Attached files

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EX-21.1 - LIST OF SUBSIDIARIES OF TAYLOR CAPITAL GROUP, INC. - TAYLOR CAPITAL GROUP INCdex211.htm
EX-23.1 - CONSENT OF KPMG LLP - TAYLOR CAPITAL GROUP INCdex231.htm
EX-31.2 - CERTIFICATION OF CHIEF FINANCIAL OFFICER PURSUANT TO RULE 13A-14(A) - TAYLOR CAPITAL GROUP INCdex312.htm
EX-99.1 - CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO SECTION 111(B)(4) - TAYLOR CAPITAL GROUP INCdex991.htm
EX-99.2 - CERTIFICATION OF CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 111(B)(4) - TAYLOR CAPITAL GROUP INCdex992.htm
EX-31.1 - CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO RULE 13A-14(A) - TAYLOR CAPITAL GROUP INCdex311.htm
EX-12.1 - COMPUTATION OF RATIOS OF EARNINGS TO FIXED CHARGES - TAYLOR CAPITAL GROUP INCdex121.htm
EX-32.1 - CERTIFICATION OF THE CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER - TAYLOR CAPITAL GROUP INCdex321.htm
Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

FORM 10-K

 

 

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended December 31, 2010

 

Commission file number 0-50034

 

 

 

TAYLOR CAPITAL GROUP, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   36-4108550
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification Number)

 

9550 West Higgins Road

Rosemont, Illinois 60018

(Address, including zip code, of principal executive offices)

 

(847) 653-7978

(Registrant’s telephone number, including area code)

 

 

 

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

Common Stock, par value $0.01 per share   The NASDAQ Stock Market, LLC
(Title of Class)   (Name of Exchange Which Registered)

 

Securities registered pursuant to Section 12(g) of the Act: None

 

 

 

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

 

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

 

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

 

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  ¨    No  ¨

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

 

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 definition of “accelerated filer,” “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer  ¨     Accelerated filer   ¨      Non-accelerated filer   ¨      Smaller reporting company   x 

 

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

 

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant, based on the closing sales price on The Nasdaq Global Select Market on June 30, 2010, the last business day of the registrant’s most recently completed second fiscal quarter was approximately $126,814,148.

 

At March 15, 2011, there were 17,904,809 shares of the registrant’s common stock outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the registrant’s Notice of Annual Meeting and Proxy Statement for the registrant’s Annual Meeting of Stockholders to be held on or around May 12, 2011 are incorporated by reference into Part III hereof.

 

 

 


Table of Contents

TAYLOR CAPITAL GROUP, INC.

 

INDEX

 

            Page No.  

Part I.

       

Item 1.

    

Business

     1   

Item 1A.

    

Risk Factors

     12   

Item 2.

    

Properties

     19   

Item 3.

    

Legal Proceedings

     20   

Item 4.

    

Reserved

     20   

Part II.

       

Item 5.

    

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

     21   

Item 6.

    

Selected Financial Data

     23   

Item 7.

    

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     25   

Item 7A.

    

Quantitative and Qualitative Disclosures about Market Risk

     77   

Item 8.

    

Financial Statements and Supplementary Data

     78   

Item 9.

    

Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

     135   

Item 9A.

    

Controls and Procedures

     135   

Item 9B.

    

Other Information

     136   

Part III.

       

Item 10.

    

Directors, Executive Officers and Corporate Governance

     137   

Item 11.

    

Executive Compensation

     137   

Item 12.

    

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

     137   

Item 13.

    

Certain Relationships and Related Transactions, and Director Independence

     137   

Item 14.

    

Principal Accountant Fees and Services

     137   

Part IV.

       

Item 15.

    

Exhibits, Financial Statement Schedules

     138   


Table of Contents

TAYLOR CAPITAL GROUP, INC.

 

PART I

 

Item 1. Business

 

Our Business

 

Taylor Capital Group, Inc. (the “Company”, “we”, “us”, or “our”) is a bank holding company headquartered in Rosemont, Illinois, a suburb of Chicago, and we derive substantially all of our revenue from our wholly-owned subsidiary, Cole Taylor Bank (the “Bank”). The Bank was founded in 1929 and has served the Chicago area for over 80 years. We were formed in 1996 and acquired Cole Taylor Bank in 1997. We provide a range of products and services primarily to closely-held commercial customers and their owner operators in the Chicago area. We also provide asset-based lending and residential mortgage origination services through offices both in Chicago and other geographic markets. At December 31, 2010, we had assets of approximately $4.5 billion, deposits of approximately $3.0 billion and stockholders’ equity of $208.8 million.

