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Section 1: 10-K (MB FINANCIAL, INC. 10K 123109)

mbfi10k_123109.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, 2009

 
OR

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

 
For the transition period from ____________ to ____________


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


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


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

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

Title of Each Class
 
Name of Each Exchange on Which Registered
     
Common Stock, par value $0.01 per share
 
The NASDAQ Stock Market LLC
     
________________________________                                                                                              _______________________________

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

None

(Title of Class)

 
 



Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes x   No o


Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes o   No x


Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.
Yes x                       No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes o                      No o

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

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

Non-accelerated filer   o(Do not check if a smaller reporting company)                                                                           Smaller reporting company o


Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).   Yes o    No x


The aggregate market value of the voting shares held by non-affiliates of the Registrant was approximately $348,320,215 as of June 30, 2009, 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 51,664,092 shares of the Registrant’s common stock as of March 3, 2010.
 

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
   
2010 Annual Meeting of Stockholders.
     


 
 



MB FINANCIAL, INC. AND SUBSIDIARIES

FORM 10-K

December 31, 2009

INDEX

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


 
 



PART I


Item 1.  Business

Special Note Regarding Forward-Looking Statements

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

Important factors that could cause actual results to differ materially from the results anticipated or projected include, but are not limited to, the following (1) expected cost savings, synergies and other benefits from our merger and acquisition activities might not be realized within the anticipated time frames or at all, and costs or difficulties relating to integration matters, including but not limited to customer and employee retention, might be greater than expected; (2) the possibility that the expected benefits of the Heritage Community Bank, InBank, Corus Bank, and Benchmark Bank transactions will not be realized; (3) the possibility that the amounts of the gains, if any, we ultimately realize on the Benchmark and InBank transactions will differ materially from the recorded gains; (4) the credit risks of lending activities, including changes in the level and direction of loan delinquencies and write-offs and changes in estimates of the adequacy of the allowance for loan losses, which could necessitate additional provisions for loan losses, resulting both from loans we originate and loans we acquire from other financial institutions; (5) results of examinations by the Office of Comptroller of Currency, the Federal Reserve Board and other regulatory authorities, including the possibility that any such regulatory authority may, among other things, require us to increase our allowance for loan losses or write-down assets; (6) competitive pressures among depository institutions; (7) interest rate movements and their impact on customer behavior and net interest margin; (8) the impact of repricing and competitors’ pricing initiatives on loan and deposit products; (9) fluctuations in real estate values; (10) the ability to adapt successfully to technological changes to meet customers’ needs and developments in the market place; (11) our ability to realize the residual values of our direct finance, leveraged, and operating leases; (12) our ability to access cost-effective funding; (13) changes in financial markets; (14) changes in economic conditions in general and in the Chicago metropolitan area in particular; (15) the costs, effects and outcomes of litigation; (16) new legislation or regulatory changes, including but not limited to changes in federal and/or state tax laws or interpretations thereof by taxing authorities, changes in laws, rules or regulations applicable to companies that have participated in the TARP Capital Purchase Program of the U.S. Department of the Treasury and other governmental initiatives affecting the financial services industry; (17) changes in accounting principles, policies or guidelines; (18) our future acquisitions of other depository institutions or lines of business; and (19) future goodwill impairment due to changes in our business, changes in market conditions, or other factors.

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

General

MB Financial, Inc., headquartered in Chicago, Illinois, is a financial holding company with 86 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 88 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, Pennsylvania.  Through MB Financial Bank, we offer a broad range of financial services primarily to small and middle market businesses and individuals in the markets that we serve.  Our primary lines of business include commercial banking, retail banking and wealth management.  As of December 31, 2009, we had total assets of $10.9 billion, deposits of $8.7 billion, stockholders’ equity of $1.3 billion, and $3.3 billion of client assets under administration in our Wealth Management Group (including $1.8 billion in our trust department, $545 million in our broker/dealer subsidiary, Vision Investment Services, Inc., and $902 million in our majority owned asset management firm, Cedar Hill Associates LLC.
 
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We have grown significantly in the past several years through a number of acquisitions, including the following most recent transactions:
 
 
·  
In August 2006, we acquired Oak Brook Bank, based in Oak Brook, Illinois, and its parent First Oak Brook Bancshares, Inc. (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.  Oak Brook Bank had assets of approximately $2.6 billion as of the acquisition date.
·  
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 February 2009, we assumed approximately $217 million of deposits of Glenwood, Illinois-based Heritage Community Bank (Heritage), and acquired loans of approximately $92.5 million in a loss-share transaction facilitated by the Federal Deposit Insurance Corporation (FDIC).
·  
In September 2009, we assumed approximately $135 million of deposits of Oak Forest, Illinois-based InBank, and acquired loans of approximately $101 million in a transaction facilitated by the FDIC.
·  
In September 2009, we assumed approximately $6.5 billion in deposits of Chicago-based Corus Bank (Corus), and acquired loans of approximately $26.1 million, in a transaction facilitated by the FDIC.  Deposits assumed in the Corus transaction decreased to $2.1 billion at December 31, 2009.  This decrease was expected and was a result of us redeeming out-of-market certificates of deposit assumed in the Corus transaction, the withdrawals of assumed out-of-market money market accounts following our reduction in interest rates paid on these deposits, and some in-market deposit run-off of previously higher rate assumed deposits.  We expect that we will ultimately retain approximately $1.6 billion to $2.0 billion of the deposits we assumed in the Corus transaction.
·  
In December 2009, we assumed $164 million of deposits of Aurora, Illinois-based Benchmark Bank (Benchmark), and acquired loans of approximately $76 million in a loss-share transaction facilitated by the FDIC.

In November 2007, we sold Union Bank (Union), based in Oklahoma City, Oklahoma, for $76.3 million in cash, resulting in an after-tax gain of $28.8 million.  Union, a former subsidiary of MidCity Financial, had assets of approximately $398.6 million as of the sale date.

In August 2009, we sold our merchant card processing business, resulting in an after-tax gain of $6.2 million.

MB Financial Bank, our largest subsidiary, has six 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.; and Ashland Management Agency, Inc.;  MB Financial Bank also has a majority owned subsidiary with significant operating activities, Cedar Hill Associates, LLC.

Ashland Management Agency, Inc. holds and/or manages certain properties purchased by the Company.

As noted above, Cedar Hill is an asset management firm located in Chicago, Illinois that we acquired in April 2008, with approximately $902 million in assets under management at December 31, 2009.

LaSalle Systems Leasing, Inc. (LaSalle) focuses primarily on leasing technology-related equipment to middle market and larger 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.  We acquired LaSalle in 2002.

MB Financial Center LLC manages 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.
 
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Vision Investment Services, Inc. (Vision) is registered with the Securities and Exchange Commission as a broker/dealer, is a member of the Financial Industry Regulatory Authority, is a member of the Securities Investor Protection Corporation, and is a licensed insurance agency.  Vision has one wholly owned subsidiary: Vision Insurance Services, Inc.  Vision Insurance Services, Inc. is a licensed insurance agency which functions as a distribution firm for certain insurance and annuity products.  Vision 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 $544.5 million in assets under administration at December 31, 2009.

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 January 27, 2010, the Company announced that it will pay a cash dividend of $0.01 per share to shareholders of record as of February 15, 2010.

Primary Lines of Business

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

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

Commercial Banking.  Commercial banking focuses on serving middle market businesses, primarily located in the Chicago metropolitan area.  We provide a full set of credit, deposit, and treasury management products to these companies.  In general, our credit products are designed for companies with annual revenues between $5 million and $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 banking products for businesses, investment sweep accounts, zero balance accounts, automated tax payments, ATM access, telephone banking, lockbox, automated clearing house transactions, account reconciliation, controlled disbursement, detail and general information reporting, wire transfers, a variety of international banking services, and checking accounts.  We also provide a full set of credit, deposit and treasury management services for real estate operators and investors.

Commercial banking also serves small and medium size equipment leasing companies located throughout the United States.  We have provided banking services to these companies for more than three decades.  Competition in serving equipment lessors generally comes from large banks, finance companies, large industrial companies and some community banks.  We compete based upon rapid decision making and excellent service and by providing flexible financial solutions to meet our customers’ needs.  We provide full banking services to leasing companies by financing the debt portion of leveraged equipment leases (referred to as lease loans), providing short and long-term equity financing and by making working capital and bridge loans.  For lease loans, a lessee’s credit is often rated as investment grade for its public debt by Moody’s, Standard & Poors or the equivalent.  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.
 
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Additionally, LaSalle primarily focuses on leasing technology-related equipment to middle market and larger businesses throughout the United States and provides us the additional ability to directly originate leases.

Retail Banking.  Retail banking is made up of approximately 87 branch offices spread principally throughout the Chicago metropolitan area with one branch in Philadelphia, PA.  Our target customer is the household looking for a complete suite of deposit and lending products and customer service that resembles that of a community bank.  Our full line of consumer deposit products consists of checking, savings, money market, time deposits and IRA accounts. Our lead product for 2009 was “MB Red Checking”, an account that rewarded customers with a high interest rate for meeting specified account transaction criteria.  Retail banking also serves our business customers (under $10 million in revenues) that desire a full business product set and the convenience of our branch network. Our business customers can choose from the same business services available to our larger commercial businesses and receive the attention within the local branch to which they are accustomed.  

        All of our deposit products are supported by an array of ancillary products: “ibankmb.com” is our robust state of the art internet banking and bill payment service provided to our customers at no cost, allowing them to bank 24/7 from anywhere around the globe;  “MB Debit MasterCard®”offers purchasing power anywhere MasterCard is accepted; “My Bank, My Rewards” allows our customers to earn rewards points for all signature debit card purchases, redeemable for merchandise, gift cards and travel; and e-statement, which conveniently delivers a paperless statement to our customer’s email inbox.

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 services needs.  MB Financial Bank subsidiaries Cedar Hill and Vision 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 have typically ranged in size from $500 thousand to $15 million.

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

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

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

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

The lessee acknowledges the bank’s security interest in the leased equipment and normally agrees to send lease payments directly to us.  Lessees tend to be companies that have an investment grade public debt rating by Moody’s or Standard & Poors or the equivalent, though, we also provide credit to below investment grade and non-rated companies 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 expected residual values of this equipment.  See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations-Critical Accounting Policies-Residual Value of Our Direct Finance, Leveraged and Operating Leases.”

Residential Real Estate.  We 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.  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 some adjustable rate residential real estate loans. On a limited basis we hold loans with 15 and 30 year maturities.
 
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Consumer Lending.  Our consumer loan portfolio is primarily focused on home equity lines of credit, fixed-rate second mortgage loans, indirect vehicle loans, and to a lesser extent, secured and unsecured consumer loans.  Home equity lines of credit are generally extended up to 80% of the appraised value of the property, less existing liens.  Indirect vehicle loans represent consumer loans made primarily through a network of motorcycle dealers in 46 states.  Consumer loans typically have shorter terms and lower balances with higher yields as compared to residential real estate loans, but carry a higher risk of default.  Terms for second mortgages typically range from five to ten years.  Consumer loan collections are dependent on the borrower’s continuing financial stability, and thus, are more likely to be affected by adverse personal circumstances.  Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount which can be recovered on these loans.

Foreign Operations

MB Financial Bank 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, 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.  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, 2009, we and our subsidiaries employed a total of 1,638 full-time equivalent employees.  We consider our relationship with our employees to be good.

Supervision and Regulation

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

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

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

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

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

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:

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

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

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

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Rules restricting types and amounts of equity investments; and

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

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

The Federal Reserve Board's risk-based guidelines establish a two-tier capital framework.  Tier 1 capital generally consists of common stockholders' equity, retained earnings, a limited amount of qualifying perpetual preferred stock, qualifying trust preferred securities and noncontrolling interests in the equity accounts of consolidated subsidiaries, less goodwill and certain intangibles.  Tier 2 capital generally consists of certain hybrid capital instruments and perpetual debt, mandatory convertible debt securities and a limited amount of subordinated debt, qualifying preferred stock, loan loss allowance, and unrealized holding gains on certain equity securities.  The sum of Tier 1 and Tier 2 capital represents qualifying total capital, at least 50% of which must consist of Tier 1 capital.

