10-Q 1 a06301410q.htm 10-Q 06.30.14 10Q




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

 
FORM 10-Q
 
(Mark One)
 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended June 30, 2014
 
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
 

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 x No o
 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer x
 
Accelerated filer o
 
 
 
Non-accelerated filer o
(Do not check if a smaller reporting company)
 
Smaller reporting company o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes o No x
 
There were issued and outstanding 55,091,974 shares of the Registrant’s common stock as of July 30, 2014.
 

1




MB FINANCIAL, INC. AND SUBSIDIARIES
 
FORM 10-Q
 
June 30, 2014
 
INDEX
 



2


PART I.        FINANCIAL INFORMATION
Item 1.
  Financial Statements

MB FINANCIAL, INC. & SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except common share data)
 
 
(Unaudited)
 
 
 
 
June 30, 2014
 
December 31, 2013
ASSETS
 
 

 
 

Cash and due from banks
 
$
294,475

 
$
205,193

Interest earning deposits with banks
 
466,820

 
268,266

Total cash and cash equivalents
 
761,295

 
473,459

Federal funds sold
 
10,000

 
42,950

Investment securities:
 
 

 
 

Securities available for sale, at fair value
 
1,154,958

 
1,118,912

Securities held to maturity, at amortized cost ($1.3 billion fair value at June 30, 2014 and $1.2 billion at December 31, 2013)
 
1,241,392

 
1,182,533

Non-marketable securities - FHLB and FRB stock
 
51,432

 
51,417

Total investment securities
 
2,447,782

 
2,352,862

Loans held for sale
 
1,219

 
629

Loans:
 
 

 
 

Total loans, excluding covered loans
 
5,421,758

 
5,476,831

Covered loans
 
134,966

 
235,720

Total loans
 
5,556,724

 
5,712,551

Less: Allowance for loan losses
 
100,910

 
111,746

Net loans
 
5,455,814

 
5,600,805

Lease investment, net
 
127,194

 
131,089

Premises and equipment, net
 
224,245

 
221,065

Cash surrender value of life insurance
 
131,842

 
130,181

Goodwill
 
423,369

 
423,369

Other intangibles
 
21,014

 
23,428

Other real estate owned, net
 
20,306

 
23,289

Other real estate owned related to FDIC-assisted transactions
 
15,349

 
20,472

FDIC indemnification asset
 
4,607

 
11,675

Other assets
 
174,655

 
186,154

Total assets
 
$
9,818,691

 
$
9,641,427

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 

 
 

LIABILITIES
 
 

 
 

Deposits:
 
 

 
 

Noninterest bearing
 
$
2,605,367

 
$
2,375,863

Interest bearing
 
5,157,697

 
5,005,396

Total deposits
 
7,763,064

 
7,381,259

Short-term borrowings
 
229,809

 
493,389

Long-term borrowings
 
71,473

 
62,159

Junior subordinated notes issued to capital trusts
 
152,065

 
152,065

Accrued expenses and other liabilities
 
236,964

 
225,873

Total liabilities
 
8,453,375

 
8,314,745

STOCKHOLDERS’ EQUITY
 
 

 
 

Common stock, ($0.01 par value; authorized 70,000,000 shares at June 30, 2014 and December 31, 2013; issued 55,348,200 shares at June 30, 2014 and 55,148,409 shares at December 31, 2013)
 
553

 
551

Additional paid-in capital
 
742,824

 
738,053

Retained earnings
 
611,741

 
581,998

Accumulated other comprehensive income
 
13,034

 
8,383

Less: 205,051 and 184,173 shares of treasury stock, at cost, at June 30, 2014 and December 31, 2013, respectively
 
(4,295
)
 
(3,747
)
Controlling interest stockholders’ equity
 
1,363,857

 
1,325,238

Noncontrolling interest
 
1,459

 
1,444

Total stockholders’ equity
 
1,365,316

 
1,326,682

Total liabilities and stockholders’ equity
 
$
9,818,691

 
$
9,641,427


     See Accompanying Notes to Consolidated Financial Statements.

3


MB FINANCIAL, INC. & SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in thousands, except share and per share data) (Unaudited)
 
 
Three Months Ended
 
Six Months Ended
 
 
June 30,
 
June 30,
 
 
2014
 
2013
 
2014
 
2013
Interest income:
 
 

 
 

 
 
 
 
Loans
 
$
55,905

 
$
59,581

 
$
112,149

 
$
120,374

Investment securities:
 
 

 
 

 
 

 
 

Taxable
 
8,794

 
6,280

 
16,940

 
12,419

Nontaxable
 
8,285

 
8,163

 
16,352

 
16,224

Federal funds sold
 
4

 
2

 
9

 
2

Other interest earning accounts
 
277

 
92

 
390

 
227

Total interest income
 
73,265

 
74,118

 
145,840

 
149,246

Interest expense:
 
 

 
 

 
 
 
 
Deposits
 
3,754

 
5,132

 
7,523

 
10,841

Short-term borrowings
 
95

 
116

 
195

 
283

Long-term borrowings and junior subordinated notes
 
1,344

 
1,390

 
2,722

 
2,957

Total interest expense
 
5,193

 
6,638

 
10,440

 
14,081

Net interest income
 
68,072

 
67,480

 
135,400

 
135,165

Provision for credit losses
 
(1,950
)
 
500

 
(800
)
 
500

Net interest income after provision for credit losses
 
70,022

 
66,980

 
136,200

 
134,665

Non-interest income:
 
 

 
 

 
 
 
 
Capital markets and international banking fees
 
1,360

 
939

 
2,338

 
1,747

Commercial deposit and treasury management fees
 
7,106

 
6,029

 
14,250

 
11,995

Lease financing, net
 
14,853

 
15,102

 
28,049

 
31,365

Trust and asset management fees
 
5,405

 
4,874

 
10,612

 
9,368

Card fees
 
3,304

 
2,735

 
6,005

 
5,430

Loan service fees
 
916

 
1,911

 
1,881

 
2,922

Consumer and other deposit service fees
 
3,156

 
3,593

 
6,091

 
6,839

Brokerage fees
 
1,356

 
1,234

 
2,681

 
2,391

Net (loss) gain on investment securities
 
(87
)
 
14

 
230

 
13

Increase in cash surrender value of life insurance
 
834

 
842

 
1,661

 
1,686

Net loss on sale of assets
 
(24
)
 
—

 
(17
)
 
—

Accretion of FDIC indemnification asset
 
28

 
100

 
59

 
243

Net gain on sale of loans
 
187

 
506

 
246

 
1,145

Other operating income
 
1,534

 
1,060

 
2,454

 
2,498

Total non-interest income
 
39,928

 
38,939

 
76,540

 
77,642

Non-interest expenses:
 
 

 
 

 
 
 
 
Salaries and employee benefits
 
46,622

 
43,909

 
90,999

 
87,423

Occupancy and equipment expense
 
9,518

 
9,408

 
19,110

 
18,812

Computer services and telecommunication expense
 
5,079

 
4,617

 
10,163

 
8,504

Advertising and marketing expense
 
2,221

 
2,167

 
4,302

 
4,270

Professional and legal expense
 
1,567

 
1,353

 
3,346

 
2,648

Other intangibles amortization expense
 
1,174

 
1,538

 
2,414

 
3,082

Net loss recognized on other real estate owned
 
191

 
(2,015
)
 
378

 
(1,685
)
Other real estate expense, net
 
337

 
193

 
733

 
332

Other operating expenses
 
11,321

 
9,083

 
22,632

 
18,296

Total non-interest expenses
 
78,030

 
70,253

 
154,077

 
141,682

Income before income taxes
 
31,920

 
35,666

 
58,663

 
70,625

Income tax expense
 
8,814

 
10,373

 
15,588

 
20,426

Net income
 
$
23,106

 
$
25,293

 
$
43,075

 
$
50,199


     See Accompanying Notes to Consolidated Financial Statements.

4



MB FINANCIAL, INC. & SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS - (Continued)
(Amounts in thousands, except share and per share data) (Unaudited)

 
 
 
Three Months Ended
 
Six Months Ended
 
 
June 30,
 
June 30,
 
 
2014
 
2013
 
2014
 
2013
Common share data:
 
 

 
 

 
 
 
 
Basic earnings per common share
 
$
0.42

 
$
0.46

 
$
0.79

 
$
0.92

Diluted earnings per common share
 
0.42

 
0.46

 
0.78

 
0.92

Weighted average common shares outstanding for basic earnings per common share
 
54,669,868

 
54,436,043

 
54,654,992

 
54,423,992

Diluted weighted average common shares outstanding for diluted earnings per common share
 
55,200,054

 
54,868,075

 
55,232,703

 
54,802,427

 
See Accompanying Notes to Consolidated Financial Statements.



5



MB FINANCIAL, INC. & SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Amounts in thousands) (Unaudited)

 
 
 
Three Months Ended
 
Six Months Ended
 
 
June 30,
 
June 30,
 
 
2014
 
2013
 
2014
 
2013
 
 
 
 
 
 
 
 
 
Net income
 
$
23,106

 
$
25,293

 
$
43,075

 
$
50,199

Unrealized holding gains (losses) on investment securities, net of reclassification adjustments
 
5,554

 
(34,071
)
 
10,500

 
(36,375
)
Reclassification adjustment for amortization of unrealized gains on investment securities transferred to held to maturity from available for sale
 
(1,239
)
 
—

 
(2,615
)
 
—

Reclassification adjustments for losses (gains) included in net income
 
87

 
(14
)
 
(230
)
 
(13
)
Other comprehensive income (loss), before tax
 
4,402

 
(34,085
)
 
7,655

 
(36,388
)
Income tax benefit (expense) related to items of other comprehensive income (loss)
 
(1,730
)
 
13,388

 
(3,004
)
 
14,293

Other comprehensive income (loss), net of tax
 
2,672

 
(20,697
)
 
4,651

 
(22,095
)
Comprehensive income
 
$
25,778

 
$
4,596

 
$
47,726

 
$
28,104




See Accompanying Notes to Consolidated Financial Statements.



6




MB FINANCIAL, INC. & SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
Six Months Ended June 30, 2014 and 2013
(Amounts in thousands, except per share data) (Unaudited)
 
 
Common
Stock
Additional
Paid-in
Capital
Retained
Earnings
Accumulated
Other
Comprehensive
Income (Loss),
Net of Tax
Treasury
Stock
Noncontrolling
Interest
Total Stock-
holders’
Equity
Balance at December 31, 2012
$
550

$
732,771

$
507,933

$
36,326

$
(3,293
)
$
1,483

$
1,275,770

Net income
—

—

50,199

—

—

91

50,290

Other comprehensive loss, net of tax
—

—

—

(22,095
)
—

—

(22,095
)
Cash dividends declared on common shares ($0.20 per share)
—

—

(11,016
)
—

—

—

(11,016
)
Restricted common stock activity, net of tax
—

28

—

—

—

—

28

Stock option activity, net of tax
—

780

—

—

464

—

1,244

Repurchase of common shares in connection with
 
 
 
 
 
 

  employee benefit plans and held in trust for
 
 
 
 
 
 

  deferred compensation plan
—

230

—

—

(729
)
—

(499
)
Stock-based compensation expense
—

2,472

—

—

—

—

2,472

Distributions to noncontrolling interest
—

—

—

—

—

(113
)
(113
)
Balance at June 30, 2013
$
550

$
736,281

$
547,116

$
14,231

$
(3,558
)
$
1,461

$
1,296,081

 
 
 
 
 
 
 
 
Balance at December 31, 2013
$
551

$
738,053

$
581,998

$
8,383

$
(3,747
)
$
1,444

$
1,326,682

Net income
—

—

43,075

—

—

141

43,216

Other comprehensive income, net of tax
—

—

—

4,651

—

—

4,651

Cash dividends declared on common shares ($0.24 per share)
—

—

(13,332
)
—

—

—

(13,332
)
Restricted common stock activity, net of tax
2

61

—

—

60

—

123

Stock option activity, net of tax
—

256

—

—

—

—

256

Repurchase of common shares in connection with
 
 
 
 
 
 

  employee benefit plans and held in trust for
 
 
 
 
 
 

  deferred compensation plan
—

199

—

—

(608
)
—

(409
)
Stock-based compensation expense
—

4,255

—

—

—

—

4,255

Distributions to noncontrolling interest
—

—

—

—

—

(126
)
(126
)
Balance at June 30, 2014
$
553

$
742,824

$
611,741

$
13,034

$
(4,295
)
$
1,459

$
1,365,316













See Accompanying Notes to Consolidated Financial Statements.


7



MB FINANCIAL, INC. & SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in Thousands) (Unaudited)
 
 
 
Six Months Ended
 
 
June 30,
 
 
2014
 
2013
Cash Flows From Operating Activities
 
 

 
 

Net income
 
$
43,075

 
$
50,199

Adjustments to reconcile net income to net cash provided by operating activities:
 
 

 
 

Depreciation of premises and equipment
 
9,003

 
8,539

Depreciation of leased equipment
 
18,862

 
16,477

Compensation expense for restricted stock awards
 
3,461

 
1,935

Compensation expense for stock option grants
 
794

 
537

Net (gain) loss on sales of premises and equipment and leased equipment
 
(1,275
)
 
238

Amortization of other intangibles
 
2,414

 
3,082

Provision for credit losses
 
(800
)
 
500

Deferred income tax expense
 
(646
)
 
3,613

Amortization of premiums and discounts on investment securities, net
 
22,022

 
23,801

Accretion of premiums and discounts on loans, net
 
(1,819
)
 
(2,977
)
Accretion of FDIC indemnification asset
 
(59
)
 
(243
)
Net gain on investment securities
 
(230
)
 
(13
)
Proceeds from sale of loans held for sale
 
9,810

 
55,850

Origination of loans held for sale
 
(10,098
)
 
(49,742
)
Net gain on sale of loans held for sale
 
(246
)
 
(1,145
)
Net gain on sales of other real estate owned
 
(100
)
 
(990
)
Fair value adjustments on other real estate owned
 
426

 
(821
)
Net (gain) loss on sales of other real estate owned related to FDIC-assisted transactions
 
52

 
126

Increase in cash surrender value of life insurance
 
(1,661
)
 
(1,686
)
Decrease in other assets, net
 
9,971

 
29,549

Decrease in other liabilities, net
 
(1,183
)
 
(76,012
)
Net cash provided by operating activities
 
101,773

 
60,817

Cash Flows From Investing Activities
 
 

 
 

Decrease (increase) in federal funds sold
 
32,950

 
(7,500
)
Proceeds from sales of investment securities available for sale
 
11,718

 
949

Proceeds from maturities and calls of investment securities available for sale
 
126,206

 
309,299

Purchases of investment securities available for sale
 
(175,645
)
 
(141,983
)
Proceeds from maturities and calls of investment securities held to maturity
 
21,319

 
1,189

Purchases of investment securities held to maturity
 
(82,841
)
 
(45,545
)
Purchases of non-marketable securities - FHLB and FRB stock
 
(15
)
 
—

Redemption of non-marketable securities - FHLB and FRB stock
 
—

 
4,515

Net decrease in loans
 
147,107

 
98,155

Purchases of premises and equipment
 
(6,766
)
 
(7,896
)
Purchases of leased equipment
 
(20,198
)
 
(10,170
)
Proceeds from sales of leased equipment
 
3,729

 
3,867

Capital improvements on other real estate owned
 
—

 
(8
)
Proceeds from sale of other real estate owned
 
3,307

 
10,017

Proceeds from sale of other real estate owned related to FDIC-assisted transactions
 
9,060

 
7,074

Principal paid on lease investments
 
—

 
(191
)
Net proceeds from FDIC related covered assets
 
1,778

 
13,419

Net cash provided by investing activities
 
71,709

 
235,191

Cash Flows From Financing Activities
 
 

 
 

Net increase (decrease) in deposits
 
381,805

 
(97,301
)
Net (decrease) increase in short-term borrowings
 
(263,580
)
 
9,945

Proceeds from long-term borrowings
 
14,853

 
3,265

Principal paid on long-term borrowings
 
(5,539
)
 
(56,529
)
Treasury stock transactions, net
 
(410
)
 
(35
)
Stock options exercised
 
134

 
1,013

Excess tax expense (benefits) from share-based payment arrangements
 
231

 
(98
)
Dividends paid on common stock
 
(13,140
)
 
(10,891
)
Net cash used in (provided by) financing activities
 
114,354

 
(150,631
)
Net increase in cash and cash equivalents
 
$
287,836

 
$
145,377

Cash and cash equivalents:
 
 

 
 

Beginning of period
 
473,459

 
287,543

End of period
 
$
761,295

 
$
432,920



8



MB FINANCIAL, INC. & SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS - (Continued)
(Amounts in Thousands) (Unaudited)

 
 
 
Six Months Ended
 
 
June 30,
 
 
2014
 
2013
Supplemental Disclosures of Cash Flow Information:
 
 

 
 

Cash payments for:
 
 

 
 

Interest paid to depositors and other borrowed funds
 
$
10,393

 
$
14,524

Net income tax payments, net
 
11,740

 
35,024

Supplemental Schedule of Noncash Investing Activities:
 
 

 
 

Investment securities available for sale purchased not settled
 
$
—

 
$
3,026

Investment securities held to maturity purchased not settled
 
7,075

 
1,606

Loans transferred to other real estate owned
 
694

 
4,214

Loans transferred to other real estate owned related to FDIC-assisted transactions
 
3,894

 
4,797

Loans transferred to repossessed vehicles
 
345

 
313

Operating leases rewritten as direct finance leases included as loans
 
4,429

 
6,777

 
See Accompanying Notes to Consolidated Financial Statements.


9




MB FINANCIAL, INC. & SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1.
   Basis of Presentation
 
 These unaudited consolidated financial statements include the accounts of MB Financial, Inc., a Maryland corporation (the “Company”), and its subsidiaries, including its wholly owned national bank subsidiary, MB Financial Bank, N.A. (“MB Financial Bank”), based in Chicago, Illinois. In the opinion of management, all normal recurring adjustments necessary for a fair presentation of the financial position, results of operations and cash flows for the interim periods have been made. The results of operations for the three months and six months ended June 30, 2014 are not necessarily indicative of the results to be expected for the entire fiscal year.
These unaudited interim financial statements have been prepared in conformity with U.S. generally accepted accounting principles (“GAAP”) and industry practice. Certain information in footnote disclosure normally included in financial statements prepared in accordance with U.S. GAAP and industry practice has been condensed or omitted pursuant to rules and regulations of the Securities and Exchange Commission. These financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s December 31, 2013 audited financial statements filed on Form 10-K.
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions which affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements, as well as the reported amounts of income and expenses during the reported periods. Actual results could differ from those estimates.
Certain prior period amounts have been reclassified to conform to current period presentation. These reclassifications did not result in any changes to previously reported net income or stockholders’ equity.


Note 2.
New Authoritative Accounting Guidance

ASC Topic 740 “Income Taxes.” New authoritative accounting guidance under ASC Topic 740, “Income Taxes” amended prior guidance to include explicit guidance on the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. An unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except as follows. To the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. The Company adopted this new authoritative guidance on January 1, 2014, and it did not have an impact on the Company's statements of operations or financial condition.

ASC Topic 310 “Receivables.” New authoritative accounting guidance under ASC Topic 310, “Receivables” amended prior guidance to clarify that an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical
possession of residential real estate property collateralizing a consumer mortgage loan, upon either (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Additionally, the amendments require interim and annual disclosures. The new authoritative guidance will be effective for reporting periods after January 1, 2015 and is not expected to have an impact on the Company's statements of operations or financial condition.

ASC Topic 323 “Investments - Equity Method and Joint Ventures.” New authoritative accounting guidance under ASC Topic 323, “Investments - Equity Method and Joint Ventures” amended prior guidance to permit entities to make an accounting policy election to account for their investments in qualified affordable housing projects using the proportional amortization method if certain conditions are met. Under the proportional amortization method, an entity amortizes the initial cost of the investment in proportion to the tax credits and other tax benefits received and recognizes the net investment performance in the statement of operation as a component of income tax expense. The new authoritative guidance will be effective for reporting periods after January 1, 2015 and is not expected to have an impact on the Company's statements of operations or financial condition.


10



ASC Topics 205 “Presentation of Financial Statements” and 360 “Property, Plant, and Equipment.” New authoritative accounting guidance under ASC Topic 205, “Presentation of Financial Statements” and ASC Topic 360 “Property, Plant, and Equipment” amended prior guidance to change the requirements for reporting discontinued operations. The disposal of a component of an entity or group of components of an entity is required to be reported in discontinued operations if the disposal represents a strategic shift that has (or will have) a major effect on an entity's operations and financial results. The new authoritative guidance also requires additional disclosures about discontinued operations. The new authoritative guidance will be effective for reporting periods after January 1, 2015 and is not expected to have an impact on the Company's statements of operations or financial condition.

ASC Topic 860 “Transfers and Servicing.” New authoritative accounting guidance under ASC Topic 860, “Transfers and Servicing” amended prior guidance to change the accounting for repurchase-to-maturity transactions to secured borrowing accounting and to require separate accounting for a transfer of a financial asset executed contemporaneously with a repurchase agreement with the same counterpart, which will result in secured borrowing accounting for the repurchase agreement. The new authoritative guidance also requires disclosures for a transfer of a financial asset accounted for as a sale and an agreement with the same transferee entered into in contemplation of the initial transfer that results in the transferor retaining substantially all of the exposure to the economic return on the transferred financial asset throughout the term of the transaction. The new authoritative guidance will be effective for reporting periods after January 1, 2015, and the Company is assessing the impact on the statements of operations and financial condition.

ASC Topic 718 “Compensation - Stock Compensation.” New authoritative accounting guidance under ASC Topic 718, “Compensation - Stock Compensation” amended prior guidance to require that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. The new authoritative guidance will be effective for reporting periods after January 1, 2015 and is not expected to have an impact on the Company's statements of operations or financial condition.

Note 3.
  Earnings Per Common Share
 
Earnings per common share is computed using the two-class method. Basic earnings per common share is computed by dividing net income available to common stockholders by the weighted-average number of common shares outstanding during the applicable period, excluding outstanding participating securities. Participating securities include non-vested restricted stock awards and restricted stock units, though no actual shares of common stock related to restricted stock units are issued until the settlement of such units, to the extent holders of these securities receive non-forfeitable dividends or dividend equivalents at the same rate as holders of the Company's common stock. Diluted earnings per common share is computed using the weighted-average number of shares determined for the basic earnings per common share computation plus the dilutive effect of stock compensation using the treasury stock method.

The following table presents a reconciliation of the number of shares used in the calculation of basic and diluted earnings per common share (amounts in thousands, except share and per share data).
 
 
 
Three Months Ended
 
Six Months Ended
 
 
June 30,
 
June 30,
 
 
2014
 
2013
 
2014
 
2013
Distributed earnings allocated to common stock
 
$
6,666

 
$
5,509

 
$
13,332

 
$
11,016

Undistributed earnings
 
16,440

 
19,784

 
29,743

 
39,183

Net income
 
23,106

 
25,293

 
43,075

 
50,199

Less: earnings allocated to participating securities
 
1

 
—

 
1

 
1

Earnings allocated to common stockholders
 
$
23,105

 
$
25,293

 
$
43,074

 
$
50,198

Weighted average shares outstanding for basic earnings per common share
 
54,669,868

 
54,436,043

 
54,654,992

 
54,423,992

Dilutive effect of equity awards
 
530,186

 
432,032

 
577,711

 
378,435

Weighted average shares outstanding for diluted earnings per common share
 
55,200,054

 
54,868,075

 
55,232,703

 
54,802,427

Basic earnings per common share
 
$
0.42

 
$
0.46

 
$
0.79

 
$
0.92

Diluted earnings per common share
 
0.42

 
0.46

 
0.78

 
0.92

 

11



Note 4.
   Business Combinations
  
On July 14, 2013, the Company and Taylor Capital Group, Inc. (“Taylor Capital”) entered into an Agreement and Plan of Merger (as amended by the amendment thereto dated as of June 30, 2014, the "Merger Agreement") whereby the Company will acquire Taylor Capital. The Merger Agreement provides that, upon the terms and subject to the conditions set forth therein, Taylor Capital will merge with and into the Company, with the Company as the surviving corporation in the merger. Immediately following the Merger, Taylor Capital's wholly owned subsidiary bank, Cole Taylor Bank, will merge with the Company's wholly owned subsidiary bank, MB Financial Bank. Cole Taylor Bank is a commercial bank headquartered in Chicago with $6.0 billion in assets, $3.7 billion in loans and $4.0 billion in deposits as of June 30, 2014.

Subject to the terms and conditions of the Merger Agreement, at the effective time of the Merger (the "Effective Time"), each share of Taylor Capital common stock and each share of Taylor Capital nonvoting convertible preferred stock ("non-voting preferred stock") will be converted into the right to receive, promptly following the Effective Time, (1) 0.64318 of a share of the Company's common stock and (2) $4.08 in cash. All "in-the-money" Taylor Capital stock options and warrants outstanding immediately prior to the Effective Time will be canceled in exchange for a cash payment as provided in the Merger Agreement, as will all then-outstanding unvested restricted stock awards of Taylor Capital; however, the cash consideration paid for such restricted stock awards will remain subject to vesting or other lapse restrictions. Each share of Taylor Capital's Perpetual Non-Cumulative Preferred Stock, Series A, will be exchanged for a share of a series of preferred stock of the Company with substantially identical terms.

The Merger Agreement was approved by the stockholders of each of MB Financial and Taylor Capital on February 26, 2014. The Merger has been approved by the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”) and the Office of the Comptroller of the Currency and remains subject to the satisfaction of customary closing conditions.
  
As previously reported, Taylor Capital had been notified by its regulators that its subsidiary bank, Cole Taylor Bank, may be cited with a violation of Section 5 of the Federal Trade Commission Act.  This matter related to the account opening process associated with a former deposit program relationship Cole Taylor Bank had with an organization that provides electronic financial disbursements and payment services to the higher education industry (the “Former Counterparty”).  Cole Taylor Bank exited the relationship with the Former Counterparty in August 2013.  Effective June 26, 2014, in connection with this matter, Cole Taylor Bank entered into an Order to Cease and Desist and Order of Assessment of Civil Money Penalty Issued Upon Consent Pursuant to the Federal Deposit Insurance Act and the Illinois Banking Act, As Amended (the “Consent Order”), with the Federal Reserve Board and the State of Illinois Department of Financial and Professional Regulation, Division of Banking (the “Illinois Department”).  Cole Taylor Bank was assessed civil money penalties under the Consent Order of $3,510,000 by the Federal Reserve Board and $600,000 by the Illinois Department.  The Consent Order also imposes a secondary obligation on Cole Taylor Bank to make restitution to account holders affected by the violation to the extent any such restitution that the Former Counterparty is ordered by the Federal Reserve Board to pay is not satisfied by the Former Counterparty, subject to a maximum of the lesser of: (i) $30,000,000; or (ii) the total amount of such restitution that relates to fees collected by the Former Counterparty from affected account holders between May 4, 2012 and June 30, 2014.

Effective June 30, 2014, MB Financial entered into a letter agreement (the “Escrow Letter Agreement”) with certain principal stockholders of Taylor Capital (the “Principal Stockholders”) collectively owning approximately 50% of the outstanding shares of Taylor Capital common stock and Taylor Capital nonvoting preferred stock, pursuant to which the Principal Stockholders have agreed to be responsible for repayment of 60% of the restitution payments made by Cole Taylor Bank or MB Financial Bank, as successor to Cole Taylor Bank, under the Consent Order for a specified period of time calculated on an after-tax basis if MB Financial realizes a tax benefit therefrom.  Aside from the Principal Stockholders, no Taylor Capital stockholders are subject to the provisions of the Escrow Letter Agreement, and the form, timing and amount of merger consideration to be paid to all stockholders of Taylor Capital, aside from the Principal Stockholders, in conjunction with the Merger will not be not affected by the Escrow Letter Agreement.
 
The Escrow Letter Agreement provides that, during the four-year period after the closing of the Merger, the payment obligation of the Principal Stockholders will be secured by their deposit into escrow of cash or a letter of credit.  The Principal Stockholders, other than two funds whose obligations represent approximately 15% of the total obligations of all Principal Stockholders, will remain obligated for an additional four years on an unsecured basis.  The two funds will remain obligated on an unsecured basis for an additional three years.
 
If, for any reason, MB Financial Bank recovers all or any portion of a restitution payment for which it received a disbursement from the escrowed funds, or a separate payment from the Principal Stockholders pursuant to the Escrow Letter Agreement, MB Financial Bank will distribute to the Principal Stockholders, on a pro rata basis, 60% of MB Financial Bank’s net after-tax recovery, including reasonable third party expenses incurred by MB Financial Bank relating to the recovery.