 

Our primary businesses are commercial banking, asset based lending, mortgage origination services and retail banking. Our target commercial lending customers are businesses in industries such as manufacturing, wholesale and retail distribution, transportation, construction contracting and professional services. Our clients are generally closely-held, middle-market companies with annual revenues between $5 million and $250 million. Our commercial lending activities primarily consist of providing loans for working capital; business expansion or acquisition; owner-occupied commercial real estate financing; revolving lines of credit; and stand-by and commercial letters of credit. We also offer to our commercial clients treasury cash management services, including repurchase agreements, internet balance reporting, remote deposit capture, positive pay, automated clearing house products, imaged lock-box processing, controlled disbursement and account reconciliation. Our commercial and industrial lending group operates primarily in the Chicago area. Through offices across the United States, we also offer asset-based financing through Cole Taylor Business Capital including revolving lines of credit supported by receivables and inventory and term loans supported by equipment and real estate.

 

In addition, we originate and sell mortgage loans through Cole Taylor Mortgage. This unit is qualified to do business in 20 states, three of which were added in January 2011. Loan production is sourced through retail offices across the United States and from the Bank’s branches, we refer to as banking centers, located in the Chicago area, as well as through relationships with mortgage brokers nationally. This line of business, launched in early 2010, is a source of noninterest fee income while providing earnings and geographic diversification.

 

In addition to our lending activities, we offer deposit products, such as checking, savings and money market accounts, as well as time deposits through nine banking centers located in the Chicago area. We also cross-sell products and services to the owners and executives of our business customers to help them meet their personal financial goals, including personal credit. In addition to commercial clients, we provide deposit and credit services to our community-based customers, typically individuals and small, local businesses located near one of our nine banking centers. We use third-party providers to offer investment management and brokerage services.

 

Our commercial and retail credit and deposit products are delivered by a single operations area located in Rosemont, Illinois. Our mortgage unit is based in Hamburg, Michigan. We do not have separate and discrete operating segments.

 

Our Strategy

 

Our strategy to increase stockholder value is a two-pronged approach, which we generally refer to as our “fix and grow” strategy, which focuses on remediating the asset quality issues brought on by the downturn of the Chicago area real estate market, while simultaneously growing and diversifying our earnings. This strategy has been in place since early 2008 when we first embarked on the repositioning of the Bank as a commercial and

 

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industrial lender to closely-held businesses in the Chicago area. At that time, we began shifting away from industries and sectors that we no longer considered economically desirable and reducing areas of significant risk concentration, such as in real estate lending.

 

Growth Strategy

 

Our Commercial and Industrial banking business was bolstered and expanded in early 2008 with the addition of new leadership and more than 50 experienced commercial bankers. The foundation of this business is built on the belief that closely-held business owners value a long-term relationship with a quality banker who provides innovative advice, creative ideas and an understanding of the challenges and opportunities these owners face. For this reason, we believe our relationship managers are the most important “product” that we offer as well as our customers’ access to our senior management. Since the repositioning began in 2008, the Commercial and Industrial banking team has established over 400 new client relationships and generated approximately $1.5 billion of new loan fundings. Today, approximately 55% of the loan portfolio is made up of commercial and industrial loans, including owner-occupied real estate, spread across many industry sectors.

 

To complement and extend our growth strategy, in 2009 we added new, experienced leadership, as well as sales and lending capability in asset-based lending, formed Cole Taylor Business Capital, and thus expanded our product set and geographic reach. Since inception, this unit has added over 70 new clients and has generated loan fundings of over $350 million and commitments of approximately $715 million. The addition of this business provides us with some geographic diversity given its nationwide reach from eight offices spread across the U.S. We expect this business will continue to grow, adding additional offices to boost coverage and increase production.

 

In January 2010, we established Cole Taylor Mortgage by hiring experienced leadership with extensive mortgage banking knowledge and relationships. The addition of a mortgage lending operation added further geographic diversity and a significant source of fee income, both important strategic considerations. In 2010, Cole Taylor Mortgage funded more than $800 million in mortgage loans, generating more than $14 million in new fee income, and had positive operating profit (revenue less noninterest expense). It is expected that this unit’s origination volumes will increase as operations grow. We anticipate further growth in loan production to result from the opening of additional retail offices, as well as through our growing network of relationships with mortgage brokers and by adding new products.