Risk-based capital ratios are calculated by dividing Tier 1 and total capital by risk-weighted assets.  Assets and off-balance sheet exposures are assigned to one of four categories of risk-weights, based primarily on relative credit risk.  For bank holding companies, generally the minimum Tier 1 risk-based capital ratio is 4% and the minimum total risk-based capital ratio is 8%.  Our Tier 1 and total risk-based capital ratios under these guidelines at December 31, 2009 were 13.51% and 15.45%, respectively.
 
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The Federal Reserve Board’s leverage capital guidelines establish a minimum leverage ratio determined by dividing Tier 1 capital by adjusted average total assets.  The minimum leverage ratio is 3% for bank holding companies that meet certain specified criteria, including having the highest regulatory rating.  All other bank holding companies generally are required to maintain a leverage ratio of at least 4%.  At December 31, 2009, we had a leverage ratio of 8.71%.

The federal regulatory authorities’ risk-based capital guidelines are based upon the 1988 capital accord (“Basel I”) of the Basel Committee on Banking Supervision (the “Basel Committee”). The Basel Committee is a committee of central banks and bank supervisors/regulators from the major industrialized countries that develops broad policy guidelines for use by each country’s supervisors in determining the supervisory policies they apply. In 2004, the Basel Committee published a new capital accord (“Basel II”) to replace Basel I. Basel II provides two approaches for setting capital standards for credit risk – an internal ratings-based approach tailored to individual institutions’ circumstances and a standardized approach that bases risk weightings on external credit assessments to a much greater extent than permitted in existing risk-based capital guidelines. Basel II also would set capital requirements for operational risk and refine the existing capital requirements for market risk exposures.

A definitive final rule for implementing the advanced approaches of Basel II in the United States, which applies only to certain large or internationally active banking organizations, or “core banks” – defined as those with consolidated total assets of $250 billion or more or consolidated on-balance sheet foreign exposures of $10 billion or more, became effective as of April 1, 2008. Other U.S. banking organizations may elect to adopt the requirements of this rule (if they meet applicable qualification requirements), but they are not required to apply them. The rule also allows a banking organization’s primary federal supervisor to determine that the application of the rule would not be appropriate in light of the bank’s asset size, level of complexity, risk profile, or scope of operations. The Company is not required to comply with the advanced approaches of Basel II.

In July 2008, the agencies issued a proposed rule that would give banking organizations that do not use the advanced approaches the option to implement a new risk-based capital framework. This framework would adopt the standardized approach of Basel II for credit risk, the basic indicator approach of Basel II for operational risk, and related disclosure requirements. While this proposed rule generally parallels the relevant approaches under Basel II, it diverges where United States markets have unique characteristics and risk profiles, most notably with respect to risk weighting residential mortgage exposures. Comments on the proposed rule were due to the agencies by October 27, 2008, but a definitive final rule has not been issued. The proposed rule, if adopted, would replace the agencies’ earlier proposed amendments to existing risk-based capital guidelines to make them more risk sensitive (formerly referred to as the “Basel I-A” approach).

On September 3, 2009, the United States Treasury Department issued a policy statement (the “Treasury Policy Statement”) entitled “Principles for Reforming the U.S. and International Regulatory Capital Framework for Banking Firms.” The Treasury Policy Statement was developed in consultation with the U.S. bank regulatory agencies and contemplates changes to the existing regulatory capital regime that would involve substantial revisions to, if not replacement of, major parts of the Basel I and Basel II capital frameworks and affects all regulated banking organizations and other systemically important institutions. The Treasury Policy Statement calls for, among other things, higher and stronger capital requirements for all banking firms. The Treasury Policy Statement suggested that changes to the regulatory capital framework be phased in over a period of several years. The recommended schedule provides for a comprehensive international agreement by December 31, 2010, with the implementation of reforms by December 31, 2012, although it does remain possible that U.S. bank regulatory agencies could officially adopt, or informally implement, new capital standards at an earlier date.

On December 17, 2009, the Basel Committee issued a set of proposals (the “Capital Proposals”) that would significantly revise the definitions of Tier 1 capital and Tier 2 capital, with the most significant changes being to Tier 1 capital. Most notably, the Capital Proposals would disqualify certain structured capital instruments, such as trust preferred securities, from Tier 1 capital status. The Capital Proposals would also re-emphasize that common equity is the predominant component of Tier 1 capital by adding a minimum common equity to risk-weighted assets ratio and requiring that goodwill, general intangibles and certain other items that currently must be deducted from Tier 1 capital instead be deducted from common equity as a component of Tier 1 capital. The Capital Proposals also suggest the possibility that the current minimum Tier 1 capital and total capital ratios of 4.0% and 8.0%, respectively, may be increased.
 
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Concurrently with the release of the Capital Proposals, the Basel Committee also released a set of proposals related to liquidity risk exposure (the “Liquidity Proposals,” and together with the Capital Proposals, the “2009 Basel Committee Proposals”). The Liquidity Proposals have three key elements, including the implementation of (i) a “liquidity coverage ratio” designed to ensure that a bank maintains an adequate level of unencumbered, high-quality assets sufficient to meet the bank’s liquidity needs over a 30-day time horizon under an acute liquidity stress scenario, (ii) a “net stable funding ratio” designed to promote more medium and long-term funding of the assets and activities of banks over a one-year time horizon, and (iii) a set of monitoring tools that the Basel Committee indicates should be considered as the minimum types of information that banks should report to supervisors and that supervisors should use in monitoring the liquidity risk profiles of supervised entities.

Comments on the 2009 Basel Committee Proposals are due by April 16, 2010, with the expectation that the Basel Committee will release a comprehensive set of proposals by December 31, 2010 and that final provisions will be implemented by December 31, 2012. The U.S. bank regulators have urged comment on the 2009 Basel Committee Proposals. Ultimate implementation of such proposals in the U.S. will be subject to the discretion of the U.S. bank regulators and the regulations or guidelines adopted by such agencies may, of course, differ from the 2009 Basel Committee Proposals and other proposals that the Basel Committee may promulgate in the future.

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

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

As of December 31, 2009, our subsidiary bank met the requirements to be classified as “well-capitalized.”

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

On December 5, 2008, as part of the Troubled Asset Relief Program (“TARP”) Capital Purchase Program of the United States Department of the Treasury (“Treasury”), the Company sold to Treasury 196,000 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A (the “Series A Preferred Stock”), having a liquidation preference amount of $1,000 per share, for a purchase price of $196.0 million in cash and (ii) issued to Treasury a ten-year warrant to purchase 1,012,048 shares (which was subsequently reduced to 506,024 shares, as explained below) of the Company’s common stock  at an exercise price of $29.05 per share (the “Warrant”).
 
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The Company may redeem the Series A Preferred Stock at any time by repaying the Treasury, without penalty, subject to the Treasury’s consultation with the Company’s appropriate regulatory agency.  Additionally, upon redemption of the Series A Preferred Stock, the Warrant may be repurchased from the Treasury at its fair market value as agreed-upon by the Company and the Treasury.

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

The securities purchase agreement between us and Treasury provides that prior to the earlier of (i) December 5, 2011 and (ii) the date on which all of the shares of the Series A Preferred Stock have been redeemed by us or transferred by Treasury to third parties, we may not, without the consent of Treasury, (a) pay a quarterly cash dividend on our common stock of more than $0.18 per share or (b) subject to limited exceptions, redeem, repurchase or otherwise acquire shares of our common stock 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.

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.

In February 2009, the FDIC adopted a final regulation that provided for the replenishment of the Deposit Insurance Fund over a period of seven years. The restoration plan changed the FDIC’s base assessment rates and the risk-based assessment system. The risk-based premium system provides for quarterly assessments based on an insured institution’s ranking in one of four risk categories based upon supervisory and capital evaluations. The assessment rate for an individual institution is determined according to a formula based on a weighted average of the institution’s individual CAMELS component ratings plus either six financial ratios or, in the case of an institution with assets of $10.0 billion or more, the average ratings of its long-term debt. Well-capitalized institutions (generally those with CAMELS composite ratings of 1 or 2) are grouped in Risk Category I and their initial base assessment rate for deposit insurance is set at an annual rate of between 12 and 16 basis points. The initial base assessment rate for institutions in Risk Categories II, III and IV is set at annual rates of 22, 32 and 50 basis points, respectively. These initial base assessment rates are adjusted to determine an institution’s final assessment rate based on its brokered deposits, secured liabilities and unsecured debt. The adjustments include higher premiums for institutions that rely significantly on excessive amounts of brokered deposits, including CDARS, higher premiums for excessive use of secured liabilities, including Federal Home Loan Bank advances and adding financial ratios and debt issuer ratings to the premium calculations for banks with over $10 billion in assets, while providing a reduction for all institutions for their unsecured debt.  Total base assessment rates after adjustments range from 7 to 24 basis points for Risk Category I, 17 to 43 basis points for Risk Category II, 27 to 58 basis points for Risk Category III, and 40 to 77.5 basis points for Risk Category IV.  Rates increase uniformly by 3 basis points effective January 1, 2011.
 
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In addition, all institutions with deposits insured by the FDIC are required to pay assessments to fund interest payments on bonds issued by the Financing Corporation, a mixed-ownership government corporation established to recapitalize a predecessor to the Deposit Insurance Fund.  These assessments will continue until the Financing Corporation bonds mature in 2019.

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

On May 22, 2009, the FDIC announced a five basis point special assessment on each insured depository institution’s assets minus its Tier 1 capital as of June 30, 2009. The FDIC collected MB Financial Bank’s special assessment amounting to $3.9 million on September 30, 2009. The special assessment was fully expensed by the Company in the second quarter of 2009.

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

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 in October 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 December 31, 2012 (extended from June 30, 2012 by subsequent amendment), certain newly issued senior unsecured debt issued by participating institutions on or after October 14, 2008, and before October 31, 2009 (extended from June 30, 2009 by subsequent amendment) and (ii) provide full FDIC deposit insurance coverage for non-interest bearing transaction deposit accounts, Negotiable Order of Withdrawal (“NOW”) accounts paying a maximum of 0.5% interest per annum and Interest on Lawyers Trust Accounts held at participating FDIC insured institutions through June 30, 2010 (extended from December 31, 2009, subject to an opt-out provision, by subsequent amendment). The Company did not issue any debt pursuant to the guaranteed debt program.  The Company elected not to opt out of the six-month extension of the transaction account guarantee program. Coverage under the TLG Program was available for the first 30 days without charge. The fee assessment for coverage of senior unsecured debt ranged from 50 basis points to 100 basis points per annum, depending on the initial maturity of the debt. The fee for full deposit insurance coverage for such transaction accounts was 10 basis points per quarter during 2009 on amounts in covered accounts exceeding $250,000.  During the six – month extension period in 2010, the fees for participating banks will range from 15 to 25 basis points, depending on the risk category to which the bank is assigned for deposit insurance assessment purposes.

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.”
 
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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.  De novo branching by a bank outside of its home state is generally subject to the law of the state where a branch is to be located as well as federal law.

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 financial institutions such as our banking and broker-dealer subsidiaries.  The regulations impose obligations on financial institutions to maintain appropriate policies, procedures and controls to detect, prevent and report money laundering and terrorist financing.  The increased obligations of financial institutions, including us, to identify their customers, watch for and report suspicious transactions, respond to requests for information by regulatory authorities and law enforcement agencies, and share information with other financial institutions, requires the implementation and maintenance of internal procedures, practices and controls which have increased, and may continue to increase, our costs and may subject us to liability.