12



Note 5.
          Investment Securities
 
Amortized cost and fair value of investment securities were as follows (in thousands):
 
 
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
June 30, 2014
 
 

 
 

 
 

 
 

Available for Sale
 
 

 
 

 
 

 
 

U.S. Government sponsored agencies and enterprises
 
$
50,096

 
$
1,631

 
$
—

 
$
51,727

States and political subdivisions
 
19,228

 
358

 
(88
)
 
19,498

Residential mortgage-backed securities
 
738,519

 
10,090

 
(684
)
 
747,925

Commercial mortgage-backed securities
 
47,977

 
1,881

 
—

 
49,858

Corporate bonds
 
271,351

 
5,143

 
(965
)
 
275,529

Equity securities
 
10,414

 
7

 
—

 
10,421

Total Available for Sale
 
1,137,585

 
19,110

 
(1,737
)
 
1,154,958

Held to Maturity
 
 

 
 

 
 

 
 

States and political subdivisions
 
993,937

 
37,347

 
(806
)
 
1,030,478

Residential mortgage-backed securities
 
247,455

 
14,312

 
—

 
261,767

Total Held to Maturity
 
1,241,392

 
51,659

 
(806
)
 
1,292,245

Total
 
$
2,378,977

 
$
70,769

 
$
(2,543
)
 
$
2,447,203

December 31, 2013
 
 

 
 

 
 

 
 

Available for Sale
 
 

 
 

 
 

 
 

U.S. Government sponsored agencies and enterprises
 
$
50,486

 
$
1,704

 
$
(122
)
 
$
52,068

States and political subdivisions
 
19,398

 
22

 
(277
)
 
19,143

Residential mortgage-backed securities
 
696,415

 
8,555

 
(3,737
)
 
701,233

Commercial mortgage-backed securities
 
50,891

 
2,050

 
—

 
52,941

Corporate bonds
 
284,083

 
1,597

 
(2,610
)
 
283,070

Equity securities
 
10,649

 
—

 
(192
)
 
10,457

Total Available for Sale
 
1,111,922

 
13,928

 
(6,938
)
 
1,118,912

Held to Maturity
 
 
 
 
 
 
 
 

States and political subdivisions
 
932,955

 
7,584

 
(4,366
)
 
936,173

Residential mortgage-backed securities
 
249,578

 
13,178

 
—

 
262,756

Total Held to Maturity
 
1,182,533

 
20,762

 
(4,366
)
 
1,198,929

Total
 
$
2,294,455

 
$
34,690

 
$
(11,304
)
 
$
2,317,841

 
 
 
 
 
 
 
 
 
 
The Company has no direct exposure to the State of Illinois, but approximately 28% of the state and political subdivisions portfolio consists of securities issued by municipalities located in Illinois as of June 30, 2014. Approximately 90% of such securities were general obligation issues as of June 30, 2014.


13



Unrealized losses on investment securities and the fair value of the related securities at June 30, 2014 were as follows (in thousands):
 
 
 
Less Than 12 Months
 
12 Months or More
 
Total
 
 
Fair
 
Unrealized
 
Fair
 
Unrealized
 
Fair
 
Unrealized
 
 
Value
 
Losses
 
Value
 
Losses
 
Value
 
Losses
Available for Sale
 
 

 
 

 
 

 
 

 
 

 
 

States and political subdivisions
 
$
—

 
$
—

 
$
4,674

 
$
(88
)
 
$
4,674

 
$
(88
)
Residential mortgage-backed securities
 
132,387

 
(440
)
 
26,492

 
(244
)
 
158,879

 
(684
)
Corporate bonds
 
—

 
—

 
10,475

 
(965
)
 
10,475

 
(965
)
Total Available for Sale
 
132,387

 
(440
)
 
41,641

 
(1,297
)
 
174,028

 
(1,737
)
Held to Maturity
 
 

 
 

 
 

 
 

 
 

 
 

States and political subdivisions
 
35,823

 
(232
)
 
27,638

 
(574
)
 
63,461

 
(806
)
Total
 
$
168,210

 
$
(672
)
 
$
69,279

 
$
(1,871
)
 
$
237,489

 
$
(2,543
)
 
Unrealized losses on investment securities and the fair value of the related securities at December 31, 2013 were as follows (in thousands):
 
 
 
Less Than 12 Months
 
12 Months or More
 
Total
 
 
Fair
 
Unrealized
 
Fair
 
Unrealized
 
Fair
 
Unrealized
 
 
Value
 
Losses
 
Value
 
Losses
 
Value
 
Losses
Available for Sale
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Government sponsored agencies and enterprises
 
$
18,598

 
$
(122
)
 
$
—

 
$
—

 
$
18,598

 
$
(122
)
States and political subdivisions
 
2,275

 
(166
)
 
4,748

 
(111
)
 
7,023

 
(277
)
Residential mortgage-backed securities
 
232,807

 
(2,905
)
 
44,182

 
(832
)
 
276,989

 
(3,737
)
Corporate bonds
 
122,344

 
(2,606
)
 
705

 
(4
)
 
123,049

 
(2,610
)
Equity securities
 
10,457

 
(192
)
 
—

 
—

 
10,457

 
(192
)
Total Available for Sale
 
386,481

 
(5,991
)
 
49,635

 
(947
)
 
436,116

 
(6,938
)
Held to Maturity
 
 

 
 

 
 

 
 

 
 

 
 

States and political subdivisions
 
235,016

 
(4,330
)
 
1,301

 
(36
)
 
236,317

 
(4,366
)
Total
 
$
621,497

 
$
(10,321
)
 
$
50,936

 
$
(983
)
 
$
672,433

 
$
(11,304
)
 
The total number of security positions in the investment portfolio in an unrealized loss position at June 30, 2014 was 94 compared to 345 at December 31, 2013. Declines in the fair value of available for sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses to the extent the impairment is related to credit losses. The amount of the impairment related to other factors is recognized in other comprehensive income. In estimating other-than-temporary impairment losses, management considers, among other things, (i) the length of time and the extent to which the fair value has been less than cost, (ii) the financial condition and near-term prospects of the issuer, and (iii) whether or not the Company is more likely than not to sell the security before recovery of its cost basis.
 
As of June 30, 2014, management does not have the intent to sell any of the securities in the table above and believes that it is more likely than not that the Company will not have to sell any such securities before a recovery of cost. The fair value is expected to recover as the bonds approach their maturity date or repricing date or if market yields for such investments decline. Accordingly, as of June 30, 2014, management believes the impairments detailed in the table above are temporary.

Changes in market interest rates can significantly influence the fair value of securities, and the fair value of our municipal securities portfolio would decline substantially if interest rates increase materially.


14



Net (losses) gains recognized on investment securities available for sale were as follows (in thousands):
 
 
 
Three Months Ended
 
Six Months Ended
 
 
June 30,
 
June 30,
 
 
2014
 
2013
 
2014
 
2013
Realized gains
 
$
7

 
$
14

 
$
325

 
$
14

Realized losses
 
(2
)
 
—

 
(3
)
 
(1
)
Impairment charges
 
(92
)
 
—

 
(92
)
 
—

Net (losses) gains
 
$
(87
)
 
$
14

 
$
230

 
$
13

 
The amortized cost and fair value of investment securities as of June 30, 2014 by contractual maturity are shown below. Maturities may differ from contractual maturities in mortgage-backed securities because the mortgages underlying the securities may be called or repaid without any penalties. Therefore, mortgage-backed securities are not included in the maturity categories in the following maturity summary.

 
 
Amortized
 
Fair
(In thousands)
 
Cost
 
Value
Available for sale:
 
 

 
 

Due in one year or less
 
$
502

 
$
502

Due after one year through five years
 
324,153

 
329,874

Due after five years through ten years
 
7,637

 
7,848

Due after ten years
 
8,383

 
8,530

Equity securities
 
10,414

 
10,421

Residential and commercial mortgage-backed securities
 
786,496

 
797,783

 
 
1,137,585

 
1,154,958

Held to maturity:
 
 

 
 

Due in one year or less
 
27,228

 
27,284

Due after one year through five years
 
247,065

 
249,459

Due after five years through ten years
 
117,694

 
121,717

Due after ten years
 
601,950

 
632,018

Residential mortgage-backed securities
 
247,455

 
261,767

 
 
1,241,392

 
1,292,245

Total
 
$
2,378,977

 
$
2,447,203

 
Investment securities with carrying amounts of $1.3 billion and $1.2 billion at June 30, 2014 and December 31, 2013, respectively, were pledged as collateral on public deposits and for other purposes as required or permitted by law, while only $982.2 million and $908.4 million were required to be pledged at June 30, 2014 and December 31, 2013, respectively. Of those pledged, the Company had investment securities pledged as collateral for advances from the Federal Home Loan Bank of $23.0 million and $29.0 million at June 30, 2014 and December 31, 2013, respectively.

 

15



Note 6.
        Loans
 
Loans consist of the following at (in thousands):

 
 
June 30,
2014
 
December 31,
2013
Commercial loans
 
$
1,272,200

 
$
1,281,377

Commercial loans collateralized by assignment of lease payments
 
1,515,446

 
1,494,188

Commercial real estate
 
1,619,322

 
1,647,700

Residential real estate
 
309,234

 
314,440

Construction real estate
 
116,996

 
141,253

Indirect vehicle
 
272,841

 
262,632

Home equity
 
245,135

 
268,289

Other consumer loans
 
70,584

 
66,952

Gross loans, excluding covered loans
 
5,421,758

 
5,476,831

Covered loans
 
134,966

 
235,720

Total loans (1)
 
$
5,556,724

 
$
5,712,551

 (1)          Gross loan balances at June 30, 2014 and December 31, 2013 are net of unearned income, including net deferred loan fees of $1.0 million and $1.9 million, respectively.
 
Loans are made to individuals as well as commercial and tax exempt entities. Specific loan terms vary as to interest rate, repayment, and collateral requirements based on the type of loan requested and the credit worthiness of the prospective borrower. Except for commercial loans collateralized by assignment of lease payments, credit risk tends to be geographically concentrated in that a majority of the loan customers are located in the markets serviced by MB Financial Bank.
 
The Company's extension of credit is governed by its Credit Risk Policy which was established to control the quality of the Company's loans. These policies and procedures are reviewed and approved by the Board of Directors on a regular basis.
 
Commercial Loans. Commercial credit is extended primarily to middle market customers. Such credits are typically comprised of working capital loans, loans for physical asset expansion, asset acquisition loans and other business loans. Loans to closely held businesses will generally be guaranteed in full or for a significant amount by the businesses' principal owners. Commercial loans are made based primarily on the historical and projected cash flow of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not behave as forecasted and collateral securing loans may fluctuate in value due to economic or individual performance factors. Minimum standards and underwriting guidelines have been established for all commercial loan types.
 
Commercial Loans Collateralized by Assignment of Lease Payments ("Lease Loans"). The Company makes lease loans to both investment grade and non-investment grade companies. Investment grade lessees are companies rated in one of the four highest categories by Moody's Investor Services or Standard & Poor's Rating Services or, in the event the related lessee has not received any such rating, where the related lessee would be viewed under the underwriting polices of the Company as an investment grade company. Whether or not companies fall into this category, each lease loan is considered on its individual merit based on financial information available at the time of underwriting.
 
Commercial Real Estate Loans. Commercial real estate loans are subject to underwriting standards and processes similar to commercial loans. These loans are viewed primarily as cash flow loans and the repayment of these loans is largely dependent on the successful operation of the property. Loan performance may be adversely affected by factors impacting the general economy or conditions specific to the real estate market such as geographic location and/or property type.
 
Construction Real Estate Loans. The Company defines construction loans as loans where the loan proceeds are controlled by the Company and used exclusively for the improvement of real estate in which the Company holds a mortgage. Due to the inherent risk in this type of loan, they are subject to other industry specific policy guidelines outlined in the Company's Credit Risk Policy.

Consumer Related Loans. The Company originates direct and indirect consumer loans, including primarily residential real estate, home equity lines and loans, credit cards, and indirect vehicle loans (motorcycle, powersports, recreational and marine vehicles), using a matrix-based credit analysis as part of the underwriting process. Each loan type has a separate matrix which consists of several factors including debt to income, type of collateral and loan to collateral value, credit history and Company relationship with the borrower. Indirect loan and credit card underwriting involves the use of risk-based pricing in the underwriting process.

16




A collateral pledge agreement exists whereby at all times, the Company must keep on hand, free of all other pledges, liens, and encumbrances, first mortgage loans and home equity loans with unpaid principal balances aggregating no less than 133% for first mortgage loans and 250% for home equity loans of the outstanding advances from the Federal Home Loan Bank.  As of June 30, 2014 and December 31, 2013, the Company had $803.8 million and $835.1 million, respectively, of loans pledged as collateral for long-term Federal Home Loan Bank advances, while only $7.0 million and $518.4 million were required to be pledged at June 30, 2014 and December 31, 2013, respectively.

The following table presents the contractual aging of the recorded investment in past due loans by class of loans as of June 30, 2014 and December 31, 2013 (in thousands):
 
 
 
Current
 
30-59 Days
Past Due
 
60-89 Days
Past Due
 
Loans Past Due
90 Days or More
 
Total
Past Due
 
Total
June 30, 2014
 
 

 
 

 
 

 
 

 
 

 
 

Commercial
 
$
1,270,198

 
$
913

 
$
49

 
$
1,040

 
$
2,002

 
$
1,272,200

Commercial collateralized by assignment of lease payments
 
1,510,925

 
464

 
1,275

 
2,782

 
4,521

 
1,515,446

Commercial real estate
 
 

 
 

 
 

 
 

 
 

 
 

Healthcare
 
209,676

 
—

 
—

 
—

 
—

 
209,676

Industrial
 
351,196

 
231

 
3,804

 
5,794

 
9,829

 
361,025

Multifamily
 
288,821

 
376

 
337

 
3,002

 
3,715

 
292,536

Retail
 
341,097

 
1,884

 
—

 
5,695

 
7,579

 
348,676

Office
 
163,433

 
44

 
—

 
2,703

 
2,747

 
166,180

Other
 
237,435

 
165

 
—

 
3,629

 
3,794

 
241,229

Residential real estate
 
300,064

 
750

 
692

 
7,728

 
9,170

 
309,234

Construction real estate
 
114,475

 
292

 
—

 
2,229

 
2,521

 
116,996

Indirect vehicle
 
269,921

 
2,094

 
560

 
266

 
2,920

 
272,841

Home equity
 
235,694

 
1,678

 
1,119

 
6,644

 
9,441

 
245,135

Other consumer
 
70,569

 
12

 
—

 
3

 
15

 
70,584

Gross loans, excluding covered loans
 
5,363,504

 
8,903

 
7,836

 
41,515

 
58,254

 
5,421,758

Covered loans
 
49,275

 
253

 
1,696

 
83,742

 
85,691

 
134,966

Total loans (1)
 
$
5,412,779

 
$
9,156

 
$
9,532

 
$
125,257

 
$
143,945

 
$
5,556,724

Non-performing loan aging
 
$
72,325

 
$
465

 
$
2,234

 
$
35,753

 
$
38,452

 
$
110,777

Non-covered loans related to FDIC transactions (2)
 
$
17,573

 
$
308

 
$
10

 
$
5,762

 
$
6,080

 
$
23,653

December 31, 2013
 
 

 
 

 
 

 
 

 
 

 
 

Commercial
 
$
1,273,302

 
$
5,952

 
$
626

 
$
1,497

 
$
8,075

 
$
1,281,377

Commercial collateralized by assignment of lease payments
 
1,489,391

 
3,841

 
656

 
300

 
4,797

 
1,494,188

Commercial real estate
 
 

 
 

 
 

 
 

 
 

 
 

Healthcare
 
213,665

 
—

 
—

 
3,064

 
3,064

 
216,729

Industrial
 
372,975

 
5,465

 
—

 
1,404

 
6,869

 
379,844

Multifamily
 
302,456

 
3,078

 
181

 
2,226

 
5,485

 
307,941

Retail
 
334,198

 
328

 
2,816

 
7,258

 
10,402

 
344,600

Office
 
155,936

 
—

 
—

 
2,066

 
2,066

 
158,002

Other
 
233,464

 
4,898

 
259

 
1,963

 
7,120

 
240,584

Residential real estate
 
302,362

 
1,422

 
1,030

 
9,626

 
12,078

 
314,440

Construction real estate
 
138,563

 
391

 
—

 
2,299

 
2,690

 
141,253

Indirect vehicle
 
259,488

 
2,210

 
657

 
277

 
3,144

 
262,632

Home equity
 
257,219

 
1,725

 
2,165

 
7,180

 
11,070

 
268,289

Other consumer
 
66,866

 
81

 
1

 
4

 
86

 
66,952

Gross loans, excluding covered loans
 
5,399,885

 
29,391

 
8,391

 
39,164

 
76,946

 
5,476,831

Covered loans
 
135,717

 
902

 
3,346

 
95,755

 
100,003

 
235,720

Total loans (1)
 
$
5,535,602

 
$
30,293

 
$
11,737

 
$
134,919

 
$
176,949

 
$
5,712,551

Non-performing loan aging
 
$
56,339

 
$
14,325

 
$
3,283

 
$
32,614

 
$
50,222

 
$
106,561

Non-covered loans related to FDIC transactions (2)
 
$
13,541

 
$
163

 
$
391

 
$
6,550

 
$
7,104

 
$
20,645

 
(1)          Includes certain loans related to the InBank and Heritage FDIC-assisted transaction completed by MB Financial Bank in 2009.
(2)          Certain loans related to the InBank and Heritage FDIC-assisted transaction completed by MB Financial Bank in 2009.


17



 
The following table presents the recorded investment in nonaccrual loans and loans past due ninety days or more and still accruing by class of loans as of June 30, 2014 and December 31, 2013 (in thousands):
 
 
 
June 30, 2014
 
December 31, 2013
 
 
 
 
Loans past due
 
 
 
Loans past due
 
 
Non-accrual
 
90 days or more
and still accruing
 
Non-accrual
 
90 days or more
and still accruing
Commercial
 
$
31,331

 
$
—

 
$
17,781

 
$
—

Commercial collateralized by assignment of lease payments
 
3,113

 
2,363

 
4,276

 
291

Commercial real estate:
 
 

 
 

 
 

 
 

Healthcare
 
—

 
—

 
3,064

 
—

Industrial
 
13,854

 
—

 
15,265

 
155

Multifamily
 
8,525

 
—

 
5,145

 
—

Office
 
7,488

 
—

 
11,703

 
—

Retail
 
3,499

 
—

 
2,969

 
—

Other
 
15,385

 
—

 
19,991

 
—

Residential real estate
 
11,879

 
—

 
13,009

 
—

Construction real estate
 
337

 
—

 
475

 
—

Indirect vehicle
 
1,555

 
—

 
1,459

 
—

Home equity
 
11,443

 
—

 
10,969

 
—

Other consumer
 
5

 
—

 
9

 
—

Total
 
$
108,414

 
$
2,363

 
$
106,115

 
$
446

 
The Company utilizes an internal asset classification system as a means of reporting problem and potential problem loans. Under the Company's risk rating system, the Company classifies potential problem and problem loans as “Special Mention,” “Substandard,” and “Doubtful.” Substandard loans include those characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected. Loans classified as Doubtful have all the weaknesses inherent in those classified as Substandard with the added characteristic that the weaknesses present make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. Loans that do not currently expose the Company to sufficient risk to warrant classification in one of the aforementioned categories but possess weaknesses that deserve management's close attention are deemed to be Special Mention. Risk ratings are updated at least annually and any time the situation warrants.


18



Loans listed as not rated are included in groups of homogeneous loans with similar risk and loss characteristics. The following tables present the risk category of loans by class of loans based on the most recent analysis performed as of June 30, 2014 and December 31, 2013 (in thousands):
 
 
 
Pass
 
Special
Mention
 
Substandard
 
Doubtful
 
Total
June 30, 2014
 
 

 
 

 
 

 
 

 
 

Commercial
 
$
1,199,428

 
$
20,357

 
$
52,415

 
$
—

 
$
1,272,200

Commercial collateralized by assignment of lease payments
 
1,509,654

 
143

 
5,649

 
—

 
1,515,446

Commercial real estate
 
 

 
 

 
 

 
 

 
 

Healthcare
 
188,795

 
6,963

 
13,918

 
—

 
209,676

Industrial
 
324,803

 
14,222

 
22,000

 
—

 
361,025

Multifamily
 
283,314

 
151

 
9,071

 
—

 
292,536

Retail
 
329,994

 
1,617

 
17,065

 
—

 
348,676

Office
 
156,725

 
862

 
8,593

 
—

 
166,180

Other
 
221,125

 
2,143

 
17,961

 
—

 
241,229

Construction real estate
 
115,833

 
826

 
337

 
—

 
116,996

Total
 
$
4,329,671

 
$
47,284

 
$
147,009

 
$
—

 
$
4,523,964

December 31, 2013
 
 

 
 

 
 

 
 

 
 

Commercial
 
$
1,193,114

 
$
26,637

 
$
61,000

 
$
626

 
$
1,281,377

Commercial collateralized by assignment of lease payments
 
1,486,899

 
553

 
6,736

 
—

 
1,494,188

Commercial real estate
 
 

 
 

 
 

 
 

 
 

Healthcare
 
189,705

 
21,186

 
2,774

 
3,064

 
216,729

Industrial
 
345,236

 
5,328

 
29,280

 
—

 
379,844

Multifamily
 
296,179

 
342

 
11,420

 
—

 
307,941

Retail
 
316,420

 
10,660

 
17,520

 
—

 
344,600

Office
 
151,393

 
2,682

 
3,927

 
—

 
158,002

Other
 
217,188

 
349

 
23,047

 
—

 
240,584

Construction real estate
 
139,847

 
540

 
866

 
—

 
141,253

Total
 
$
4,335,981

 
$
68,277

 
$
156,570

 
$
3,690

 
$
4,564,518

 
Approximately $83.5 million and $80.7 million of the substandard and doubtful loans were non-performing as of June 30, 2014 and December 31, 2013, respectively.
 
For residential real estate, home equity, indirect vehicle and other consumer loan classes, the Company also evaluates credit quality based on the aging status of the loan, which was previously presented, and by payment activity. The following table presents the recorded investment in those loan classes based on payment activity as of June 30, 2014 and December 31, 2013 (in thousands):
 
 
 
Performing
 
Non-performing
 
Total
June 30, 2014
 
 

 
 

 
 

Residential real estate
 
$
297,355

 
$
11,879

 
$
309,234

Indirect vehicle
 
271,286

 
1,555

 
272,841

Home equity
 
233,692

 
11,443

 
245,135

Other consumer
 
70,579

 
5

 
70,584

Total
 
$
872,912

 
$
24,882

 
$
897,794

December 31, 2013
 
 

 
 

 
 

Residential real estate
 
$
301,431

 
$
13,009

 
$
314,440

Indirect vehicle
 
261,173

 
1,459

 
262,632

Home equity
 
257,320

 
10,969

 
268,289

Other consumer
 
66,943

 
9

 
66,952

Total
 
$
886,867

 
$
25,446

 
$
912,313

 

19



The following tables present loans individually evaluated for impairment by class of loans as of June 30, 2014 and December 31, 2013 (in thousands):
 
 
 
June 30, 2014
 
 
 
 
 
 
 
 
 
 
Three Months Ended
 
Six Months Ended
 
 
Unpaid
Principal
Balance
 
Recorded
Investment
 
Partial
Charge-offs
 
Allowance for
Loan Losses
Allocated
 
Average
Recorded
Investment
 
Interest
Income
Recognized
 
Average
Recorded
Investment
 
Interest
Income
Recognized
With no related allowance recorded:
 
 

 
 

 
 

 
 

 
 

 
 

 
 
 
 
Commercial
 
$
6,093

 
$
6,093

 
$
—

 
$
—

 
$
6,707

 
$
—

 
$
8,309

 
$
—

Commercial collateralized by assignment of lease payments
 
2,518

 
2,518

 
—

 
—

 
2,566

 
29

 
2,804

 
50

Commercial real estate:
 
 

 
 

 
 

 
 

 
 

 
 

 
 
 
 
Healthcare
 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

Industrial
 
5,712

 
4,535

 
1,177

 
—

 
4,841

 
—

 
8,184

 
—

Multifamily
 
2,461

 
2,461

 
—

 
—

 
2,298

 
7

 
1,695

 
38

Retail
 
4,961

 
3,875

 
1,086

 
—

 
3,962

 
—

 
5,450

 
—

Office
 
2,339

 
1,576

 
763

 
—

 
2,164

 
—

 
1,470

 
—

Other
 
2,115

 
2,074

 
41

 
—

 
2,199

 
—

 
2,200

 
—

Residential real estate
 
3,084

 
3,084

 
—

 
—

 
3,051

 
—

 
3,595

 
—

Construction real estate
 
—

 
—

 
—

 
—

 
—

 
—

 
68

 
—

Indirect vehicle
 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

Home equity
 
577

 
577

 
—

 
—

 
577

 
—

 
950

 
—

Other consumer
 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

With an allowance recorded:
 
 

 
 

 
 

 
 

 
 

 
 

 
 
 
 
Commercial
 
28,024

 
28,024

 
—

 
5,500

 
29,858

 
—

 
21,813

 
—

Commercial collateralized by assignment of lease payments
 
749

 
749

 
—

 
98

 
642

 
2

 
780

 
24

Commercial real estate:
 
 

 
 

 
 

 
 

 
 

 
 

 
 
 
 
Healthcare
 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

Industrial
 
13,319

 
11,463

 
1,856

 
1,157

 
11,757

 
—

 
8,181

 
—

Multifamily
 
8,156

 
7,185

 
971

 
1,733

 
6,759

 
35

 
6,534

 
105

Retail
 
11,699

 
8,746

 
2,953

 
782

 
8,786

 
—

 
8,027

 
—

Office
 
2,275

 
1,923

 
352

 
589

 
2,177

 
—

 
2,709

 
—

Other
 
13,834

 
13,749

 
85

 
250

 
14,581

 
4

 
14,436

 
8

Residential real estate
 
15,030

 
13,804

 
1,226

 
3,135

 
14,355

 
—

 
14,499

 
—

Construction real estate
 
2,707

 
337

 
2,370

 
161

 
431

 
—

 
479

 
—

Indirect vehicle
 
290

 
187

 
103

 
29

 
315

 
—

 
308

 
—

Home equity
 
25,801

 
24,874

 
927

 
1,727

 
25,716

 
—

 
25,130

 
—

Other consumer
 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

Total
 
$
151,744

 
$
137,834

 
$
13,910

 
$
15,161

 
$
143,742

 
$
77

 
$
137,621

 
$
225


 

20



 
 
December 31, 2013
 
 
Unpaid
Principal
Balance
 
Recorded
Investment
 
Partial
Charge-offs
 
Allowance for
Loan Losses
Allocated
 
Average
Recorded
Investment
 
Interest
Income
Recognized
With no related allowance recorded:
 
 

 
 

 
 

 
 

 
 
 
 
Commercial
 
$
8,903

 
$
8,903

 
$
—

 
$
—

 
$
8,259

 
$
—

Commercial collateralized by assignment of lease payments
 
3,401

 
3,401

 
—

 
—

 
1,030

 
6

Commercial real estate:
 
 

 
 

 
 

 
 

 
 

 
 

Healthcare
 
—

 
—

 
—

 
—

 
2,698

 
—

Industrial
 
7,560

 
7,560

 
—

 
—

 
8,900

 
—

Multifamily
 
1,166

 
1,166

 
—

 
—

 
758

 
11

Retail
 
4,466

 
4,466

 
—

 
—

 
3,628

 
—

Office
 
559

 
527

 
32

 
—

 
922

 
—

Other
 
2,963

 
2,963

 
—

 
—

 
4,380

 
—

Residential real estate
 
4,234

 
4,234

 
—

 
—

 
3,260

 
—

Construction real estate
 
—

 
—

 
—

 
—

 
—

 
—

Indirect vehicle
 
—

 
—

 
—

 
—

 
—

 
—

Home equity
 
577

 
577

 
—

 
—

 
797

 
—

Other consumer
 
—

 
—

 
—

 
—

 
—

 
—

With an allowance recorded:
 
 

 
 

 
 

 
 

 
 

 
 

Commercial
 
8,923

 
8,919

 
4

 
4,284

 
13,476

 
4

Commercial collateralized by assignment of lease payments
 
1,060

 
1,060

 
—

 
144

 
1,279

 
192

Commercial real estate:
 
 

 
 

 
 

 
 

 
 

 
 

Healthcare
 
3,186

 
3,064

 
122

 
382

 
8,189

 
—

Industrial
 
7,707

 
7,705

 
2

 
3,038

 
3,699

 
—

Multifamily
 
5,374

 
5,374

 
—

 
1,661

 
6,443

 
340

Retail
 
14,169

 
12,428

 
1,741

 
1,511

 
12,885

 
280

Office
 
2,442

 
2,442

 
—

 
791

 
4,045

 
—

Other
 
20,367

 
17,029

 
3,338

 
796

 
12,868

 
20

Residential real estate
 
13,496

 
12,710

 
786

 
3,119

 
12,966

 
245

Construction real estate
 
475

 
475

 
—

 
227

 
1,603

 
—

Indirect vehicle
 
173

 
123

 
50

 
57

 
86

 
—

Home equity
 
23,840

 
23,395

 
445

 
1,358

 
24,283

 
772

Other consumer
 
—

 
—

 
—

 
—

 
—

 
—

Total
 
$
135,041

 
$
128,521

 
$
6,520

 
$
17,368

 
$
136,454

 
$
1,870

 
Impaired loans included accruing restructured loans of $26.8 million and $29.4 million that have been modified and are performing in accordance with those modified terms as of June 30, 2014 and December 31, 2013, respectively.  In addition, impaired loans included $14.5 million and $25.0 million of non-performing, restructured loans as of June 30, 2014 and December 31, 2013, respectively.
 