 

Asset Quality Improvement Strategy

 

With the downturn of the Chicago area real estate market that began in late 2008, and because of the years prior when the Bank was more heavily concentrated in real estate construction and land development lending, we augmented our growth strategy with a focus on asset quality remediation. Since 2008, we added significant workout capabilities to support that effort, retained additional experienced asset quality remediation consultants and we overhauled our loan operations.

 

As necessitated by the deterioration in the residential real estate construction and land loan portfolio as a result of the rapid market downturn in the Chicago area, a significant focus of the asset quality remediation strategy has been in reducing our residential construction and land portfolio. At the beginning of 2008, this portfolio was approximately $500 million and at year end 2010 was approximately $100 million, an 80% reduction. This reduction was largely accomplished through charge-offs and foreclosures. As this exposure has decreased over time and as other parts of the Chicago commercial real estate market have also weakened, we had directed our expanded workout resources to include other areas of the Bank’s loan portfolio that have shown the most propensity for losses, including commercial construction and land loans, loans to banks and bank holding companies and other categories of commercial real estate loans.

 

Throughout 2009 and 2010, we improved our core operating results by increasing the level of net interest income and noninterest income while attempting to hold the level of noninterest expense relatively flat. We also improved our loan pricing, including the use of interest rate floors in new loan originations. Although we kept the

 

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size of our investment portfolio relatively flat, we did capture gains and reduced our refinancing risk by selling some securities in 2010. On the liability side, we continued to strengthen our liquidity position by obtaining more funding from core customers which allowed us to reduce our reliance on more expensive brokered deposits.

 

To support our strategy, in 2011 we improved our product and processing capabilities by upgrading our core processing system, which will allow us to expand our product offerings, improve customer service and further complement the other improvements in infrastructure that we have made in the past three years.

 

Competition

 

We encounter intense competition for all of our products and services, including substantial competition in attracting and retaining deposits and in obtaining loan customers in the Chicago area. We also encounter intense competition in the pricing of our products and services: including interest rates paid on deposits, interest rates charged on loans, as well as credit terms and underwriting criteria, residential mortgage origination fees charged and other professional services. Our principal competitors are numerous and include other commercial banks, both locally and nationally, savings and loan associations, mutual funds, money market funds, finance companies, credit unions, mortgage companies, the United States Government, private issuers of debt obligations and suppliers of other investment alternatives, such as securities firms. We may also face a competitive disadvantage as a result of our smaller size, limited banking center network and narrower product offerings. Many of our competitors are significantly larger than us and have access to greater financial and other resources. In addition, many of our non-bank competitors are not subject to all of the same federal regulations that govern bank holding companies and federally insured banks or the state regulations governing state chartered banks. As a result, our non-bank competitors may have advantages over us in providing some services.

 

Employees

 

Together with the Bank, we had 591 full-time employees as of December 31, 2010. None of our employees is subject to a collective bargaining agreement. We consider our relationship with our employees to be good.

 

Supervision and Regulation

 

The following is a summary of the material elements of the regulatory framework that applies to us and our banking subsidiary. It does not describe all of the statutes, regulations and regulatory policies that apply or restate all of the requirements, and the descriptions of, and references to, the statutes, regulations and agreements below are qualified in their entirety to applicable summaries and do not purport to be complete.

 

The regulatory scheme described below, if altered by legislation, regulation, or by interpretation and practice of regulatory authorities, could have the effect of increasing our cost of doing business, limiting permissible activities, increasing competition or causing other difficulties for us, any of which could adversely affect our business, results of operations, growth prospects, lending activities and our ability to pay dividends or service debt. Legislative, regulatory and policy changes with respect to the banking industry generally, or with respect to the Bank in particular, cannot be predicted with certainty.

 

Financial institution regulation and supervision are intended for the protection of depositors, the Federal Deposit Insurance Corporation’s (“FDIC”) Deposit Insurance Fund and the banking system as a whole, and not necessarily for the protection of a bank or the bank holding company’s stockholders or creditors. As such, the banking regulators have extensive discretion in connection with their supervisory and enforcement powers over the Company, as a regulated bank holding company, and over the Bank, as a regulated subsidiary depository institution

 

General Discussion

 

Financial institutions are highly regulated both at the federal and state levels. Numerous statutes and regulations affect the business of the Company.