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

Regulatory Reform.  In June 2009, the U.S. President’s administration proposed a wide range of regulatory reforms that, if enacted, may have significant effects on the financial services industry in the United States. Significant aspects of the administration’s proposals that may affect the Company included, among other things, proposals: (i) to reassess and increase capital requirements for banks and bank holding companies and examine the types of instruments that qualify as regulatory capital; (ii) to combine the OCC and the Office of Thrift Supervision into a National Bank Supervisor with a unified federal bank charter; (iii) to expand the current eligibility requirements for financial holding companies, such as MB Financial, so that the financial holding company must be “well capitalized” and “well managed” on a consolidated basis; (iv) to create a federal consumer financial protection agency to be the primary federal consumer protection supervisor with broad examination, supervision and enforcement authority with respect to consumer financial products and services; (v) to further limit the ability of banks to engage in transactions with affiliates; and (vi) to subject all “over-the-counter” derivatives markets to comprehensive regulation.
 
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The U.S. Congress, state lawmaking bodies and federal and state regulatory agencies continue to consider a number of wide-ranging and comprehensive proposals for altering the structure, regulation and competitive relationships of the nation’s financial institutions, including rules and regulations related to the administration’s proposals. Various financial reform bills intended to address the proposals set forth by the administration have been introduced in both houses of Congress and further proposals may be made. In addition, both the U.S. Treasury Department and the Basel Committee have issued policy statements regarding proposed significant changes to the regulatory capital framework applicable to banking organizations as discussed above. The Company cannot predict whether or in what form further legislation or regulations may be adopted or the extent to which the Company may be affected thereby.

TARP-Related Compensation and Corporate Governance Requirements. The Emergency Economic Stabilization Act of 2008 (“EESA”) was signed into law on October 3, 2008 and authorized the U.S. Treasury to provide funds to be used to restore liquidity and stability to the U.S. financial system pursuant to the TARP.  Under the authority of EESA, Treasury instituted the TARP Capital Purchase Program to encourage U.S. financial institutions to build capital to increase the flow of financing to U.S. businesses and consumers and to support the U.S. economy.  As noted above, on December 5, 2009, the Company participated in this program by issuing 196,000 shares of the Company’s Series A Preferred Stock to Treasury for a purchase price of $196.0 million in cash and issued the Warrant to Treasury.

In addition to the restrictions on the Company’s ability to pay dividends on and repurchase its stock, as described above under “Dividends,” participation in the TARP Capital Purchase Program also includes certain requirements and restrictions regarding compensation that were expanded significantly by the American Recovery and Reinvestment Act of 2009 (“ARRA”), as implemented by Treasury’s Interim Final Rule on TARP Standards for Compensation and Corporate Governance.  These requirements and restrictions include, among others, the following: (i) a prohibition on paying or accruing bonuses, retention awards and incentive compensation, other than qualifying long-term restricted stock or pursuant to certain preexisting employment contracts, to the Company’s five most highly-compensated employees; (ii) a general prohibition on providing severance benefits, or other benefits due to a change in control of the Company, to the Company’s senior executive officers (“SEOs”) and next five most highly compensated employees; (iii) a requirement to make subject to clawback any bonus, retention award, or incentive compensation paid to any of the SEOs and any of the next twenty most highly compensated employees if such compensation was based on materially inaccurate financial statements or any other materially inaccurate performance metric criteria; (iv) a requirement to establish a policy on luxury or excessive expenditures; (v) a requirement to provide shareholders with a non-binding advisory “say on pay” vote on executive compensation; (vi) a prohibition on deducting more than $500,000 in annual compensation, including performance-based compensation, to the executives covered under Internal Revenue Code Section 162(m); (vii) a requirement that the compensation committee of the board of directors evaluate and review on a semi-annual basis the risks involved in employee compensation plans; and (viii) a prohibition on providing tax “gross-ups” to the Company’s SEOs and the next 20 most highly compensated employees.  These requirements and restrictions will remain applicable to the Company until it has redeemed the Series A Preferred Stock in full.

Incentive Compensation.  On October 22, 2009, the Federal Reserve issued a comprehensive proposal on incentive compensation policies (the “Incentive Compensation Proposal”) intended to ensure that the incentive compensation policies of banking organizations do not undermine the safety and soundness of such organizations by encouraging excessive risk-taking. The Incentive Compensation Proposal, which covers all employees that have the ability to materially affect the risk profile of an organization, either individually or as part of a group, is based upon the key principles that a banking organization’s incentive compensation arrangements should (i) provide incentives that do not encourage risk-taking beyond the organization’s ability to effectively identify and manage risks, (ii) be compatible with effective internal controls and risk management, and (iii) be supported by strong corporate governance, including active and effective oversight by the organization’s board of directors. Banking organizations are instructed to begin an immediate review of their incentive compensation policies to ensure that they do not encourage excessive risk-taking and implement corrective programs as needed. Where there are deficiencies in the incentive compensation arrangements, they must be immediately addressed.

Additionally, the Incentive Compensation Proposal will require the Federal Reserve to review, as part of the regular, risk-focused examination process, the incentive compensation arrangements of banking organizations, such as us, that are not “large, complex banking organizations.” These reviews will be tailored to each organization based on the scope and complexity of the organization’s activities and the prevalence of incentive compensation arrangements. The findings of the supervisory initiatives will be included in reports of examination. Deficiencies will be incorporated into the organization’s supervisory ratings, which can affect the organization’s ability to make acquisitions and take other actions. Enforcement actions may be taken against a banking organization if its incentive compensation arrangements, or related risk-management control or governance processes, pose a risk to the organization’s safety and soundness and the organization is not taking prompt and effective measures to correct the deficiencies.
 
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In addition, on January 12, 2010, the FDIC announced that it would seek public comment on whether banks with compensation plans that encourage risky behavior should be charged at higher deposit assessment rates than such banks would otherwise be charged.

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

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

Internet Website

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

Item 1A.  Risk Factors

An investment in our 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.
 
A large percentage of our loan portfolio is secured by real estate, in particular commercial real estate. Continued deterioration in the real estate markets or other segments of our loan portfolio could lead to additional losses, which could have a material negative effect on our financial condition and results of operations.
 
As of December 31, 2009, excluding loans acquired in the Heritage and Benchmark acquisitions and covered by our loss-sharing agreements with the FDIC for those transactions, approximately 57% of our loan portfolio was secured by real estate, the majority of which is commercial real estate.  The commercial real estate market continues to experience a variety of difficulties.  In particular, market conditions in the Chicago metropolitan area, in which a majority of our commercial real estate loans are concentrated, have declined significantly in the past year.  As a result of increased levels of commercial and consumer delinquencies and declining real estate values, which reduce the customer's borrowing power and the value of the collateral securing the loan, we have experienced increasing levels of charge-offs and provisions for loan losses. Continued increases in delinquency levels or continued declines in real estate values, which cause our borrowers’ loan-to-value ratios to increase, could result in additional charge-offs and provisions for loan losses. This could have a material negative effect on our business and results of operations.
 
Our construction loans are based upon estimates of costs and value associated with the complete project. These estimates may be inaccurate.  A substantial portion of our construction loans were non-performing at December 31, 2009.
 
17

 
We provide loans for the acquisition and development of land and for the acquisition, development, and construction of condominiums, townhomes, and one-to-four family residences. We also provide acquisition, development and construction loans for retail and other commercial properties, primarily in our market areas.
 
Construction lending can involve a higher level of risk than other types of lending because funds are often advanced based upon the value of the project, which is uncertain prior to the project's completion. Because of the uncertainties inherent in estimating construction costs and the timing of project completion as well as the market value of a completed project and the effects of governmental regulation of real property, our estimates with regard to the total funds required to complete a project, the proceeds from a project’s sale or refinance, and the related loan-to-value ratio may vary from actual results. Construction loans of for sale properties (residential or commercial) often involve the disbursement of substantial funds with repayment dependent, in part, on the success of the ultimate project and the ability of the borrower to sell or lease the property or refinance the indebtedness. If our estimate of the value of a project at completion proves to be overstated, we may have inadequate security for repayment of the loan and we may incur a loss.
 
At December 31, 2009, excluding loans acquired in the Heritage and Benchmark acquisitions and covered by our loss-sharing agreements with the FDIC for those transactions, our construction loans totaled approximately $594.5 million, or 9% of our total loan portfolio. Of these loans, approximately $312.7 million, or 53%, were residential construction-related and approximately $262.9 million, or 44%, were commercial construction related. Approximately $181.0 million, or 30%, of the $594.5 million of our construction loans were non-performing at December 31, 2009. These loans represented approximately 67% of our total non-performing loans as of December 31, 2009, excluding loans covered by our loss-sharing agreements with the FDIC for the Heritage and Benchmark acquisitions.
 
The deterioration in the quality of our construction loan portfolio has been the primary factor behind the substantial increases in charge-offs and provisions for loan losses we have experienced in recent periods.  Our provision for loan losses was $70.0 million for the fourth quarter of 2009, while our net charge-offs were $82.2 million.  For the third quarter of 2009, our provision for loan losses and net charge-offs were $45.0 million and $37.1 million, respectively.  Our provisions for loan losses and net charge offs for the full 2009 year were $231.8 million and $198.7 million, respectively, compared with $125.7 million and $46.8 million, respectively, for 2008.  The Chicago area real estate market remains very weak, and we believe that further deterioration in the quality of our construction loan portfolio is a possibility.  This could result in additional charge-offs and provisions for loan losses, which could have a material negative effect on our financial condition and results of operations.
 
Repayment of our commercial loans and lease loans is often dependent on the cash flows of the borrower or lessee, which may be unpredictable, and the collateral securing these loans may fluctuate in value.
 
We make our commercial loans primarily based on the identified cash flow of the borrower and secondarily on the underlying collateral provided by the borrower. Collateral securing commercial loans may depreciate over time, be difficult to appraise and fluctuate in value. In 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.
 
We lend money to small and mid-sized independent leasing companies to finance the debt portion of leases (which we refer to as lease loans). A lease loan arises when a leasing company discounts the equipment rental revenue stream owed to the leasing company by a lessee. Our lease loans entail many of the same types of risks as our commercial loans. Lease loans generally are non-recourse to the leasing company, and, consequently, our recourse is limited to the lessee and the leased equipment. As with commercial loans secured by equipment, the equipment securing our lease loans may depreciate over time, may be difficult to appraise and may fluctuate in value. We rely on the lessee's continuing financial stability, rather than the value of the leased equipment, for the repayment of all required amounts under lease loans. In the event of a default on a lease loan, it is unlikely that the proceeds from the sale of the leased equipment will be sufficient to satisfy the outstanding unpaid amounts under the terms of the loan.
 
Changes in economic conditions, particularly a further economic slowdown in the Chicago area, could hurt our business.
 
Our business is directly affected by market conditions, trends in industry and finance, legislative and regulatory changes, and changes in governmental monetary and fiscal policies and inflation, all of which are beyond our control. In 2007, the housing and real estate sectors experienced an economic slowdown that continued through 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:
 
18

 
·  
loan delinquencies may increase;
 
·  
problem assets and foreclosures may increase;

·  
demand for our products and services may decline;
 
·  
collateral for our loans may decline in value, in turn reducing a customer's borrowing power and reducing the value of collateral securing our loans; and

·  
the net worth and liquidity of loan guarantors may decline, impairing their ability to honor commitments to us.
 
Difficult market conditions and economic trends have adversely affected our industry and our business.
 
The United States experienced a severe economic recession in 2008 and 2009.  While economic growth may have resumed recently, the rate of this growth has been very low and unemployment remains at high levels.  Many lending institutions, including us, have experienced declines in the performance of their loans, especially construction and commercial real estate loans. In addition, the values of real estate collateral supporting many loans have declined and may continue to decline. Bank and bank holding company stock prices have been negatively affected, as has the ability of banks and bank holding companies to raise capital or borrow in the debt markets compared to recent years. These conditions may have a material negative effect on our financial condition and results of operations. In addition, as a result of the foregoing factors, there is a potential for new laws and regulations regarding lending and funding practices and capital and liquidity standards, and bank regulatory agencies have been and are expected to continue to be very aggressive in responding to concerns and trends identified in examinations. In this regard, the U.S. Department of the Treasury (the "U.S. Treasury") has announced that more rigorous regulatory capital and liquidity standards for banks should be established by December 31, 2010 and implemented by December 31, 2012, but no specific measures have yet been published.
 