Loans may be restructured in an effort to maximize collections from financially distressed borrowers. We use various restructuring techniques, including, but not limited to, deferring past due interest or principal, implementing an A/B note structure, redeeming past due taxes, reducing interest rates, extending maturities and modifying amortization schedules. Residential real estate loans are restructured in an effort to minimize losses while allowing borrowers to remain in their primary residences when possible. Programs that we offer to residential real estate borrowers include the Home Affordable Refinance Program (“HARP”), a restructuring program similar to the Home Affordable Modification Program (“HAMP”) for first mortgage borrowers, the Second Lien Modification Program (“2MP”) and similar programs for home equity borrowers in keeping with the restructuring techniques discussed above.

Periodically, the Company will restructure a note into two separate notes (A/B structure), charging off the entire B portion of the note. The A note is structured with appropriate loan-to-value and cash flow coverage ratios that provide for a high likelihood of

21



repayment. The A note is classified as a non-performing note until the borrower has displayed a historical payment performance for a reasonable time prior to and subsequent to the restructuring. A period of sustained repayment for at least six months generally is required to return the note to accrual status provided that management has determined that the performance is reasonably expected to continue. The A note will be classified as a restructured note (either performing or non-performing) through the calendar year of the restructuring that the historical payment performance has been established. As of June 30, 2014 and December 31, 2013, there was approximately $1.1 million in recorded investment in relation to one A/B structure. 

A loan classified as a troubled debt restructuring will no longer be included in the troubled debt restructuring disclosures in the years after the restructuring if the loan performs in accordance with the terms specified by the restructuring agreement and the interest rate specified in the restructuring agreement represents a market rate at the time of modification. The specified interest rate is considered a market rate when the interest rate is equal to or greater than the rate the Company is willing to accept at the time of restructuring for a new loan with comparable risk. If there are concerns that the borrower will not be able to meet the modified terms of the loan, the loan will continue to be included in the troubled debt restructuring disclosures.

Impairment analyses on commercial-related loans classified as troubled debt restructurings are performed in conjunction with the normal allowance for loan loss process. Consumer loans classified as troubled debt restructurings are aggregated in two pools that share common risk characteristics, home equity and residential real estate loans, with impairment measured on a quarterly basis based on the present value of expected future cash flows discounted at the loan's effective interest rate.

The following table presents loans that have been restructured during the three months ended June 30, 2014 (dollars in thousands):
 
 
 
June 30, 2014
 
 
Number of
Loans
 
Pre-Modification Recorded
Investment
 
Post-Modification Recorded
Investment
 
Charge-offs and
Specific Reserves
Performing:
 
 
 
 

 
 

 
 

Home equity
 
3
 
$
843

 
$
843

 
$
—

Total
 
3
 
$
843

 
$
843

 
$
—

Non-Performing:
 
 
 
 

 
 

 
 

Commercial
 
1
 
$
263

 
$
263

 
$
85

Commercial real estate:
 
 
 
 

 
 

 
 

Multifamily
 
1
 
158

 
158

 
40

Indirect vehicle
 
11
 
59

 
59

 
27

Home equity
 
3
 
531

 
531

 
—

Total
 
16
 
$
1,011

 
$
1,011

 
$
152



22



The following table presents loans that have been restructured during the six months ended June 30, 2014 (dollars in thousands):

 
 
June 30, 2014
 
 
Number of
Loans
 
Pre-Modification Recorded
Investment
 
Post-Modification Recorded
Investment
 
Charge-offs and
Specific Reserves
Performing:
 
 
 
 

 
 

 
 

Indirect vehicle
 
1
 
$
5

 
$
5

 
$
—

Home equity
 
6
 
1,883

 
1,883

 
—

Total
 
7
 
$
1,888

 
$
1,888

 
$
—

Non-Performing:
 
 
 
 

 
 

 
 

Commercial
 
1
 
$
263

 
$
263

 
$
85

Commercial real estate:
 
 
 
 

 
 
 
 
Multifamily
 
1
 
158

 
158

 
40

Residential real estate
 
4
 
1,439

 
1,439

 
—

Indirect vehicle
 
29
 
167

 
167

 
27

Home equity
 
7
 
1,063

 
1,063

 
—

Total
 
42
 
$
3,090

 
$
3,090

 
$
152


The following table presents loans that have been restructured during the three months ended June 30, 2013 (dollars in thousands):
 
 
 
June 30, 2013
 
 
Number of
Loans
 
Pre-Modification Recorded
Investment
 
Post-Modification Recorded
Investment
 
Charge-offs and
Specific Reserves
Performing:
 
 

 
 

 
 

 
 

Commercial real estate:
 
 
 
 

 
 

 
 

Multifamily
 
1

 
$
601

 
$
601

 
$
—

Residential real estate
 
1

 
281

 
281

 
—

Home equity
 
1

 
156

 
156

 
—

Total
 
3

 
$
1,038

 
$
1,038

 
$
—

Non-Performing:
 
 

 
 

 
 

 
 

Commercial
 
1

 
$
1,209

 
$
1,209

 
$
660

Commercial real estate:
 
 
 
 

 
 

 
 

Industrial
 
4

 
2,570

 
2,570

 
1,425

Residential real estate
 
1

 
424

 
424

 
—

Indirect vehicle
 
3

 
14

 
14

 
—

Home equity
 
4

 
831

 
831

 
—

Total
 
13

 
$
5,048

 
$
5,048

 
$
2,085



23



The following table presents loans that have been restructured during the six months ended June 30, 2013 (dollars in thousands):

 
 
June 30, 2013
 
 
Number of
Loans
 
Pre-Modification Recorded
Investment
 
Post-Modification Recorded
Investment
 
Charge-offs and
Specific Reserves
Performing:
 
 
 
 

 
 

 
 

Multifamily
 
1
 
$
601

 
$
601

 
$
—

Residential real estate
 
4
 
760

 
760

 
—

Home equity
 
6
 
704

 
704

 
—

Total
 
11
 
$
2,065

 
$
2,065

 
$
—

Non-Performing:
 
 
 
 

 
 

 
 

Commercial
 
2
 
$
1,251

 
$
1,251

 
$
673

Commercial real estate:
 
 
 
 
 
 
 
 
Industrial
 
4
 
2,570

 
2,570

 
1,425

Multifamily
 
1
 
187

 
187

 
50

Retail
 
2
 
657

 
657

 
179

Other
 
1
 
84

 
84

 
23

Residential real estate
 
5
 
755

 
755

 
—

Indirect vehicle
 
3
 
14

 
14

 
—

Home equity
 
20
 
2,936

 
2,936

 
—

Total
 
38
 
$
8,454

 
$
8,454

 
$
2,350


Of the troubled debt restructurings entered into during the past twelve months, none subsequently defaulted during the six months ended June 30, 2014.  Performing troubled debt restructurings are considered to have defaulted when they become 90 days or more past due post restructuring or are placed on non-accrual status.

The following tables present the troubled debt restructurings activity during the six months ended June 30, 2014 (in thousands):
 
 
Performing
 
Non-performing
Beginning balance
 
$
29,430

 
$
24,952

Additions
 
1,888

 
3,090

Charge-offs
 
(353
)
 
(1,946
)
Principal payments, net
 
(725
)
 
(2,888
)
Removals
 
(8,573
)
 
(3,572
)
Transfer to other real estate owned
 
—

 
—

Transfer from/to performing
 
5,713

 
587

Transfer from/to non-performing
 
(587
)
 
(5,713
)
Ending balance
 
$
26,793

 
$
14,510


Approximately $5.7 million of non-performing troubled debt restructurings were transferred to performing status. A majority of these loans were identified as non-performing troubled debt restructurings during the first half of 2013 and have performed in accordance with the modified terms. The loans continue to be reported as performing troubled debt restructurings. The loans transferred to non-performing in the table above were restructured in 2011 and 2012. Loans removed from troubled debt restructuring status are those that were restructured in a previous calendar year at a market rate of interest and have performed in compliance with the modified terms.

24




The following table presents the type of modification for loans that have been restructured during the six months ended June 30, 2014 (in thousands):
 
June 30, 2014
 
 
 
 
 
 
 
 
 
Extended
 
Extended
 
 
 
 
 
Maturity,
 
Maturity and
 
Delay in
 
 
 
Amortization
 
Delay in Payments
 
Payments or
 
 
 
and Reduction
 
or Reduction of
 
Reduction of
 
 
 
of Interest Rate
 
Interest Rate
 
Interest Rate
 
Total
Commercial
$
—

 
$
263

 
$
—

 
$
263

Commercial real estate:
 
 
 
 
 
 
 
   Multifamily
—

 
158

 
—

 
158

Residential real estate
—

 
1,269

 
170

 
1,439

Indirect vehicle
—

 
—

 
172

 
172

Home equity
1,442

 
1,210

 
294

 
2,946

     Total
$
1,442

 
$
2,900

 
$
636

 
$
4,978



25



The following table presents the activity in the allowance for credit losses, balance in allowance for credit losses and recorded investment in loans by portfolio segment and based on impairment method as of June 30, 2014 and 2013 (in thousands):
 
 
 
Commercial
 
Commercial
collateralized  by
assignment of
lease payments
 
Commercial
real estate
 
Residential
real estate
 
Construction
real estate
 
Indirect
vehicle
 
Home
equity
 
Other consumer
 
Unfunded
commitments
 
Total
June 30, 2014
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Allowance for credit losses:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Three Months Ended
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
 
$
23,938

 
$
9,058

 
$
47,540

 
$
8,087

 
$
6,484

 
$
1,684

 
$
8,397

 
$
1,564

 
$
1,643

 
$
108,395

Charge-offs
 
446

 
40

 
1,727

 
433

 
14

 
583

 
817

 
590

 
—

 
4,650

Recoveries
 
696

 
130

 
567

 
6

 
77

 
439

 
127

 
68

 
—

 
2,110

Provision
 
(1,034
)
 
277

 
(2,447
)
 
(165
)
 
(1,934
)
 
187

 
574

 
1,240

 
1,352

 
(1,950
)
Ending balance
 
$
23,154

 
$
9,425

 
$
43,933

 
$
7,495

 
$
4,613

 
$
1,727

 
$
8,281

 
$
2,282

 
$
2,995

 
$
103,905

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Six Months Ended
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
 
$
23,461

 
$
9,159

 
$
51,628

 
$
8,872

 
$
6,856

 
$
1,662

 
$
8,478

 
$
1,630

 
$
1,716

 
$
113,462

Charge-offs
 
536

 
40

 
8,883

 
698

 
70

 
1,503

 
1,436

 
1,085

 
—

 
14,251

Recoveries
 
2,324

 
130

 
1,052

 
525

 
176

 
881

 
260

 
146

 
—

 
5,494

Provision
 
(2,095
)
 
176

 
136

 
(1,204
)
 
(2,349
)
 
687

 
979

 
1,591

 
1,279

 
(800
)
Ending balance
 
$
23,154

 
$
9,425

 
$
43,933

 
$
7,495

 
$
4,613

 
$
1,727

 
$
8,281

 
$
2,282

 
$
2,995

 
$
103,905

Ending allowance balance attributable to loans:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Individually evaluated for impairment
 
$
5,500

 
$
98

 
$
4,511

 
$
3,135

 
$
161

 
$
29

 
$
1,727

 
$
—

 
$
1,307

 
$
16,468

Collectively evaluated for impairment
 
17,128

 
9,327

 
38,734

 
4,360

 
4,447

 
1,698

 
6,554

 
2,282

 
1,688

 
86,218

Acquired and accounted for under ASC 310-30 (1)
 
526

 
—

 
688

 
—

 
5

 
—

 
—

 
—

 
—

 
1,219

Total ending allowance balance
 
$
23,154

 
$
9,425

 
$
43,933

 
$
7,495

 
$
4,613

 
$
1,727

 
$
8,281

 
$
2,282

 
$
2,995

 
$
103,905

Loans:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Individually evaluated for impairment
 
$
34,117

 
$
3,267

 
$
57,587

 
$
16,888

 
$
337

 
$
187

 
$
25,451

 
$
—

 
$
—

 
$
137,834

Collectively evaluated for impairment
 
1,217,963

 
1,512,179

 
1,561,735

 
288,813

 
116,659

 
272,654

 
219,684

 
70,584

 
—

 
5,260,271

Acquired and accounted for under ASC 310-30 (1)
 
26,680

 
—

 
73,708

 
5,695

 
28,554

 
—

 
121

 
23,861

 
—

 
158,619

Total ending loans balance
 
$
1,278,760

 
$
1,515,446

 
$
1,693,030

 
$
311,396

 
$
145,550

 
$
272,841

 
$
245,256

 
$
94,445

 
$
—

 
$
5,556,724

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

26



 
 
Commercial
 
Commercial
collateralized  by
assignment of
lease payments
 
Commercial
real estate
 
Residential
real estate
 
Construction
real estate
 
Indirect
vehicle
 
Home
equity
 
Other consumer
 
Unfunded
commitments
 
Total
June 30, 2013
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Allowance for credit losses:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Three Months Ended
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
 
$
24,154

 
$
8,099

 
$
63,147

 
$
6,648

 
$
9,170

 
$
1,399

 
$
7,902

 
$
1,283

 
$
2,931

 
$
124,733

Transfer to (from) allowance for unfunded credit commitments
 
—

 
—

 
—

 
—

 
500

 
—

 
—

 
—

 
(500
)
 
—

Charge-offs
 
433

 
—

 
1,978

 
399

 
747

 
629

 
1,323

 
451

 
—

 
5,960

Recoveries
 
777

 
987

 
3,647

 
199

 
131

 
324

 
100

 
59

 
—

 
6,224

Provision
 
2,779

 
(557
)
 
(4,802
)
 
1,673

 
(359
)
 
443

 
1,527

 
415

 
(619
)
 
500

Ending balance
 
$
27,277

 
$
8,529

 
$
60,014

 
$
8,121

 
$
8,695

 
$
1,537

 
$
8,206

 
$
1,306

 
$
1,812

 
$
125,497

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Six Months Ended
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
 
$
24,943

 
$
7,755

 
$
61,056

 
$
6,941

 
$
11,222

 
$
1,324

 
$
9,401

 
$
1,562

 
$
4,075

 
$
128,279

Transfer to (from) allowance for unfunded credit commitments
 
—

 
—

 
—

 
—

 
500

 
—

 
—

 
—

 
(500
)
 
—

Charge-offs
 
1,344

 
—

 
3,895

 
1,361

 
829

 
1,358

 
2,110

 
1,016

 
—

 
11,913

Recoveries
 
1,229

 
1,131

 
4,387

 
413

 
407

 
739

 
214

 
111

 
—

 
8,631

Provision
 
2,449

 
(357
)
 
(1,534
)
 
2,128

 
(2,605
)
 
832

 
701

 
649

 
(1,763
)
 
500

Ending balance
 
$
27,277

 
$
8,529

 
$
60,014

 
$
8,121

 
$
8,695

 
$
1,537

 
$
8,206

 
$
1,306

 
$
1,812

 
$
125,497

Ending allowance balance attributable to loans:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Individually evaluated for impairment
 
$
6,544

 
$
420

 
$
9,451

 
$
2,958

 
$
251

 
$
—

 
$
685

 
$
—

 
$
875

 
$
21,184

Collectively evaluated for impairment
 
19,989

 
8,109

 
47,652

 
5,163

 
8,444

 
1,537

 
7,521

 
1,306

 
937

 
100,658

Acquired and accounted for under ASC 310-30 (1)
 
744

 
—

 
2,911

 
—

 
—

 
—

 
—

 
—

 
—

 
3,655

Total ending allowance balance
 
$
27,277

 
$
8,529

 
$
60,014

 
$
8,121

 
$
8,695

 
$
1,537

 
$
8,206

 
$
1,306

 
$
1,812

 
$
125,497

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Individually evaluated for impairment
 
$
23,123

 
$
3,035

 
$
67,322

 
$
14,641

 
$
1,650

 
$
11

 
$
24,108

 
$
—

 
$
—

 
$
133,890

Collectively evaluated for impairment
 
1,157,459

 
1,419,866

 
1,643,642

 
287,304

 
119,770

 
242,953

 
257,226

 
75,476

 
—

 
5,203,696

Acquired and accounted for under ASC 310-30 (1)
 
46,738

 
—

 
177,966

 
6,297

 
67,911

 
—

 
149

 
31,540

 
—

 
330,601

Total ending loans balance
 
$
1,227,320

 
$
1,422,901

 
$
1,888,930

 
$
308,242

 
$
189,331

 
$
242,964

 
$
281,483

 
$
107,016

 
$
—

 
$
5,668,187


(1)  Loans acquired in FDIC-assisted transactions and accounted for under ASC Subtopic 310-30 “Receivables — Loans and Debt Securities Acquired with Deteriorated Credit Quality.”

Purchased loans acquired in a business combination are recorded at estimated fair value on their purchase date without a carryover of the related allowance for loan losses. These acquired loans are segregated into three types: pass rated loans with no discount attributable to credit quality, non-impaired loans with a discount attributable at least in part to credit quality and impaired loans with evidence of significant credit deterioration.  

•
Pass rated loans (typically performing loans) are accounted for in accordance with ASC 310-20 "Nonrefundable Fees and Other Costs" as these loans do not have evidence of credit deterioration since origination.
•
Non-impaired loans (typically past-due loans, special mention loans and performing substandard loans) are accounted for in accordance with ASC 310-30 if they display at least some level of credit deterioration since origination.
•
Impaired loans (typically substandard loans on non-accrual status) are accounted for in accordance with ASC 310-30 as they display significant credit deterioration since origination.

In accordance with ASC 310-30, for both purchased non-impaired loans and purchased impaired loans, the difference between contractually required payments at acquisition and the cash flows expected to be collected is referred to as the non-accretable difference. Further, any excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable yield and is recognized into interest income over the remaining life of the loan when there is a reasonable expectation about the amount and timing of such cash flows.


27



Substantially all of the loans acquired in transactions with the FDIC displayed at least some level of credit deterioration and as such are included as non-impaired and impaired loans as described immediately above.

During the six months ended June 30, 2014 there was a negative provision for credit losses of $163 thousand and net charge-offs of $850 thousand, in relation to 16 pools of purchased loans with a total carrying amount of $119.5 million as of June 30, 2014. There was $1.2 million and $2.2 million in allowance for loan losses related to these purchased loans at June 30, 2014 and December 31, 2013, respectively.  The provision for credit losses and accompanying charge-offs are included in the table above.
 
Changes in the accretable yield for loans acquired in FDIC-assisted transactions and accounted for under ASC 310-30 were as follows for the three and six months ended June 30, 2014 and 2013 (in thousands):
 
 
 
Three Months Ended
 
Six Months Ended
 
 
June 30,
 
June 30,
 
 
2014
 
2013
 
2014
 
2013
Balance at beginning of period
 
$
2,361

 
$
4,320

 
$
2,337

 
$
5,685

Accretion
 
(1,143
)
 
(1,422
)
 
(1,693
)
 
(2,879
)
Other
 
—

 
3,462

 
574

 
3,554

Balance at end of period
 
$
1,218

 
$
6,360

 
$
1,218

 
$
6,360

 
In our FDIC-assisted transactions, the fair value of purchased impaired loans, on the acquisition date, was determined based on assigned risk ratings, expected cash flows and the fair value of loan collateral. The fair value of loans that were non-impaired was determined based on estimates of losses on defaults and other market factors. Due to the loss-share agreements with the FDIC, MB Financial Bank recorded a receivable (FDIC indemnification asset) from the FDIC equal to the present value of the corresponding reimbursement percentages on the estimated losses embedded in the loan portfolio.

When cash flow estimates are adjusted downward for a particular loan pool, the FDIC indemnification asset is increased. An allowance for loan losses is established for the impairment of the loans. A provision for loan losses is recognized for the difference between the increase in the FDIC indemnification asset and the decrease in cash flows.

When cash flow estimates are adjusted upward for a particular loan pool, the FDIC indemnification asset is decreased. The difference between the decrease in the FDIC indemnification asset and the increase in cash flows is accreted over the estimated life of the loan pool.

When cash flow estimates are adjusted downward for covered foreclosed real estate, the FDIC indemnification asset is increased. A charge is recognized for the difference between the increase in the FDIC indemnification asset and the decrease in cash flows.

When cash flow estimates are adjusted upward for covered foreclosed real estate, the FDIC indemnification asset is decreased. Any write-down after the transfer to covered foreclosed real estate is reversed.

In both scenarios, the clawback liability (the amount the FDIC requires MB Financial Bank to pay back if certain thresholds are met) will increase or decrease accordingly.
 

28



The carrying amount of covered loans and other purchased non-covered loans at June 30, 2014 consisted of loans as shown in the following table (in thousands):

June 30, 2014
 
Purchased
Impaired
Loans
 
Purchased Non-Impaired
Loans
 
Total
Covered loans:
 
 

 
 

 
 

Commercial related (1)
 
$
1,908

 
$
2,546

 
$
4,454

Commercial
 
734

 
1,372

 
2,106

Commercial real estate
 
46,557

 
27,151

 
73,708

Construction real estate
 
23,116

 
5,438

 
28,554

Other
 
2,842

 
23,302

 
26,144

Total covered loans
 
$
75,157

 
$
59,809

 
$
134,966

Estimated receivable amount from the FDIC under the loss-share agreement (2)
 
$
4

 
$
4,769

 
$
4,773

Non-covered loans:
 
 

 
 

 
 

Commercial related (3)
 
$
6,546

 
$
13,574

 
$
20,120

Other
 
89

 
3,444

 
3,533

Total non-covered loans
 
$
6,635

 
$
17,018

 
$
23,653


(1)
Covered commercial related loans include commercial, commercial real estate and construction real estate loans acquired in connection with the Heritage and Benchmark FDIC-assisted transactions.
(2)
Estimated reimbursable amounts from the FDIC under the loss-share agreement exclude $166 thousand in amounts due to the FDIC related to covered other real estate owned.
(3)
Non-covered commercial related loans include commercial, commercial real estate and construction real estate for InBank and Heritage.
 
Outstanding balances on purchased loans from the FDIC were $163.2 million and $268.5 million as of June 30, 2014 and December 31, 2013, respectively.  The related carrying amount on loans purchased from the FDIC was $158.6 million and $256.4 million as of June 30, 2014 and December 31, 2013, respectively.

Effective April 1, 2014, the losses on commercial related loans (commercial, commercial real estate and construction real estate) acquired in connection with the Heritage FDIC-assisted transaction ceased being covered under the loss-share agreement for that transaction. The carrying amount of those loans was $3.9 million as of June 30, 2014. Any recoveries, net of expenses, received on commercial related loans on which losses were incurred prior to April 1, 2014 will continue to be covered (and any such net recoveries must be shared with the FDIC in accordance with the loss-share agreement) through March 31, 2017. The losses on consumer related loans acquired in connection with the Heritage FDIC-assisted transaction will continue to be covered under the loss-share agreement through March 31, 2019.

The losses on commercial related loans acquired in connection with the Benchmark FDIC-assisted transaction will cease to be covered under the loss-share agreement for that transaction effective January 1, 2015. Effective July 1, 2015, the losses on commercial related loans acquired in connection with Broadway and New Century FDIC-assisted transactions will cease to be covered under the loss-share agreements for those transactions. Any recoveries, net of expenses, received on commercial related loans on which losses were incurred prior to January 1, 2015 and July 1, 2015, for the respective transactions, will continue to be covered (and any such net recoveries must be shared with the FDIC in accordance with the loss-share agreements) through December 31, 2017 and June 30, 2018 for the Benchmark FDIC-assisted transaction and Broadway and New Century FDIC-assisted transactions, respectively. The losses on consumer related loans acquired in connection with the Benchmark FDIC-assisted transaction and Broadway and New Century FDIC-assisted transactions will continue to be covered under the loss-share agreements through December 31, 2019 and June 30, 2020, respectively.
 
Note 7.
  Goodwill and Intangibles
 
The excess of the cost of an acquisition over the fair value of the net assets acquired, including core deposit and client relationship intangibles, consists of goodwill. Under ASC Topic 350, goodwill is subject to at least annual assessments for impairment by applying a fair value based test. The Company reviews goodwill to determine potential impairment annually, or more frequently if events and circumstances indicate that goodwill might be impaired, by comparing the carrying value of the reporting units with the fair value of the reporting units.
 

29



The Company's annual assessment date is as of December 31. Goodwill is tested for impairment at the reporting unit level. The Company has two reporting units: banking and leasing. No impairment losses were recognized during the three or six months ended June 30, 2014 or 2013.   The carrying amount of goodwill was $423.4 million at June 30, 2014 and December 31, 2013.
 
The Company has other intangible assets consisting of core deposit and client relationship intangibles that had a remaining weighted average amortization period of approximately four years as of June 30, 2014.
 
The following table presents the changes in the carrying amount of core deposit and client relationship intangibles, gross carrying amount, accumulated amortization, and net book value as of June 30, 2014 (in thousands):
 
 
 
Six Months Ended
 
 
June 30,
2014
Balance at beginning of period
 
$
23,428

Amortization expense
 
(2,414
)
Balance at end of period
 
$
21,014

 
 
 
Gross carrying amount
 
$
54,368

Accumulated amortization
 
(33,354
)
Net book value
 
$
21,014

 
The following presents the estimated future amortization expense of other intangible assets (in thousands):
 
Year ending December 31,
 
Amount
2014
 
$
2,334

2015
 
4,030

2016
 
3,418

2017
 
3,071

2018
 
2,812

Thereafter
 
5,349

 
 
$
21,014

 
Note 8.
Deposits
 
The composition of deposits was as follows (in thousands):
 
 
 
June 30,
 
December 31,
 
 
2014
 
2013
Demand deposit accounts, noninterest bearing
 
$
2,605,367

 
$
2,375,863

NOW and money market accounts
 
2,932,089

 
2,682,419

Savings accounts
 
872,324

 
855,394

Certificates of deposit, $100,000 or more
 
758,906

 
827,413

Other certificates of deposit
 
594,378

 
640,170

Total
 
$
7,763,064

 
$
7,381,259

 
Certificates of deposit of $100,000 or more included $216.0 million and $224.2 million of brokered deposits at June 30, 2014 and December 31, 2013, respectively.  Brokered deposits typically consist of smaller individual time certificates that have the same liquidity characteristics and yields consistent with time certificates of $100,000 or more.



30



Note 9.
Short-Term Borrowings
 
Short-term borrowings were as follows as of June 30, 2014 and December 31, 2013 (dollars in thousands):
 
 
 
June 30, 2014
 
December 31, 2013
 
 
Weighted Average Cost
 
Amount
 
Weighted Average Cost
 
Amount
Customer repurchase agreements
 
0.21
%
 
$
229,809

 
0.20
%
 
$
193,389

Federal Home Loan Bank advances
 
—

 
—

 
0.17

 
300,000

 
 
0.21
%
 
$
229,809

 
0.18
%
 
$
493,389

 
Securities sold under agreements to repurchase are agreements in which the Company acquires funds by selling assets to another party under a simultaneous agreement to repurchase the same assets at a specified price and date.  The Company enters into repurchase agreements and also offers a demand deposit account product to customers that sweeps their balances in excess of an agreed upon target amount into overnight repurchase agreements.  All securities sold under agreements to repurchase are recorded on the face of the balance sheet.
 
The Company had a Federal Home Loan Bank fixed rate advance with a maturity date less than one year of $300.0 million at December 31, 2013 that matured early in the first quarter of 2014.  The Company has investment securities available for sale and loans pledged as collateral on this FHLB advance. See Note 4. Investment Securities and Note 5. Loans of the notes to the consolidated financial statements.