 

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As a registered bank holding company under the Bank Holding Company Act (“BHC Act”), we are regulated and supervised by the Board of Governors of the Federal Reserve System (“Federal Reserve”) and the Illinois Department of Financial and Professional Regulation (“IDFPR”). In addition, pursuant to the Dodd-Frank Act, the FDIC has backup enforcement authority over a depository institution holding company, such as the Company, if the conduct or threatened conduct of such holding company poses a risk to the Deposit Insurance Fund (“DIF”), although such authority may not be used if such holding company is generally in sound condition and does not pose a foreseeable and material risk to the DIF. The Bank, an Illinois state-chartered bank that is a member of the Federal Reserve System, is regulated by both the IDFPR and the Federal Reserve. The Bank is required to file periodic reports with both agencies and is subject to periodic examination by both the IDFPR and Federal Reserve. The Bank also accepts deposits which are insured by the FDIC and thus is also subject to supervision by the FDIC.

 

Capital Requirements

 

We are subject to various regulatory capital requirements administered by the federal and state banking agencies noted above. Failure to meet regulatory capital requirements could result in certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on our financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action (described below), we must meet specific capital guidelines that involve quantitative measures of our assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting policies. Our capital amounts and classification are also subject to judgments by the regulators regarding qualitative components, risk weightings, and other factors. For further detail on our capital raise as well as capital and capital ratios see Notes to Consolidated Financial Statements, Note 16—Regulatory Disclosures.

 

Under the risk-based capital requirements for bank holding companies, the minimum requirement for the ratio of Total Capital to risk-weighted assets (including certain off-balance sheet activities, such as standby letters of credit) is 8%. At least half of the Total Capital (as defined below) is to be composed of common stockholders’ equity, retained earnings, qualifying perpetual preferred stock (in a limited amount in the case of cumulative preferred stock), minority interests in the equity accounts of consolidated subsidiaries and qualifying trust preferred securities, less goodwill and certain intangibles (“Tier 1 Capital”). The remainder of Total Capital may consist of qualifying subordinated debt and redeemable preferred stock, qualifying cumulative perpetual preferred stock and allowance for loan losses (“Tier 2 Capital”), and together with Tier 1 Capital, (“Total Capital”). At December 31, 2010, our Tier 1 Capital ratio was 8.93% and Total Capital ratio was 12.98%.

 

The Federal Reserve has established minimum leverage ratio guidelines for bank holding companies. These requirements provide for a minimum leverage ratio of Tier 1 Capital to adjusted average quarterly assets (“leverage ratio”) equal to 3% for bank holding companies that meet specified criteria, including having the highest regulatory rating. All other bank holding companies will generally be required to maintain a leverage ratio of at least 4%. Our leverage ratio at December 31, 2010, was 6.89%. The guidelines also provide that bank holding companies experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels without significant reliance on intangible assets. Furthermore, the guidelines indicate that the Federal Reserve will continue to consider a “tangible tier 1 leverage ratio” (deducting all intangibles) in evaluating proposals for expansion or to engage in new activity. The Federal Reserve has not advised us of any higher specific minimum leverage ratio or tier 1 leverage ratio applicable to us.

 

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Emergency Economic Stabilization Act of 2008

 

On October 3, 2008, President Bush signed into law the Emergency Economic Stabilization Act of 2008 (“EESA”), giving the United States Department of the Treasury (“UST”) authority to take certain actions to restore liquidity and stability to the U.S. banking markets. Based upon its authority in the EESA, a number of programs were announced, including the following:

 

Capital Purchase Program (“CPP”). Pursuant to this program, the UST, on behalf of the U.S. government, purchased preferred stock, along with warrants to purchase common stock, from certain financial institutions, including bank holding companies, savings and loan holding companies and banks or savings associations not controlled by a holding company. The investment required a dividend rate of 5% per year, until the fifth anniversary of the UST’s investment and a dividend of 9% thereafter. During the time the UST holds securities issued pursuant to this program, participating financial institutions are required to comply with (i) certain provisions regarding executive compensation paid to senior executives and certain other employees, and (ii) corporate governance disclosure and certification requirements. Participation in this program also imposes certain restrictions upon an institution’s dividends to common stockholders and stock repurchase activities. As described further herein, we elected to participate in the CPP and on November 21, 2008, received $105 million pursuant to the program.