Negative developments in the financial industry and the impact of new legislation and regulations in response to those developments could restrict our business operations, including our ability to originate loans, and negatively impact our results of operations and financial condition. Overall, during the past few years, the general business environment has had a negative effect on our business. Until there is a sustained improvement in economic conditions, we expect our business, financial condition and results of operations to be negatively affected.
 
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 collateral; and
·  
current macroeconomic factors and model imprecision factors.
 
The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and requires us to make significant estimates of current credit risks and future trends, all of which may undergo material changes. Continuing deterioration in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of our control, may require an increase in the allowance for loan losses. In addition, bank regulatory agencies periodically review our allowance for loan losses and may require an increase in the provision for possible loan losses or the recognition of further loan charge-offs, based on judgments different than those of management. In addition, if charge-offs in future periods exceed the allowance for loan losses, we will need additional provisions to increase the allowance for loan losses. Any increases in the allowance for loan losses will result in a decrease in net income and, possibly, capital, and may have a material negative effect on our financial condition and results of operations.
 
19

 
The value of the securities in our investment securities portfolio may be negatively affected by continued disruptions in securities markets.
 
Due to heightened credit and liquidity risks and the volatile economy, among other things, the market for some of the securities held in our investment portfolio has become increasingly volatile over the past two years, making the determination of the value of these securities less certain.  There can be no assurance that the declines in market value associated with these disruptions will not result in other-than-temporary or permanent impairments of these assets, which would lead to accounting charges that could have a material negative effect on our financial condition and results of operations.
 
Higher FDIC deposit insurance premiums and assessments could significantly increase our non-interest expense.
 
FDIC insurance premiums increased significantly in 2009 and we expect to pay higher FDIC premiums in the future. Recent bank failures have substantially depleted the insurance fund of the FDIC and reduced the fund's ratio of reserves to insured deposits.  The FDIC implemented a special assessment equal to five basis points of each insured depository institution's assets minus Tier 1 capital as of June 30, 2009.  We recorded an expense of $3.6 million in the second quarter of 2009 for this special assessment.  In November 2009, the FDIC amended its assessment regulations to require insured depository institutions to prepay their estimated quarterly regular risk-based assessments for the fourth quarter of 2009, and for all of 2010, 2011, and 2012, on December 30, 2009.  We prepaid $45.0 million, which will be expensed in the normal course of business throughout this three-year period.
 
We participate in the FDIC's Transaction Account Guarantee Program, or TAGP, for non-interest-bearing transaction deposit accounts. The TAGP is a component of the FDIC's Temporary Liquidity Guarantee Program, or TLGP. The TAGP was originally set to expire on December 31, 2009, but the FDIC established an extension period for the TAGP to run from January 1, 2010 through June 30, 2010. During the extension period, the fees for participating banks range from 15 to 25 basis points on the amounts in such accounts above the amounts covered by FDIC deposit insurance, depending on the risk category to which the bank is assigned for deposit insurance assessment purposes.
 
To the extent that assessments under the TAGP are insufficient to cover any loss or expenses arising from the TLGP, the FDIC is authorized to impose an emergency special assessment on all FDIC-insured depository institutions. The FDIC has authority to impose charges for the TLGP upon depository institution holding companies, as well. These charges would cause the premiums and TAGP assessments charged by the FDIC to increase. These actions could significantly increase our non-interest expense for the foreseeable future.
 
Changes in interest rates may reduce our net interest income.
 
Our consolidated operating results are largely dependent on our net interest income. Net interest income is the difference between interest earned on loans and investments and interest expense incurred on deposits and other borrowings. Our net interest income is impacted by changes in market rates of interest, changes in credit spreads, changes in the shape of the yield curve, the interest rate sensitivity of our assets and liabilities, prepayments on our loans and investments, and the mix of our funding sources and assets.
 
Our interest earning assets and interest bearing liabilities may react in different degrees to changes in market interest rates. Interest rates on some types of assets and liabilities may fluctuate prior to changes in broader market interest rates, while rates on other types may lag behind. The result of these changes to rates may cause differing spreads on interest earning assets and interest bearing liabilities. While we take measures intended to manage the risks from changes in market interest rates, we cannot control or accurately predict changes in market rates of interest or be sure our protective measures are adequate.
 
Our strategy of pursuing acquisitions exposes us to financial, execution and operational risks that could negatively affect us.
 
We pursue a strategy of supplementing internal growth by acquiring other financial institutions or their assets and liabilities that will help us fulfill our strategic objectives and enhance our earnings. There are risks associated with this strategy, including the following:
 
20

 
·  
We may be exposed to potential asset quality issues or unknown or contingent liabilities of the banks, businesses, assets, and liabilities we acquire. If these issues or liabilities exceed our estimates, our earnings and financial condition may be negatively affected;
·  
Prices at which acquisitions can be made fluctuate with market conditions. We have experienced times during which acquisitions could not be made in specific markets at prices we considered acceptable and expect that we will experience this condition in the future;
·  
The acquisition of other entities generally requires integration of systems, procedures and personnel of the acquired entity into our company to make the transaction economically successful. This integration process is complicated and time consuming and can also be disruptive to the customers of the acquired business. If the integration process is not conducted successfully and with minimal effect on the acquired business and its customers, we may not realize the anticipated economic benefits of particular acquisitions within the expected time frame, and we may lose customers or employees of the acquired business. We may also experience greater than anticipated customer losses even if the integration process is successful. These risks are present in our recently completed FDIC-assisted transaction involving our assumption of the deposits and the acquisition of certain assets of Benchmark;
·  
The Company entered into loss sharing agreements with the FDIC as part of the Heritage and Benchmark transactions. These loss sharing agreements require that MB Financial Bank follow certain servicing procedures as specified in the agreement or risk losing FDIC reimbursement of losses on covered loans and other real estate owned.
·  
To finance an acquisition, we may borrow funds, thereby increasing our leverage and diminishing our liquidity, or raise additional capital, which could dilute the interests of our existing stockholders; and
·  
We have completed various acquisitions and opened additional banking offices in the past few years that enhanced our rate of growth. We may not be able to continue to sustain our past rate of growth or to grow at all in the future.
 
Our growth or future losses may require us to raise additional capital in the future, but that capital may not be available when it is needed or the cost of that capital may be very high.
 
We are required by federal and state regulatory authorities to maintain adequate levels of capital to support our operations. We anticipate that our capital resources will satisfy our capital requirements for the foreseeable future. We may at some point need to raise additional capital to support continued growth or losses, both internally and through acquisitions. Any capital we obtain may result in the dilution of the interests of existing holders of our common stock.
 
Our ability to raise additional capital, if needed, will depend on conditions in the capital markets at that time, which are outside our control, and on our financial condition and performance. Accordingly, we cannot make assurances of our ability to raise additional capital if needed, or if the terms will be acceptable to us. If we cannot raise additional capital when needed, our ability to further expand our operations through internal growth and acquisitions could be materially impaired and our financial condition and liquidity could be materially and negatively affected.
 
Conditions in the financial markets may limit our access to additional funding to meet our liquidity needs.
 
Liquidity is essential to our business, as we must maintain sufficient funds to respond to the needs of depositors and borrowers. An inability to raise funds through deposits, borrowings, the sale or pledging as collateral of loans and other assets could have a substantial negative effect on our liquidity. Our access to funding sources in amounts adequate to finance our activities could be impaired by factors that affect us specifically or the financial services industry in general. Factors that could negatively affect our access to liquidity sources include a decrease in the level of our business activity due to a market downturn or negative regulatory action against us. Our ability to borrow could also be impaired by factors that are not specific to us, such as severe disruption of the financial markets or negative news and expectations about the prospects for the financial services industry as a whole, as evidenced by recent turmoil in the domestic and worldwide credit markets.
 
Our wholesale funding sources may prove insufficient to replace deposits or support our future growth.
 
As a part of our liquidity management, we use a number of funding sources in addition to core deposit growth and repayments and maturities of loans and investments. These sources include brokered certificates of deposit, repurchase agreements, federal funds purchased, Federal Reserve term auction funds and Federal Home Loan Bank advances. Negative operating results or changes in industry conditions could lead to an inability to replace these additional  funding sources at maturity. Our financial flexibility could be constrained if we are unable to maintain our access to funding or if adequate financing is not available to accommodate future growth at acceptable interest rates. Finally, if we are required to rely more heavily on more expensive funding sources to support future growth, our revenues may not increase proportionately to cover our costs. In this case, our results of operations and financial condition would be negatively affected.
 
21

 
Since our business is concentrated in the Chicago metropolitan area, a further decline in the economy of this area may negatively affect our business.
 
Except for our 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. Deterioration in the real estate markets where collateral for a mortgage loan is located could negatively affect the borrower's ability to repay the loan and the value of the collateral securing the loan. Real estate values are affected by various other factors, including changes in general or regional economic conditions, governmental rules or policies and natural disasters such as tornados.
 
Negative changes in the regional and general economy could reduce our growth rate, impair our ability to collect loans and generally have a negative effect on our financial condition and results of operations.
 
The soundness of other financial institutions could negatively affect us.
 
Our ability to engage in routine funding and other transactions could be negatively affected by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships. Defaults by, or even rumors or questions about, one or more financial services institutions, or the financial services industry generally, have led to market-wide liquidity problems and losses of depositor, creditor and counterparty confidence and could lead to losses or defaults by us or by other institutions. We could experience increases in deposits and assets as a result of the difficulties or failures of other banks, which would increase the capital we need to support our growth.
 
Non-compliance with the USA PATRIOT Act, Bank Secrecy Act, or other laws and regulations could result in fines or sanctions.
 
The USA PATRIOT and Bank Secrecy Acts require financial institutions to develop programs to prevent financial institutions from being used for money laundering and terrorist activities. If such activities are detected, financial institutions are obligated to file suspicious activity reports with the U.S. Treasury's Office of Financial Crimes Enforcement Network. These rules require financial institutions to establish procedures for identifying and verifying the identity of customers seeking to open new financial accounts. Failure to comply with these regulations could result in fines or sanctions. During the last year, several banking institutions have received large fines for non-compliance with these laws and regulations. Although we have developed policies and procedures designed to assist in compliance with these laws and regulations, no assurance can be given that these policies and procedures will be effective in preventing violations of these laws and regulations.
 
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 stockholders. These regulations may sometimes impose significant limitations on operations. The significant federal and state banking regulations that affect us are described in this report under the heading “Item 1. Business-Supervision and Regulation”. These regulations, along with the currently existing tax, accounting, securities, insurance, and monetary laws, regulations, rules, standards, policies, and interpretations control the methods by which financial institutions conduct business, implement strategic initiatives and tax compliance, and govern financial reporting and disclosures. These laws, regulations, rules, standards, policies, and interpretations are constantly evolving and may change significantly over time.
 
Significant legal actions could subject us to substantial liabilities.
 
We are from time to time subject to claims related to our operations. These claims and legal actions, including supervisory actions by our regulators, could involve large monetary claims and significant defense costs. As a result, we may be exposed to substantial liabilities, which could negatively affect our results of operations and financial condition.
 
22

 
The loss of certain key personnel could negatively affect our operations.
 
Our success depends in large part on the retention of a limited number of key management, 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.
 
As a result of our participation in the TARP Capital Purchase Program, we are subject to significant restrictions on compensation payable to our executive officers and other key employees.
 
Our ability to attract and retain key officers and employees may be impacted by legislation and regulation affecting the financial services industry. In 2009, the American Recovery and Reinvestment Act (the “ARRA”) became law. The ARRA, through the implementing regulations of the U.S. Treasury, significantly expanded the executive compensation restrictions originally imposed on TARP participants, including us. Among other things, these restrictions limit our ability to pay bonuses and other incentive compensation and make severance payments. These restrictions will continue to apply to us for as long as the preferred stock we issued pursuant to the TARP Capital Purchase Program remains outstanding. These restrictions may negatively affect our ability to compete with financial institutions that are not subject to the same limitations.
 