On March 9, 2012, the Company entered into a $35.0 million unsecured line of credit with a correspondent bank. Interest is payable at a rate of one month LIBOR + 2.00%. As of June 30, 2014, no amount was outstanding. The line originally matured on March 8, 2013, was renewed and is scheduled to mature on September 7, 2014.

 
Note 10.
Long-term Borrowings
 
The Company had Federal Home Loan Bank advances with remaining contractual maturities greater than one year of $4.2 million at June 30, 2014 and $4.3 million at December 31, 2013. As of June 30, 2014, the advances had fixed terms with effective interest rates, net of discounts, ranging from 3.23% to 5.87% and maturities ranging from April 2021 to April 2035. The Company has investment securities available for sale and loans pledged as collateral on this FHLB advance. See Note 5. Investment Securities and Note 6. Loans of the notes to the consolidated financial statements.
 
The Company had notes payable to banks totaling $27.0 million and $17.5 million at June 30, 2014 and December 31, 2013, respectively, which as of June 30, 2014, were accruing interest at rates ranging from 2.50% to 12.00%.  Lease investments includes equipment with an amortized cost of $25.6 million and $25.7 million at June 30, 2014 and December 31, 2013, respectively, that is pledged as collateral on these notes.
 
The Company had a $40.0 million 10-year structured repurchase agreement as of June 30, 2014 and December 31, 2013, which bears interest at a fixed rate borrowing of 4.75% and expires in 2016.


 


31



Note 11.
Junior Subordinated Notes Issued to Capital Trusts
 
The Company has established statutory trusts for the sole purpose of issuing trust preferred securities and related trust common securities.  The proceeds from such issuances were used by the trusts to purchase junior subordinated notes of the Company, which are the sole assets of each trust.  Concurrently with the issuance of the trust preferred securities, the Company issued guarantees for the benefit of the holders of the trust preferred securities.  The Company’s outstanding trust preferred securities qualify, and are treated by the Company, as Tier 1 regulatory capital.  The Company owns all of the common securities of each trust.  The trust preferred securities issued by each trust rank equally with the common securities in right of payment, except that if an event of default under the indenture governing the notes has occurred and is continuing, the preferred securities will rank senior to the common securities in right of payment.
 
The table below summarizes the outstanding junior subordinated notes and the related trust preferred securities issued by each trust as of June 30, 2014 (in thousands):
 
 
 
Coal City
Capital Trust I
 
MB Financial
Capital Trust II
 
MB Financial
Capital Trust III
 
MB Financial
Capital Trust IV
Junior Subordinated Notes:
 
 

 
 

 
 

 
 

Principal balance
 
$
25,774

 
$
36,083

 
$
10,310

 
$
20,619

Annual interest rate
 
3-mo LIBOR + 1.80%

 
3-mo LIBOR + 1.40%

 
3-mo LIBOR + 1.50%

 
3-mo LIBOR + 1.52%

Stated maturity date
 
September 1, 2028

 
September 15, 2035

 
September 23, 2036

 
September 15, 2036

Call date
 
September 1, 2008

 
December 15, 2010

 
September 23, 2011

 
September 15, 2011

Trust Preferred Securities:
 
 

 
 

 
 

 
 

Face Value
 
$
25,000

 
$
35,000

 
$
10,000

 
$
20,000

Annual distribution rate
 
3-mo LIBOR + 1.80%

 
3-mo LIBOR + 1.40%

 
3-mo LIBOR + 1.50%

 
3-mo LIBOR + 1.52%

Issuance date
 
July 1998

 
August 2005

 
July 2006

 
August 2006

Distribution dates (1)
 
Quarterly

 
Quarterly

 
Quarterly

 
Quarterly

 
 
MB Financial
Capital Trust V
 
MB Financial
Capital Trust VI
 
FOBB
Statutory Trust III (2)
Junior Subordinated Notes:
 
 

 
 

 
 

Principal balance
 
$
30,928

 
$
23,196

 
$
5,155

Annual interest rate
 
3-mo LIBOR + 1.30%

 
3-mo LIBOR + 1.30%

 
3-mo LIBOR + 2.80%

Stated maturity date
 
December 15, 2037

 
October 30, 2037

 
January 23, 2034

Call date
 
December 15, 2012

 
October 30, 2012

 
January 23, 2009

Trust Preferred Securities:
 
 

 
 

 
 

Face Value
 
$
30,000

 
$
22,500

 
$
5,000

Annual distribution rate
 
3-mo LIBOR + 1.30%

 
3-mo LIBOR + 1.30%

 
3-mo LIBOR + 2.80%

Issuance date
 
September 2007

 
October 2007

 
December 2003

Distribution dates (1)
 
Quarterly

 
Quarterly

 
Quarterly

 
(1)
All distributions are cumulative and paid in cash.
(2)
FOBB Statutory Trust III was established by First Oak Brook Bancshares, Inc. (“FOBB”) prior to the Company's acquisition of FOBB, and the junior subordinated note issued by FOBB to FOBB Statutory Trust III was assumed by the Company upon completion of the acquisition.
 
The trust preferred securities are subject to mandatory redemption, in whole or in part, upon repayment of the junior subordinated notes at the stated maturity date or upon redemption of the junior subordinated notes.  Each trust’s ability to pay amounts due on the trust preferred securities is solely dependent upon the Company making payment on the related junior subordinated notes.  The Company’s obligation under the junior subordinated notes and other relevant trust agreements, in aggregate, constitutes a full and unconditional guarantee by the Company of each trust’s obligations under the trust preferred securities issued by each trust.  The Company has the right to defer payment of interest on the notes and, therefore, distributions on the trust preferred securities, for up to five years, but not beyond the stated maturity date in the table above.  During any such deferral period the Company may not pay cash dividends on its stock and generally may not repurchase its stock.
  

32



Note 12.
Commitments and Contingencies
 
Commitments: The Company is a party to credit-related financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers.  These financial instruments include commitments to extend credit, standby letters of credit and commercial letters of credit.  Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets.
 
The Company’s exposure to credit loss is represented by the contractual amount of these commitments.  The Company follows the same credit policies in making commitments as it does for on-balance-sheet instruments.
 
At June 30, 2014 and December 31, 2013, the following financial instruments were outstanding, the contractual amounts of which represent off-balance sheet credit risk (in thousands):
 
 
 
Contractual Amount
 
 
June 30, 2014
 
December 31, 2013
Commitments to extend credit:
 
 

 
 

Home equity lines
 
$
194,711

 
$
208,581

Other commitments
 
1,211,154

 
1,214,391

Letters of credit:
 
 

 
 

Standby
 
71,948

 
69,556

Commercial
 
3,874

 
708

 
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract.  Commitments generally have fixed expiration dates or other termination clauses and may require a payment of a fee.  The commitments for home equity lines of credit may expire without being drawn upon.  Therefore, the total commitment amounts do not necessarily represent future cash requirements.  The amount of collateral obtained, if it is deemed necessary by the Company, is based on management’s credit evaluation of the customer.
 
The Company, in the normal course of its business, regularly offers standby and commercial letters of credit to its bank customers.  Standby and commercial letters of credit are a conditional but irrevocable form of guarantee.  Under letters of credit, the Company typically guarantees payment to a third party beneficiary upon the default of payment or nonperformance by the bank customer and upon receipt of complying documentation from that beneficiary.
 
Both standby and commercial letters of credit may be issued for any length of time, but normally do not exceed a period of five years.  These letters of credit may also be extended or amended from time to time depending on the bank customer’s needs.  As of June 30, 2014, the maximum remaining term for any standby letters of credit was December 31, 2020.  A fee is charged to the bank customer and is recognized as income over the life of the letter of credit, unless considered non-rebatable under the terms of a letter of credit application.
 
At June 30, 2014, the aggregate contractual amount of these letters of credit, which represents the maximum potential amount of future payments that the Company would be obligated to pay, increased $5.6 million to $75.8 million from $70.3 million at December 31, 2013.  Of the $75.8 million in commitments outstanding at June 30, 2014, approximately $34.8 million of the letters of credit have been issued or renewed since December 31, 2013.
 
Letters of credit issued on behalf of bank customers may be done on either a secured, partially secured or an unsecured basis.  If a letter of credit is secured or partially secured, the collateral can take various forms including bank accounts, investments, fixed assets, inventory, accounts receivable or real estate, among other things.  The Company takes the same care in making credit decisions and obtaining collateral when it issues letters of credit on behalf of its customers as it does when making other types of loans.
 
As of June 30, 2014, the Company had approximately $1.9 million in capital expenditure commitments outstanding which relate to various projects to renovate existing branches.
 
Concentrations of credit risk:  The majority of the loans, commitments to extend credit and standby letters of credit have been granted to customers in the Company’s market area.  As of June 30, 2014, approximately 28% of our investments in securities issued by states and political subdivisions were within the state of Illinois.  We did not hold any direct exposure to the state of Illinois as of June 30, 2014. The distribution of commitments to extend credit approximates the distribution of loans outstanding. 

33



Standby letters of credit are granted primarily to commercial borrowers. Lease banking provides banking services to lessors located throughout the United States. Our leasing subsidiaries originate leases to companies located through the United States.
 
Contingencies: In the normal course of business, the Company is involved in various legal proceedings.  In the opinion of management, any liability resulting from pending proceedings would not be expected to have a material adverse effect on the Company’s consolidated financial statements.

On July 26, 2013, an action captioned James Sullivan v. Taylor Capital Group, Inc., et al., Case No. 2013-CH17751 (the “Sullivan Action”) was commenced against Taylor Capital, the board of directors of Taylor Capital (the “Taylor Capital Board”), and MB Financial (collectively, the “Defendants”) in the Circuit Court of Cook County, Illinois (the “Court”), alleging that the Taylor Capital Board breached its fiduciary duties in connection with the pending MB Financial/Taylor Capital merger (the “Merger”) and that MB Financial aided and abetted those breaches of fiduciary duty. On August 8, 2013, a stockholder class action captioned Dennis Panozzo v. Taylor Capital Group, Inc., et. al., Case No. 2013-CH-18546 (the “Panozzo Action”) was commenced against the Defendants in the Court making similar allegations in connection with the Merger. Subsequently, on September 10, 2013, the Sullivan Action and the Panozzo Action were consolidated pursuant to Court order under the first-filed Sullivan Action, Case No. 2013-CH17751 (as so consolidated, the “Action”). On October 24, 2013, the plaintiffs in the Action (the “Plaintiffs”) filed a consolidated amended class action complaint, alleging that the Taylor Capital Board breached its fiduciary duties in connection with the Merger, including by making incomplete and misleading disclosures concerning the Merger, and that MB Financial aided and abetted those breaches of fiduciary duty.

On February 17, 2014, solely to eliminate the costs, risks, burden, distraction and expense of further litigation and to put the claims that were or could have been asserted to rest, the Defendants entered into a memorandum of understanding (the “MOU”) with the Plaintiffs regarding the settlement of the Action pursuant to which Taylor Capital and MB Financial agreed to make certain supplemental disclosures concerning the Merger, which each of Taylor Capital and MB Financial did in a Current Report on Form 8-K filed by each company on February 18, 2014 (the “Form 8-Ks”). On July 10, 2014, the parties entered into a definitive settlement agreement. The agreement is subject to Court approval. The agreement provides that, solely for purposes of settlement, the Court will certify a class consisting of all persons who were record or beneficial stockholders of Taylor Capital when the Merger was approved by the Taylor Capital Board or any time thereafter (the “Class”). In addition, the agreement provides that, subject to approval by the Court after notice to the members of the Class (the “Class Members”), the Action will be dismissed with prejudice and all claims that the Class Members may possess with regard to the Merger, with the exception of claims for statutory appraisal, will be released. Class Members will be afforded an opportunity to opt out of the class solely with regard to any monetary claims they may possess. In connection with the settlement, the Plaintiffs’ counsel has expressed their intention to seek an award by the Court of attorneys’ fees and expenses. The amount of the award to the Plaintiffs’ counsel will ultimately be determined by the Court. This payment will not affect the amount of merger consideration to be paid by MB Financial or that any Taylor Capital stockholder will receive in the Merger. The proposed settlement has not yet been presented to the Court for approval. There can be no assurance that the Court will approve the settlement. In the absence of such approval, the proposed settlement will terminate.

The Defendants continue to believe that the Action is without merit, have vigorously denied, and continue to vigorously deny, all of the allegations of wrongful or actionable conduct asserted in the Action, and the Taylor Capital Board vigorously maintains that it diligently and scrupulously complied with its fiduciary duties, that the joint proxy statement/prospectus dated January 14, 2014 mailed to the stockholders of Taylor Capital and MB Financial was complete and accurate in all material respects and that no further disclosure was required under applicable law. The Defendants are entering into the MOU and the contemplated settlement solely to eliminate the costs, risks, burden, distraction and expense of further litigation and to put the claims that were or could have been asserted to rest. Nothing in the MOU, any settlement agreement or any public filing, including the Form 8-Ks, shall be deemed an admission of the legal necessity of filing or the materiality under applicable laws of any of the additional information contained therein or in any public filing associated with the proposed settlement of the Action.

Based on information currently available, consultations with counsel and established reserves, management believes that the eventual outcome of this litigation will not have a material adverse effect on the Company's consolidated financial position or results of operations.

 

34



Note 13.
Fair Value Measurements
 
ASC Topic 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. The price in the principal (or most advantageous) market used to measure the fair value of the asset or liability shall not be adjusted for transaction costs. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets and liabilities; it is not a forced transaction. Market participants are buyers and sellers in the principal market that are (i) independent, (ii) knowledgeable, (iii) able to transact and (iv) willing to transact.

ASC Topic 820 requires the use of valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets and liabilities. The income approach uses valuation techniques to convert expected future amounts, such as cash flows or earnings, to a single present value amount on a discounted basis. The cost approach is based on the amount that currently would be required to replace the service capacity of an asset (replacement cost). Valuation techniques should be consistently applied. Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability. Inputs may be observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from independent sources, or unobservable, meaning those that reflect the reporting entity's own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. In that regard, ASC Topic 820 establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3: Significant unobservable inputs that reflect a reporting entity's own assumptions about the assumptions that market participants would use in pricing an asset or liability.

A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below.

In general, fair value is based upon quoted market prices, where available. If such quoted market prices are not available, fair value is based upon internally developed models that primarily use, as inputs, observable market-based parameters. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. These adjustments may include amounts to reflect counterparty credit quality, the Company's creditworthiness, among other things, as well as unobservable parameters. Any such valuation adjustments are applied consistently over time. Our valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. While management believes the Company's valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date. Transfers between levels of the fair value hierarchy are recognized on the actual date of the event or circumstances that caused the transfer, which generally coincides with the Company's monthly and/or quarterly valuation process.

Financial Instruments Recorded at Fair Value on a Recurring Basis

Securities Available for Sale. The fair values of securities available for sale are determined by quoted prices in active markets, when available, and classified as Level 1. If quoted market prices are not available, the fair value is determined by a matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities' relationship to other benchmark quoted securities and classified as Level 2. In cases where significant credit valuation adjustments are incorporated into the estimation of fair value, reported amounts are classified as Level 3.

Loans Held for Sale. Mortgage loans originated and held for sale in the secondary market are carried at fair value. The fair value of loans held for sale is determined using quoted secondary market prices and classified as level 2.

35




Assets Held in Trust for Deferred Compensation and Associated Liabilities. Assets held in trust for deferred compensation are recorded at fair value and included in “Other Assets” on the consolidated balance sheets. These assets are invested in mutual funds and classified as Level 1. Deferred compensation liabilities, also classified as Level 1, are carried at the fair value of the obligation to the employee, which corresponds to the fair value of the invested assets.

Derivatives. Currently, we use interest rate swaps to manage our interest rate risk. The valuation of these instruments is determined using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of each derivative and classified as Level 2. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including LIBOR rate curves. We also obtain dealer quotations for these derivatives for comparative purposes to assess the reasonableness of the model valuations. We also offer other derivatives, including foreign currency forward contracts and interest rate lock commitments, to our customers and offset our exposure from such contracts by purchasing other financial contracts, which are valued using market consensus prices.
 

36



The following table summarizes financial assets and financial liabilities measured at fair value on a recurring basis as of June 30, 2014 and December 31, 2013, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value (in thousands):
 
 
 
Total
 
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
 
Significant Other
Observable Inputs
(Level 2)
 
Significant
Unobservable Inputs
(Level 3)
June 30, 2014
 
 

 
 

 
 

 
 

Financial assets
 
 

 
 

 
 

 
 

Securities available for sale:
 
 

 
 

 
 

 
 

U.S Government sponsored agencies and enterprises
 
$
51,727

 
$
—

 
$
51,727

 
$
—

States and political subdivisions
 
19,498

 
—

 
19,498

 
—

Residential mortgage-backed securities
 
747,925

 
—

 
747,352

 
573

Commercial mortgage-backed securities
 
49,858

 
—

 
49,858

 
—

Corporate bonds
 
275,529

 
—

 
270,486

 
5,043

Equity securities
 
10,421

 
10,421

 
—

 
—

Loans held for sale
 
1,219

 
—

 
1,219

 
—

Assets held in trust for deferred compensation
 
11,990

 
11,990

 
—

 
—

Derivative financial instruments
 
16,745

 
—

 
16,745

 
—

Financial liabilities
 
 

 
 

 
 

 
 

Other liabilities (1)
 
11,806

 
11,806

 
—

 
—

Derivative financial instruments
 
16,606

 
—

 
16,606

 
—

December 31, 2013
 
 

 
 

 
 

 
 

Financial assets
 
 

 
 

 
 

 
 

Securities available for sale:
 
 

 
 

 
 

 
 

U.S. Government sponsored agencies and enterprises
 
$
52,068

 
$
—

 
$
52,068

 
$
—

States and political subdivisions
 
19,143

 
—

 
19,143

 
—

Residential mortgage-backed securities
 
701,233

 
—

 
700,542

 
691

Commercial mortgage-backed securities
 
52,941

 
—

 
52,941

 
—

Corporate bonds
 
283,070

 
—

 
277,905

 
5,165

Equity securities
 
10,457

 
10,457

 
—

 
—

   Loans held for sale
 
629

 
—

 
629

 
—

Assets held in trust for deferred compensation
 
10,679

 
10,679

 
—

 
—

Derivative financial instruments
 
18,645

 
—

 
18,645

 
—

Financial liabilities
 
 

 
 

 
 

 
 

Other liabilities (1)
 
10,569

 
10,569

 
—

 
—

Derivative financial instruments
 
18,632

 
—

 
18,632

 
—

 
(1) Liabilities associated with assets held in trust for deferred compensation
 

37



The following table presents additional information about the unobservable inputs used in the fair value measurement of financial assets measured on a recurring basis that were categorized within the Level 3 of the fair value hierarchy:
 
Fair Value at
Valuation
Unobservable
 
 
June 30, 2014
Technique
Input
Range
 
 
 
 
 
Residential mortgage-backed securities
$
573

Discounted cash flows
Constant pre-payment rates
 
 
 
 
   (CPR) assumption
1% - 3% CPR
Corporate bonds
5,043

Discounted cash flows
Credit assumption
20% Loss

The Company did not have any transfers between Level 1 and Level 2 of the fair value hierarchy during the three or six months ended June 30, 2014. The Company's policy for determining transfers between levels occurs at the end of the reporting period when circumstances in the underlying valuation criteria change and result in transfer between levels.

The following table presents additional information about financial assets measured at fair value on a recurring basis for which the Company used significant unobservable inputs (Level 3):
 
 
 
Six Months Ended
 
 
June 30,
(in thousands)
 
2014
 
2013
Balance, beginning of period
 
$
5,856

 
$
6,071

Other comprehensive income
 
108

 
(41
)
Principal payments
 
(256
)
 
(80
)
Balance, ending of period
 
$
5,616

 
$
5,950

 
Financial Instruments Recorded at Fair Value on a Nonrecurring Basis

The Company may be required, from time to time, to measure certain financial assets and financial liabilities at fair value on a nonrecurring basis in accordance with U.S. GAAP. These include assets that are measured at the lower of cost or fair value that were recognized at fair value below cost at the end of the period.

Impaired Loans. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures impairment in accordance with ASC Topic 310. The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. In accordance with ASC Topic 820, impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. Collateral values are estimated using Level 3 inputs based on customized discounting criteria. For a majority of impaired real estate loans where an allowance is established based on the fair value of collateral (90% at June 30, 2014), the Company obtains a current external appraisal. Other valuation techniques are used as well, including internal valuations, comparable property analysis and contractual sales information.

Non-Financial Assets and Non-Financial Liabilities Recorded at Fair Value

The Company has no non-financial assets or non-financial liabilities measured at fair value on a recurring basis. Certain non-financial assets and non-financial liabilities measured at fair value on a non-recurring basis include foreclosed assets and non-financial long-lived assets.

Other Real Estate and Repossessed Vehicles Owned (Foreclosed Assets). Foreclosed assets, upon initial recognition, are measured and reported at fair value through a charge-off to the allowance for loan losses based upon the fair value of the foreclosed asset. The fair value of foreclosed assets, upon initial recognition, are estimated using Level 3 inputs based on customized discounting criteria.
 
Non-Financial Long-Lived Assets.  Non-financial long-lived assets, when determined to be impaired, are measured and reported at fair value using Level 3 inputs based on customized discounting criteria.

38



 
Assets measured at fair value on a nonrecurring basis as of June 30, 2014 and December 31, 2013 are included in the table below (in thousands):
 
 
 
Total
 
Quoted Prices in Active
Markets for Identical
Assets (Level 1)
 
Significant Other
Observable Inputs
(Level 2)
 
Significant
Unobservable Inputs
(Level 3)
June 30, 2014
 
 

 
 

 
 

 
 

Financial assets:
 
 

 
 

 
 

 
 

Impaired loans
 
$
99,384

 
$
—

 
$
—

 
$
99,384

Non-financial assets:
 
 
 
 
 
 
 
 
Foreclosed assets
 
35,728

 
—

 
—

 
35,728

December 31, 2013
 
 

 
 

 
 

 
 

Financial assets:
 
 

 
 

 
 

 
 

Impaired loans
 
$
77,497

 
$
—

 
$
—

 
$
77,497

Non-financial assets:
 
 
 
 
 
 
 
 
Foreclosed assets
 
44,601

 
—

 
—

 
44,601

 
The following table presents additional information about the unobservable inputs used in the fair value measurement of financial assets measured on a nonrecurring basis that were categorized within the Level 3 of the fair value hierarchy:

 
Fair Value at
Valuation
Unobservable
 
 
June 30, 2014
Technique
Input
Range
 
 
 
 
 
Impaired loans
$
99,384

Appraisal of collateral
Appraisal adjustments - sales costs
5% - 10%
Foreclosed assets
35,728

Appraisal of collateral
Appraisal adjustments - sales costs
5% - 10%

ASC Topic 825 requires disclosure of the fair value of financial assets and financial liabilities, including those financial assets and financial liabilities that are not measured and reported at fair value on a recurring basis or non-recurring basis. The methodologies for estimating the fair value of financial assets and financial liabilities that are measured at fair value on a recurring or non-recurring basis are discussed above. The estimated fair value approximates carrying value for cash and cash equivalents, accrued interest and the cash surrender value of life insurance policies. The methodologies for other financial assets and financial liabilities are discussed below:

The following methods and assumptions were used by the Company in estimating the fair values of its other financial instruments:

Cash and due from banks, interest earning deposits with banks and federal funds sold: The carrying amounts reported in the balance sheet approximate fair value.

Securities held to maturity: The fair values of securities held to maturity are determined by quoted prices in active markets, when available, and classified as Level 1. If quoted market prices are not available, the fair value is determined by a matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities' relationship to other benchmark quoted securities and classified as Level 2. In cases where significant credit valuation adjustments are incorporated into the estimation of fair value, reported amounts are classified as Level 3.
  
Non-marketable securities - FHLB and FRB Stock: The carrying amounts reported in the balance sheet approximate fair value.

Loans: The fair values for loans are estimated using discounted cash flow analyses, using the corporate bond curve adjusted for liquidity for commercial loans and the swap curve adjusted for liquidity for retail loans.

Non-interest bearing deposits: The fair values disclosed are equal to their balance sheet carrying amounts, which represent the amount payable on demand.

39




Interest bearing deposits: The fair values disclosed for deposits with no defined maturities are equal to their carrying amounts, which represent the amounts payable on demand. Fair values for certificates of deposit are estimated using a discounted cash flow calculation that applies the Company's current incremental borrowing rates for similar terms.
 
Short-term borrowings: The carrying amounts of federal funds purchased, borrowings under repurchase agreements and other short-term borrowings with maturities of 90 days or less approximate their fair values.  The fair value of short-term borrowings greater than 90 days is based on the discounted value of contractual cash flows.
 
Long-term borrowings: The fair values of the Company's long-term borrowings (other than deposits) are estimated using discounted cash flow analyses, based on the Company's current incremental borrowing rates for similar types of borrowing arrangements.

Junior subordinated notes issued to capital trusts: The fair values of the Company's junior subordinated notes issued to capital trusts are estimated based on the quoted market prices, when available, of the related trust preferred security instruments, or are estimated based on the quoted market prices of comparable trust preferred securities.

Accrued interest: The carrying amount of accrued interest receivable and payable approximate their fair values.
 
Off-balance-sheet instruments: Fair values for the Company’s off-balance-sheet lending commitments (guarantees, letters of credit and commitments to extend credit) are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements.
 
The estimated fair values of financial instruments are as follows (in thousands):
 
 
June 30, 2014
 
 
Carrying Amount
 
Estimated Fair Value
Quoted Prices in Active
Markets for Identical
Assets (Level 1)
Significant Other
Observable Inputs
(Level 2)
Significant
Unobservable Inputs
(Level 3)
 
 
 
 
 
 
 
 
Financial Assets:
 
 
 
 
 
 
 
   Cash and due from banks
 
$
294,475

 
$
294,475

$
294,475

$
—

$
—

   Interest earning deposits with banks
 
466,820

 
466,820

466,820

—

—

   Federal funds sold
 
10,000

 
10,000

10,000

—

—

   Investment securities available for sale
 
1,154,958

 
1,154,958

10,421

1,138,921

5,616

   Investment securities held to maturity
 
1,241,392

 
1,292,245

—

1,292,245

—

   Non-marketable securities - FHLB and FRB stock
 
51,432

 
51,432

—

—

51,432

   Loans held for sale
 
1,219

 
1,219

—

1,219

—

   Loans, net
 
5,455,814

 
5,412,549

—

—

5,412,549

   Accrued interest receivable
 
34,971

 
34,971

34,971

—

—

   Derivative financial instruments
 
16,745

 
16,745

—

16,745

—

Financial Liabilities:
 
 
 
 
 
 
 
   Noninterest bearing deposits
 
$
2,605,367

 
$
2,605,367

$
2,605,367

$
—

$
—

   Interest bearing deposits
 
5,157,697

 
5,165,317

—

—

5,165,317

   Short-term borrowings
 
229,809

 
229,801

—

—

229,801

   Long-term borrowings
 
71,473

 
74,960

—

—

74,960

   Junior subordinated notes issued to capital trusts
 
152,065

 
104,167

—

—

104,167

   Accrued interest payable
 
2,089

 
2,089

2,089

—

—

   Derivative financial instruments
 
16,606

 
16,606

—

16,606

—




40



 
 
December 31, 2013
 
 
Carrying Amount
 
Estimated Fair Value
Quoted Prices in Active
Markets for Identical
Assets (Level 1)
Significant Other
Observable Inputs
(Level 2)
Significant
Unobservable Inputs
(Level 3)
Financial Assets:
 
 

 
 

 
 
 
Cash and due from banks
 
$
205,193

 
$
205,193

$
205,193

$
—

$
—

Interest earning deposits with banks
 
268,266

 
268,266

268,266

—

—

Federal funds sold
 
42,950

 
42,950

42,950

—

—

Investment securities available for sale
 
1,118,912

 
1,118,912

10,457

1,102,599

5,856

Investment securities held to maturity
 
1,182,533

 
1,198,929

—

1,198,929

—

Non-marketable securities - FHLB and FRB stock
 
51,417

 
51,417

—

—

51,417

Loans held for sale
 
629

 
629

—

629

—

Loans, net
 
5,600,805

 
5,583,759

—

—

5,583,759

Accrued interest receivable
 
36,593

 
36,593

36,593

—

—

Derivative financial instruments
 
18,645

 
18,645

—

18,645

—

Financial Liabilities:
 
 

 
 

 
 
 
Non-interest bearing deposits
 
$
2,375,863

 
$
2,375,863

$
2,375,863

$
—

$
—

Interest bearing deposits
 
5,005,396

 
5,012,928

—

—

5,012,928

Short-term borrowings
 
493,389

 
493,384

—

—

493,384

Long-term borrowings
 
62,159

 
66,301

—

—

66,301

Junior subordinated notes issued to capital trusts
 
152,065

 
101,247

—

—

101,247

Accrued interest payable
 
2,042

 
2,042

2,042

—

—

Derivative financial instruments
 
18,632

 
18,632

—

18,632

—

 

41



Note 14.
Stock Incentive Plans
 
ASC Topic 718 requires that the grant date fair value of equity awards to employees be recognized as compensation expense over the period during which an employee is required to provide service in exchange for such award.
 
