common shareholders.
 
Net interest income is affected by changes in the volume and mix of interest earning assets, interest earned on those assets, the volume and mix of interest bearing liabilities and interest paid on interest bearing liabilities.  Other income and other expenses are impacted by growth of operations and growth in the number of loan and deposit accounts through both acquisitions and core banking business growth.  Growth in operations affects other expenses primarily as a result of additional employees, branch facilities and promotional marketing expense.  Growth in the number of loan and deposit accounts affects other income, including service fees as well as other expenses such as computer services, supplies, postage, telecommunications and other miscellaneous expenses.
 
As noted under “Item 6. Selected Financial Data," on November 28, 2007, we completed the sale of our Oklahoma City-based subsidiary bank, Union Bank for $76.3 million, resulting in an after-tax gain of $28.8 million.  Prior to closing, Union Bank sold to MB Financial Bank approximately $100 million in performing loans previously purchased from and originated by MB Financial Bank.
 
For purposes of the following discussion, balances, average rate, income and expenses associated with Union Bank, including the gain recognized on the sale, have been excluded from continuing operations.  See Note 3 of the notes to our consolidated financial statements for additional information on discontinued operations.
 
Recent Market Developments
 
In response to the financial crises affecting the banking system and financial markets and going concern threats to investment banks and other financial institutions, on October 3, 2008, the Emergency Economic Stabilization Act of 2008 (the “EESA”) was signed into law. Pursuant to the EESA, the U.S. Treasury was given the authority to, among other things, purchase up to $700 billion of mortgages, mortgage-backed securities and certain other financial instruments from financial institutions for the purpose of stabilizing and providing liquidity to the U.S. financial markets.
 
On October 14, 2008, the Secretary of the Department of the Treasury announced that the Department of the Treasury would purchase equity stakes in a wide variety of banks and thrifts. Under the program, known as the Troubled Asset Relief Program Capital Purchase Program (the “TARP Capital Purchase Program”), from the $700 billion authorized by the EESA, the Treasury made $250 billion of capital available to U.S. financial institutions in the form of preferred stock. In conjunction with the purchase of preferred stock, the Treasury received, from participating financial institutions, warrants to purchase common stock with an aggregate market price equal to 15% of the preferred investment. Participating financial institutions were required to adopt the Treasury’s standards for executive compensation and corporate governance for the period during which the Treasury holds equity issued under the TARP Capital Purchase Program.  On December 5, 2008, we received $196.0 million from the issuance of preferred stock and stock warrants to the Treasury pursuant to the TARP Capital Purchase Program.
 
On November 21, 2008, the Board of Directors of the FDIC adopted a final rule relating to the Temporary Liquidity Guarantee Program (“TLG Program”). The TLG Program was announced by the FDIC on October 14, 2008, preceded by the determination of systemic risk by the Secretary of the Department of Treasury (after consultation with the President), as an initiative to counter the system-wide crisis in the nation’s financial sector. Under the TLG Program the FDIC will (i) guarantee, through the earlier of maturity or June 30, 2012, certain
 
29

 
newly issued senior unsecured debt issued by participating institutions on or after October 14, 2008, and before June 30, 2009 and (ii) provide full FDIC deposit insurance coverage for non-interest bearing transaction deposit accounts, Negotiable Order of Withdrawal (“NOW”) accounts paying less than 0.5% interest per annum and Interest on Lawyers Trust Accounts held at participating FDIC insured institutions through December 31, 2009. Coverage under the TLG Program was available for the first 30 days without charge. The fee assessment for coverage of senior unsecured debt ranges from 50 basis points to 100 basis points per annum, depending on the initial maturity of the debt. The fee assessment for the Transaction Account Guarantee Program is 10 basis points per quarter on amounts in covered accounts exceeding $250,000.  On December 5, 2008, the Company elected not to opt-out of either guarantee program.  As of December 31, 2008, the Company did not have any debt issued under the TLG Program.  The FDIC has announced that for an additional premium, it will extend the TLG Program through October 2009, but no regulations have been published in proposed or final form.
 