We may experience future goodwill impairment.
 
If our estimates of the fair value of our goodwill change as a result of changes in our business or other factors, we may determine that an impairment charge is necessary. Estimates of fair value are based on a complex model using, among other things, cash flows and company comparisons.  To the extent our market capitalization (market value of total common shares outstanding) is less than the book value of our total stockholders’ equity, 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.
 
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. In addition, increased competition among financial services companies due to the recent consolidation of certain competing financial institutions and the conversion of certain investment banks to bank holding companies may negatively affect our ability to successfully market our products and services. As a result, these competitors have certain advantages over us in accessing funding and in providing various services.
 
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.
 
23


Item 1B.  Unresolved Staff Comments

None.

Item 2.  Properties

We conduct our business at 87 retail banking center locations, with 86 in the Chicago metropolitan area and one in Philadelphia, Pennsylvania.  We own 52 of our banking center facilities.  The other facilities are leased for various terms.  All of our branches have ATMs, and we have 17 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.  See Note 8 of the notes to our consolidated financial statements for additional information regarding our premises and equipment.

We also have non-bank office locations in Chicago, Illinois, Paramus, New Jersey, Troy, Michigan, Columbus, Ohio, and Freeport, The Bahamas.  The Chicago office is used as the headquarters for Cedar Hill.  The Paramus location is a lease banking services office.  The Troy and Columbus locations are LaSalle sales offices.  The Freeport office houses the headquarters for MBRE Holdings LLC.  None of these locations provide banking services to our customers.

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

Item 3.  Legal Proceedings

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

Item 4.  Reserved

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 1,640 holders of record of our common stock as of December 31, 2009.
 
The following table presents quarterly market price information and cash dividends paid per share for our common stock for 2009 and 2008:
 
 
Market Price Range
   
High
 
Low
 
Dividends Paid
2009
           
Quarter ended December 31, 2009
 
 $   21.77
 
 $   16.67
 
 $     0.01
Quarter ended September 30, 2009
 
 $   21.45
 
 $     9.95
 
 $     0.01
Quarter ended June 30, 2009
 
 $   17.44
 
 $     9.25
 
 $     0.01
Quarter ended March 31, 2009
 
 $   28.04
 
 $     9.77
 
 $     0.12
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
 
24

 
The timing and amount of cash dividends paid depends on our earnings, capital requirements, financial condition and other relevant factors.  In this regard, after reviewing these factors and giving consideration to the current economic environment, we reduced our quarterly common stock cash dividend to $0.12 per share in the first quarter of 2009 and to $0.01 per share in the second quarter of 2009.  The primary source for dividends paid to stockholders is dividends paid to us from MB Financial Bank.  We have an internal policy which provides that dividends paid to us by MB Financial Bank cannot exceed an amount that would cause the bank’s total risk-based capital, Tier 1 risk-based capital and Tier 1 leverage capital ratios to fall below 12%, 9% and 7%, respectively.  These ratios are in excess of the minimum ratios required for a bank to be considered “well capitalized” for regulatory purposes (10%, 6% and 5%, respectively).  In addition to adhering to our internal policy, there are regulatory restrictions on the ability of national banks to pay dividends.  See “Item 1. Business - Supervision and Regulation - Dividends” above and Note 18 of notes to consolidated financial statements contained in Item 8 of this report.

The following table sets forth information for the three months ended December 31, 2009 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, 2009 – October 31, 2009
68
 
$   21.73
 
-
 
-
November 1, 2009 – November 30, 2009
-
 
-
 
-
 
-
December 1, 2009 – December 31, 2009
-
 
-
 
-
 
-
Total
68
 
$   21.73
 
-
   

(1)  
Represents shares of stock withheld upon vesting of restricted shares and exercise of stock options 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 amount of $1,000 per share, for a purchase price of $196.0 million in cash and issued to Treasury a ten-year warrant to purchase 1,012,048 shares of the Company’s common stock at an exercise price of $29.05 per share (the “Warrant”).  As explained below, the number of shares underlying the Warrant has been reduced to 506,024.

The Company may redeem the Series A Preferred Stock at any time by repaying Treasury, without penalty, subject to Treasury’s consultation with the Company’s appropriate regulatory agency.  Additionally, upon redemption of the Series A Preferred Stock, the Warrant may be repurchased from Treasury at its fair market value as agreed-upon by the Company and Treasury.
 
On September 17, 2009, the Company completed a public offering of its common stock by issuing 12,578,125 shares of common stock for aggregate gross proceeds of $201.3 million.  The net proceeds to the Company after deducting underwriting discounts and commissions and offering expenses were approximately $190.9 million.  With the proceeds from this offering and the proceeds received by the Company from issuances pursuant to its Dividend Reinvestment and Stock Purchase Plan, the Company received aggregate gross proceeds from “Qualified Equity Offerings” in excess of the $196.0 million aggregate liquidation preference amount of the Series A Preferred Stock.  As a result, the number of shares of the Company’s common stock underlying the Warrant was reduced by 50%, from 1,012,048 shares to 506,024 shares.

The securities purchase agreement between us and Treasury provides that prior to the earlier of (i) December 5, 2011 and (ii) the date on which all of the shares of the Series A Preferred Stock have been redeemed by us or transferred by Treasury to third parties, we may not, without the consent of Treasury, (a) pay a cash dividend on our common stock of more than $0.18 per share or (b) subject to limited exceptions, redeem, repurchase or otherwise acquire shares of our common stock or preferred stock, other than the Series A Preferred Stock, or trust preferred securities.  In addition, under the terms of the Series A Preferred Stock, we may not pay dividends on our common stock unless we are current in our dividend payments on the Series A Preferred Stock.   Dividends on the Series A Preferred Stock are payable quarterly at a rate of 5% per annum for the first five years and a rate of 9% per annum thereafter if not redeemed prior to that time.
 
25

 
Stock Performance Presentation

The following line graph shows a comparison of the cumulative returns for the Company, the NASDAQ Market Bank Index, an index of peer corporations selected by the Company and the NASDAQ Composite Index, for the period beginning December 31, 2004 and ending December 31, 2009.  The information assumes that $100 was invested at the closing price on December 31, 2004 in the Common Stock and each index, and that all dividends were reinvested.

COMPARISON OF 5-YEAR CUMULATIVE TOTAL RETURN
AMONG MB FINANCIAL, INC.,
NASDAQ BANK INDEX, PEER GROUP INDEX AND NASDAQ COMPOSITE INDEX
 
               Graphic - Total Return Performance
 
 
   
Fiscal Year Ending
 
Index
12/31/2004
12/31/2005
12/31/2006
12/31/2007
12/31/2008
12/31/2009
MB Financial, Inc.
100.00
85.21
92.22
77.16
71.77
51.13
NASDAQ Bank Index
100.00
95.67
106.20
82.76
62.96
51.31
Peer Group Index*
100.00
101.40
106.01
78.91
48.21
28.56
NASDAQ Composite
100.00
101.37
111.03
121.92
72.49
104.31

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

26

 
Item 6.  Selected Financial Data

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

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

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

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

Our summary consolidated financial information and other financial data contain information determined by methods other than in accordance with 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; efficiency ratio, with net gains and losses on securities available for sale, net gains and losses on sale of assets, and acquisition related gains excluded from  the non-interest income component of this ratio and the FDIC special assessment expense, contributions to MB Financial Charitable Foundation, executive separation agreement expense, unamortized issuance costs related to redemption of trust preferred securities and impairment charges excluded from the non-interest expense component of this ratio; ratios of tangible equity to assets, tangible common equity to assets, and tangible common equity to risk-weighted assets; and tangible book value per common share.  Our management uses these non-GAAP measures in its analysis of our performance.  The tax equivalent adjustment to net interest income recognizes the income tax savings when comparing taxable and tax-exempt assets and assumes a 35% tax rate.  Management believes that it is a standard practice in the banking industry to present net interest income and net interest margin on a fully tax equivalent basis, and accordingly believes that providing these measures may be useful for peer comparison purposes.  Management also believes that by excluding net gains and losses on securities available for sale, net gains and losses on sale of assets, and acquisition related gains from the non-interest income component and the FDIC special assessment expense and impairment charges from other non-interest expense of the efficiency, this ratio better reflects our operating performance.  The other measures exclude the ending balances of acquisition-related goodwill and other intangible assets, net of tax benefit, in determining tangible 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.
 
Reconciliations of net interest margin on a fully tax equivalent basis to net interest margin, efficiency ratio as adjusted to efficiency ratio, and tangible common book value per common share to common book value per common share are contained in the “Selected Financial Data” discussed below.

27

 
Selected Financial Data:


 
As of or for the Year Ended December 31,
   
2009 (1)
 
2008
 
2007
 
2006 (2)
 
2005
Statement of Income Data:
                   
Interest income
 
 $       393,538
 
 $      413,788
 
 $     457,266
 
 $     374,371
 
 $      274,522
Interest expense
 
 142,986
 
 192,900
 
 244,960
 
 186,192
 
 105,689
Net interest income
 
 250,552
 
 220,888
 
 212,306
 
 188,179
 
 168,833
Provision for loan losses
 
 231,800
 
 125,721
 
 19,313
 
 10,100
 
 8,150
Net interest income after provision for loan losses
 
 18,752
 
 95,167
 
 192,993
 
 178,079
 
 160,683
Other income
 
 127,154
 
 80,393
 
 83,528
 
 64,376
 
 57,822
Other expenses
 
 223,750
 
 183,390
 
 191,506
 
 152,218
 
 131,155
Income (loss) before income taxes
 
 (77,844)
 
 (7,830)
 
 85,015
 
 90,237
 
 87,350
Applicable income tax expense (benefit)
 
 (45,265)
 
 (23,555)
 
 23,670
 
 27,238
 
 26,641
Income (loss) from continuing operations
 
 (32,579)
 
 15,725
 
 61,345
 
 62,999
 
 60,709
Income from discontinued operations, net of income tax
 
 6,453
 
 439
 
 32,518
 
 4,115
 
 4,045
Net income (loss)
 
 (26,126)
 
 16,164
 
 93,863
 
 67,114
 
 64,754
Dividends on preferred shares
 
 10,298
 
 789
 
 -
 
 -
 
 -
Net income (loss) available to common shareholders
 
 $      (36,424)
 
 $        15,375
 
 $       93,863
 
 $       67,114
 
 $        64,754
                     
Common Share Data:
                   
Basic earnings (loss) per common share from continuing operations
 
 $          (0.81)
 
 $            0.45
 
 $           1.70
 
 $           2.02
 
 $            2.13
Basic earnings per common share from discontinued operations
 
 0.16
 
 0.01
 
 0.91
 
 0.13
 
 0.14
Impact of preferred stock dividends on basic earnings (loss) per common share
 
 (0.26)
 
 (0.02)
 
 -
 
 -
 
 -
Basic earnings (loss) per common share
 
 (0.91)
 
 0.44
 
 2.61
 
 2.15
 
 2.27
Diluted earnings (loss) per common share from continuing operations
 
 (0.81)
 
 0.45
 
 1.68
 
 1.99
 
 2.10
Diluted earnings per common share from discontinued operations
 
 0.16
 
 0.01
 
 0.89
 
 0.13
 
 0.14
Impact of preferred stock dividends on diluted earnings (loss) per common share
 
 (0.26)
 
 (0.02)
 
 -
 
 -
 
 -
Diluted earnings (loss) per common share
 
 (0.91)
 
 0.44
 
 2.57
 
 2.12
 
 2.24
Common book value per common share
 
 20.75
 
 25.17
 
 24.91
 
 23.10
 
 17.81
Less: goodwill and other tangible assets, net of tax benefit, per common share
 
 8.07
 
 11.56
 
 11.43
 
 10.85
 
 4.66
Tangible common book value per common share
 
 12.68
 
 13.61
 
 13.48
 
 12.25
 
 13.15
Weighted average common shares outstanding:
                   
Basic
 
 40,042,655
 
 34,706,092
 
 35,919,900
 
 31,156,887
 
 28,480,909
Diluted
 
 40,042,655
 
 35,061,712
 
 36,439,561
 
 31,687,220
 
 28,895,042
Dividend payout ratio (3)
 
NM
 
163.64%
 
27.59%
 
30.70%
 
24.63%
Cash dividends per common share
 
 $             0.15
 
 $            0.72
 
 $           0.72
 
 $           0.66
 
 $            0.56
 
(1)  
In 2009 we completed four FDIC-assisted transactions.  See Note 2 in the notes to consolidated financial statements contained under Item 8. Financial Statements and Supplementary Data.
(2)  
In 2006 we acquired First Oak Brook Bancshares, Inc.
(3)  
Not meaningful, due to our net loss for 2009.
 