The following table summarizes the impact of the Company’s share-based payment plans in the financial statements for the periods shown (in thousands):
 
 
 
Three Months Ended
 
Six Months Ended
 
 
June 30,
 
June 30,
 
 
2014
 
2013
 
2014
 
2013
Total cost of share-based payment plans during the period
 
$
2,243

 
$
1,212

 
$
4,255

 
$
2,472

Amount of related income tax benefit recognized in income
 
880

 
482

 
1,670

 
$
983

 
The Company adopted the Omnibus Incentive Plan (the “Omnibus Plan”) in 1997.  On May 28, 2014, the Company’s stockholders approved the third amendment and restatement of the Omnibus Plan to add 3,100,000 authorized shares for a total of 11,400,000 shares of common stock authorized to be utilized in connection with awards under the Omnibus Plan to directors, officers, and employees of the Company or any of its subsidiaries. The amended and restated plan provides that if and when the Taylor Capital merger is completed, an additional 2,400,000 shares will be authorized, increasing the total number of shares authorized to 13,800,000.  Equity grants under the Omnibus Plan can be in the form of incentive stock options, non-qualified stock options, stock appreciation rights, restricted stock, restricted stock units, performance shares, performance units, and other stock-based awards.  Shares awarded in the form of restricted stock, restricted stock units, performance shares, performance units, or other stock-based awards generally will reduce the shares available under the Omnibus Plan on a 2-for-1 basis. Following May 28, 2014, no more than 10% of the total number of authorized shares may be issued with respect to awards granted after that date, other than stock appreciation rights, stock options and performance-based awards, which at the date of grant are scheduled to fully vest prior to three years from the date of grant (although such awards may provide scheduled vesting earlier with respect to some of such shares and for acceleration of vesting as provided in the Omnibus Plan).   As of June 30, 2014, there were 4,043,347 shares available for future grants.
 
Prior to 2014, annual equity-based incentive awards were typically granted to selected officers and employees mid-year. In 2014, these awards began being granted in the first quarter of the year.  Options are granted with an exercise price equal to no less than the market price of the Company’s shares at the date of grant; those option awards generally vest over four years of service and have 10-year contractual terms.  Restricted shares and units typically vest over a two to four year period.  Equity awards may also be granted at other times throughout the year in connection with the recruitment and retention of officers and employees.  Directors currently may elect, in lieu of cash, to receive up to 70% of their fees in stock options with a five year term, which are fully vested on the grant date (provided that the director may not sell the underlying shares for at least six months after the grant date), and up to 100% of their fees in restricted shares, which vest one year after the grant date.
 
The following table summarizes stock options outstanding for the six months ended June 30, 2014:
 
 
 
Number of
Options
 
Weighted
Average
Exercise
Price
 
Weighted
Average
Remaining
Contractual
Term
(In Years)
 
Aggregate
Intrinsic
Value
(in thousands)
Options outstanding as of December 31, 2013
 
2,443,752

 
$
27.57

 
 
 
 

Granted
 
207,897

 
29.59

 
 
 
 

Exercised
 
(71,059
)
 
17.23

 
 
 
 

Expired or cancelled
 
(18,800
)
 
31.10

 
 
 
 

Forfeited
 
(21,555
)
 
22.01

 
 
 
 

Options outstanding as of June 30, 2014
 
2,540,235

 
$
28.04

 
4.63
 
$
6,648

Options exercisable as of June 30, 2014
 
1,714,949

 
$
30.38

 
3.00
 
$
2,968

 
The fair value of each option award is estimated on the date of grant using the Black-Scholes option pricing model based on certain assumptions.  Expected volatility is based on historical volatility and the expectations of future volatility of Company shares.  The risk free interest rate for periods within the contractual term of the option is based on the U.S. Treasury yield curve in effect at the

42



time of the grant.  The expected life of options is estimated based on historical employee behavior and represents the period of time that options granted are expected to remain outstanding.

 The following assumptions were used for options granted during the six months ended June 30, 2014:
 
 
June 30, 2014
Risk-free interest rate
 
1.84
%
Expected volatility of Company’s stock
 
23.21
%
Expected dividend yield
 
1.62
%
Expected life of options
 
5.7 years

Weighted average fair value per option of options granted during the year
 
$
6.05

 
The total intrinsic value of options exercised during the six months ended June 30, 2014 and 2013 was $874 thousand and $127 thousand, respectively.
 
The following is a summary of changes in restricted shares and units for the six months ended June 30, 2014:
 
 
 
Number of
Shares and Units
 
Weighted
Average
Grant Date
Fair Value
Shares Outstanding at December 31, 2013
 
685,719

 
$
22.59

Granted
 
259,432

 
30.58

Vested
 
(37,277
)
 
21.65

Forfeited
 
(13,879
)
 
24.33

Shares Outstanding at June 30, 2014
 
893,995

 
$
24.92


The total intrinsic value of restricted shares that vested during the six months ended June 30, 2014 and 2013 was $1.1 million and $317 thousand, respectively.
 
The Company issued 48,569, 56,752 and 65,333 market-based restricted stock units in 2014, 2013 and 2012, respectively, which entitle recipients to shares of common stock at the end of a three year vesting period. Recipients will earn shares, totaling between 0% and 175% of the number of units issued, based on the Company's total stockholder return relative to a specified peer group of financial institutions over the three year period. The market-based restricted stock units are included in the preceding table as if the recipients earned shares equal to 100% of the units issued. A Monte Carlo simulation model was used to value the market-based restricted stock units at the time of issuance.

The Company issued 92,717 shares of market-based restricted stock in 2011.  The market component of the vesting terms for the award requires that, for ten consecutive trading days, the closing price of the Company’s stock be at least $27.00.  The market component for this award has been satisfied as of June 30, 2014 and will vest in full in the third quarter of 2014, on the third anniversary of the grant date. A Monte Carlo simulation model was used to value the market-based restricted stock awards at the time of issuance.

As of June 30, 2014, there was $17.2 million of total unrecognized compensation cost related to nonvested share-based compensation arrangements (including share option and nonvested share awards) granted under the Omnibus Plan.  At June 30, 2014, the weighted-average period over which the unrecognized compensation expense is expected to be recognized was approximately 2.7 years.

Note 15.
Derivative Financial Instruments
 
The Company offers various derivatives, including interest rate swaps and foreign currency forward contracts, to our customers which can mitigate our exposure to market risk through the execution of off-setting positions with inter-bank dealer counterparties. This also permits the Company to offer customized risk management solutions to our customers. These customer accommodations and any offsetting financial contracts are treated as non-designated derivative instruments and carried at fair value through an adjustment to the income statement.


43



Interest rate swap and foreign currency forward contracts involve the risk of dealing with counterparties and their ability to meet contractual terms. The net amount payable or receivable under interest rate swaps is accrued as an adjustment to interest income.  The net amount payable as of June 30, 2014 was approximately $25 thousand, and the net amount payable as of December 31, 2013 was approximately $25 thousand.  The Company's credit exposure on interest rate swaps is limited to the Company's net favorable value and interest payments of all swaps to each counterparty. In such cases, collateral is generally required from the counterparties involved if the net value of the swaps exceeds a nominal amount.  At June 30, 2014, the Company’s credit exposure relating to interest rate swaps was approximately $15.7 million, which is secured by the underlying collateral on customer loans. 
 
The Company also enters into mortgage banking derivatives which are classified as non-designated derivatives. These derivatives include interest rate lock commitments provided to customers to fund certain mortgage loans to be sold into the secondary market and forward commitments for the future delivery of such loans. It is the Company's practice to enter into forward commitments for the future delivery of residential mortgage loans when interest rate lock commitments are entered into in order to economically hedge the effect of future changes in interest rates on its commitments to fund the loans as well as on its portfolio of mortgage loans held-for-sale.
 
The Company had fair value commercial loan interest rate swaps, to hedge its interest rate risk, with an aggregate notional amount of $218 thousand at June 30, 2014.  For fair value hedges, the changes in fair values of both the hedging derivative and the hedged item were recorded in current earnings as other income.
 
The Company’s derivative financial instruments are summarized below as of June 30, 2014 and December 31, 2013 (in thousands):
 
 
 
Asset Derivatives
 
Liability Derivatives
 
 
June 30, 2014
 
December 31, 2013
 
June 30, 2014
 
December 31, 2013
 
 
Notional
 
Estimated
 
Notional
 
Estimated
 
Notional
 
Estimated
 
Notional
 
Estimated
 
 
Amount
 
Fair Value
 
Amount
 
Fair Value
 
Amount
 
Fair Value
 
Amount
 
Fair Value
Derivative instruments designated as hedges of fair value:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Interest rate swap contracts (1)
 
$
—

 
$
—

 
$
—

 
$
—

 
$
218

 
$
(20
)
 
$
238

 
$
(23
)
Stand-alone derivative instruments (2)
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Interest rate swap contracts
 
585,733

 
15,635

 
550,883

 
17,298

 
586,622

 
(15,669
)
 
551,798

 
(17,350
)
Interest rate options contracts
 
85,855

 
188

 
83,907

 
323

 
85,855

 
(188
)
 
84,953

 
(323
)
Foreign exchange contracts
 
26,574

 
839

 
31,361

 
1,006

 
21,045

 
(711
)
 
47,760

 
(935
)
Spot foreign exchange contracts
 
2,260

 
8

 
—

 
—

 
122

 
—

 
—

 
—

Mortgage banking derivatives
 
4,236

 
75

 
1,783

 
18

 
2,500

 
(18
)
 
250

 
(1
)
Total non-hedging derivative instruments
 
704,658

 
16,745

 
667,934

 
18,645

 
696,144

 
(16,586
)
 
684,761

 
(18,609
)
Total
 
$
704,658

 
$
16,745

 
$
667,934

 
$
18,645

 
$
696,362

 
$
(16,606
)
 
$
684,999

 
$
(18,632
)

(1) Hedged fixed-rate commercial real estate loans
(2) These portfolio swaps are not designated as hedging instruments under ASC Topic 815.

 

44



Amounts included in the other income in the consolidated statements of operations related to derivative financial instruments were as follows (in thousands):
 
 
 
Three Months Ended
 
Six Months Ended
 
 
June 30,
 
June 30,
 
 
2014
 
2013
 
2014
 
2013
Derivative instruments designated as hedges of fair value:
 
 

 
 

 
 
 
 
Interest rate swap contracts
 
$
(2
)
 
$
11

 
$
(2
)
 
$
10

Stand-alone derivative instruments:
 
 

 
 

 
 

 
 

Interest rate swap contracts
 
9

 
12

 
18

 
23

Interest rate options contracts
 
—

 
—

 
—

 
—

Foreign exchange contracts
 
(4
)
 
—

 
57

 
5

Spot foreign exchange contracts
 
—

 
—

 
8

 
—

Mortgage banking derivatives
 
37

 
(51
)
 
40

 
(64
)
Total non-hedging derivative instruments
 
42

 
(39
)
 
123

 
(36
)
Total
 
$
40

 
$
(28
)
 
$
121

 
$
(26
)
 
Methods and assumptions used by the Company in estimating the fair value of its interest rate swaps are discussed in Note 13 to consolidated financial statements.

Certain instruments and transactions subject to an agreement similar to a master netting arrangement are eligible for offset in the consolidated balance sheet. The instruments and transactions would include derivatives, sale and repurchase agreements and reverse sale and repurchase agreements, and securities borrowing and securities lending arrangements. The Company’s derivative transactions with financial institution counterparties are generally executed under International Swaps and Derivative Association (“ISDA”) master agreements which include “right of set-off” provisions. Under these agreements, there is generally a legally enforceable right to offset recognized amounts, and there may be an intention to settle such amounts on a net basis. The Company, however, does not generally offset such financial instruments for financial reporting purposes.

Information about the Company's financial instruments that are eligible for offset in the consolidated balance sheet as of June 30, 2014 is summarized below (in thousands):

 
 
Financial Assets
 
Financial Liabilities
 
 
Gross Amount Recognized
 
Gross Amount Offset
 
Net Amount Recognized
 
Gross Amount Recognized
 
Gross Amount Offset
 
Net Amount Recognized
Derivatives:
 
 
 
 
 
 
 
 
 
 
 
 
   Interest rate swaps, caps and floors
 
$
1,957

 
$
—

 
$
1,957

 
$
13,920

 
$
—

 
$
13,920

   Foreign currency forward contracts
 
132

 
—

 
132

 
628

 
—

 
628

   Mortgage banking derivatives
 
—

 
—

 
—

 
18

 
—

 
18

     Total derivatives
 
2,089

 
—

 
2,089

 
14,566

 
—

 
14,566

Repurchase agreements
 
—

 
—

 
—

 
229,809

 
—

 
229,809

   Total
 
$
2,089

 
$
—

 
$
2,089

 
$
244,375

 
$
—

 
$
244,375



45



 
 
Financial Assets
 
Financial Liabilities
 
 
Net Amount Recognized
 
Financial Instruments
 
Collateral
 
Net Amount
 
Net Amount Recognized
 
Financial Instruments
 
Collateral
 
Net Amount
Derivatives:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
   Counterparty A
 
$
134

 
$
(134
)
 
$
—

 
$
—

 
$
11,005

 
$
(134
)
 
$
(10,871
)
 
$
—

   Counterparty B
 
520

 
(520
)
 
—

 
—

 
1,299

 
(520
)
 
(779
)
 
—

   Counterparty C
 
1,081

 
(1,081
)
 
—

 
—

 
2,232

 
(1,081
)
 
(1,151
)
 
—

   Other counterparties
 
354

 
(4
)
 
—

 
350

 
30

 
(4
)
 
—

 
26

     Total derivatives
 
2,089

 
(1,739
)
 
—

 
350

 
14,566

 
(1,739
)
 
(12,801
)
 
26

Repurchase agreements
 
—

 
—

 
—

 
—

 
229,809

 
—

 
(229,809
)
 
—

   Total
 
$
2,089

 
$
(1,739
)
 
$
—

 
$
350

 
$
244,375

 
$
(1,739
)
 
$
(242,610
)
 
$
26


Information about the Company's financial instruments that are eligible for offset in the consolidated balance sheet as of December 31, 2013 is summarized below (in thousands):

 
 
Financial Assets
 
Financial Liabilities
 
 
Gross Amount Recognized
 
Gross Amount Offset
 
Net Amount Recognized
 
Gross Amount Recognized
 
Gross Amount Offset
 
Net Amount Recognized
Derivatives:
 
 
 
 
 
 
 
 
 
 
 
 
   Interest rate swaps, caps and floors
 
$
5,792

 
$
—

 
$
5,792

 
$
11,904

 
$
—

 
$
11,904

   Foreign currency forward contracts
 
80

 
—

 
80

 
848

 
—

 
848

   Mortgage banking derivatives
 
3

 
—

 
3

 
1

 
—

 
1

     Total derivatives
 
5,875

 
—

 
5,875

 
12,753

 
—

 
12,753

Repurchase agreements
 
—

 
—

 
—

 
193,389

 
—

 
193,389

   Total
 
$
5,875

 
$
—

 
$
5,875

 
$
206,142

 
$
—

 
$
206,142


 
 
Financial Assets
 
Financial Liabilities
 
 
Net Amount Recognized
 
Financial Instruments
 
Collateral
 
Net Amount
 
Net Amount Recognized
 
Financial Instruments
 
Collateral
 
Net Amount
Derivatives:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
   Counterparty A
 
$
883

 
$
(883
)
 
$
—

 
$
—

 
$
10,669

 
$
(883
)
 
$
(9,786
)
 
$
—

   Counterparty B
 
1,836

 
(412
)
 
—

 
1,424

 
412

 
(412
)
 
—

 
—

   Counterparty C
 
2,380

 
(1,612
)
 
—

 
768

 
1,612

 
(1,612
)
 
—

 
—

   Other counterparties
 
776

 
(5
)
 
—

 
771

 
60

 
(5
)
 
—

 
55

     Total derivatives
 
5,875

 
(2,912
)
 
—

 
2,963

 
12,753

 
(2,912
)
 
(9,786
)
 
55

Repurchase agreements
 
—

 
—

 
—

 
—

 
193,389

 
—

 
(193,389
)
 
—

   Total
 
$
5,875

 
$
(2,912
)
 
$
—

 
$
2,963

 
$
206,142

 
$
(2,912
)
 
$
(203,175
)
 
$
55



46



Note 16.
  Operating Segments

The Company's operations consist of two reportable operating segments: banking and leasing. The Company offers different products and services through its two segments, and the regulatory environment is significantly different for banking compared to leasing. The accounting policies of the segments are generally the same as those of the consolidated company.

The banking segment generates its revenues primarily from its lending and deposit gathering activities. The profitability of this segment's operations depends primarily on its net interest income after provision for credit losses, which is the difference between interest earned on interest earning assets and interest paid on interest bearing liabilities less provision for credit losses.  The provision for credit losses is dependent on changes in its loan portfolio and management’s assessment of the collectability of the loan portfolio as well as prevailing economic and market conditions.  The banking segment is also subject to an extensive system of laws and regulations that are intended primarily for the protection of customers and depositors.  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. 

The leasing segment generates its revenues through lease originations and related services offered through the Company's leasing subsidiaries, LaSalle Systems Leasing, Inc. and Celtic Leasing Corp. The leasing subsidiaries invest directly in equipment that we lease (referred to as direct finance, leveraged or operating leases) to "Fortune 1000," large middle-market companies and healthcare providers located throughout the United States. The lease portfolio is made up of various kinds of equipment, generally technology related, such as computer systems, satellite equipment, medical equipment and general manufacturing equipment. The leasing subsidiaries also specialize in selling third party equipment maintenance contracts to large companies.

Net interest income for the leasing segment includes adjustments based on the Company's internal funds transfer pricing model as well as interest on loans originated for the sole purpose of funding equipment purchases related to leases at the Company's lease subsidiaries. The provision for credit losses and non-interest expense for the leasing segment includes adjustments for internal allocations of certain expenses.

The following tables present summary financial information for the reportable segments (in thousands):

 
Banking
 
Leasing
 
Consolidated
Three months ended June 30, 2014
 
 
 
 
 
Net interest income
$
65,266

 
$
2,806

 
$
68,072

Provision for credit losses
(1,764
)
 
(186
)
 
(1,950
)
Non-interest income
25,865

 
14,063

 
39,928

Non-interest expense
67,930

 
10,100

 
78,030

Income tax expense
6,149

 
2,665

 
8,814

Net income
$
18,816

 
$
4,290

 
$
23,106

Total assets
$
9,153,407

 
$
665,284

 
$
9,818,691

Three months ended June 30, 2013
 
 
 
 
 
Net interest income
$
66,332

 
$
1,148

 
$
67,480

Provision for credit losses
465

 
35

 
500

Non-interest income
24,450

 
14,489

 
38,939

Non-interest expense
61,632

 
8,621

 
70,253

Income tax expense
7,767

 
2,606

 
10,373

Net income
$
20,918

 
$
4,375

 
$
25,293

Total assets
$
8,903,856

 
$
465,803

 
$
9,369,659




47



 
Banking
 
Leasing
 
Consolidated
Six months ended June 30, 2014
 
 
 
 
 
Net interest income
$
130,385

 
$
5,015

 
$
135,400

Provision for credit losses
(684
)
 
(116
)
 
(800
)
Non-interest income
50,123

 
26,417

 
76,540

Non-interest expense
135,627

 
18,450

 
154,077

Income tax expense
10,632

 
4,956

 
15,588

Net income
$
34,933

 
$
8,142

 
$
43,075

Total assets
$
9,153,407

 
$
665,284

 
$
9,818,691

Six months ended June 30, 2013
 
 
 
 
 
Net interest income
$
133,138

 
$
2,027

 
$
135,165

Provision for credit losses
418

 
82

 
500

Non-interest income
47,359

 
30,283

 
77,642

Non-interest expense
125,309

 
16,373

 
141,682

Income tax expense
14,467

 
5,959

 
20,426

Net income
$
40,303

 
$
9,896

 
$
50,199

Total assets
$
8,903,856

 
$
465,803

 
$
9,369,659



48




Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
The following is a discussion and analysis of MB Financial, Inc.’s financial condition and results of operations and should be read in conjunction with the consolidated financial statements and notes thereto appearing elsewhere in this report. The words “the Company,” “we,” “our” and “us” refer to MB Financial, Inc. and its consolidated subsidiaries, unless we indicate otherwise.

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

Our net income is also affected by non-interest income and non-interest expenses.  During the periods under report, non-interest income included revenue from our key fee initiatives: capital markets and international banking fees, commercial deposit and treasury management fees, net lease financing income, trust and asset management fees, and card fees. Non-interest income also included loan service fees, consumer and other deposit service fees, brokerage fees, net gain (loss) on investment securities, increase in cash surrender value of life insurance, net gain (loss) on sale of assets, accretion of the FDIC indemnification asset, net gains on sale of loans and other operating income. During the periods under report, non-interest expenses included salaries and employee benefits, occupancy and equipment expense, computer services and telecommunication expense, advertising and marketing expense, professional and legal expense, other intangibles amortization expense, net loss on other real estate owned, other real estate expenses (net of rental income) and other operating expenses.

Net interest income is affected by changes in the volume and mix of interest earning assets, interest earned on those assets, the volume and mix of interest bearing liabilities and interest paid on interest bearing liabilities. Non-interest income and non-interest expenses are impacted by growth of banking and leasing operations and growth in the number of loan and deposit accounts through both acquisitions and core banking and leasing business growth. Growth in operations affects other expenses primarily as a result of additional employee, branch facility and promotional marketing expense. Growth in the number of loan and deposit accounts affects other income, including service fees as well as other expenses such as computer services, supplies, postage, telecommunications and other miscellaneous expenses. Non-performing asset levels impact salaries and benefits, legal expenses and other real estate owned expenses.

The Company had net income of $23.1 million for the three months ended June 30, 2014 compared to net income of $25.3 million for the three months ended June 30, 2013. Fully diluted earnings per common share were $0.42 for the three months ended June 30, 2014 compared to $0.46 per common share for the three months ended June 30, 2013.

The Company had net income of $43.1 million for the six months ended June 30, 2014 compared to net income of $50.2 million for the six months ended June 30, 2013. Fully diluted earnings per common share were $0.78 for the six months ended June 30, 2014 compared to $0.92 per common share for the six months ended June 30, 2013.


49



Critical Accounting Policies
 
Our consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of America and follow general practices within the industries in which we operate.  This preparation requires management to make estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes.  These estimates, assumptions, and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, actual results could differ from the estimates, assumptions, and judgments reflected in the financial statements.  Certain policies inherently have a greater reliance on the use of estimates, assumptions, and judgments and, as such, have a greater possibility of producing results that could be materially different than originally reported.  Management believes the following policies are both important to the portrayal of our financial condition and results of operations and require subjective or complex judgments; therefore, management considers the following to be critical accounting policies.  Management has reviewed the application of these polices with the Compliance and Audit Committee of our Board of Directors.
 
Allowance for Loan Losses.  The allowance for loan losses is subject to the use of estimates, assumptions, and judgments in management's evaluation process used to determine the adequacy of the allowance for loan losses, which combines several factors: management's ongoing review and grading of the loan portfolio, consideration of past loan loss experience, trends in past due and non-performing loans, risk characteristics of the various classifications of loans, existing economic conditions, the fair value of underlying collateral, and other qualitative and quantitative factors which could affect probable credit losses. Because current economic conditions can change and future events are inherently difficult to predict, the anticipated amount of estimated loan losses, and therefore the adequacy of the allowance, could change significantly. As an integral part of their examination process, various regulatory agencies also review the allowance for loan losses. Such agencies may require that certain loan balances be charged off when their credit evaluations differ from those of management or require that adjustments be made to the allowance for loan losses, based on their judgments about information available to them at the time of their examination. We believe the allowance for loan losses is appropriate and properly recorded in the financial statements.  See “Allowance for Loan Losses” section below for further analysis.
 
Residual Value of Our Direct Finance, Leveraged, and Operating Leases.  Lease residual value represents the present value of the estimated fair value of the leased equipment at the termination date of the lease. Realization of these residual values depends on many factors, including management’s use of estimates, assumptions, and judgment to determine such values. Several other factors outside of management’s control may reduce the residual values realized, including general market conditions at the time of expiration of the lease, whether there has been technological or economic obsolescence or unusual wear and tear on, or use of, the equipment and the cost of comparable equipment. If, upon the expiration of a lease, we sell the equipment and the amount realized is less than the recorded value of the residual interest in the equipment, we will recognize a loss reflecting the difference. On a quarterly basis, management reviews the lease residuals for potential impairment. If we fail to realize our aggregate recorded residual values, our financial condition and profitability could be adversely affected.  At June 30, 2014, the aggregate residual value of the equipment leased under our direct finance, leveraged, and operating leases totaled $76.4 million.  See Note 1 and Note 6 of our December 31, 2013 audited consolidated financial statements contained in our Annual Report Form 10-K for the year ended December 31, 2013 for additional information.

Income Tax Accounting.  ASC Topic 740 provides guidance on accounting for income taxes by prescribing the minimum recognition threshold that a tax position must meet to be recognized in the financial statements. ASC Topic 740 also provides guidance on measurement, recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.  As of June 30, 2014, the Company had $82 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 June 30, 2014, the Company had approximately $9 thousand of accrued interest related to tax reserves.  The application of income tax law is inherently complex. Laws and regulations in this area are voluminous and are often ambiguous. As such, we are required to make many subjective assumptions and judgments regarding our income tax exposures. Interpretations of, and guidance surrounding income tax laws and regulations change over time. As such, changes in our subjective assumptions and judgments can materially affect amounts recognized in the consolidated balance sheets and statements of income.
 
Fair Value of Assets and Liabilities.  ASC Topic 820 defines fair value as the price that would be received to sell a financial asset or paid to transfer a financial liability in an orderly transaction between market participants at the measurement date.
The degree of management judgment involved in determining the fair value of assets and liabilities is dependent upon the availability of quoted market prices or observable market parameters. For financial instruments that trade actively and have quoted market prices or observable market parameters, there is minimal subjectivity involved in measuring fair value. When observable market prices and parameters are not fully available, management judgment is necessary to estimate fair value. In addition, changes in

50



market conditions may reduce the availability of quoted prices or observable data. For example, reduced liquidity in the capital markets or changes in secondary market activities could result in observable market inputs becoming unavailable. Therefore, when market data is not available, the Company would use valuation techniques requiring more management judgment to estimate the appropriate fair value measurement.
See Note 13 to the consolidated financial statements for a complete discussion on the Company’s use of fair valuation of assets and liabilities and the related measurement techniques.
 
Goodwill.  The excess of the cost of an acquisition over the fair value of the net assets acquired consists of goodwill, and core deposit and client relationship intangibles.  See Note 8 of our December 31, 2013 audited consolidated financial statements contained in our Annual Report Form 10-K for the year ended December 31, 2013 for further information regarding core deposit and client relationship intangibles.  The Company reviews goodwill to determine potential impairment annually, or more frequently if events and circumstances indicate that goodwill might be impaired, by comparing the carrying value of the reporting units with the fair value of the reporting units.
 
The Company’s annual assessment date for goodwill impairment testing is as of December 31. Goodwill is tested for impairment at the reporting unit level. The Company has two reporting units: banking and leasing.  No impairment losses were recognized during the three or six months ended June 30, 2014 and 2013. We are not aware of any events or circumstances subsequent to our annual goodwill impairment testing date of December 31, 2013 that would indicate impairment of goodwill at June 30, 2014.
  
Recent Accounting Pronouncements.  Refer to Note 2 of our consolidated financial statements for a description of recent accounting pronouncements including the respective dates of adoption and effects on results of operations and financial condition.
 
Net Interest Income
 
The following tables present, for the periods indicated, the total dollar amount of interest income from average interest earning assets and the related yields, as well as the interest expense on average interest bearing liabilities, and the related costs, expressed both in dollars and rates (dollars in thousands).  The tables below and the discussion that follows contain presentations of net interest income and net interest margin on a tax-equivalent basis, which is adjusted for the tax-favored status of income from certain loans and investments.  We believe this measure to be the preferred industry measurement of net interest income, as it provides a relevant comparison between taxable and non-taxable amounts.
 