Overall, during 2008, the business environment has been adverse for many households and businesses in the United States, including the Chicago metropolitan area, and worldwide.  It is expected that the business environment in the Chicago metropolitan area, the United States and worldwide will continue to deteriorate for the foreseeable future. There can be no assurance that these conditions will improve in the near term. These conditions could adversely affect the Company’s asset quality, results of operations and financial condition.
 
At December 31, 2008, the Company’s market capitalization (based on total shares outstanding) was greater than our total common stockholders’ equity of $876.6 million.  However, as of February 27, 2009, our market capitalization was less than our stockholders’ common equity.  Should this situation continue to exist during 2009, the Company will consider this and other factors, including the Company’s anticipated future cash flows, to determine whether goodwill is impaired.  No assurance can be given that the Company will not record an impairment loss on goodwill in 2009.  Because goodwill is not included in the calculation of regulatory capital, the Company’s regulatory capital ratios would not be affected by this potential non-cash expense.

Critical Accounting Policies
 
Our consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of America and follow general practices within the industries in which we operate.  This preparation requires management to make estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes.  These estimates, assumptions, and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, actual results could differ from the estimates, assumptions, and judgments reflected in the financial statements.  Certain policies inherently have a greater reliance on the use of estimates, assumptions, and judgments and, as such, have a greater possibility of producing results that could be materially different than originally reported.  Management believes the following policies are both important to the portrayal of our financial condition and results of operations and require subjective or complex judgments; therefore, management considers the following to be critical accounting policies.  Management has reviewed the application of these polices with the Audit Committee of our board of directors.
 
Allowance for Loan Losses.  Subject to the use of estimates, assumptions, and judgments is management's evaluation process used to determine the adequacy of the allowance for loan losses, which combines several factors: management's ongoing review and grading of the loan portfolio, consideration of past loan loss experience, trends in past due and nonperforming loans, risk characteristics of the various classifications of loans, existing economic conditions, the fair value of underlying collateral, and other qualitative and quantitative factors which could affect probable credit losses.  Because current economic conditions can change and future events are inherently difficult to predict, the anticipated amount of estimated loan losses, and therefore the adequacy of the allowance, could change significantly.  As an integral part of their examination process, various regulatory agencies also review the allowance for loan losses.  Such agencies may require that certain loan balances be charged off when their credit evaluations differ from those of management or require that adjustments be made to the allowance for loan losses, based on their judgments about information available to them at the time of their examination.  We believe the allowance for loan losses is adequate and properly recorded in the financial statements.  See "Allowance for Loan Losses" section below for further analysis.
 
Residual Value of Our Direct Finance, Leveraged, and Operating Leases. Lease residual value represents the present value of the estimated fair value of the leased equipment at the termination date of the lease.  Realization of these residual values depends on many factors, including management’s use of estimates, assumptions, and judgment to determine such values.  Several other factors outside of management’s control may reduce the residual values realized, including general market conditions at the time of expiration of the lease, whether there has been technological or economic obsolescence or unusual wear and tear on, or use of, the equipment and the cost of comparable equipment.  If, upon the expiration of
 
30

 
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, 2008, the aggregate residual value of the equipment leased under our direct finance, leveraged, and operating leases totaled $46.4 million.  See Note 1 and Note 7 of our audited consolidated financial statements for additional information.
 