28

 
Selected Financial Data (continued):
   
As of or for the Year Ended December 31,
(Dollars in thousands)
 
2009
 
2008
 
2007
 
2006
 
2005
                     
Balance Sheet Data:
                   
Cash and due from banks
 
$     136,763
 
$       79,824
 
$     141,248
 
$     142,207
 
$       82,751
Investment securities
 
2,913,594
 
1,400,376
 
1,241,385
 
1,628,348
 
1,316,149
Loans, gross
 
6,524,547
 
6,228,563
 
5,615,627
 
4,971,494
 
3,480,447
Allowance for loan losses
 
177,072
 
144,001
 
65,103
 
58,983
 
42,290
Assets held for sale
 
-
 
-
 
-
 
393,608
 
370,103
Total assets
 
10,865,393
 
8,819,763
 
7,834,703
 
7,978,298
 
5,719,065
Deposits
 
8,683,276
 
6,495,571
 
5,513,783
 
5,580,553
 
3,906,212
Short-term and long-term borrowings
 
323,917
 
960,085
 
1,186,586
 
934,384
 
771,088
Junior subordinated notes issued to capital trusts
 
158,677
 
158,824
 
159,016
 
179,162
 
123,526
Liabilities held for sale
 
-
 
-
 
-
 
361,008
 
341,988
Stockholders’ equity
 
1,251,180
 
1,068,824
 
862,369
 
846,952
 
506,986
      Less: goodwill
 
387,069
 
387,069
 
379,047
 
379,047
 
125,010
      Less: other intangible assets, net of tax benefit
 
24,510
 
16,754
 
16,479
 
18,756
 
8,186
Tangible equity
 
839,601
 
665,001
 
466,843
 
449,149
 
373,790
      Less: preferred stock
 
193,522
 
193,025
 
-
 
-
 
-
Tangible common equity
 
646,079
 
471,976
 
466,843
 
449,149
 
373,790
                     
Performance Ratios:
                   
Return on average assets
 
(0.27%)
 
0.20%
 
1.19%
 
1.02%
 
1.17%
Return on average common equity
 
(3.91%)
 
1.74%
 
11.03%
 
10.70%
 
13.15%
Net interest margin (1)
 
2.85%
 
3.03%
 
3.22%
 
3.41%
 
3.63%
Tax equivalent effect
 
0.12%
 
0.13%
 
0.11%
 
0.11%
 
0.11%
Net interest margin – fully tax equivalent basis (1)
 
2.97%
 
3.16%
 
3.33%
 
3.52%
 
3.74%
Efficiency ratio (2)
 
62.44%
 
58.94%
 
60.29%
 
58.92%
 
56.07%
Loans to deposits
 
75.14%
 
95.89%
 
101.85%
 
89.09%
 
89.10%
                     
Asset Quality Ratios:
                   
Non-performing loans to total loans (3)
 
4.16%
 
2.34%
 
0.44%
 
0.43%
 
0.58%
Non-performing assets to total assets (4)
 
2.84%
 
1.71%
 
0.33%
 
0.31%
 
0.36%
Allowance for loan losses to total loans
 
2.71%
 
2.31%
 
1.16%
 
1.19%
 
1.22%
Allowance for loan losses to non-performing loans (3)
 
65.26%
 
98.67%
 
266.17%
 
274.75%
 
209.66%
Net loan charge-offs to average loans
 
3.09%
 
0.79%
 
0.25%
 
0.24%
 
0.24%
                     
Liquidity and Capital Ratios:
                   
Tier 1 capital to risk -weighted assets
 
13.51%
 
12.07%
 
9.75%
 
10.49%
 
11.70%
Total capital to risk -weighted assets
 
15.45%
 
14.08%
 
11.58%
 
11.80%
 
12.91%
Tier 1 capital to average assets
 
8.71%
 
9.85%
 
8.18%
 
8.39%
 
9.08%
Average equity to average assets
 
11.51%
 
10.90%
 
10.76%
 
9.50%
 
8.93%
Tangible equity to assets (5)
 
8.03%
 
7.90%
 
6.28%
 
5.93%
 
6.69%
Tangible common equity to assets (6)
 
6.18%
 
5.61%
 
6.28%
 
5.93%
 
6.69%
 Tangible common equity to risk-weighted assets (7)  
8.83%
  7.10%   7.40%   7.47%   8.70%
                     
Other:
                   
Banking facilities
 
87
 
72
 
73
 
70
 
45
Full time equivalent employees (8)
 
1,638
 
1,342
 
1,282
 
1,380
 
1,123
 
(1)  
Net interest margin represents net interest income from continuing operations as a percentage of average interest earning assets.
(2)  
Equals total other expense excluding FDIC special assessment, contributions to the MB Financial Charitable Foundation, executive separation agreement expense, unamortized issuance costs related to redemption of trust preferred securities, and impairment charges 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, net gains (losses) on sale of other assets, and acquisition related gains.
(3)  
Non-performing loans include loans accounted for on a non-accrual basis, accruing loans contractually past due 90 days or more as to interest or principal and loans the terms of which have been renegotiated to provide reduction or deferral of interest or principal because of a deterioration in the financial position of the borrower.  Non-performing loans excludes purchased credit-impaired loans that were acquired as part of the Heritage, InBank, Corus, and Benchmark FDIC-assisted transactions.  See Note 6 in the notes to consolidated financial statements contained under Item 8. Financial Statements and Supplementary Data.
(4)  
Non-performing assets include non-performing loans, other real estate owned and other repossessed assets.  Non-performing assets exclude other real estate owned that is related to the Heritage, InBank, and Benchmark FDIC-assisted transactions.  See Note 2 in the notes to consolidated financial statements contained under Item 8. Financial Statements and Supplementary Data.
(5)  
Equals total ending shareholders’ equity less goodwill and other intangibles, net of tax benefit, divided by total assets less goodwill and other intangibles, net of tax benefit.
(6)  
Equals total ending shareholders’ equity less preferred stock, goodwill and other intangibles, net of tax benefit, divided by total assets less goodwill and other intangibles, net of tax benefit.
(7)  
Equals total ending shareholders’ equity less preferred stock, goodwill and other intangibles, net of tax benefit, divided by risk-weighted assets.
(8)  
Includes Union Bank employees for 2006 and 2005 and employees of our merchant card processing business for all years shown.
 
29


Selected Financial Data (continued):

Efficiency Ratio Calculation (Dollars in Thousands)
 
     
2009
2008
2007
2006
2005
Non-interest expense
 $   223,750
 $   183,390
 $   191,506
 $   152,218
 $   131,155
Less FDIC special assessment
 3,850
 -
 -
 -
 -
Less contributions to MB Financial Charitable Foundation
 -
 -
 4,500
 -
 -
Less executive separation agreement expense
 -
 -
 5,908
 -
 -
Less unamortized issuance costs related to redemption
         
 
of trust preferred securities
 -
 -
 1,914
 -
 -
Less impairment charges
 4,000
 -
 -
 -
 -
 
Non-interest expense - as adjusted
 $   215,900
 $   183,390
 $   179,184
 $   152,218
 $   131,155
               
Net interest income
 $   250,552
 $   220,888
 $   212,306
 $   188,179
 $   168,833
Tax equivalent adjustment
 10,625
 9,890
 7,728
 6,191
 5,185
Net interest income on a fully tax equivalent basis
 261,177
 230,778
 220,034
 194,370
 174,018
Plus other income
 127,154
 80,393
 83,528
 64,376
 57,822
Less net gains (losses) on securities available for sale
 14,029
 1,130
 (3,744)
 (445)
 (2,077)
Less net gains (losses) on sale of other assets
 (13)
 (1,104)
 10,097
 860
 20
Less acquisition related gains
 28,547
 -
 -
 -
 -
Net interest income plus non-interest income -
         
 
as adjusted
 $   345,768
 $   311,145
 $   297,209
 $   258,331
 $   233,897
               
Efficiency ratio
62.44%
58.94%
60.29%
58.92%
56.07%
               
Efficiency ratio (without adjustments)
59.24%
60.87%
64.73%
60.27%
57.87%

The following table sets forth our selected quarterly financial data (in thousands, except common share data):
 
 
Three Months Ended 2009
Three Months Ended 2008
Statement of Income Data:
December
September
June
March
December
September
June
March
Interest income
 $       110,250
 $        93,609
 $       93,864
 $          95,815
 $      101,535
 $      103,061
 $     101,390
 $      107,802
Interest expense
 36,049
 32,675
 34,475
 39,787
 46,789
 46,455
 45,317
   54,339
                 
Net interest income
 74,201
 60,934
 59,389
 56,028
 54,746
 56,606
 56,073
 53,463
Provision for loan losses
 70,000
 45,000
 27,100
 89,700
 72,581
 18,400
 12,200
 22,540
                 
Net interest income (loss) after provision for loan losses
 4,201
 15,934
 32,289
 (33,672)
 (17,835)
 38,206
 43,873
 30,923
                 
Other income
 42,927
 30,900
 24,925
 28,402
 17,603
 21,880
 20,916
 19,993
Other expenses
 61,072
 59,158
 54,508
 49,012
 44,011
 47,773
 47,665
 43,940
Income (loss) before income taxes
 (13,944)
 (12,324)
 2,706
 (54,282)
 (44,243)
 12,313
 17,124
 6,976
Income tax expense (benefit)
 (4,164)
 (13,596)
 (1,480)
 (26,025)
 (19,374)
 (743)
 (4,759)
 1,321
Income (loss) from continuing operations
 (9,780)
 1,272
 4,186
 (28,257)
 (24,869)
 13,056
 21,883
 5,655
Income from discontinued operations, net of income tax
 -
 6,172
 129
 152
 48
 98
 124
 169
Net income (loss)
 $         (9,780)
 $          7,444
 $          4,315
 $       (28,105)
 $      (24,821)
 $        13,154
 $       22,007
 $          5,824
Dividends on preferred shares
 2,591
 2,589
 2,587
 2,531
 789
 -
 -
 -
Net income (loss) available to common shareholders
 $       (12,371)
 $          4,855
 $          1,728
 $       (30,636)
 $      (25,610)
 $        13,154
 $       22,007
         $          5,824
                 
Net Interest Margin
2.74%
2.74%
3.05%
2.88%
2.86%
3.04%
3.11%
3.10%
Tax equivalent effect
0.12%
0.11%
0.13%
0.13%
0.14%
0.14%
0.14%
0.12%
Net interest margin on a fully tax equivalent basis
2.86%
2.85%
3.18%
3.01%
3.00%
3.18%
3.25%
3.22%
                 
Common Share Data :
               
Basic earnings (loss) per common share from continuing operations
 $           (0.19)
 $            0.03
 $            0.12
 $           (0.81)
 $          (0.72)
 $            0.38
 $           0.63
 $            0.16
Basic earnings per common share from discontinued operations
 $                   -
 $            0.16
 $            0.00
 $              0.00
 $             0.00
 $            0.00
 $           0.00
 $            0.00
Impact of preferred stock dividends on basic earnings (loss) per common share
 $           (0.05)
 $         (0.07)
 $         (0.07)
 $           (0.07)
 $          (0.02)
 $            0.00
 $                 -
 $                  -
Basis earnings (loss) per common share
 $           (0.25)
 $            0.12
 $            0.05
 $           (0.88)
 $          (0.74)
 $            0.38
 $           0.63
 $            0.17
Diluted earnings (loss) per common share from continuing operations
 $           (0.19)
 $            0.03
 $            0.12
 $           (0.81)
 $          (0.72)
 $            0.38
 $           0.62
 $            0.16
Diluted earnings per common share from discontinued operations
 $                   -
 $            0.16
 $            0.00
 $              0.00
 $             0.00
 $            0.00
 $           0.00
 $            0.00
Impact of preferred stock dividends on diluted earnings (loss) per common share
 $           (0.05)
 $         (0.07)
 $         (0.07)
 $           (0.07)
 $          (0.02)
 $            0.00
 $                 -
 $                  -
Diluted earnings (loss) per common share
 $           (0.25)
 $            0.12
 $            0.05
 $           (0.88)
 $          (0.74)
 $            0.38
 $           0.63
 $            0.17
                 
Weighted average common shares outstanding
 50,279,008
 39,104,894
 35,726,879
 34,914,012
 34,777,651
 34,732,633
 34,692,571
 34,620,435
Diluted weighted average common shares outstanding
 50,279,008
 39,299,168
 35,876,483
 34,914,012
 35,164,585
 35,074,297
 35,047,596
 34,994,731
 
30

 
Fourth Quarter Results

We had a net loss available to common shareholders of $12.4 million for the fourth quarter of 2009, compared to a net loss available to common shareholders of $25.6 million for the fourth quarter of 2008.  The results for the fourth quarter of 2009 generated annualized return on average assets of (0.33%), and an annualized return on average common equity of (4.54%), compared to (1.15%) and (11.38%), respectively, for the same period in 2008.