Reconciliations of net interest income and net interest margin on a tax-equivalent basis to net interest income and net interest margin in accordance with accounting principles generally accepted in the United States of America are provided in the table.
 

51



 
 
Three Months Ended June 30,
(dollars in thousands)
 
2014
 
2013
 
 
Average
 
 
 
Yield/
 
Average
 
 
 
Yield/
 
 
Balance
 
Interest
 
Rate
 
Balance
 
Interest
 
Rate
Interest Earning Assets:
 
 

 
 

 
 

 
 

 
 

 
 

Loans (1) (2) (3)
 
$
5,199,981

 
$
53,649

 
4.18
%
 
$
5,320,472

 
$
57,356

 
4.32
%
Loans exempt from federal income taxes (4)
 
317,251

 
3,470

 
4.33

 
310,751

 
3,423

 
4.36

Taxable investment securities
 
1,434,300

 
8,794

 
2.45

 
1,377,369

 
6,280

 
1.82

Investment securities exempt from federal income taxes (4)
 
966,518

 
12,748

 
5.28

 
933,442

 
12,559

 
5.38

Federal funds sold
 
4,359

 
4

 
0.36

 
2,879

 
2

 
0.27

Other interest earning deposits
 
448,173

 
277

 
0.25

 
183,010

 
92

 
0.20

Total interest earning assets
 
8,370,582

 
$
78,942

 
3.78

 
8,127,923

 
$
79,712

 
3.93

Non-interest earning assets
 
1,205,314

 
 
 
 
 
1,161,459

 
 
 
 
Total assets
 
$
9,575,896

 
 
 
 
 
$
9,289,382

 
 
 
 
Interest Bearing Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
Deposits:
 
 
 
 
 
 
 
 
 
 
 
 
NOW and money market deposit
 
$
2,880,910

 
$
899

 
0.13
%
 
$
2,675,189

 
$
833

 
0.12
%
Savings deposit
 
868,694

 
97

 
0.04

 
840,154

 
136

 
0.06

Time deposits
 
1,378,201

 
2,758

 
0.80

 
1,700,970

 
4,163

 
0.98

Short-term borrowings
 
184,204

 
95

 
0.21

 
189,029

 
116

 
0.24

Long-term borrowings and junior subordinated notes
 
236,266

 
1,344

 
2.25

 
214,839

 
1,390

 
2.56

Total interest bearing liabilities
 
5,548,275

 
$
5,193

 
0.38

 
5,620,181

 
$
6,638

 
0.47

Non-interest bearing deposits
 
2,476,396

 
 
 
 
 
2,179,284

 
 
 
 
Other non-interest bearing liabilities
 
199,621

 
 
 
 
 
192,553

 
 
 
 
Stockholders’ equity
 
1,351,604

 
 
 
 
 
1,297,364

 
 
 
 
Total liabilities and stockholders’ equity
 
$
9,575,896

 
 
 
 
 
$
9,289,382

 
 
 
 
Net interest income/interest rate spread (5)
 
 

 
$
73,749

 
3.40
%
 
 
 
$
73,074

 
3.46
%
Less: taxable equivalent adjustment
 
 

 
5,677

 
 
 
 
 
5,594

 
 
Net interest income, as reported
 
 

 
$
68,072

 
 
 
 
 
$
67,480

 
 
Net interest margin (6)
 
 

 
 

 
3.26
%
 
 

 
 

 
3.33
%
Tax equivalent effect
 
 

 
 

 
0.27
%
 
 

 
 

 
0.28
%
Net interest margin on a fully tax equivalent basis (6)
 
 

 
 

 
3.53
%
 
 

 
 

 
3.61
%
 
(1)       Non-accrual loans are included in average loans.
(2)       Interest income includes amortization of net deferred loan origination fees of $28 thousand and $817 thousand for the three months ended June 30, 2014 and 2013, respectively.
(3)       Loans held for sale are included in the average loan balance listed.  Related interest income is included in loan interest income.
(4)       Non-taxable loan and investment income is presented on a fully tax equivalent basis assuming a 35% tax rate.
(5)       Interest rate spread represents the difference between the average yield on interest earning assets and the average cost of interest bearing liabilities and is presented on a fully tax equivalent basis.
(6)       Net interest margin represents net interest income as a percentage of average interest earning assets.

Net interest income on a fully tax equivalent basis increased $675 thousand during the three months ended June 30, 2014 compared to the three months ended June 30, 2013, primarily due to higher yields on taxable investment securities partly offset by lower loan yields. The net interest margin, expressed on a fully tax equivalent basis, was 3.53% for the second quarter of 2014 and 3.61% for the second quarter of 2013. This eight basis point decrease was primarily due to higher cash balances held during the second quarter of 2014 as a result of the strong deposit inflows. Higher deposits and cash balances had minimal impact on net interest income.

52



 
 
Six Months Ended June 30,
(dollars in thousands)
 
2014
 
2013
 
 
Average
 
 
 
Yield/
 
Average
 
 
 
Yield/
 
 
Balance
 
Interest
 
Rate
 
Balance
 
Interest
 
Rate
Interest Earning Assets:
 
 

 
 

 
 

 
 

 
 

 
 

Loans (1) (2) (3)
 
$
5,241,582

 
$
107,595

 
4.14
%
 
$
5,341,062

 
$
115,892

 
4.38
%
Loans exempt from federal income taxes (4)
 
320,371

 
7,006

 
4.35

 
311,128

 
6,895

 
4.41

Taxable investment securities
 
1,409,473

 
16,940

 
2.40

 
1,430,539

 
12,419

 
1.74

Investment securities exempt from federal income taxes (4)
 
951,275

 
25,158

 
5.29

 
922,652

 
24,960

 
5.41

Federal funds sold
 
5,120

 
9

 
0.35

 
1,448

 
2

 
0.27

Other interest bearing deposits
 
318,332

 
390

 
0.25

 
189,994

 
227

 
0.24

Total interest earning assets
 
8,246,153

 
$
157,098

 
3.84

 
8,196,823

 
$
160,395

 
3.95

Non-interest earning assets
 
1,226,340

 
 
 
 
 
1,172,219

 
 
 
 
Total assets
 
$
9,472,493

 
 
 
 
 
$
9,369,042

 
 
 
 
Interest Bearing Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
Deposits:
 
 
 
 
 
 
 
 
 
 
 
 
NOW and money market deposit
 
$
2,804,688

 
$
1,747

 
0.13
%
 
$
2,706,170

 
$
1,759

 
0.13
%
Savings deposit
 
865,463

 
206

 
0.05

 
831,233

 
272

 
0.07

Time deposits
 
1,406,003

 
5,570

 
0.80

 
1,753,640

 
8,810

 
1.01

Short-term borrowings
 
192,346

 
195

 
0.20

 
190,458

 
283

 
0.30

Long-term borrowings and junior subordinated notes
 
229,021

 
2,722

 
2.36

 
231,770

 
2,957

 
2.54

Total interest bearing liabilities
 
5,497,521

 
$
10,440

 
0.38

 
5,713,271

 
$
14,081

 
0.50

Non-interest bearing deposits
 
2,424,917

 
 
 
 
 
2,162,266

 
 
 
 
Other non-interest bearing liabilities
 
206,597

 
 
 
 
 
204,318

 
 
 
 
Stockholders’ equity
 
1,343,458

 
 
 
 
 
1,289,187

 
 
 
 
Total liabilities and stockholders’ equity
 
$
9,472,493

 
 
 
 
 
$
9,369,042

 
 
 
 
Net interest income/interest rate spread (5)
 
 

 
$
146,658

 
3.46
%
 
 
 
$
146,314

 
3.45
%
Less: taxable equivalent adjustment
 
 

 
11,258

 
 
 
 
 
11,149

 
 
Net interest income, as reported
 
 

 
$
135,400

 
 
 
 
 
$
135,165

 
 
Net interest margin (6)
 
 

 
 

 
3.31
%
 
 

 
 

 
3.33
%
Tax equivalent effect
 
 

 
 

 
0.28
%
 
 

 
 

 
0.27
%
Net interest margin on a fully tax equivalent basis (6)
 
 

 
 

 
3.59
%
 
 

 
 

 
3.60
%

(1)       Non-accrual loans are included in average loans.
(2)       Interest income includes amortization of net deferred loan origination costs of $27 thousand for the six months ended June 30, 2014 compared to net deferred loan origination fees of $1.8 million for the six months ended June 30, 2013.
(3)       Loans held for sale are included in the average loan balance listed.  Related interest income is included in loan interest income.
(4)       Non-taxable loan and investment income is presented on a fully tax equivalent basis assuming a 35% tax rate.
(5)       Interest rate spread represents the difference between the average yield on interest earning assets and the average cost of interest bearing liabilities and is presented on a fully tax equivalent basis.
(6)       Net interest margin represents net interest income as a percentage of average interest earning assets.
 
Net interest income on a fully tax equivalent basis increased $344 thousand during the six months ended June 30, 2014 compared to the six months ended June 30, 2013, primarily due to improved taxable investment securities yields and a lower cost of funds, partially offset by lower loan yields. The net interest margin, expressed on a fully tax equivalent basis, was 3.59% for the six months ended June 30, 2014 and 3.60% for the six months ended June 30, 2013.
    

53



Non-interest Income

 
 
Three Months Ended
 
 
 
 
 
 
June 30,
 
 
 
 
 
 
2014
 
2013
 
Increase/
(Decrease)
 
Percentage
Change
Non-interest income (in thousands):
 
 
 
 
 
 
 
 
Capital markets and international banking fees
 
$
1,360

 
$
939

 
$
421

 
44.8
 %
Commercial deposit and treasury management fees
 
7,106

 
6,029

 
1,077

 
17.9

Lease financing, net
 
14,853

 
15,102

 
(249
)
 
(1.6
)
Trust and asset management fees
 
5,405

 
4,874

 
531

 
10.9

Card fees
 
3,304

 
2,735

 
569

 
20.8

Loan service fees
 
916

 
1,911

 
(995
)
 
(52.1
)
Consumer and other deposit service fees
 
3,156

 
3,593

 
(437
)
 
(12.2
)
Brokerage fees
 
1,356

 
1,234

 
122

 
9.9

Net (loss) gain on investment securities
 
(87
)
 
14

 
(101
)
 
(721.4
)
Increase in cash surrender value of life insurance
 
834

 
842

 
(8
)
 
(1.0
)
Net loss on sale of assets
 
(24
)
 
—

 
(24
)
 
(100.0
)
Accretion of FDIC indemnification asset
 
28

 
100

 
(72
)
 
(72.0
)
Net gain on sale of loans
 
187

 
506

 
(319
)
 
(63.0
)
Other operating income
 
1,534

 
1,060

 
474

 
44.7

Total non-interest income
 
$
39,928

 
$
38,939

 
$
989

 
2.5
 %
NM - not meaningful

Non-interest income increased by $1.0 million, or 2.5%, for the three months ended June 30, 2014 compared to the three months ended June 30, 2013.

•
Commercial deposit and treasury management fees increased due to robust new customer activity.
•
Card fees increased due to a new payroll prepaid card program.
•
Trust and asset management fees increased due to the growth in investment management fees as a result of new customers added and the impact of higher equity values on assets under management and related fee revenue.
•
Capital markets and international banking service fees increased due to higher M&A advisory and syndication fees.
•
Loan service fees decreased due to lower late, prepayment and miscellaneous loan fees collected.
•
Consumer and other deposit service fees decreased due to lower demand deposit service and overdraft charges.
•
Net gain on sale of loans decreased as a result of less mortgage origination activity.
 


54



 
 
Six Months Ended
 
 
 
 
 
 
June 30,
 
 
 
 
 
 
2014
 
2013
 
Increase/
(Decrease)
 
Percentage
Change
Non-interest income (in thousands):
 
 
 
 
 
 
 
 
Capital markets and international banking fees
 
$
2,338

 
$
1,747

 
$
591

 
33.8
 %
Commercial deposit and treasury management fees
 
14,250

 
11,995

 
2,255

 
18.8

Lease financing, net
 
28,049

 
31,365

 
(3,316
)
 
(10.6
)
Trust and asset management fees
 
10,612

 
9,368

 
1,244

 
13.3

Card fees
 
6,005

 
5,430

 
575

 
10.6

Loan service fees
 
1,881

 
2,922

 
(1,041
)
 
(35.6
)
Consumer and other deposit service fees
 
6,091

 
6,839

 
(748
)
 
(10.9
)
Brokerage fees
 
2,681

 
2,391

 
290

 
12.1

Net gain on investment securities
 
230

 
13

 
217

 
NM

Increase in cash surrender value of life insurance
 
1,661

 
1,686

 
(25
)
 
(1.5
)
Net loss on sale of assets
 
(17
)
 
—

 
(17
)
 
(100.0
)
Accretion of FDIC indemnification asset
 
59

 
243

 
(184
)
 
(75.7
)
Net gain on sale of loans
 
246

 
1,145

 
(899
)
 
(78.5
)
Other operating income
 
2,454

 
2,498

 
(44
)
 
(1.8
)
Total non-interest income
 
$
76,540

 
$
77,642

 
$
(1,102
)
 
(1.4
)%
NM - Note meaningful

Non-interest income decreased by $1.1 million, or 1.4%, for the six months ended June 30, 2014 compared to the six months ended June 30, 2013.

•
Commercial deposit and treasury management fees increased in the first half of 2014 due to robust new customer activity.
•
Capital markets and international banking service fees increased due to higher M&A advisory and syndication fees.
•
Trust and asset management fees increased due to the growth in investment management fees as a result of new customers added and the impact of higher equity values on assets under management and related fee revenue.
•
Card fees increased due to a new payroll prepaid card program as well as higher ATM and debit card fees.
•
Leasing revenues declined due to lower equipment remarketing gains and lower fees from the sale of third-party equipment maintenance contracts.
•
Loan service fees decreased due to lower late, prepayment and miscellaneous loan fees collected.
•
Consumer and other deposit service fees decreased due to lower demand deposit service and overdraft charges.
•
Net gain on sale of loans decreased as a result of less mortgage origination activity.


55



Non-interest Expenses
 
 
 
Three Months Ended
 
 
 
 
 
 
June 30,
 
 
 
 
 
 
2014
 
2013
 
Increase/
(Decrease)
 
Percentage
Change
Non-interest expenses (in thousands):
 
 

 
 

 
 

 
 

Salaries and employee benefits
 
$
46,622

 
$
43,909

 
$
2,713

 
6.2
 %
Occupancy and equipment expense
 
9,518

 
9,408

 
110

 
1.2

Computer services and telecommunication expense
 
5,079

 
4,617

 
462

 
10.0

Advertising and marketing expense
 
2,221

 
2,167

 
54

 
2.5

Professional and legal expense
 
1,567

 
1,353

 
214

 
15.8

Other intangibles amortization expense
 
1,174

 
1,538

 
(364
)
 
(23.7
)
Net loss (gain) recognized on other real estate owned
 
191

 
(2,015
)
 
2,206

 
(109.5
)
Other real estate expense, net
 
337

 
193

 
144

 
74.6

Other operating expenses
 
11,321

 
9,083

 
2,238

 
24.6

Total non-interest expenses
 
$
78,030

 
$
70,253

 
$
7,777

 
11.1
 %
 
Non-interest expenses increased by $7.8 million, or 11.1%, for the three months ended June 30, 2014 from the three months ended June 30, 2013. Non-interest expenses include $488 thousand in expenses related to the pending merger with Taylor Capital Group, Inc. ("Taylor Capital"), mainly for advertising and marketing, computer services and telecommunication, and professional and legal services expenses.

•
Salaries and employee benefits increased due to annual salary increases, long-term incentive expense, taxes and temporary staffing needs.
•
A net loss was recognized on other real estate owned for the three months ended June 30, 2014 compared to a net gain for the same period in the prior year.
•
Other operating expense increased primarily as a result of an increase in filing and other loan expense as well as higher FDIC assessments due to our larger balance sheet, an increase in the clawback liability related to our loss share agreements with the FDIC, and higher currency delivery expenses related to new treasury management accounts.
•
Computer services and telecommunication expenses increased due primarily to an increase in spending on IT security, data warehouse, investments in our key fee initiatives, as well as higher transaction volumes in leasing, treasury management and card areas. The increase was also due to increased telecommunication expense related to the transitioning to a new provider.


56



 
 
Six Months Ended
 
 
 
 
 
 
June 30,
 
 
 
 
 
 
2014
 
2013
 
Increase/
(Decrease)
 
Percentage
Change
Non-interest expenses (in thousands):
 
 

 
 

 
 

 
 

Salaries and employee benefits
 
$
90,999

 
$
87,423

 
$
3,576

 
4.1
 %
Occupancy and equipment expense
 
19,110

 
18,812

 
298

 
1.6

Computer services and telecommunication expense
 
10,163

 
8,504

 
1,659

 
19.5

Advertising and marketing expense
 
4,302

 
4,270

 
32

 
0.7

Professional and legal expense
 
3,346

 
2,648

 
698

 
26.4

Other intangibles amortization expense
 
2,414

 
3,082

 
(668
)
 
(21.7
)
Net loss recognized on other real estate owned
 
378

 
(1,685
)
 
2,063

 
(122.4
)
Other real estate expense, net
 
733

 
332

 
401

 
120.8

Other operating expenses
 
22,632

 
18,296

 
4,336

 
23.7

Total non-interest expenses
 
$
154,077

 
$
141,682

 
$
12,395

 
8.7
 %

Non-interest expenses increased by $12.4 million, or 8.7%, for the six months ended June 30, 2014 from the six months ended June 30, 2013. Non-interest expenses include $1.2 million in expenses related to the pending merger with Taylor Capital, mainly for advertising and marketing, computer services and telecommunication, and professional and legal services expenses.

•
Other operating expenses increased due to a $2.0 million write-off recognized in the first quarter of 2014 of an investment in low-income housing funds that invested in real estate projects. This investment was made in 2006 as a community development initiative. The extended slow real estate recovery in some low income areas of Chicago negatively impacted this investment.
•
Other operating expenses also increased as a result of an increase in filing and other loan expense as well as higher FDIC assessments due to our larger balance sheet, higher ATM and debit card processing costs and higher currency delivery expenses related to new treasury management accounts.
•
Salaries and employee benefits increased due to annual salary increases, long-term incentive expense, taxes and temporary staffing needs.
•
A net loss was recognized on other real estate owned for the six months ended June 30, 2014 compared to a net gain for the same period in the prior year.
•
Computer services and telecommunication expenses increased due primarily to an increase in spending on IT security, data warehouse, investments in our key fee initiatives, as well as higher transaction volumes in leasing, treasury management and card areas. The increase was also due to increased telecommunication expense related to the transitioning to a new provider.

Income Taxes

Income tax expense for the six months ended June 30, 2014 was $15.6 million compared to $20.4 million for the six months ended June 30, 2013. The decrease was primarily due to a decrease in our pre-tax income during the six months ended June 30, 2014. 

Balance Sheet
 
Total assets increased $177.3 million, or 1.8%, from $9.6 billion at December 31, 2013 to $9.8 billion at June 30, 2014. 

•
Cash and cash equivalents increased $287.8 million, or 60.8% from $473.5 million at December 31, 2013 to $761.3 million at June 30, 2014 primarily due to the deposit inflows.
 
•
Investment securities increased $94.9 million, or 4.0%, from December 31, 2013 to June 30, 2014 mostly as a result of the partial deployment of the increased deposits.

•
Gross loans, excluding covered loans, decreased by $55.1 million to $5.4 billion at June 30, 2014 from December 31, 2013.
 

57



Total liabilities increased by $138.6 million, or 1.7%, from $8.3 billion at December 31, 2013 to $8.5 billion at June 30, 2014.
 
•
Total deposits increased by $381.8 million, or 5.2%, to $7.8 billion at June 30, 2014 from December 31, 2013 due to the increase in low cost deposits (noninterest bearing deposits, money market and NOW accounts and savings accounts).

•
Over the past year and quarter, our deposit mix continued to improve as low cost deposits increased by $614.7 million, or 10.6%, compared to June 30, 2013 and by $496.1 million, or 8.4%, compared to December 31, 2013. This improvement was driven by the growth in noninterest bearing deposits which were 34% of total deposits at June 30, 2014.
  
•
Noninterest bearing deposits increased by 16.8% and 9.7% compared to June 30, 2013 and December 31, 2013, respectively.

•
Total borrowings decreased by $254.3 million, or 35.9%, to $453.3 million at June 30, 2014. The decrease in total borrowings was primarily due to the repayment of the $300.0 million FHLB advance entered into the fourth quarter of 2013 to increase our balance sheet liquidity in preparation for an adverse market reaction to the Federal government shutdown and potential breach of the debt ceiling.

Total stockholders’ equity increased $38.6 million to $1.4 billion at June 30, 2014 compared to December 31, 2013 primarily as a result of our earnings for the six months ended June 30, 2014 partly offset by dividends.

Investment Securities
 
The following table sets forth the amortized cost and fair value of our investment securities, by type of security as indicated (in thousands):
 
 
 
June 30, 2014
 
December 31, 2013
 
June 30, 2013
 
 
Amortized
Cost
 
Fair
Value
 
Amortized
Cost
 
Fair
Value
 
Amortized
Cost
 
Fair
Value
Available for sale
 
 

 
 

 
 

 
 

 
 

 
 

U.S. Government sponsored agencies and enterprises
 
$
50,096

 
$
51,727

 
$
50,486

 
$
52,068

 
$
32,050

 
$
33,935

States and political subdivisions
 
19,228

 
19,498

 
19,398

 
19,143

 
669,791

 
684,710

Residential mortgage-backed securities
 
738,519

 
747,925

 
696,415

 
701,233

 
639,681

 
647,858

Commercial mortgage-backed securities
 
47,977

 
49,858

 
50,891

 
52,941

 
51,000

 
53,343

Corporate bonds
 
271,351

 
275,529

 
284,083

 
283,070

 
219,362

 
215,256

Equity securities
 
10,414

 
10,421

 
10,649

 
10,457

 
10,560

 
10,570

Total Available for Sale
 
1,137,585

 
1,154,958

 
1,111,922

 
1,118,912

 
1,622,444

 
1,645,672

Held to maturity
 
 

 
 

 
 

 
 

 
 

 
 

States and political subdivisions
 
993,937

 
1,030,478

 
932,955

 
936,173

 
282,655

 
285,904

Residential mortgage-backed securities
 
247,455

 
261,767

 
249,578

 
262,756

 
253,779

 
268,675

Total Held to Maturity
 
1,241,392

 
1,292,245

 
1,182,533

 
1,198,929

 
536,434

 
554,579

Total
 
$
2,378,977

 
$
2,447,203

 
$
2,294,455

 
$
2,317,841

 
$
2,158,878

 
$
2,200,251

 
Securities of states and political subdivisions with a fair value of $656.6 million were transferred from available for sale to held to maturity during the third quarter of 2013, which is the new cost basis. As of the date of the transfer, the resulting unrealized holding gain continues to be reported as a separate component of stockholders’ equity as accumulated other comprehensive income, net of tax. This unrealized gain will be amortized over the remaining life of the securities as a yield adjustment.

    

58




Loan Portfolio
 
The following table sets forth the composition of our loan portfolio (dollars in thousands):
 
 
 
June 30, 2014
 
December 31, 2013
 
June 30, 2013
 
 
Amount
 
% of
Total
 
Amount
 
% of
Total
 
Amount
 
% of
Total
Commercial related credits:
 
 

 
 

 
 

 
 

 
 

 
 

Commercial loans
 
$
1,272,200

 
23
%
 
$
1,281,377

 
22
%
 
$
1,198,862

 
22
%
Commercial loans collateralized by assignment of lease payments
 
1,515,446

 
27

 
1,494,188

 
26

 
1,422,901

 
25

Commercial real estate
 
1,619,322

 
29

 
1,647,700

 
29

 
1,710,964

 
30

Construction real estate
 
116,996

 
2

 
141,253

 
3

 
121,420

 
2

Total commercial related credits
 
4,523,964

 
81

 
4,564,518

 
80

 
4,454,147

 
79

Other loans:
 
 

 
 

 
 

 
 

 
 

 
 

Residential real estate
 
309,234

 
6

 
314,440

 
5

 
305,710

 
5

Indirect vehicle
 
272,841

 
5

 
262,632

 
5

 
242,964

 
5

Home equity
 
245,135

 
4

 
268,289

 
5

 
281,334

 
5

Other consumer loans
 
70,584

 
1

 
66,952

 
1

 
75,476

 
1

Total other loans
 
897,794

 
16

 
912,313

 
16

 
905,484

 
16

Gross loans excluding covered loans
 
5,421,758

 
97

 
5,476,831

 
96

 
5,359,631

 
95

Covered loans (1)
 
134,966

 
3

 
235,720

 
4

 
308,556

 
5

Total loans (2)
 
$
5,556,724

 
100
%
 
$
5,712,551

 
100
%
 
$
5,668,187

 
100
%
 
(1)
Loans that MB Financial Bank will share losses with the FDIC are referred to as “covered loans.”
(2)
Gross loan balances at June 30, 2014, December 31, 2013, and June 30, 2013 are net of unearned income, including net deferred loans fees of $1.0 million, $1.9 million, and $955 thousand, respectively.
 
Gross loans, excluding covered loans, decreased by $55.1 million to $5.4 billion at June 30, 2014 from December 31, 2013. Gross loans decreased by $155.8 million to $5.6 billion at June 30, 2014 from $5.7 billion at December 31, 2013.

Asset Quality

Non-performing loans include loans accounted for on a non-accrual basis and accruing loans contractually past due 90 days or more as to interest or principal. Management reviews the loan portfolio for problem loans on an ongoing basis. During the ordinary course of business, management becomes aware of borrowers that may not be able to meet the contractual requirements of loan agreements. These loans are placed under close supervision with consideration given to placing the loan on non-accrual status, increasing the allowance for loan losses and (if appropriate) partial or full charge-off. After a loan is placed on non-accrual status, any interest previously accrued but not yet collected is reversed against current income. Generally, if interest payments are received on non-accrual loans, these payments will be applied to principal and not taken into income. Loans will not be placed back on accrual status unless back interest and principal payments are made. Our general policy is to place loans 90 days past due on non-accrual status, as well as those loans that continue to pay, but display a well-defined material weakness.
 
Non-performing loans exclude purchased credit-impaired loans that were acquired as part of the Heritage, InBank, Corus, Benchmark, Broadway, and New Century FDIC-assisted transactions. Fair value of these loans as of acquisition includes estimates of credit losses. See Note 6 of the notes to our consolidated financial statements for further information regarding purchased credit-impaired loans.
 

59



The following table sets forth the amounts of non-performing loans and non-performing assets at the dates indicated (dollars in thousands):
 
 
 
 
 
 
 
 
 
 
June 30,
2014
 
December 31,
2013
 
June 30,
2013
Non-performing loans:
 
 

 
 

 
 

Non-accruing loans
 
$
108,414

 
$
106,115

 
$
112,926

Loans 90 days or more past due, still accruing interest
 
2,363

 
446

 
2,322

Total non-performing loans
 
110,777

 
106,561

 
115,248

Other real estate owned
 
20,306

 
23,289

 
32,993

Repossessed assets
 
73

 
840

 
749

Total non-performing assets
 
$
131,156

 
$
130,690

 
$
148,990

Total allowance for loan losses
 
$
100,910

 
$
111,746

 
$
123,685

Accruing restructured loans (1)
 
26,793

 
29,430

 
28,270

Total non-performing loans to total loans
 
1.99
%
 
1.87
%
 
2.03
%
Total non-performing assets to total assets
 
1.34

 
1.36

 
1.59

Allowance for loan losses to non-performing loans
 
91.09

 
104.87

 
107.32

 
(1)
Accruing restructured loans consists primarily of residential real estate and home equity loans that have been modified and are performing in accordance with those modified terms.

A loan is classified as a troubled debt restructuring when a borrower is experiencing financial difficulties that leads to a restructuring of the loan, and the Company grants concessions to the borrower in the restructuring that it would not otherwise consider. These concessions may include rate reductions, principal forgiveness, extension of maturity date and other actions intended to minimize potential losses. A loan that is modified at a market rate of interest may no longer be classified as troubled debt restructuring in the calendar year subsequent to the restructuring if it is in compliance with the modified terms. Payment performance prior and subsequent to the restructuring is taken into account in assessing whether it is likely that the borrower can meet the new terms. This may result in the loan being returned to accrual at the time of restructuring. A period of sustained repayment for at least six months generally is required for return to accrual status.