Income Tax Accounting. In June 2006, the FASB issued FASB interpretation No. 48, "Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109" (FIN 48). FIN 48 clarifies the accounting for income taxes by prescribing the minimum recognition threshold that a tax position must meet to be recognized in the financial statements.  FIN 48 also provides guidance on measurement, recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.  The Company adopted FIN 48 as of January 1, 2007.  As a result of the implementation of FIN 48, the Company recognized no material adjustment in the liability for uncertain income tax positions.  During the year ended December 31, 2008, the Company increased the reserve for uncertain tax positions, which was more than offset by a reduction in the valuation allowances on state net operating loss carryforwards, resulting in a reduction of tax expense of $5.9 million.  The Company reassessed the likelihood of the state net operating losses being more likely than not utilized as a result of prospective tax law changes.  The potential future usage of these net operating losses also had a direct impact on the amount of state tax contingency reserves.  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 FIN 48 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, 2008, the Company had $964 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.  On January 1, 2008, the Company adopted SFAS 157 which defines fair value as the price that would be received to sell the financial asset or paid to transfer the financial liability in an orderly transaction between market participants at the measurement date.

The degree of management judgment involved in determining the fair value of assets and liabilities is dependent upon the availability of quoted market prices or observable market parameters.  For financial instruments that trade actively and have quoted market prices or observable market parameters, there is minimal subjectivity involved in measuring fair value.  When observable market prices and parameters are not fully available, management judgment is necessary to estimate fair value.  In addition, changes in market conditions may reduce the availability of quoted prices or observable data.  For example, reduced liquidity in the capital markets or changes in secondary market activities could result in observable market inputs becoming unavailable.  Therefore, when market data is not available, the Company would use valuation techniques requiring more management judgment to estimate the appropriate fair value measurement.

At December 31, 2008, $1.3 billion of investment securities, or 15.1 percent of total assets, were recorded at fair value on a recurring basis.  All but one of these financial instruments used valuation methodologies involving market-based or market-derived information, collectively Level 1 and 2 measurements, to measure fair value.  One investment security with a fair value of $1.6 million at December 31, 2008, used significant unobservable inputs that are supported by little or no market activity (Level 3) to measure fair value.  At December 31, 2008, $24.2 million, or less than one percent of total liabilities, consisted of financial instruments recorded at fair value on a recurring basis.

At December 31, 2008, $91.3 million of impaired loans, or one percent of total assets, were recorded at fair value on a nonrecurring basis.  These assets were measured using Level 3 measurements.  At December 31, 2008, no liabilities were measured at fair value on a nonrecurring basis.
 
See Note 19 to the consolidated financial statements for a complete discussion on the Company’s use of fair valuation of assets and liabilities and the related measurement techniques.
 
31

 
Recent Accounting Pronouncements. Refer to Note 1 of our consolidated financial statements for a description of recent accounting pronouncements including the respective dates of adoption and effects on results of operations and financial condition.
 
Net Interest Income
 
The following table presents, for the periods indicated, the total dollar amount of interest income from average interest earning assets and the related yields, as well as the interest expense on average interest bearing liabilities, and the related costs, expressed both in dollars and rates (dollars in thousands).  The table below and the discussion that follows contain presentations of net interest income and net interest margin on a tax-equivalent basis, which is adjusted for the tax-favored status of income from certain loans and investments.  Net interest margin also is presented on a tax-equivalent basis in “Item 6. Selected Financial Data.”  We believe this measure to be the preferred industry measurement of net interest income, as it provides a relevant comparison between taxable and non-taxable amounts.
 
Reconciliations of net interest income and net interest margin on a tax-equivalent basis to net interest income and net interest margin in accordance with accounting principles generally accepted in the United States of America are provided in the table.
 
 
Year Ended December 31,
 
2008
 
2007
 
2006
 
Average
 
Yield/
 
Average
 
Yield/
 
Average
 
Yield/
 
Balance
Interest
Rate
 
Balance
Interest
Rate
 
Balance
Interest
Rate
Interest Earning Assets:
                     
Loans (1) (2)
$5,892,845
$354,210
6.01%
 
$5,198,249
$392,526
7.55%
 
$4,082,920
$309,951
7.59%
Loans exempt from federal income taxes (3)
59,746
4,408
7.26
 
9,338
754
7.96
 
5,027
373
7.32
Taxable investment securities
868,700
40,468
4.66
 
1,037,129
49,675
4.79
 
1,115,585
51,836
4.65
Investment securities exempt from federal income taxes (3)
414,234
23,849
5.66
 