 

Pursuant to the terms of the CPP, while any senior preferred stock is outstanding, dividends are permissible on our common stock, provided that all accrued and unpaid dividends for all past dividend periods on the senior preferred stock are fully paid. Prior to November 21, 2012, unless the senior preferred stock has been redeemed or the UST has transferred all of the senior preferred stock to third parties, we need the consent of the UST before paying any dividends on our common stock.

 

Temporary Liquidity Guarantee Program. This program contained both (i) a debt guarantee component (“Debt Guarantee Program”), whereby the FDIC guaranteed certain senior unsecured debt issued by eligible financial institutions; and (ii) a transaction account guarantee component (“TAG Program”), whereby the FDIC insured 100% of noninterest-bearing deposit transaction accounts held at eligible financial institutions, such as payment processing accounts, payroll accounts and working capital accounts. This program is no longer in effect, however, as the Dodd-Frank Act requires all insured financial institutions, such as the Bank, to provide noninterest-bearing deposit transaction accounts with full deposit insurance without limit through December 31, 2012. Such accounts include only traditional, noninterest demand deposit (or checking) accounts that allow for an unlimited number of transfers and withdrawals at any time, whether held by a business, individual or other type of depositor. Although not encompassed within the Dodd-Frank Act, interest on Lawyers Trust Accounts was subsequently included by Congress in late 2010 and will also receive full deposit insurance until December 31, 2012. Negotiated Order of Withdrawal (NOW) accounts are not provided with this coverage. Insured financial institutions are not permitted to opt out of this insurance program and the FDIC will not charge a separate assessment for this coverage. This coverage is separate from, and in addition to, coverage a depositor has with respect to other accounts at an insured depository institution.

 

FDIC Liquidation Authority under the Dodd-Frank Act

 

The FDIC issued in January 2011, an interim final rule on depositor preference which clarifies how the agency will treat certain creditors’ claims under the FDIC’s new liquidation authority. Pursuant to the Dodd-Frank Act, the agency may be appointed as receiver for a financial company if the failure of such company and its liquidation under the Bankruptcy Code or other insolvency proceeding would pose significant risks to U.S. financial stability. Pursuant to the interim final rule, the FDIC will allow additional payments to a creditor in rare circumstances after the agency’s board of directors has determined that such payments meet certain statutory standards. The payments would be subject to recoupment, however, if the ultimate recoveries are insufficient to repay any temporary government-provided liquidity support. The interim final rule also (i) provides the FDIC with authority to continue a company’s operations by paying for services provided by employees and others; (ii) clarifies how damages will be calculated for creditors’ contingent claims; and (iii) describes the application of proceeds from the liquidation of subsidiaries.

 

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Banking Acquisitions

 

As a bank holding company, we are required to obtain prior Federal Reserve approval before acquiring more than 5% of the voting shares, or substantially all of the assets, of a financial institution holding company, bank or savings association. In determining whether to approve a proposed bank acquisition, federal bank regulators will consider, among other factors, the effect of the acquisition on competition, the public benefits expected to be received from the acquisition, the projected capital ratios and levels on a post-acquisition basis, and the acquiring institution’s safety and soundness and record of addressing the credit needs of the communities it serves, including the needs of low and moderate income neighborhoods, consistent with the safe and sound operation of the bank, under the Community Reinvestment Act (“CRA”).

 

Dividend Payments

 

We are a legal entity separate and distinct from our banking and other subsidiaries. A substantial portion of our revenue comes from dividends paid to us by the Bank. The Federal Reserve has the authority to prohibit bank holding companies from paying dividends if it deems such payment to be an unsafe or unsound practice. With respect to this authority, the Federal Reserve has indicated generally that it may be an unsafe or unsound practice for a bank holding company to pay dividends unless the company’s net income is sufficient to fund the dividends and the company’s expected rate of earnings retention is consistent with its capital needs, asset quality and overall financial condition.

 

Both we and our banking subsidiary are subject to various general regulatory policies and requirements relating to the payment of dividends, including requirements to maintain adequate capital above regulatory minimums. The appropriate federal regulatory authority is authorized to determine under certain circumstances relating to the financial condition of a bank or bank holding company, that the payment of dividends would be an unsafe or unsound practice and to prohibit payment thereof. The appropriate federal regulatory authorities have indicated that paying dividends that deplete a bank’s capital base to an inadequate level would be an unsafe and unsound banking practice and that banking organizations should generally pay dividends only out of current operating earnings.