Occasionally, the Company will restructure a note into two separate notes (A/B structure), charging off the entire B portion of the note. The A note is structured with appropriate loan-to-value and cash flow coverage ratios that provide for a high likelihood of repayment. The A note is classified as a non-performing note until the borrower has displayed a historical payment performance for a reasonable time prior to and subsequent to the restructuring. A period of sustained repayment for at least six months generally is required to return the note to accrual status provided that management has determined that the performance is reasonably expected to continue. The A note will be classified as a restructured note (either performing or non-performing) through the calendar year of the restructuring that the historical payment performance has been established.

Non-performing assets consists of non-performing loans as well as other repossessed assets and other real estate owned. Other real estate owned represents properties acquired through foreclosure or other proceedings and is recorded at fair value less the estimated cost of disposal at the date of acquisition. Other real estate owned is evaluated regularly to ensure that the recorded amount is supported by its current fair value. Valuation allowances to reduce the carrying amount to fair value less estimated costs of disposal are recorded as necessary. Gains and losses and changes in valuations on other real estate owned are included in net gain (loss) recognized on other real estate within non-interest expense. Expenses, net of rental income, from the operations of other real estate owned are reflected as a separate line item on the income statement. Other repossessed assets primarily consist of repossessed vehicles. Losses on repossessed vehicles are charged-off to the allowance when title is taken and the vehicle is valued. Once MB Financial Bank obtains title, repossessed vehicles are not included in loans, but are classified as “other assets” on the consolidated balance sheets. The typical holding period for resale of repossessed automobiles is less than 90 days unless significant repairs to the vehicle are needed which occasionally results in a longer holding period. The typical holding period for motorcycles can be more than 90 days, as the average motorcycle re-sale period is longer than the average automobile re-sale period. The longer average period for motorcycles is a result of cyclical trends in the motorcycle market.
 

60



Other real estate owned that is related to our FDIC-assisted transactions is excluded from non-performing assets.  Other real estate owned related to the Heritage, Benchmark, Broadway, and New Century transactions, which totaled $12.6 million and $19.6 million at June 30, 2014 and December 31, 2013, respectively, is subject to the loss-share agreements with the FDIC.  See Note 6 of the notes to our consolidated financial statements for further information.

The following table presents a summary of other real estate owned, excluding assets related to FDIC-assisted transactions, for the six months ended June 30, 2014 and 2013 (in thousands):
 
 
 
June 30,
 
 
2014
 
2013
Beginning balance
 
$
23,289

 
$
36,977

Transfers in at fair value less estimated costs to sell
 
651

 
4,214

Capitalized other real estate owned costs
 
—

 
8

Fair value adjustments
 
(426
)
 
821

Net gains on sales of other real estate owned
 
100

 
990

Cash received upon disposition
 
(3,308
)
 
(10,017
)
Ending balance
 
$
20,306

 
$
32,993

 
 Potential Problem Loans
 
We define potential problem loans as performing loans rated substandard and that do not meet the definition of a non-performing loan (See “Asset Quality” section above for non-performing loans). We do not necessarily expect to realize losses on potential problem loans, but we recognize potential problem loans carry a higher probability of default and require additional attention by management. The following table sets forth the aggregate principal amount of potential problem loans at the dates indicated (in thousands):
 
 
 
June 30,
2014
 
December 31,
2013
 
 
 
 
 
Commercial loans
 
$
21,083

 
$
43,844

Commercial loans collateralized by assignment of lease payments
 
2,536

 
2,459

Commercial real estate
 
39,858

 
32,895

Construction real estate
 
—

 
391

Total
 
$
63,477

 
$
79,589


Allowance for Loan Losses
 
Management believes the allowance for loan losses accounting policy is critical to the portrayal and understanding of our financial condition and results of operations. Selection and application of this “critical accounting policy” involves judgments, estimates, and uncertainties that are subject to change. In the event that different assumptions or conditions were to prevail, and depending upon the severity of such changes, materially different financial condition or results of operations is a reasonable possibility.

We maintain our allowance for loan losses at a level that management believes is appropriate to absorb probable losses on existing loans based on an evaluation of the collectability of loans, underlying collateral and prior loss experience.

Our allowance for loan losses is comprised of three elements: a commercial related general loss reserve; a commercial related specific reserve for impaired loans; and a consumer related reserve for smaller-balance homogenous loans. Each element is discussed below.
 
Commercial Related General Loss Reserve.  We maintain a general loan loss reserve for the four categories of commercial-related loans in our portfolio: commercial loans, commercial loans collateralized by the assignment of lease payments (lease loans), commercial real estate loans and construction real estate loans.


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Under our loan risk rating system, each loan, with the exception of those included in large groups of smaller-balance homogeneous consumer related loans, is risk rated between one and nine by the originating loan officer, Senior Credit Management, Loan Review or any loan committee. Loans rated "one" represent those loans least likely to default and a loan rated "nine" represents a loss. The probability of loans defaulting for each risk rating, sometimes referred to as default factors, are estimated based on the frequency with which loans migrate from one risk rating to another and to default status over time. We use a loan loss reserve model that incorporates the migration of loan risk ratings and historical default data over a multi-year period to develop our estimated default factors (EDFs). The model tracks annual loan rating migrations by loan type and currently uses loan risk rating migrations for 13 years. The migration data is adjusted by using average losses for an economic cycle (approximately 12 years) to develop EDFs by loan type, risk rating and maturity. EDFs are updated annually in December.
 
Estimated loan default factors are multiplied by individual loan balances in each risk-rating category and again multiplied by an historical loss given default estimate for each loan type (which incorporates estimated recoveries) to determine the appropriate allowance by loan type. This approach is applied to the commercial, lease, commercial real estate, and construction real estate components of the portfolio.

To account for current economic conditions, the general allowance for loan and lease losses (ALLL) also includes adjustments for macroeconomic factors. Macroeconomic factors adjust the ALLL upward or downward based on the current point in the economic cycle using predictive economic data and are applied to the loan loss model through a separate allowance element for the commercial, commercial real estate, construction real estate and lease loan components. To determine our macroeconomic factors, we use specific economic data that has shown to be a statistically reliable predictor of our credit losses relative to our long term average credit losses. We tested over 20 economic variables (U.S. manufacturing index, unemployment rate, U.S. GDP growth, etc.). We annually review this data to determine that such a relationship continues to exist. We currently use the following macroeconomic indicators in our macroeconomic factor computation:
 
Commercial loans and lease loans:  Japanese bilateral dollar exchange, our prior period charge-off rates and the consumer confidence index.
 
Commercial real estate loans and construction loans:  Prime rate, our prior period charge-off rates and the annual change in the U.S. commercial real estate index.
 
Using the indicators noted above, a predicted charge-off percentage is calculated. The predicted charge-off percentage is then compared to the cycle average charge-off percentage used in our EDF computation discussed above, and a macroeconomic adjustment factor is calculated. The macroeconomic adjustment factor is applied to each commercial loan type. Each year, we review the predictive nature of the macroeconomic factors by comparing actual charge-offs to the predicted model charge-offs, re-run our regression analysis and re-calibrate the macroeconomic factors as appropriate.
 
The commercial related general loss reserve was $70.9 million as of June 30, 2014 and $78.3 million as of December 31, 2013. The decrease in the general reserve related primarily to an improvement in risk ratings. Reserves on impaired commercial related loans are included in the “Commercial Related Specific Reserves” section below. 
 
Commercial Related Specific Reserves.  Our allowance for loan losses also includes specific reserves on impaired commercial loans. A loan is considered to be impaired when management believes, after considering collection efforts and other factors, the borrower's financial condition is such that the collection of all contractual principal and interest payments due is doubtful.
 
At each quarter-end, impaired commercial loans are reviewed individually, with adjustments made to the general calculated reserve for each loan as deemed necessary. Specific adjustments are made depending on expected cash flows and/or the value of the collateral securing each loan. Generally, the Company obtains a current external appraisal (within 12 months) on real estate secured impaired loans. Our appraisal policy is designed to comply with the Interagency Appraisal and Evaluation Guidelines, most recently updated in December 2010. As part of our compliance with these guidelines, we maintain an internal Appraisal Review Department that engages and reviews all third party appraisals.

In addition, each impaired commercial loan with real estate collateral is reviewed quarterly by our appraisal department to determine that the most recent valuation remains appropriate during subsequent quarters until the next appraisal is received. If considered necessary by our appraisal department, the appraised value may be further discounted by internally applying accepted appraisal methodologies to an older appraisal. Accepted appraisal methodologies include: income capitalization approach adjusting for changes in underlying leases, adjustments related to condominium projects with units sales, adjustments for loan fundings, and “As is” compared to “As Stabilized” valuations.
 

62



Other valuation techniques are also used to value non-real estate assets. Discounts may be applied in the impairment analysis used for general business assets (GBA). Examples of GBA include accounts receivable, inventory, and any marketable securities pledged. The discount is used to reflect collection risk in the event of default that may not have been included in the valuation of the asset.

The total commercial related specific reserves component of the allowance decreased from $12.8 million as of December 31, 2013 to $10.3 million as of June 30, 2014. 
 
Consumer Related Reserves.  Pools of homogenous loans with similar risk and loss characteristics are also assessed for probable losses. These loan pools include consumer, residential real estate, home equity, credit cards and indirect vehicle loans. Migration probabilities obtained from past due roll rate analyses and historical loss rates are applied to current balances to forecast charge-offs over a one-year time horizon. The reserves for consumer related loans totaled $19.8 million at June 30, 2014 and $20.6 million at December 31, 2013.
 
We consistently apply our methodology for determining the appropriateness of the allowance for loan losses but may adjust our methodologies and assumptions based on historical information related to charge-offs and management's evaluation of the loan portfolio. In this regard, we periodically review the following to validate our allowance for loan losses: historical net charge-offs as they relate to prior periods' allowance for loan loss, comparison of historical loan migration in past years compared to the current year, overall credit trends and ratios and any significant changes in loan concentrations. In reviewing this data, we adjust qualitative factors within our allowance methodology to appropriately reflect any changes warranted by the validation process. Management believes it has established an allowance for probable loan losses as appropriate under GAAP.


63



The following table presents an analysis of the allowance for loan losses for the periods presented (dollars in thousands):

 
 
Three Months Ended
 
Six Months Ended
 
 
June 30,
 
June 30,
 
 
2014
 
2013
 
2014
 
2013
Balance at beginning of period
 
$
108,395

 
$
124,733

 
$
113,462

 
$
128,279

Provision for credit losses
 
(1,950
)
 
500

 
(800
)
 
500

Charge-offs:
 
 

 
 

 
 
 
 

Commercial loans
 
446

 
433

 
536

 
1,344

Commercial loans collateralized by assignment of lease payments
 
40

 
—

 
40

 
—

Commercial real estate
 
1,727

 
1,978

 
8,883

 
3,895

Construction real estate
 
14

 
747

 
70

 
829

Residential real estate
 
433

 
399

 
698

 
1,361

Home equity
 
817

 
1,323

 
1,436

 
2,110

Indirect vehicles
 
583

 
629

 
1,503

 
1,358

Other consumer loans
 
590

 
451

 
1,085

 
1,016

Total charge-offs
 
4,650

 
5,960

 
14,251

 
11,913

Recoveries:
 
 

 
 

 
 

 
 

Commercial loans
 
696

 
777

 
2,324

 
1,229

Commercial loans collateralized by assignment of lease payments
 
130

 
987

 
130

 
1,131

Commercial real estate
 
567

 
3,647

 
1,052

 
4,387

Construction real estate
 
77

 
131

 
176

 
407

Residential real estate
 
6

 
199

 
525

 
413

Home equity
 
127

 
100

 
260

 
214

Indirect vehicles
 
439

 
324

 
881

 
739

Other consumer loans
 
68

 
59

 
146

 
111

Total recoveries
 
2,110

 
6,224

 
5,494

 
8,631

Net charge-offs
 
2,540

 
(264
)
 
8,757

 
3,282

Allowance for credit losses
 
103,905

 
125,497

 
103,905

 
125,497

Allowance for unfunded credit commitments
 
(2,995
)
 
(1,812
)
 
(2,995
)
 
(1,812
)
Allowance for loan losses
 
$
100,910

 
$
123,685

 
$
100,910

 
$
123,685

Total loans
 
$
5,556,724

 
$
5,668,187

 
$
5,556,724

 
$
5,668,187

Ratio of allowance to total loans
 
1.82
%
 
2.18
 %
 
1.82
%
 
2.18
%
Ratio of net charge-offs to average loans
 
0.18

 
(0.02
)
 
0.32

 
0.12


Net charge-offs of $8.8 million were recorded in the six months ended June 30, 2014 compared to net charge-offs of $3.3 million in the six months ended June 30, 2013. A negative provision for credit losses of $800 thousand was recorded for the six months ended June 30, 2014 compared to a provision for credit losses of $500 thousand for the six months ended June 30, 2013 as a result of reduced levels of classified and special mention assets.

Additions to the allowance for loan losses, which are charged to earnings through the provision for credit losses, are determined based on a variety of factors, including specific reserves, current loan risk ratings, delinquent loans, historical loss experience and economic conditions in our market area. In addition, federal regulatory authorities, as part of the examination process, periodically review our allowance for loan losses. The regulators may require us to record adjustments to the allowance level based upon their assessment of the information available to them at the time of examination. Although management believes the allowance for loan losses is sufficient to cover probable losses inherent in the loan portfolio, there can be no assurance that the allowance will prove sufficient to cover actual loan losses.

We utilize an internal asset classification system as a means of reporting problem and potential problem assets. At scheduled meetings of the board of directors of MB Financial Bank, a watch list is presented, showing significant loan relationships listed as “Special Mention,” “Substandard,” and “Doubtful.” An asset is classified Substandard if it is inadequately protected by the current net worth and paying capacity of the obligor or the collateral pledged, if any. Substandard assets include those characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected. Assets classified as Doubtful have all the weaknesses inherent in those classified Substandard with the added characteristic that the weaknesses present make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. Assets classified as Loss are those considered uncollectible and viewed as valueless assets and have been charged-

64



off. Assets that do not currently expose us to sufficient risk to warrant classification in one of the aforementioned categories, but possess weaknesses that deserve management's close attention are deemed to be Special Mention.

Our determination as to the classification of our assets and the amount of our valuation allowances is subject to review by the Office of the Comptroller of the Currency, MB Financial Bank's primary regulator, which can order the establishment of additional general or specific loss allowances. There can be no assurance that regulators, in reviewing our loan portfolio, will not request us to materially adjust our allowance for loan losses. The Office of the Comptroller of the Currency, in conjunction with the other federal banking agencies, has adopted an interagency policy statement on the allowance for loan losses. The policy statement provides guidance for financial institutions on both the responsibilities of management for the assessment and establishment of adequate allowances and guidance for banking agency examiners to use in determining the adequacy of general valuation guidelines. Generally, the policy statement recommends that (1) institutions have effective systems and controls to identify, monitor and address asset quality problems; (2) management has analyzed all significant factors that affect the collectability of the portfolio in a reasonable manner; and (3) management has established acceptable allowance evaluation processes that meet the objectives set forth in the policy statement. We analyze our process regularly, with modifications made if needed, and report those results four times per year at meetings of our board of directors. However, there can be no assurance that regulators, in reviewing our loan portfolio, will not request us to materially adjust our allowance for loan losses at the time of their examination.

Although management believes that appropriate specific and general loan loss allowances have been established, actual losses are dependent upon future events and, as such, further additions to the level of specific and general loan loss allowances may become necessary.
 
Lease Investments

The lease portfolio is comprised of various types of equipment, generally technology related, including computer systems and satellite equipment, material handling and general manufacturing equipment. 
 
Lease investments by categories follow (in thousands):
 
 
 
June 30,
2014
 
December 31,
2013
 
June 30,
2013
Direct finance leases:
 
 

 
 

 
 
Minimum lease payments
 
$
190,216

 
$
155,945

 
$
124,549

Estimated unguaranteed residual values
 
30,309

 
31,272

 
31,789

Less: unearned income
 
(15,518
)
 
(14,473
)
 
(10,783
)
Direct finance leases (1)
 
$
205,007

 
$
172,744

 
$
145,555

Leveraged leases:
 
 

 
 

 
 

Minimum lease payments
 
$
16,620

 
$
24,320

 
$
27,023

Estimated unguaranteed residual values
 
1,908

 
2,508

 
2,672

Less: unearned income
 
(979
)
 
(1,644
)
 
(2,081
)
Less: related non-recourse debt
 
(15,979
)
 
(23,243
)
 
(25,627
)
Leveraged leases (1)
 
$
1,570

 
$
1,941

 
$
1,987

Operating leases:
 
 

 
 

 
 

Equipment, at cost
 
$
218,688

 
$
218,473

 
$
205,541

Less accumulated depreciation
 
(91,494
)
 
(87,384
)
 
(91,583
)
Lease investments, net
 
$
127,194

 
$
131,089

 
$
113,958

 
(1)          Direct finance and leveraged leases are included as commercial loans collateralized by assignment of lease payments for financial statement purposes.
 
Leases that transfer substantially all of the benefits and risk related to the equipment ownership are classified as direct finance leases. If these direct finance leases have non-recourse debt associated with them and meet the additional requirements for a leveraged lease, they are further classified as leverage leases, and the associated debt is netted with the outstanding balance in the consolidated financial statements. Interest income on direct finance and leveraged leases is recognized using methods which approximate a level yield over the term of the lease. Operating leases are investments in equipment leased to other companies, where the residual component makes up more than 10% of the investment.  The Company funds most of the lease equipment

65



purchases internally, but has some loans at other banks which totaled $27.0 million at June 30, 2014, $17.5 million at December 31, 2013 and $18.0 million at June 30, 2013.

At June 30, 2014, the following reflects the residual values for leases by category in the year the initial lease term ends (in thousands):
 
 
 
Residual Values
 
 
Direct
 
 
 
 
 
 
End of initial lease term
 
Finance
 
Leveraged
 
Operating
 
 
December 31,
 
Leases
 
Leases
 
Leases
 
Total
2014
 
$
8,384

 
$
210

 
$
8,633

 
$
17,227

2015
 
7,504

 
968

 
8,302

 
16,774

2016
 
6,463

 
607

 
10,141

 
17,211

2017
 
4,335

 
105

 
8,501

 
12,941

2018
 
1,763

 
18

 
6,081

 
7,862

Thereafter
 
1,860

 
—

 
2,484

 
4,344

 
 
$
30,309

 
$
1,908

 
$
44,142

 
$
76,359

 
The lease residual value represents the present value of the estimated fair value of the leased equipment at the termination of the lease. Lease residual values are reviewed quarterly, and any write-downs or charge-offs deemed necessary are recorded in the period in which they become known. To mitigate this risk of loss, we usually limit individual leased equipment residuals to approximately $500 thousand per transaction and seek to diversify both the type of equipment leased and the industries in which the lessees participate. Often times, there are several individual lease schedules under one master lease. There were 3,569 leases at June 30, 2014 compared to 3,590 at December 31, 2013.  The average residual value per lease schedule was approximately $21 thousand at June 30, 2014 and December 31, 2013.  The average residual value per master lease schedule was approximately $83 thousand at June 30, 2014 and $82 thousand at December 31, 2013, respectively.
 
Liquidity and Sources of Capital
 
Our cash flows are composed of three classifications: cash flows from operating activities, cash flows from investing activities, and cash flows from financing activities.

Cash flows from operating activities primarily include net income, adjusted for items in net income that did not impact cash.  Net cash flows provided by operating activities were $101.8 million for the six months ended June 30, 2014 compared to net cash flows provided by operating activities of $60.8 million for the six months ended June 30, 2013.  The change is primarily due to the decrease in payables partly offset by the decrease in the change in other assets.

Cash used in investing activities reflects the impact of loans and investment securities acquired for the Company’s interest-earning asset portfolios, as well as cash flows from asset sales and the impact of acquisitions.  For the six months ended June 30, 2014, the Company had net cash flows provided by investing activities of $71.7 million compared to net cash flows provided by investing activities of $235.2 million for the six months ended June 30, 2013.  The change was primarily due to a decrease in principal payments received on mortgage-backed securities.

Cash flows from financing activities include transactions and events whereby cash is obtained from depositors, creditors or investors.  For the six months ended June 30, 2014, the Company had net cash flows provided by financing activities of $114.4 million compared to net cash flows used in financing activities of $150.6 million for the six months ended June 30, 2013.  The change in cash flows from financing activities was primarily due to the increase in deposits partly offset by the repayment of the $300.0 million FHLB advance.

In the event that additional short-term liquidity is needed, we have established relationships with several large and regional banks to provide short-term borrowings in the form of federal funds purchases.  While, at June 30, 2014, there were no firm lending commitments in place, management believes that we could borrow approximately $280 million for a short time from these banks on a collective basis.  Additionally, we are a member of Federal Home Loan Bank of Chicago (FHLB).  As of June 30, 2014, the Company had $4.2 million outstanding in FHLB advances, and could borrow an additional amount of approximately $480.4 million.  As a contingency plan for significant funding needs, the Asset/Liability Committee may also consider the sale of investment securities, selling securities under agreement to repurchase, or the temporary curtailment of lending activities.  As of June 30, 2014, the Company had approximately $1.4 billion of unpledged securities, excluding securities available for pledge at the FHLB.

66




Our main sources of liquidity at the holding company level are dividends from MB Financial Bank and cash on hand. In addition, the Company has a $35.0 million unsecured line of credit with a correspondent bank. As of June 30, 2014, no amount was outstanding. The holding company had $154.7 million in cash as of June 30, 2014.

See Notes 9 and 10 of the Financial Statements presented under Item 1 of this report for details of period end balances and other information for these various funding sources. There were no material changes outside the ordinary course of business in the Company’s contractual obligations at June 30, 2014 as compared to December 31, 2013.

MB Financial Bank is subject to various regulatory capital requirements which affect its ability to pay dividends to us.  Failure to meet minimum capital requirements can initiate certain mandatory and discretionary actions by regulators that, if undertaken, could have a direct material effect on our financial statements.  Additionally, our current internal policy effectively limits the amount of dividends our subsidiary bank may pay to us by requiring the bank to maintain total risk-based capital, Tier 1 risk-based capital and Tier 1 leverage capital ratios of 12.00%, 9.00% and 8.00%, respectively.  The minimum ratios required for a bank to be considered “well capitalized” for regulatory purposes are 10.00%, 6.00% and 5.00%, respectively.  In addition to adhering to our policy, there are regulatory restrictions on the ability of national banks to pay dividends.  See “Item 1. Business — Supervision and Regulation” in our Annual Report on Form 10-K for the year ended December 31, 2013.

At June 30, 2014, the Company’s total risk-based capital ratio was 17.18%, Tier 1 capital to risk-weighted assets ratio was 15.92% and Tier 1 capital to average asset ratio was 11.61%. MB Financial Bank’s total risk-based capital ratio was 14.67%, Tier 1 capital to risk-weighted assets ratio was 13.42% and Tier 1 capital to average asset ratio was 9.77%. MB Financial Bank was categorized as “Well-Capitalized” at June 30, 2014 under the regulations of the Office of the Comptroller of the Currency.

Non-GAAP Financial Information

This report contains certain financial 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 and net interest margin on a fully tax equivalent basis. Our management uses these non-GAAP measures, together with the related GAAP measures, in its analysis of our performance and in making business decisions. Management also uses these measures for peer comparisons. 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. 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 income on a fully tax equivalent basis to net interest income and net interest margin on a fully tax equivalent basis to net interest margin are contained in the tables under “Net Interest Margin.”

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

Important factors that could cause actual results to differ materially from the results anticipated or projected include, but are not limited to, the following: (1) expected revenues, cost savings, synergies and other benefits from the pending MB Financial-Taylor Capital merger and our other merger and acquisition activities might not be realized within the anticipated time frames or at all, and costs or difficulties relating to integration matters, including but not limited to customer and employee retention, might be greater than expected; (2) the possibility that the expected benefits of the FDIC-assisted and other transactions we previously completed will not be realized; (3) the credit risks of lending activities, including changes in the level and direction of loan delinquencies and write-offs and changes in estimates of the adequacy of the allowance for loan losses, which could necessitate additional provisions for loan losses, resulting both from loans we originate and loans we acquire from other financial institutions; (4) results of examinations by the Office of Comptroller of Currency, the Federal Reserve Board and other regulatory authorities,

67



including the possibility that any such regulatory authority may, among other things, require us to increase our allowance for loan losses or write-down assets; (5) competitive pressures among depository institutions; (6) interest rate movements and their impact on customer behavior and net interest margin; (7) the impact of repricing and competitors’ pricing initiatives on loan and deposit products; (8) fluctuations in real estate values; (9) the ability to adapt successfully to technological changes to meet customers’ needs and developments in the market-place; (10) our ability to realize the residual values of our direct finance, leveraged, and operating leases; (11) our ability to access cost-effective funding; (12) changes in financial markets; (13) changes in economic conditions in general and in the Chicago metropolitan area in particular; (14) the costs, effects and outcomes of litigation, including, without limitation, litigation relating to the pending MB Financial-Taylor Capital merger; (15) new legislation or regulatory changes, including but not limited to the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the "Dodd-Frank Act") and regulations adopted thereunder, changes in capital requirements pursuant to the Dodd-Frank Act and the implementation of the Basel III capital standards, other governmental initiatives affecting the financial services industry and changes in federal and/or state tax laws or interpretations thereof by taxing authorities; (16) changes in accounting principles, policies or guidelines; (17) our future acquisitions of other depository institutions or lines of business; and (18) future goodwill impairment due to changes in our business, changes in market conditions, or other factors.
 
We do not undertake any obligation to update any forward-looking statement to reflect circumstances or events that occur after the date on which the forward-looking statement is made.

Item 3.
  Quantitative and Qualitative Disclosures about Market Risk
 
Market Risk and Asset Liability Management
 
Market Risk.  Market risk is the risk that the market value or estimated fair value of our assets, liabilities, and derivative financial instruments will decline as a result of changes in interest rates or financial market volatility, or that our net income will be significantly reduced by interest rate changes.  Market risk is managed operationally in our Treasury Group and is addressed through a selection of funding and hedging instruments supporting balance sheet growth, as well as monitoring our asset investment strategies.
 
Asset Liability Management.  Management and our Treasury Group continually monitor our sensitivity to interest rate changes.  It is our policy to maintain an acceptable level of interest rate risk over a range of possible changes in interest rates while remaining responsive to market demand for loan and deposit products.  The strategy we employ to manage our interest rate risk is to measure our risk using an asset/liability simulation model.  The model considers several factors to determine our potential exposure to interest rate risk, including measurement of repricing gaps, duration, convexity, value at risk, and the market value of portfolio equity under assumed changes in the level of interest rates, shape of the yield curves, and general market volatility.  Management controls our interest rate exposure using several strategies, which include adjusting the maturities of securities in our investment portfolio, and limiting fixed rate loans or fixed rate deposits with terms of more than five years.  We also use derivative instruments, principally interest rate swaps, to manage our interest rate risk.  See Note 15 to the Consolidated Financial Statements.
 
Interest Rate Risk.  Interest rate risk can come in a variety of forms, including repricing risk, yield curve risk, basis risk, and prepayment risk.  We experience repricing risk when the change in the average yield of our interest earning assets or average rate of our interest bearing liabilities is more sensitive than the other to changes in market interest rates.  Such a change in sensitivity could reflect a number of possible mismatches in the repricing opportunities of our assets and liabilities.
 
In the event that yields on our assets and liabilities do adjust to changes in market rates to the same extent, we may still be exposed to yield curve risk.  Yield curve risk reflects the possibility the changes in the shape of the yield curve could have different effects on our assets and liabilities.
 
Variable rate assets and liabilities that reprice at similar times, have similar maturities or repricing dates, are based on different indexes still have interest rate risk.  Basis risk reflects the possibility that indexes will not move in a coordinated manner.
 
We hold mortgage-related investments, including mortgage loans and mortgage-backed securities.  Prepayment risk is associated with mortgage-related investments and results from homeowners’ ability to pay off their mortgage loans prior to maturity.  We limit this risk by restricting the types of mortgage-backed securities we own to those with limited average life changes under certain interest-rate shock scenarios, or securities with embedded prepayment penalties.
 
Measuring Interest Rate Risk.  As noted above, interest rate risk can be measured by analyzing the extent to which the repricing of assets and liabilities are mismatched to create an interest sensitivity gap.  An asset or liability is said to be interest rate sensitive within a specific period if it will mature or reprice within that period.  The interest rate sensitivity gap is defined as the difference between the amount of interest earning assets maturing or repricing within a specific time period and the amount of interest bearing

68



liabilities maturing or repricing within that same time period.  A gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities.  A gap is considered negative when the amount of interest rate sensitive liabilities exceeds the amount of interest rate sensitive assets.  During a period of rising interest rates, therefore, a negative gap would tend to adversely affect net interest income.  Conversely, during a period of falling interest rates, a negative gap position would tend to result in an increase in net interest income.