374,025
21,326
5.62
 
305,930
17,316
5.58
Federal funds sold
12,849
276
2.11
 
8,853
449
5.00
 
15,148
774
5.04
Other interest bearing deposits
52,497
467
0.89
 
7,193
264
3.67
 
7,952
312
3.92
     Total interest earning assets
7,300,871
$423,678
5.80
 
6,634,787
$464,994
7.01
 
5,532,562
$380,562
6.88
Assets available for sale
-
     
341,734
     
393,003
   
Non-interest earning assets
939,473
     
934,089
     
676,505
   
     Total assets
$8,240,344
     
$7,910,610
     
$6,602,070
   
                       
Interest Bearing Liabilities:
                     
Deposits:
                     
  NOW and money market deposit
$1,292,407
$  23,176
1.79%
 
$1,213,001
$  37,568
3.10%
 
$   778,795
$  18,475
2.37%
  Savings deposit
383,534
1,239
0.32
 
428,087
3,051
0.71
 
457,723
3,334
0.73
  Time deposits
3,426,332
126,955
3.71
 
2,986,964
145,030
4.86
 
2,674,892
119,299
4.46
Short-term borrowings
681,074
17,590
2.58
 
812,681
37,354
4.60
 
631,892
27,944
4.42
Long-term borrowings and  junior subordinated notes
581,026
23,940
4.05
 
364,441
21,957
5.94
 
293,310
17,140
5.76
     Total interest bearing liabilities
6,364,373
$192,900
3.03
 
5,805,174
$244,960
4.22
 
4,836,612
$186,192
3.85
Non-interest bearing deposits
891,072
     
860,557
     
708,100
   
Liabilities held for sale
-
     
313,414
     
365,380
   
Other non-interest bearing liabilities
86,884
     
80,141
     
64,909
   
Stockholders’ equity
898,015
     
851,324
     
627,069
   
     Total liabilities and stockholders’ equity
$8,240,344
     
$7,910,610
     
$6,602,070
   
     Net interest income/interest rate spread (4)
 
$230,778
2.77%
   
$220,034
2.79%
   
$194,370
3.03%
     Taxable equivalent adjustment
 
(9,890)
     
7,728
     
6,191
 
     Net interest income, as reported
 
$220,888
     
$212,306
     
$188,179
 
     Net interest margin  (5)
   
3.03%
     
3.20%
     
3.40%
     Tax equivalent effect
   
0.13%
     
0.12%
     
0.11%
     Net interest margin on a fully tax equivalent basis (5)
   
3.16%
     
3.32%
     
3.51%

(1)  
Non-accrual loans are included in average loans.
(2)  
Interest income includes loan origination fees of $7.0 million, $6.7 million and $6.9 million for the years ended December 31, 2008, 2007 and 2006, respectively.
(3)  
Non-taxable loan and investment income is presented on a fully tax equivalent basis assuming a 35% tax rate.
(4)  
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.
(5)  
Net interest margin represents net interest income as a percentage of average interest earning assets.
 
Net interest income on a tax equivalent basis was $230.8 million for the year ended December 31, 2008, an increase of $10.7 million, or 4.9% from $220.0 million for the comparable period in 2007.  The growth in net interest income reflects a $666.1 million, or 10.0%, increase in average interest earning assets, and a $559.2 million, or 9.6%, increase in average interest bearing liabilities.  This was partially offset by approximately 16 basis points of margin compression on a fully tax equivalent basis.  The increase in average interest earning assets and the increase in average interest bearing liabilities was due to organic growth.  The net interest margin, expressed on a fully tax equivalent basis, was 3.16% for 2008 and 3.32% for
 
32

 
2007.  The decline in the net interest margin was primarily due to an increase in non-performing loans during 2008, and our interest earning assets repricing faster than our interest bearing liabilities during 2008 due to the dramatic decrease in Fed funds and LIBOR rates during the second half of 2008.
 