Net interest income increased 35.5% to $74.2 million in the fourth quarter of 2009, compared to $54.7 million for fourth quarter of 2008.  Our average interest earning assets increased by $3.1 billion from the fourth quarter of 2008 to the fourth quarter of 2009.  The increase in average interest earning assets was partially offset by a 14 basis point decrease in our net interest margin, on a fully tax equivalent basis.  Average interest earning assets increased primarily due to our FDIC assisted transactions during 2009.  See Note 2 in the notes to consolidated financial statements contained under Item 8. Financial Statements and Supplementary Data for additional information.

The provision for loan losses was $70.0 million in the fourth quarter of 2009 and $72.6 million in the fourth quarter of 2008.  Net charge-offs were $82.2 million in the fourth quarter of 2009 compared to $17.4 million in the fourth quarter of 2008.  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 $42.9 million during the fourth quarter of 2009, an increase of $25.3 million, or 143.9% compared to $17.6 million for the fourth quarter of 2008.  Deposit service fees increased from $7.5 million in the fourth quarter of 2008 to $9.3 million in the fourth quarter of 2009, primarily due to an increase in commercial deposit fees related to deposits assumed in our FDIC assisted transactions.  Net lease financing increased primarily due to an increase in the sales of third party equipment maintenance to customers.  During the fourth quarter of 2009 we recorded an $18.3 million gain relating to our FDIC assisted Benchmark transaction.  Other operating income increased primarily due to a decrease in market value of assets held in trust for deferred compensation.

Other expense increased $17.1 million or 38.8% to $61.1 million for the fourth quarter of 2009 from $44.0 million for the fourth quarter of 2008.  Our Heritage, InBank, Corus and Benchmark transactions increased salaries and employee benefits expense, occupancy and equipment expense, computer services expense, other intangible amortization expense, and FDIC insurance premiums by approximately $4.9 million, $1.8 million, $903 thousand, $993 thousand and $1.2 million, respectively.  Our Heritage, InBank, Corus and Benchmark transactions increased total other expense by approximately $11.2 million for the fourth quarter of 2009.  Additionally, FDIC insurance premium expense increased due to our FDIC credits being fully utilized during the fourth quarter of 2008, the FDIC increasing its assessment rate from the fourth quarter of 2008 to the fourth quarter of 2009, and our higher level of deposits in 2009.
 
Income tax benefit from continuing operations for the fourth quarter of 2009 was $4.2 million, compared to an income tax benefit from continuing operations of $19.4 million for the three months ended December 31, 2008.  See Note 16 of notes to consolidated financial statements contained in Item 8 of this report for further analysis of income taxes.
 
31


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 a net loss available to common shareholders of $36.4 million for the year ended December 31, 2009 compared to net income available to common shareholders of $15.4 million for the year ended December 31, 2008.  The decrease in earnings was primarily due to a $106.1 million increase in provision for loan losses.  Fully diluted earnings (loss) per common share were ($0.91) for the year ended December 31, 2009, compared to $0.44 per common share in 2008.

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.  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 (losses) on sale of other assets, acquisition related gains and other operating income.  Other expenses include salaries and employee benefits, occupancy and equipment expense, computer services expense, advertising and marketing expense, professional and legal expense, brokerage fee expense, telecommunication expense, other intangibles amortization expense, FDIC insurance premiums, charitable contributions, impairment charges 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 August 10, 2009, the Company sold its merchant card processing business, resulting in an after-tax gain of $6.2 million.

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 and the Company’s merchant card processing business, including the gains recognized on the sales, have been excluded from continuing operations.  See Note 3 of the notes to our consolidated financial statements for additional information on discontinued operations.

The Financial Accounting Standards Board’s (FASB) Accounting Standards Codification (ASC) became effective on July 1, 2009. At that date, the ASC became FASB’s officially recognized source of authoritative U.S. GAAP applicable to all public and non-public non-governmental entities, superseding existing FASB, American Institute of Certified Public Accountants (AICPA), Emerging Issues Task Force (EITF) and related literature. Rules and interpretive releases of the SEC under the authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. All other accounting literature is considered non-authoritative. The switch to the ASC affects the way companies refer to U.S. GAAP in financial statements and accounting policies. Citing particular content in the ASC involves specifying the unique numeric path to the content through the Topic, Subtopic, Section and Paragraph structure.
 
32

 
Critical Accounting Policies

Our consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of America and follow general practices within the industries in which we operate.  This preparation requires management to make estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes.  These estimates, assumptions, and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, actual results could differ from the estimates, assumptions, and judgments reflected in the financial statements.  Certain policies inherently have a greater reliance on the use of estimates, assumptions, and judgments and, as such, have a greater possibility of producing results that could be materially different than originally reported.  Management believes the following policies are both important to the portrayal of our financial condition and results of operations and require subjective or complex judgments; therefore, management considers the following to be critical accounting policies.  Management has reviewed the application of these polices with the Audit Committee of our Board of Directors.

Allowance for Loan Losses.  Subject to the use of estimates, assumptions, and judgments is management's evaluation process used to determine the adequacy of the allowance for loan losses, which combines several factors: management's ongoing review and grading of the loan portfolio, consideration of past loan loss experience, trends in past due and nonperforming loans, risk characteristics of the various classifications of loans, existing economic conditions, the fair value of underlying collateral, and other qualitative and quantitative factors which could affect probable credit losses.  Because current economic conditions can change and future events are inherently difficult to predict, the anticipated amount of estimated loan losses, and therefore the adequacy of the allowance, could change significantly.  As an integral part of their examination process, various regulatory agencies also review the allowance for loan losses.  Such agencies may require that certain loan balances be charged off when their credit evaluations differ from those of management or require that adjustments be made to the allowance for loan losses, based on their judgments about information available to them at the time of their examination.  We believe the allowance for loan losses is adequate and properly recorded in the financial statements.  See "Allowance for Loan Losses" section below for further analysis.

Residual Value of Our Direct Finance, Leveraged, and Operating Leases.  Lease residual value represents the present value of the estimated fair value of the leased equipment at the termination date of the lease.  Realization of these residual values depends on many factors, including management’s use of estimates, assumptions, and judgment to determine such values.  Several other factors outside of management’s control may reduce the residual values realized, including general market conditions at the time of expiration of the lease, whether there has been technological or economic obsolescence or unusual wear and tear on, or use of, the equipment and the cost of comparable equipment.  If, upon the expiration of a lease, we sell the equipment and the amount realized is less than the recorded value of the residual interest in the equipment, we will recognize a loss reflecting the difference.  On a quarterly basis, management reviews the lease residuals for potential impairment.  If we fail to realize our aggregate recorded residual values, our financial condition and profitability could be adversely affected.   At December 31, 2009, the aggregate residual value of the equipment leased under our direct finance, leveraged, and operating leases totaled $55.0 million.  See Note 1 and Note 7 of our audited consolidated financial statements for additional information.

Income Tax Accounting.  ASC Topic 740 provides guidance on accounting for income taxes by prescribing the minimum recognition threshold that a tax position must meet to be recognized in the financial statements.  ASC Topic 740 also provides guidance on measurement, recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.  As of December 31, 2009, the Company had $291 thousand of uncertain tax positions.  The Company elects to treat interest and penalties recognized for the underpayment of income taxes as income tax expense.  However, interest and penalties imposed by taxing authorities on issues specifically addressed in ASC Topic 740 will be taken out of the tax reserves up to the amount allocated to interest and penalties.  The amount of interest and penalties exceeding the amount allocated in the tax reserves will be treated as income tax expense.  As of December 31, 2009, the Company had approximately $50 thousand of accrued interest related to tax reserves.  The application of income tax law is inherently complex.  Laws and regulations in this area are voluminous and are often ambiguous.  As such, we are required to make many subjective assumptions and judgments regarding our income tax exposures.  Interpretations of and guidance surrounding income tax laws and regulations change over time.  As such, changes in our subjective assumptions and judgments can materially affect amounts recognized in the consolidated balance sheets and statements of income.

Fair Value of Assets and Liabilities.  ASC Topic 820 defines fair value as the price that would be received to sell the financial asset or paid to transfer the financial liability in an orderly transaction between market participants at the measurement date.
 
33

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

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

See Note 19 to the consolidated financial statements for a complete discussion on the Company’s use of fair valuation of assets and liabilities and the related measurement techniques.

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.

34


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,
 
2009
 
2008
 
2007
 
Average
 
Yield/
 
Average
 
Yield/
 
Average
 
Yield/
 
Balance
Interest
Rate
 
Balance
Interest
Rate
 
Balance
Interest
Rate
Interest Earning Assets:
                     
Loans (1) (2) (3)
 $   6,339,229
 $  326,293
5.15%
 
 $   5,892,845
 $  354,210
6.01%
 
 $   5,198,249
 $  392,526
7.55%
Loans exempt from federal income taxes (4)
 82,019
 7,658
9.21
 
 59,746
 4,408
7.26
 
 9,338
 754
7.96
Taxable investment securities
 1,444,552
 45,777
3.17
 
 868,700
 40,468
4.66
 
 1,037,129
 49,675
4.79
Investment securities exempt from federal income taxes (4)
 391,071
 22,698
5.72
 
 414,234
 23,849
5.66
 
 374,025
 21,326
5.62
Federal funds sold
 -
 -
 -
 
 12,849
 276
2.11
 
 8,853
 449
5.00
Other interest bearing deposits
 545,314
 1,737
0.32
 
 52,497
 467
0.89
 
 7,193
 264
3.67
     Total interest earning assets
 8,802,185
 $  404,163
4.59
 
 7,300,871
 $  423,678
5.80
 
 6,634,787
 $  464,994
7.01
Assets available for sale
 -
     
 -
     
 341,734
   
Non-interest earning assets
 975,103
     
 939,473
     
 934,089
   
     Total assets
 $   9,777,288
     
 $   8,240,344
     
 $   7,910,610
   
                       
Interest Bearing Liabilities:
                     
Deposits:
                     
  NOW and money market deposit
 $   2,098,530
 $    17,773
0.85%
 
 $   1,292,407
 $    23,176
1.79%
 
 $   1,213,001
 $   37,568
3.10%
  Savings deposit
 473,477
 1,717
0.36
 
 383,534
 1,239
0.32
 
 428,087
 3,051
0.71
  Time deposits
 3,725,326
 102,124
2.74
 
 3,426,332
 126,955
3.71
 
 2,986,964
 145,030
4.86
Short-term borrowings
 449,548
 5,166
1.15
 
 681,074
 17,590
2.58
 
 812,681
 37,354
4.60
Long-term borrowings and  junior subordinated notes
 512,267
 16,206
3.12
 