The following table sets forth the amounts of interest earning assets and interest bearing liabilities outstanding at June 30, 2014 that we anticipate, based upon certain assumptions, to reprice or mature in each of the future time periods shown.  Except as stated below, the amount of assets and liabilities shown which reprice or mature during a particular period were determined based on the earlier of the term to repricing or the term to repayment of the asset or liability.  The table is intended to provide an approximation of the projected repricing of assets and liabilities at June 30, 2014 based on contractual maturities and scheduled rate adjustments within a three-month period and subsequent selected time intervals.  The loan amounts in the table reflect principal balances expected to be reinvested and/or repriced because of contractual amortization and rate adjustments on adjustable-rate loans.  Loan and investment securities’ contractual maturities and amortization reflect expected prepayment assumptions.  While NOW, money market and savings deposit accounts have adjustable rates, it is assumed that the interest rates on some of the accounts will not adjust immediately to changes in other interest rates.
 
Therefore, the information in the table is calculated assuming that NOW, money market and savings deposits will reprice as follows: 4%, 10%, and 6%, respectively, in the first three months, 11%, 26%, and 15%, respectively, in the next nine months, 52%, 58%, and 57%, respectively, from one year to five years, and 33%, 6%, and 22%, respectively over five years (dollars in thousands):
 
 
 
Time to Maturity or Repricing
 
 
0 – 90
 
91 - 365
 
1 – 5
 
Over 5
 
 
 
 
Days
 
Days
 
Years
 
Years
 
Total
Interest Earning Assets:
 
 

 
 

 
 

 
 

 
 

Interest earning deposits with banks
 
$
465,883

 
$
—

 
$
937

 
$
—

 
$
466,820

Federal funds sold
 
10,000

 
—

 
—

 
—

 
10,000

Investment securities
 
165,614

 
241,777

 
1,316,417

 
723,974

 
2,447,782

Loans held for sale
 
1,219

 
—

 
—

 
—

 
1,219

Loans, including covered loans
 
2,354,445

 
1,055,794

 
2,031,070

 
115,415

 
5,556,724

Total interest earning assets
 
$
2,997,161

 
$
1,297,571

 
$
3,348,424

 
$
839,389

 
$
8,482,545

Interest Bearing Liabilities:
 
 

 
 

 
 

 
 

 
 

NOW and money market deposit accounts
 
$
213,235

 
$
578,625

 
$
1,614,893

 
$
525,336

 
$
2,932,089

Savings deposits
 
47,784

 
134,704

 
495,440

 
194,396

 
872,324

Time deposits
 
380,729

 
681,236

 
236,718

 
54,601

 
1,353,284

Short-term borrowings
 
22,981

 
59,750

 
133,289

 
13,789

 
229,809

Long-term borrowings
 
3,407

 
8,972

 
56,904

 
2,190

 
71,473

Junior subordinated notes issued to capital trusts
 
152,065

 
—

 
—

 
—

 
152,065

Total interest bearing liabilities
 
$
820,201

 
$
1,463,287

 
$
2,537,244

 
$
790,312

 
$
5,611,044

Rate sensitive assets (RSA)
 
$
2,997,161

 
$
4,294,732

 
$
7,643,156

 
$
8,482,545

 
$
8,482,545

Rate sensitive liabilities (RSL)
 
820,201

 
2,283,488

 
4,820,732

 
5,611,044

 
5,611,044

Cumulative GAP (GAP=RSA-RSL)
 
2,176,960

 
2,011,244

 
2,822,424

 
2,871,501

 
2,871,501

RSA/Total assets
 
30.53
%
 
43.74
%
 
77.84
%
 
86.39
%
 
86.39
%
RSL/Total assets
 
8.35

 
23.26

 
49.10

 
57.15

 
57.15

GAP/Total assets
 
22.17

 
20.48

 
28.75

 
29.25

 
29.25

GAP/RSA
 
72.63

 
46.83

 
36.93

 
33.85

 
33.85

 
Certain shortcomings are inherent in the method of analysis presented in the foregoing table.  For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates.  Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types of assets may lag behind changes in market rates.  Additionally, in the event of a

69



change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed in calculating the table.  Therefore, we do not rely on a gap analysis to manage our interest rate risk, but rather we use what we believe to be the more reliable simulation model relating to changes in net interest income.

Based on simulation modeling which assumes gradual changes in interest rates over a one-year period, we believe that our net interest income would change due to changes in interest rates as follows (dollars in thousands):
 
Gradual
 
Changes in Net Interest Income Over One Year Horizon
Changes in
 
June 30, 2014
 
December 31, 2013
Levels of
 
Dollar
 
Percentage
 
Dollar
 
Percentage
Interest Rates
 
Change
 
Change
 
Change
 
Change
+ 2.00%
 
$
12,370

 
4.80
 %
 
$
10,596

 
3.84
 %
+ 1.00%
 
6,187

 
2.40

 
5,554

 
2.01

- 1.00%
 
(6,680
)
 
(2.59
)
 
(6,553
)
 
(2.38
)
 
In the interest rate sensitivity table above, changes in net interest income between June 30, 2014 and December 31, 2013 reflect changes in the composition of interest earning assets and interest bearing liabilities, related interest rates, repricing frequencies, and the fixed or variable characteristics of the interest earning assets and interest bearing liabilities.  The changes in net interest income incorporate the impact of loan floors as well as shifts from low cost deposits to higher cost certificates of deposit in a rising rate environment.
 
The assumptions used in our interest rate sensitivity simulation discussed above are inherently uncertain and, as a result, the simulations cannot precisely measure net interest income or precisely predict the impact of changes in interest rates on net interest income.  Our model assumes that a portion of our variable rate loans that have minimum interest rates will remain in our portfolio regardless of changes in the interest rate environment.  Actual results will differ from simulated results due to timing, magnitude and frequency of interest rate changes as well as changes in market conditions and management strategies.
 
Item 4.
Controls and Procedures
 
Evaluation of Disclosure Controls and Procedures: An evaluation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the “Act”)) was carried out as of June 30, 2014 under the supervision and with the participation of our Chief Executive Officer, Chief Financial Officer and several other members of our senior management.  Our Chief Executive Officer and Chief Financial Officer concluded that, as of June 30, 2014, our disclosure controls and procedures were effective in ensuring that the information we are required to disclose in the reports we file or submit under the Act is (i) accumulated and communicated to our management (including the Chief Executive Officer and Chief Financial Officer) to allow timely decisions regarding required disclosure, and (ii) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.
 
Changes in Internal Control Over Financial Reporting: During the quarter ended June 30, 2014, no change occurred in our internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
 
We do not expect that our disclosure controls and procedures and internal control over financial reporting will prevent all error and all fraud.  A control procedure, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control procedure are met.  Because of the inherent limitations in all control procedures, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected.  These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns in controls or procedures can occur because of simple error or mistake.  Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control.  The design of any control procedure also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate.  Because of the inherent limitations in a cost-effective control procedure, misstatements due to error or fraud may occur and not be detected.
 

70



PART II.        OTHER INFORMATION

Item 1.
  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.

On July 26, 2013, an action captioned James Sullivan v. Taylor Capital Group, Inc., et al., Case No. 2013-CH17751 (the “Sullivan Action”) was commenced against Taylor Capital, the board of directors of Taylor Capital (the “Taylor Capital Board”), and MB Financial (collectively, the “Defendants”) in the Circuit Court of Cook County, Illinois (the “Court”), alleging that the Taylor Capital Board breached its fiduciary duties in connection with the pending MB Financial/Taylor Capital merger (the “Merger”) and that MB Financial aided and abetted those breaches of fiduciary duty. On August 8, 2013, a stockholder class action captioned Dennis Panozzo v. Taylor Capital Group, Inc., et. al., Case No. 2013-CH-18546 (the “Panozzo Action”) was commenced against the Defendants in the Court making similar allegations in connection with the Merger. Subsequently, on September 10, 2013, the Sullivan Action and the Panozzo Action were consolidated pursuant to Court order under the first-filed Sullivan Action, Case No. 2013-CH17751 (as so consolidated, the “Action”). On October 24, 2013, the plaintiffs in the Action (the “Plaintiffs”) filed a consolidated amended class action complaint, alleging that the Taylor Capital Board breached its fiduciary duties in connection with the Merger, including by making incomplete and misleading disclosures concerning the Merger, and that MB Financial aided and abetted those breaches of fiduciary duty.

On February 17, 2014, solely to eliminate the costs, risks, burden, distraction and expense of further litigation and to put the claims that were or could have been asserted to rest, the Defendants entered into a memorandum of understanding (the “MOU”) with the Plaintiffs regarding the settlement of the Action pursuant to which Taylor Capital and MB Financial agreed to make certain supplemental disclosures concerning the Merger, which each of Taylor Capital and MB Financial did in a Current Report on Form 8-K filed by each company on February 18, 2014 (the “Form 8-Ks”). On July 10, 2014, the parties entered into a definitive settlement agreement. The agreement is subject to Court approval. The agreement provides that, solely for purposes of settlement, the Court will certify a class consisting of all persons who were record or beneficial stockholders of Taylor Capital when the Merger was approved by the Taylor Capital Board or any time thereafter (the “Class”). In addition, the agreement provides that, subject to approval by the Court after notice to the members of the Class (the “Class Members”), the Action will be dismissed with prejudice and all claims that the Class Members may possess with regard to the Merger, with the exception of claims for statutory appraisal, will be released. Class Members will be afforded an opportunity to opt out of the class solely with regard to any monetary claims they may possess. In connection with the settlement, the Plaintiffs’ counsel has expressed their intention to seek an award by the Court of attorneys’ fees and expenses. The amount of the award to the Plaintiffs’ counsel will ultimately be determined by the Court. This payment will not affect the amount of merger consideration to be paid by MB Financial or that any Taylor Capital stockholder will receive in the Merger. The proposed settlement has not yet been presented to the Court for approval. There can be no assurance that the Court will approve the settlement. In the absence of such approval, the proposed settlement will terminate.

The Defendants continue to believe that the Action is without merit, have vigorously denied, and continue to vigorously deny, all of the allegations of wrongful or actionable conduct asserted in the Action, and the Taylor Capital Board vigorously maintains that it diligently and scrupulously complied with its fiduciary duties, that the joint proxy statement/prospectus dated January 14, 2014 mailed to the stockholders of Taylor Capital and MB Financial was complete and accurate in all material respects and that no further disclosure was required under applicable law. The Defendants are entering into the MOU and the contemplated settlement solely to eliminate the costs, risks, burden, distraction and expense of further litigation and to put the claims that were or could have been asserted to rest. Nothing in the MOU, any settlement agreement or any public filing, including the Form 8-Ks, shall be deemed an admission of the legal necessity of filing or the materiality under applicable laws of any of the additional information contained therein or in any public filing associated with the proposed settlement of the Action.

Based on information currently available, consultations with counsel and established reserves, management believes that the eventual outcome of this litigation will not have a material adverse effect on the Company's consolidated financial position or results of operations.
 


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Item 1A.
  Risk Factors
 
There have been no material changes to the risk factors disclosed in Item 1A. Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2013.

Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
 
The following table sets forth information for the three months ended June 30, 2014 with respect to our repurchases of our outstanding common shares:
 
 
 
Total Number of
Shares Purchased (1)
 
Average Price Paid
per Share
 
Number of Shares Purchased
as Part of Publicly Announced
Plans or Programs
 
Maximum Number of
Shares that May Yet Be
Purchased Under the Plans
or Programs
April 1, 2014 — April 30, 2014
 
—

 
$
—

 
—

 
1,000,000

May 1, 2014 — May 31, 2014
 
2,489

 
26.88

 
66,906

 
1,000,000

June 1, 2014 — June 30, 2014
 
322

 
27.89

 
8,981

 
1,000,000

Total
 
2,811

 
$
27.00

 
75,887

 
 

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

Item 6.
  Exhibits

See Exhibit Index.



72




SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
MB FINANCIAL, INC.
(registrant)
 
Date:
July 30, 2014
By:
/s/Mitchell Feiger
 
 
 
Mitchell Feiger
 
 
 
President and Chief Executive Officer
 
 
 
(Principal Executive Officer)
 
 
 
 
Date:
July 30, 2014
By:
/s/Jill E. York
 
 
 
Jill E. York
 
 
 
Vice President and Chief Financial Officer
 
 
 
(Principal Financial and Principal Accounting Officer)
 



73



EXHIBIT INDEX
Exhibit Number
 
Description
 
 
 
2.1
 
Agreement and Plan of Merger, dated as of July 14, 2013, by and among the Registrant and Taylor Capital Group, Inc. (incorporated herein by reference to Exhibit 2.1 to the Registrant's Current Report on Form 8-K filed on July 18, 2013 (File No.0-24566-01))

 
 
 
2.2
 
Amendment, dated as of June 30, 3014, to Agreement and Plan of Merger, dated as of July 14, 2013, by and between the Registrant and Taylor Capital Group, Inc. (incorporated herein by reference to Exhibit 2.1 to the Registrant's Current Report on Form 8-K filed on July 1, 2014 (File No.0-24566-01))
 
 
 
2.3
 
Letter Agreement, dated as of June 30, 3014, by and between the Registrant and Taylor Capital Group, Inc. (incorporated herein by reference to Exhibit 2.2 to the Registrant's Current Report on Form 8-K filed on July 1, 2014 (File No.0-24566-01))
 
 
 
2.4
 
Agreement and Plan of Merger, dated as of May 1, 2006, by and among the Registrant, MBFI Acquisition Corp. and First Oak Brook Bancshares, Inc. (“First Oak Brook”)(incorporated herein by reference to Exhibit 2.1 to the Registrant’s Current Report on Form 8-K filed on May 2, 2006 (File No.0-24566-01))
 
 
 
2.5
 
Purchase and Assumption Agreement among Federal Deposit Insurance Corporation, Receiver of Corus Bank, National Association, Chicago, Illinois, Federal Deposit Insurance Corporation and MB Financial Bank, N.A., dated as of September 11, 2009 (incorporated herein by reference to Exhibit 2.1 to the Registrant’s Current Report on Form 8-K filed on September 17, 2010 (File No.0-24566-01))
 
 
 
2.6
 
Purchase and Assumption Agreement among Federal Deposit Insurance Corporation, Receiver of Broadway Bank, Chicago, Illinois, Federal Deposit Insurance Corporation and MB Financial Bank, N.A., dated as of April 23, 2010 (incorporated herein by reference to Exhibit 2.6 to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2010 (File No. 0-24566-01))
 
 
 
2.7
 
Purchase and Assumption Agreement among Federal Deposit Insurance Corporation, Receiver of New Century Bank, Chicago, Illinois, Federal Deposit Insurance Corporation and MB Financial Bank, N.A., dated as of April 23, 2010 (incorporated herein by reference to Exhibit 2.7 to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2010 (File No. 0-24566-01))
 
 
 
3.1
 
Charter of the Registrant, as amended (incorporated herein by reference to Exhibit 3.1 to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2011 (File No. 0-24566-01))
 
 
 
3.1A
 
Articles Supplementary to the Charter of the Registrant for the Registrant’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A (incorporated herein by reference to Exhibit 3.1 to the Registrant’s Current Report on Form 8-K filed on December 8, 2008 (File No.0-24566-01))
 
 
 
3.2
 
Bylaws of the Registrant, as amended (incorporated herein by reference to Exhibit 3.1 to the Registrant’s Current Report on Form 8-K filed on April 2, 2012 (File No. 0-24566-01))
 
 
 
4.1
 
The Registrant hereby agrees to furnish to the Commission, upon request, the instruments defining the rights of the holders of each issue of long-term debt of the Registrant and its consolidated subsidiaries
 
 
 
4.2
 
Certificate of Registrant’s Common Stock (incorporated herein by reference to Exhibit 4.1 to Amendment No. One to the Registrant’s Registration Statement on Form S-4 (No. 333-64584))
 
 
 


74




EXHIBIT INDEX
Exhibit Number
 
Description
 
 
 
4.3
 
Warrant to purchase shares of the Registrant’s Common Stock (incorporated herein by reference to Exhibit 4.1 to the Registrant’s Current Report on Form 8-K filed on December 8, 2008 (File No.0-24566-01))
 
 
 
10.1
 
Letter Agreement, dated as of December 5, 2008, between the Registrant and the United States Department of the Treasury (incorporated herein by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on December 8, 2008 (File No.0-24566-01))
 
 
 
10.2
 
Amended and Restated Employment Agreement between the Registrant and Mitchell Feiger (incorporated herein by reference to Exhibit 10.2 to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2008 (File No. 0-24566-01))
 
 
 
10.3
 
Employment Agreement between MB Financial Bank, N.A. and Burton J. Field (incorporated herein by reference to Exhibit 10.3 to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2008 (File No. 0-24566-01))
 
 
 
10.4
 
Form of Change and Control Severance Agreement between MB Financial Bank, National Association and Jill E. York (incorporated herein by reference to Exhibit 10.4 to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2008 (File No. 0-24566-01))
 
 
 
10.4B
 
Form of Change and Control Severance Agreement between MB Financial Bank, National Association and each of Burton Field, Larry J. Kallembach, Brian Wildman, Rosemarie Bouman and Susan Peterson (incorporated herein by reference to Exhibit 10.4B to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2008 (File No. 0-24566-01))
 
 
 
10.4C
 
Form of Change in Control Severance Agreement between MB Financial Bank, National Association and each of Mark A. Heckler and Edward F. Milefchik (incorporated herein by reference to Exhibit 10.4C to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2011 (File No. 0-24566-01))
 
 
 
10.5
 
Form of Letter Agreement dated December 4, 2008 between MB Financial, Inc. and each of Mitchell Feiger, Jill E. York, Burton Field, Larry J. Kallembach, Brian Wildman, Rosemarie Bouman, and Susan Peterson relating to the TARP Capital Purchase Program (incorporated herein by reference to Exhibit 10.5 to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2008 (File No. 0-24566-01))
 
 
 
10.5A
 
Form of Compensation Amendment and Waiver Agreement under the TARP Capital Purchase Program between MB Financial, Inc. and certain employees (incorporated herein by reference to Exhibit 10.5A to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2009 (File No. 0-24566-01))
 
 
 
10.5B
 
Form of Compensation Amendment and Waiver Agreement under the TARP Capital Purchase Program between MB Financial, Inc. and each of Mark A. Heckler and Edward F. Milefchik (incorporated herein by reference to Exhibit 10.5B to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2011 (File No. 0-24566-01))
 
 
 
10.7
 
MB Financial, Inc. Second Amended and Restated Omnibus Incentive Plan (the “Omnibus Incentive Plan”) (incorporated herein by reference to Appendix A to the Registrant’s definitive proxy statement filed on April 27, 2011 (File No. 0-24566-01))
 
 
 
 
 
 
 

75



EXHIBIT INDEX
Exhibit Number
 
Description
 
 
 
10.8
 
MB Financial Stock Deferred Compensation Plan (incorporated herein by reference to Exhibit 10.8 to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2008 (File No. 0-24566-01))
 
 
 
10.9
 
MB Financial Non-Stock Deferred Compensation Plan (incorporated herein by reference to Exhibit 10.9 to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2008 (File No. 0-24566-01))
 
 
 
10.10
 
Avondale Federal Savings Bank Supplemental Executive Retirement Plan Agreement (incorporated herein by reference to Exhibit 10.2 to Old MB Financial’s (then known as Avondale Financial Corp.) Annual Report on Form 10-K for the year ended December 31, 1996 (File No. 0-24566))
 
 
 
10.11
 
Agreement Regarding Salary Adjustment and Portion of Salary Payable by Stock, dated as of December 21, 2009, between MB Financial, Inc. and Mitchell Feiger (incorporated herein by reference to Exhibit 10.11 to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2009 (File No. 0-24566-01))
 
 
 
10.11A
 
Form of Agreement Regarding Salary Adjustment and Portion of Salary Payable by Stock between MB Financial, Inc. and Rosemarie Bouman, Burton J. Field, Mark A. Heckler, Larry J. Kallembach, Edward F. Milefchik, Susan G. Peterson and Brian J. Wildman (incorporated herein by reference to Exhibit 10.11A to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2011 (File No. 0-24566-01))
 
 
 
10.12
 
Agreement Regarding Salary Adjustment and Portion of Salary Payable by Stock, dated as of December 21, 2009, between MB Financial, Inc. and Jill E. York (incorporated herein by reference to Exhibit 10.12 to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2009 (File No. 0-24566-01))
 
 
 
10.13
 
Amended and Restated Employment Agreement between MB Financial Bank, N.A. and Ronald D. Santo (incorporated herein by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on December 14, 2004 (File No. 0-24566-01))
 
 
 
10.13A
 
Amendment to Amended and Restated Employment Agreement between MB Financial Bank, N.A. and Ronald D. Santo ((incorporated herein by reference to Exhibit 10.13A to the Registrant’s Annual Report on Form 10-K/A for the year ended December 31, 2006, filed on March 2, 2007 (File No. 0-24566-01))
 
 
 
10.15
 
Tax Gross Up Agreements between the Registrant and each of Mitchell Feiger, Burton J. Field, Jill E. York, Larry J. Kallembach, Brian Wildman, and Susan Peterson (incorporated herein by reference to Exhibit 10.15 to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2008 (File No. 0-24566-01))
 
 
 
10.15A
 
Tax Gross Up Agreement between the Registrant and Rosemarie Bouman (incorporated herein by reference to Exhibit 10.15A to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2008 (File No. 0-24566-01))
 
 
 
10.16
 
Form of Incentive Stock Option Agreement for Executive Officers under the Omnibus Incentive Plan (incorporated herein by reference to Exhibit 10.16 to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2007 (File No. 0-24566-01))
 
 
 


76



EXHIBIT INDEX
Exhibit Number
 
Description
 
 
 
10.17
 
Form of Non-Qualified Stock Option Agreement for Directors under the Omnibus Incentive Plan (incorporated herein by reference to Exhibit 10.16 to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2007 (File No. 0-24566-01))
 
 
 
10.18
 
Form of Restricted Stock Agreement for Executive Officers under the Omnibus Incentive Plan (incorporated herein by reference to Exhibit 10.16 to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2007 (File No. 0-24566-01))
 
 
 
10.18A
 
Amendment to Form of Incentive Stock Option Agreement and Form of Restricted Stock Agreement for Executive Officers under the Omnibus Incentive Plan (incorporated herein by reference to Exhibit 10.18A to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2008 (File No. 0-24566-01))
 
 
 
10.18B
 
Form of Performance-Based Restricted Stock Agreement for Executive Officers under the Omnibus Incentive Plan (incorporated herein by reference to Exhibit 10.18B to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2009 (File No. 0-24566-01))
 
 
 
10.18C
 
Form of Restricted Stock Agreement for grants on December 2, 2009 to Mitchell Feiger, Jill E. York and Burton J. Field (incorporated herein by reference to Exhibit 10.18C to the Registrant’s Current Report on Form 8-K filed on December 7, 2009 (File No. 0-24566-01))
 
 
 
10.19
 
Form of Restricted Stock Agreement for Directors under the Omnibus Incentive Plan (incorporated herein by reference to Exhibit 10.16 to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2007 (File No. 0-24566-01))
 
 
 
10.20
 
First Oak Brook Bancshares, Inc. Incentive Compensation Plan (incorporated herein by reference to Appendix A to the definitive proxy statement filed by First Oak Brook on March 30, 2004 (File No. 0-14468))
 
 
 
10.20A
 
Amendment to First Oak Brook Bancshares, Inc. Incentive Compensation Plan ((incorporated herein by reference to Exhibit 10.20A to the Registrant’s Annual Report on Form 10-K/A for the year ended December 31, 2006, filed on March 2, 2007 (File No. 0-24566-01))
 
 
 
10.21
 
First Oak Brook Bancshares, Inc. 2001 Stock Incentive Plan (incorporated herein by reference to Appendix A to the definitive proxy statement filed by First Oak Brook on April 2, 2001 (File No. 0-14468))
 
 
 
10.21A
 
Amendment to First Oak Brook Bancshares, Inc. 2001 Stock Incentive Plan ((incorporated herein by reference to Exhibit 10.21A to the Registrant’s Annual Report on Form 10-K/A for the year ended December 31, 2006, filed on March 2, 2007 (File No. 0-24566-01))
 
 
 
10.22
 
First Oak Brook Bancshares, Inc. Directors Stock Plan (incorporated herein by reference to Exhibit 4.1 to the Registration Statement on Form S-8 filed by First Oak Brook on October 25, 1999 (File No. 333-89647))
 
 
 
10.22A
 
Amendment to First Oak Brook Bancshares, Inc. Directors Stock Plan (incorporated herein by reference to Exhibit 10.22A to the Registrant’s Quarterly Report on Form 10-Q/A for the quarter ended March 31, 2007 filed on May 15, 2007 (File No. 0-24566-01))
 
 
 
10.23
 
Letter Agreement, dated as of June 30, 2014, by and among the Registrant and certain principal stockholders of Taylor Capital Group, Inc. (incorporated herein by reference to Exhibit 10.1 to the Registrant's Current Report on Form 8-K filed on July 1, 2014 (File No.0-24566-01))
 
 
 
10.24
 
Reserved.


77




EXHIBIT INDEX
Exhibit Number
 
Description
 
 
 
10.25
 
Reserved.
 
 
 
10.26
 
Reserved.
 
 
 
10.27
 
First Oak Brook Bancshares, Inc. Executive Deferred Compensation Plan (incorporated by reference to Exhibit 10.3 to First Oak Brook’s Annual Report on Form 10-K for the year ended December 31, 1997 (File No. 0-14468))
 
 
 
10.27A
 
Amendment to First Oak Brook Bancshares, Inc. Executive Deferred Compensation Plan (incorporated herein by reference to Exhibit 10.27A to the Registrant’s Quarterly Report on Form 10-Q/A for the quarter ended March 31, 2007 filed on May 15, 2007)
 
 
 
10.29
 
Form of Transitional Employment Agreement between the Registrant (as successor to First Oak Brook) and Rosemarie Bouman (incorporated herein by reference to Exhibit 10.10 to First Oak Brook’s Annual Report on Form 10-K for the year ended December 31, 1998 (File No. 0-14468))
 
 
 
10.29A
 
First Amendment to Transitional Employment Agreement between the Registrant (as successor to First Oak Brook) and Rosemarie Bouman ((incorporated herein by reference to Exhibit 10.28A to the Registrant’s Annual Report on Form 10-K/A for the year ended December 31, 2006, filed March 2, 2007 (File No. 0-24566-01))
 
 
 
10.29B
 
Second Amendment to Transitional Employment Agreement between the Registrant (as successor to First Oak Brook) and Rosemarie Bouman ((incorporated herein by reference to Exhibit 10.28B to the Registrant’s Annual Report on Form 10-K/A for the year ended December 31, 2006, filed March 2, 2007 (File No. 0-24566-01))
 
 
 
10.30
 
Form of Performance Share Unit Award Agreement (incorporated herein by reference to Exhibit 10.30 to the Registrant's Current Report on Form 8-K filed on September 5, 2012 (File No. 0-24566-01))
 
 
 
10.31
 
Form of Incentive Stock Option Agreement (Management Committee) (incorporated herein by reference to Exhibit 10.31 to the Registrant's Current Report on Form 8-K filed on September 5, 2012 (File No. 0-24566-01))
 
 
 
10.32
 
Form of Restricted Stock Agreement (Management Committee) (incorporated herein by reference to Exhibit 10.32 to the Registrant's Current Report on Form 8-K filed on September 5, 2012 (File No. 0-24566-01))
 
 
 
10.32A
 
Form of Restricted Stock Unit Agreement (Management Committee) (incorporated herein by reference to Exhibit 10.32A to the Registrant's Current Report on Form 8-K filed on September 5, 2012 (File No. 0-24566-01))
 
 
 
31.1
 
Rule 13a — 14(a)/15d — 14(a) Certification (Chief Executive Officer)*
 
 
 
31.2
 
Rule 13a — 14(a)/15d — 14(a) Certification (Chief Financial Officer)*
 
 
 
32
 
Section 1350 Certifications*
 
 
 

78



 
EXHIBIT INDEX
Exhibit Number
 
Description
 
 
 
101
 
The following financial statements from the MB Financial, Inc. Quarterly Report on Form 10-Q for the quarter ended June 30, 2014, formatted in Extensive Business Reporting Language (XBRL): (i) consolidated balance sheets, (ii) consolidated statements of operations, (iii) consolidated statements of comprehensive income, (iv) consolidated statements of cash flows and (v) the notes to consolidated financial statements*


*  Filed herewith

79