Net interest income on a tax equivalent basis increased $25.7 million, or 13.2%, to $220.0 million for the year ended December 31, 2007 from $194.4 million for the year ended December 31, 2006.  Tax-equivalent interest income increased by $84.4 million, primarily due to a $1.1 billion, or 19.9%, increase in average interest earning assets.  The yield on average interest earning assets increased 13 basis points to 7.01%.  The increase in average interest earning assets was primarily due to the acquisition of FOBB in the third quarter of 2006, and organic growth.  Interest expense increased by $58.8 million due to a $968.6 million, or 20.0%, increase in average interest bearing liabilities.  The increase in average interest bearing liabilities was primarily due to the acquisition of FOBB and organic growth.  The rate on average interest bearing liabilities increased 37 basis points to 4.22% due to the increase in overall short-term interest rates and the acquisition of FOBB.  The net interest margin expressed on a fully tax equivalent basis for the year ended December 31, 2007, decreased by 19 basis points from 3.51% for the year ended December 31, 2006, due to the acquisition of FOBB, the inverted yield curve, continued tight credit spreads on loans and fierce competition for deposits.
 
Volume and Rate Analysis of Net Interest Income
 
The following table presents the extent to which changes in volume and interest rates of interest earning assets and interest bearing liabilities have affected our interest income and interest expense during the periods indicated.  Information is provided in each category with respect to (i) changes attributable to changes in volume (changes in volume multiplied by prior period rate), (ii) changes attributable to changes in rates (changes in rates multiplied by prior period volume) and (iii) change attributable to a combination of changes in rate and volume (change in rates multiplied by the changes in volume) (in thousands).  Changes attributable to the combined impact of volume and rate have been allocated proportionately to the changes due to volume and the changes due to rate.
 
   
Year Ended December 31,
   
2008 Compared to 2007
 
2007 Compared to 2006
   
Change
 
Change
     
Change
 
Change
   
   
Due to
 
Due to
 
Total
 
Due to
 
Due to
 
Total
   
Volume
 
Rate
 
Change
 
Volume
 
Rate
 
Change
Interest Earning Assets:
                       
Loans
 
 $47,821
 
 $(86,137)
 
 $(38,316)
 
 $84,217
 
 $  (1,642)
 
 $82,575
Loans exempt from federal income taxes (1)
 
 3,725
 
 (71)
 
 3,654
 
 345
 
 36
 
 381
Taxable investment securities
 
 (7,878)
 
 (1,329)
 
 (9,207)
 
 (3,724)
 
 1,563
 
 (2,161)
Investment securities exempt from federal income taxes (1)
 
 2,313
 
 210
 
 2,523
 
 3,882
 
 128
 
 4,010
Federal funds sold
 
 152
 
 (325)
 
 (173)
 
 (319)
 
 (6)
 
 (325)
Other interest bearing deposits
 
 538
 
 (335)
 
 203
 
 (29)
 
 (19)
 
 (48)
Total increase in interest income
 
 46,671
 
 (87,987)
 
 (41,316)
 
 84,372
 
 60
 
 84,432
                         
Interest Bearing Liabilities:
                       
Deposits
                       
   NOW and money market deposit accounts
 
 2,320
 
 (16,712)
 
 (14,392)
 
 12,334
 
 6,759
 
 19,093
   Savings deposits
 
 (290)
 
 (1,522)
 
 (1,812)
 
 (212)
 
 (71)
 
 (283)
   Time deposits
 
 19,397
 
 (37,472)
 
 (18,075)
 
 14,619
 
 11,112
 
 25,731
Short-term borrowings
 
 (5,334)
 
 (14,430)
 
 (19,764)
 
 8,272
 
 1,138
 
 9,410
Long-term borrowings and junior subordinated notes
 
 10,356
 
 (8,373)
 