 581,026
 23,940
4.05
 
 364,441
 21,957
5.94
     Total interest bearing liabilities
 7,259,148
 $  142,986
1.97
 
 6,364,373
 $  192,900
3.03
 
 5,805,174
 $  244,960
4.22
Non-interest bearing deposits
 1,307,021
     
 891,072
     
 860,557
   
Liabilities held for sale
 -
     
 -
     
 313,414
   
Other non-interest bearing liabilities
 85,890
     
 85,368
     
 80,141
   
Stockholders’ equity
 1,125,229
     
 899,531
     
 851,324
   
     Total liabilities and stockholders’ equity
 $   9,777,288
     
 $   8,240,344
     
 $   7,910,610
   
     Net interest income/interest rate spread (5)
 
 $  261,177
2.62%
   
 $  230,778
2.77%
   
 $  220,034
2.79%
     Taxable equivalent adjustment
 
 (10,625)
     
 (9,890)
     
 7,728
 
     Net interest income, as reported
 
 $  250,552
     
 $  220,888
     
 $  212,306
 
     Net interest margin  (6)
   
2.85%
     
3.03%
     
3.20%
     Tax equivalent effect
   
0.12%
     
0.13%
     
0.12%
     Net interest margin on a fully tax equivalent basis (6)
   
2.97%
     
3.16%
     
3.32%

(1)  
Non-accrual loans are included in average loans.
(2)  
Interest income includes amortization of deferred loan origination fees of $5.1 million, $7.0 million and $6.7 million for the years ended December 31, 2009, 2008 and 2007, respectively.
(3)  
Loans held for sale are included in the average loan balance listed.  Related interest income is included in loan interest income.
(4)  
Non-taxable loan and investment income is presented on a fully tax equivalent basis assuming a 35% tax rate.
(5)  
Interest rate spread represents the difference between the average yield on interest earning assets and the average cost of interest bearing liabilities and is presented on a fully tax equivalent basis.
(6)  
Net interest margin represents net interest income as a percentage of average interest earning assets.

Net interest income on a tax equivalent basis was $261.2 million for the year ended December 31, 2009, an increase of $30.4 million, or 13.2% from $230.8 million for the comparable period in 2008.  The growth in net interest income reflects a $1.5 billion, or 20.6%, increase in average interest earning assets, and an $894.8 million, or 14.1%, increase in average interest bearing liabilities.  This was partially offset by approximately 19 basis points of margin compression on a fully tax equivalent basis.  The increase in average interest earning assets and the increase in average interest bearing liabilities was primarily due to interest earning assets acquired and interest bearing liabilities assumed in four FDIC assisted transactions during 2009.  See Note 2 in the notes to consolidated financial statements contained under Item 8. Financial Statements and Supplementary Data.  The net interest margin, expressed on a fully tax equivalent basis, was 2.97% for 2009 and 3.16% for 2008.  Our non-performing loans negatively impacted the net interest margin during 2009 and 2008 by approximately 15 basis points, and 9 basis points, respectively.
 
35

 
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 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.

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,
   
2009 Compared to 2008
 
2008 Compared to 2007
   
Change
 
Change
     
Change
 
Change
   
   
Due to
 
Due to
 
Total
 
Due to
 
Due to
 
Total
   
Volume
 
Rate
 
Change
 
Volume
 
Rate
 
Change
Interest Earning Assets:
                       
Loans
 
 $   27,016
 
 $   (54,933)
 
 $   (27,917)
 
 $   47,821
 
 $   (86,137)
 
 $   (38,316)
Loans exempt from federal income taxes (1)
 
 1,899
 
 1,351
 
 3,250
 
 3,725
 
 (71)
 
 3,654
Taxable investment securities
 
 21,039
 
 (15,730)
 
 5,309
 
 (7,878)
 
 (1,329)
 
 (9,207)
Investment securities exempt from federal income taxes (1)
 
 (1,343)
 
 192
 
 (1,151)
 
 2,313
 
 210
 
 2,523
Federal funds sold
 
 (138)
 
 (138)
 
 (276)
 
 152
 
 (325)
 
 (173)
Other interest bearing deposits
 
 1,750
 
 (480)
 
 1,270
 
 538
 
 (335)
 
 203
Total increase (decrease) in interest income
 
 50,223
 
 (69,738)
 
 (19,515)
 
 46,671
 
 (87,987)
 
 (41,316)
                         
Interest Bearing Liabilities:
                       
Deposits
                       
   NOW and money market deposit accounts
 
 10,323
 
 (15,726)
 
 (5,403)
 
 2,320
 
 (16,712)
 
 (14,392)
   Savings deposits
 
 314
 
 164
 
 478
 
 (290)
 
 (1,522)
 
 (1,812)
   Time deposits
 
 10,354
 
 (35,185)
 
 (24,831)
 
 19,397
 
 (37,472)
 
 (18,075)
Short-term borrowings
 
 (4,719)
 
 (7,705)
 
 (12,424)
 
 (5,334)
 
 (14,430)
 
 (19,764)
Long-term borrowings and junior subordinated notes
 
 (2,611)
 
 (5,123)
 
 (7,734)
 
 10,356
 
 (8,373)
 
 1,983
Total (decrease) increase in interest expense
 
 13,661
 
 (63,575)
 
 (49,914)
 
 26,449
 
 (78,509)
 
 (52,060)
Total increase (decrease) in net interest income
 
 $   36,562
 
 $     (6,163)
 
 $      30,399
 
 $   20,222
 
 $     (9,478)
 
 $     10,744

(1)  
Non-taxable loan and investment income is presented on a fully tax equivalent basis assuming a 35% rate.
 
36

 
Other Income
 
     
Year Ended
     
     
December 31,
December 31,
 
Increase/
Percentage
     
2009
2008
 
(Decrease)
Change
Other income (in thousands):
         
 
Loan service fees
$               6,913
$               9,180
 
$      (2,267)
(25%)
 
Deposit service fees
30,600
28,225
 
2,375
8%
 
Lease financing, net
18,528
16,973
 
1,555
9%
 
Brokerage fees
4,606
4,317
 
289
7%
 
Trust and asset management fees
12,593
11,869
 
724
6%
 
Net gain on sale of investment securities
14,029
1,130
 
12,899
1,142%
 
Increase in cash surrender value of life insurance
2,459
5,299
 
(2,840)
(54%)
 
Net loss on sale of other assets
(13)
(1,104)
 
1,091
(99%)
 
Acquisition related gains
28,547
-
 
28,547
N/A
 
Other operating income
8,892
4,504
 
4,388
97%
Total other income
$           127,154
$             80,393
 
$       46,761
58%
 
Other income increased from the year ended December 31, 2009 to the year ended December 31, 2008 primarily due to gains recognized on the FDIC assisted transactions during 2009, totaling $28.5 million, as well as a net gain on sale of investment securities of $14.0 million compared with a net gain on sale of investment securities of $1.1 million during the year ended December 31, 2008.  Loan service fees decreased, primarily due to a decrease in letter of credit and prepayment fees.  The decrease in cash surrender value of life insurance was primarily due to a decrease in overall interest rates from the year ended December 31, 2008 to the year ended December 31, 2009, and $1.4 million of death benefits on bank owned life insurance policies that we recognized during the year ended December 31, 2008.  Other operating income increased primarily due to an increase in gains recognized on the sale of loans, and an increase in market value of assets held in trust for deferred compensation during the year ended December 31, 2009.
 
     
Year Ended
     
     
December 31,
December 31,
 
Increase/
Percentage
     
2008
2007
 
(Decrease)
Change
Other income (in thousands):
         
 
Loan service fees
$               9,180
$               6,258
 
$         2,922
47%
 
Deposit service fees
28,225
23,918
 
4,307
18%
 
Lease financing, net
16,973
15,847
 
1,126
7%
 
Brokerage fees
4,317
9,581
 
(5,264)
(55%)
 
Trust and asset management fees
11,869
10,447
 
1,422
14%
 
Net gain (loss) on sale of investment securities
1,130
(3,744)
 
4,874
(130%)
 
Increase in cash surrender value of life insurance
5,299
5,003
 
296
6%
 
Net (loss) gain on sale of other assets
(1,104)
10,097
 
(11,201)
(111%)
 
Acquisition related gains
-
-
 
-
N/A
 
Other operating income
4,504
6,121
 
(1,617)
(26%)
Total other income
$             80,393
$             83,528
 
$      (3,135)
(4%)
 
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 of investment securities during the year ended December 31, 2008, compared to a $3.7 million loss on the sale of investment securities for the comparable period in 2007.  Deposit service fees increased 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 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.

37

 
Other Expenses
 
     
Year Ended
     
     
December 31,
December 31,
 
Increase/
Percentage
     
2009
2008
 
(Decrease)
Change
Other expense (in thousands):
         
 
Salaries and employee benefits
 $   120,654
 $   108,835
 
 $   11,819
11%
 
Occupancy and equipment expense
 31,521
 28,872
 
 2,649
9%
 
Computer services expense
 10,011
 7,392
 
 2,619
35%
 
Advertising and marketing expense
 4,185
 5,089
 
 (904)
(18%)
 
Professional and legal expense
 4,680
 3,110
 
 1,570
50%
 
Brokerage fee expense
 1,999
 1,929
 
 70
4%
 
Telecommunication expense
 3,433
 2,818
 
 615
22%
 
Other intangibles amortization expense
 4,491
 3,554
 
 937
26%
 
FDIC insurance premiums
 16,762
 1,877
 
 14,885
793%
 
Charitable contributions
 73
 30
 
 43
143%
 
Impairment charges
 4,000
 -
 
 4,000
N/A
 
Other operating expenses
 21,941
 19,884
 
 2,057
10%
Total other expense
 $   223,750
 $   183,390
 
 $   40,360
22%
 
        The FDIC assisted transactions increased salaries and employee benefits expense, occupancy and equipment expense, computer services expense, other intangible amortization expense, and FDIC insurance premiums from the year ended December 31, 2008 to the year ended December 31, 2009 by approximately $6.6 million, $2.6 million, $2.1 million, $973 thousand, and $1.9 million, respectively.  Salaries and employee benefits expense also increased due to additional credit remediation staff hired in 2009.  Our Heritage, InBank, Corus and Benchmark transactions increased total other expense by approximately $17.1 million for the year ended December 31, 2009.  Additionally, FDIC insurance premium expense increased as general insurance assessment rates increased and the FDIC imposed a special premium on all insured depository institutions based on assets as of June 30, 2009.  During 2009, the Company conducted an impairment review of branch office locations to be consolidated due to the Company’s recent acquisitions.   As a result, the Company recognized a $4.0 million impairment charge related to three branches in 2009.  See Note 2 to the Consolidated Financial Statements for further information regarding the Heritage, InBank, Corus, and Benchmark transactions.  Other operating expenses increased primarily due to an increase in expenses related to other real estate owned from the year ended December 31, 2008 to the year ended December 31, 2009. 

     
Year Ended
     
     
December 31,
December 31,
 
Increase/
Percentage
     
2008
2007
 
(Decrease)
Change
Other expense (in thousands):
         
 
Salaries and employee benefits
$     108,835
$    110,809
 
$   (1,974)
(2%)
 
Occupancy and equipment expense
28,872
28,878
 
(6)
(0%)
 
Computer services expense
7,392
6,699
 
693
10%
 
Advertising and marketing expense
5,089
4,859
 
230
5%
 
Professional and legal expense
3,110
4,543
 
(1,433)
(32%)
 
Brokerage fee expense
1,929
4,802
 
(2,873)
(60%)
 
Telecommunication expense
2,818
2,805
 
13
0%
 
Other intangibles amortization expense
3,554
3,504
 
50
1%
 
FDIC insurance premiums
1,877
664
 
1,213
183%
 
Charitable contributions
30
4,686
 
(4,656)
(99%)
 
Other operating expenses
19,884
19,257
 
627