 1,983
 
 4,271
 
 546
 
 4,817
Total increase in interest expense
 
 26,449
 
 (78,509)
 
 (52,060)
 
 39,284
 
 19,484
 
 58,768
Total increase (decrease) in net interest income
 
 $20,222
 
 $  (9,478)
 
 $   10,744
 
 $45,088
 
 $(19,424)
 
 $25,664

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

Other Income

Other income did not change significantly from the year ended December 31, 2007 to the year ended December 31, 2008.  Net gain on sale of other assets decreased by $11.2 million.  During the year ended December 31, 2007, we realized a gain of $2.4 million on the sale of artwork that was acquired as a result of our acquisition of FOBB and a gain of $7.4 million on the sale of two real estate properties.  Brokerage fees decreased by $5.3 million, primarily due to the sale of our third party brokerage business during the second quarter of 2007, and conversion of customer accounts to the purchaser’s platform in third quarter.  This decrease was offset by a corresponding reduction in brokerage expense.  These decreases were partially offset by a $1.1 million gain on the sale investment securities during the year ended December 31, 2008, compared to a $3.7 million loss on the sale of investment securities
 
33

 
for the comparable period in 2007.  Deposit service fees increased by $4.3 million, primarily due to an increase in commercial deposit and treasury management fees as a result of a lower earnings credit rate.  Loan service fees increased $2.9 million, primarily due to an increase in letter of credit fees, prepayment fees and swap fees recognized during 2008 compared to 2007.  Other income decreased primarily due to a decrease in market value of assets held in trust for deferred compensation and was offset by the same amount recorded as other expense.
 
Other income increased $28.6 million, or 40.1% to $99.9 million for the year ended December 31, 2007 from $71.3 million for the year ended December 31, 2006.  Merchant card processing income increased by $9.5 million mostly due to the acquisition of FOBB and an increase in transactions processed during the year ended December 31, 2007 compared to the same period in 2006.  Net gain on sale of other assets increased by $9.2 million.  During the year ended December 31, 2007, we also sold two properties for a total gain of $7.4 million.  Also, during the year ended December 31, 2007, we realized a gain of $2.4 million on the sale of artwork that was acquired as a result of our acquisition of FOBB.  Deposit service fees increased $4.5 million, primarily due to the acquisition of FOBB, enhancements made to our courtesy overdraft program, and a fee increase that was implemented during the second quarter of 2007.  Asset management and trust fees increased $3.5 million, primarily due to the acquisition of FOBB, a $909 thousand gain realized on the sale of our land trust operations during the first quarter of 2007, an increase in fees generated from new customers, and expansion of our existing customer relationships during the year ended December 31, 2007 compared to the same period in 2006.  Net lease financing increased $2.5 million, primarily due to higher residual realizations during the year ended December 31, 2007 compared to the year ended December 31, 2006.  During the year ended December 31, 2007, we sold approximately $563.9 million in investment securities that resulted in a net loss of $3.7 million.  The proceeds were redeployed to fund loan growth, and new investment purchases.  During the second quarter of 2007 we sold our third party brokerage business.  We recognized a $947 thousand gain on the sale.
 
Other Expenses
 
Other expense for the year ended December 31, 2008, decreased $6.0 million, or 2.9%, to $200.8 million, compared to $206.8 million for the year ended December 31, 2007.  Salaries and employee benefits expense decreased $1.9 million, primarily due to an executive separation agreement expense incurred in 2007, partially offset by the additional commercial bankers hired from the end of the third quarter of 2007 through the second quarter of 2008 and the acquisition of Cedar Hill.  Professional and legal expense decreased by $1.4 million, primarily due to $1.9 million of unamortized issuance costs recognized during 2007, as a result of the redemption of trust preferred securities in October 2007.  Charitable contributions decreased by $4.7 million, primarily due to contributions totaling $4.5 million made during 2007 to the MB Financial Charitable Foundation, which is dedicated to strengthening the communities where MB Financial Bank operates. Other operating expenses increased by $2.0 million, primarily due to an increase in FDIC insurance premiums, as our FDIC credits were fully utilized during 2008.  As noted earlier, the decrease in our brokerage fee expense from the year ended December 31, 2007 to the comparable period in 2008 was primarily due to the sale of our third party brokerage business during the second quarter of 2007.
 
Other expense increased by $47.8 million, or 30.0% to $206.8 million for the year ended December 31, 2007 from $159.1 million for the year ended December 31, 2006.  Salaries and employee benefits increased by $22.5 million primarily due to the acquisition of FOBB and organic growth, and partially due to an executive separation agreement expense incurred in 2007.  Merchant card processing expense increased by $8.6 million due to the acquisition of FOBB and an increase in transactions processed during the year ended December 31, 2007, compared to the same period in 2006.  Charitable contributions increased by $4.0 million primarily due to contributions totaling $4.5 million made during 2007 to the MB Financial Charitable Foundation, which is dedicated to strengthening the communities where MB Financial Bank operates.  Occupancy and equipment expense increased by $4.5 million, primarily due to the acquisition of FOBB and organic growth.  On October 2, 2007, we redeemed $61.7 million of trust preferred securities with a fixed coupon rate of 8.60%.  As a result of redeeming these securities, we recorded $1.9 million of unamortized issuance costs that was recorded as professional and legal expense.
 
Income Taxes
 
Income tax benefit from continuing operations for the year ended December 31, 2008 was $23.3 million, compared to income tax expense from continuing operations of $24.0 million for the year ended December 31, 2007, primarily due to a decrease in taxable income and a reduction in the valuation allowances on state net operating loss carryforwards during 2008.  During the fourth quarter of 2008, our taxable income significantly decreased compared to prior quarters in 2008, primarily due to our results of operations in the fourth quarter.
 
Income tax expense for the year ended December 31, 2007 decreased $3.2 million to $24.0 million compared to $27.3 million for the same period in 2006.  The effective tax rates
 
34

 
were 27.9% and 30.2% for the years ended December 31, 2007 and 2006, respectively.  The decline in the effective tax rate was primarily due to a higher percentage of pre-tax income generated from tax exempt sources for the year ended December 31, 2007, compared to the same time period in 2006.
 
As previously stated in the “Critical Accounting Policies” section above, income tax expense recorded in the consolidated income statement involves interpretation and application of certain accounting pronouncements and federal and state tax codes, and is, therefore, considered a critical accounting policy.  See Note 1 and Note 16 of the notes to our audited consolidated financial statements for our income tax accounting policy and additional income tax information.
 
Balance Sheet
 
Total assets increased $985.1 million or 12.6% to $8.8 billion at December 31, 2008 from December 31, 2007.  Net loans increased by $534.0 million or 9.6%, to $6.1 billion at December 31, 2008 from December 31, 2007.  In aggregate, commercial related credits grew by $587.3 million, or 13.0%.  See “Loan Portfolio” section below for further analysis.  Investment securities increased $159.0 million or 12.8%, to $1.4 billion at December 31, 2008 from December 31, 2007.  In 2008, we securitized $50.9 million of residential real estate loans and held those securities in our investment portfolio.  As noted earlier, we built significant excess liquidity during the second half of 2008.  As a result, our interest bearing deposits with banks increased by $252.7 million from December 31, 2007 to December 31, 2008.
 
Total liabilities increased by $778.6 million or 11.2% to $7.8 billion at December 31, 2008 from December 31, 2007.  Total deposits increased by $981.8 million or 17.8% to $6.5 billion at December 31, 2008 from December 31, 2007, primarily due to increases in certificates of deposit, brokered deposit accounts, and money market and NOW accounts of $410.8 million, $386.3 million, and $202.4 million, respectively.  Short-term borrowings decreased $489.1 million.  This decrease was primarily due to decreases in short-term Federal Home Loan Bank advances and federal funds purchased of $339.2 million and $165.0 million, respectively.  Long-term borrowings increased $262.6 million, primarily due to a $247.4 million increase in long-term Federal Home Loan Bank advances.
 
Total stockholders’ equity increased $203.8 million to $1.1 billion at December 31, 2008 compared to $862.4 million at December 31, 2007.  The increase was primarily due to a $192.9 million increase in preferred stock, net of discount, due to the issuance of preferred stock pursuant to the TARP Capital Purchase Program during 2008.
 
Investment Securities
 
The primary purpose of the investment portfolio is to provide a source of earnings, for liquidity management purposes, and to control interest rate risk.  In managing the portfolio, we seek safety of principal, liquidity, diversification and maximized return on funds.  See “Liquidity” and “Capital Resources” in this Item 7 and “Quantitative and Qualitative Disclosures About Market Risk - Asset Liability Management” under Item 7A.
 
The following table sets forth the amortized cost and fair value of our investment securities available for sale, by type of security as indicated (in thousands):
 
 
Year-ended December 31,
 
2008
2007
2006
   
Amortized
 
Fair
 
Amortized
 
Fair
 
Amortized
 
Fair
   
Cost
 
Value
 
Cost
 
Value
 
Cost
 
Value
                         
U.S. Treasury securities
 
$               -
 
$              -
 
$               -
 
$              -
 
$     11,287
 
$     11,248
Government sponsored agencies
 
171,385
 
179,373
 
305,768
 
310,538
 
666,855
 
665,435
States and political subdivisions
 
417,608
 
427,999
 
407,973
 
412,302
 
369,204
 
370,036
Mortgage-backed securities
 
682,679
 
690,285
 
435,743
 
438,056
 
505,241
 
495,215
Corporate bonds
 
34,546
 
34,565
 
12,797
 
13,057
 
27,477
 
27,316
Equity securities
 
3,595
 
3,606
 
3,446
 
3,460
 
7,069
 
6,993
Debt securities issued by foreign governments
 
301
 
302
 
299
 
301
 
547
 
547
                         
Total
 
$1,310,114
 
$1,336,130
 
$1,166,026
 
$1,177,714
 
$1,587,680
 
$1,576,790

35

 
U.S. Treasury securities and securities of government sponsored agencies generally consist of fixed rate securities with maturities of three months to three years.  States and political subdivisions investment securities consist of investment grade and local non-rated issues with maturities of one year to fifteen years.  The average expected life of mortgage-backed securities generally ranges between one and four years.  Corporate bonds typically have terms of five years or less.
 
Securities of a single issuer which had book values in excess of 10.0% of our stockholder’s equity at December 31, 2008, other than government sponsored agencies and corporations, included mortgage-backed securities issued by the Federal National Mortgage Association (FNMA) and the Federal Home Loan Mortgage Corporation (FHLMC).  FNMA issued mortgage-backed securities had an aggregate book value and market value of $164.3 million and $165.7 million, respectively, at December 31, 2008.  FHLMC issued mortgage-backed securities had an aggregate book value and market value of $445.5 million and $451.5 million, respectively, at December 31, 2008.  We do not have any meaningful direct or indirect holdings of subprime residential mortgage loans, home equity lines of credit, or any Fannie Mae or Freddie Mac preferred or common equity securities in our investment portfolio.  Additionally, more than 99% of our mortgage-backed securities are agency guaranteed.
 
The following table sets forth certain information regarding contractual maturities and the weighted average yields of our investment securities available for sale at December 31, 2008 (dollars in thousands):
 
       
Due after One
Due after Five
     
 
Due in One
Year through
Years through
Due after
 
Year or Less
Five Years
Ten Years
Ten Years
     
Weighted
   
Weighted
   
Weighted
   
Weighted
     
Average
   
Average
   
Average
   
Average
   
Balance
Yield
 
Balance
Yield
 
Balance
Yield
 
Balance
Yield
                         
U.S. Treasury securities
 
$          -
-