 

Since 2008, the Bank has not paid cash dividends to us, and no further dividends may be paid by the Bank to us, or by us to our stockholders, without prior notice to our regulators.

 

Bank Holding Company Act Requirements

 

We are a registered bank holding company under the BHC Act and Illinois law. As such, we are subject to regulation, supervision and examination by the Federal Reserve and the IDFPR. In connection with applicable requirements, bank holding companies file periodic reports and other information with the Federal Reserve. In addition to supervision and regulation, the BHC Act also governs the activities that are permissible to bank holding companies and their affiliates and permits the Federal Reserve, in certain circumstances, to issue cease and desist orders and other enforcement actions against bank holding companies and their non-banking affiliates to correct and curtail unsafe or unsound banking practices. Under the Dodd-Frank Act and longstanding Federal Reserve policy, bank holding companies are required to act as a source of financial strength to each of their subsidiaries pursuant to which such holding company may be required to commit financial resources to support such subsidiaries in circumstances when, absent such requirements, they might not otherwise do so.

 

The BHC Act further regulates holding company activities, including requirements and limitations relating to capital, transactions with officers, directors and affiliates, securities issuances, dividend payments, inter-affiliate liabilities, extensions of credit, and expansion through mergers and acquisitions.

 

The Gramm-Leach-Bliley Act of 1999 significantly amended the BHC Act. The amendments, among other things, allow certain qualifying bank holding companies that elect treatment as “financial holding companies” to engage in activities that are financial in nature and that explicitly include the underwriting and sale of insurance.

 

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The Company has not elected to be treated as a financial holding company. Bank holding companies that have not elected such treatment generally must limit their activities to banking activities and activities that are closely related to banking.

 

Guidance on Sound Incentive Compensation Policies

 

In July 2010, the federal banking agencies issued guidance which applies to all banking organizations supervised by the agencies (thereby including both the Company and its subsidiary bank). Pursuant to the guidance, to be consistent with safety and soundness principles a banking organization’s incentive compensation arrangements should: (i) provide employees with incentives that appropriately balance risk and reward; (ii) be compatible with effective controls and risk management; and (iii) be supported by strong corporate governance including active and effective oversight by the banking organization’s board of directors. Monitoring methods and processes used by a banking organization should be commensurate with the size and complexity of the organization and its use of incentive compensation.

 

Changes to Mortgage Loan Originator Compensation

 

Regulations concerning the compensation of mortgage loan originators were recently amended. Effective April 1, 2011, mortgage loan originators may not receive compensation based on a mortgage transaction’s terms or conditions except the amount of credit extended. Mortgage loan originators may receive compensation from a consumer or from a lender, but not both. In addition, employees of mortgage loan originators cannot receive compensation based on commission. Instead, employee compensation must be based upon a salary or salary plus bonus structure.

 

These rules contain requirements designed to prohibit mortgage loan originators from “steering” consumers to loans that provide mortgage loan originators with greater compensation and other requirements concerning record-keeping.

 

These rules could delay Cole Taylor Mortgage’s geographic expansion in the first half of 2011 and perhaps through 2011 as we evaluate and implement the changes required by these rules.

 

Enforcement Powers of Our Bank Regulators; Prompt Corrective Action

 

Our regulatory authorities have broad authority to enforce the regulatory requirements to which we are subject. This enforcement authority includes, among other things, the power to compel higher reserves, the ability to assess civil money penalties, the ability to issue cease-and-desist, removal orders, and the ability to initiate injunctive actions. In general, these enforcement actions may be initiated for violations of laws and regulations or for unsafe or unsound banking practices. Other actions or inactions by the Company or the Bank may provide the basis for enforcement action, including misleading or untimely reports. Under the Federal Deposit Insurance Act (“FDIA”), all commonly controlled FDIC insured depository institutions may be held liable for any loss incurred by the FDIC resulting from a failure of, or any assistance given by the FDIC to, any commonly controlled institutions.

 

Federal banking regulators are also authorized and, under certain circumstances, required to take certain actions against institutions that fail to meet their capital requirements. Under the regulations, an institution is deemed to be (i) “well capitalized” if it has total risk-based capital of 10.0% or more, has a Tier 1 risk-based capital ratio of 6.0% or more, has a Tier 1 leverage capital ratio of 5.0% or more and is not subject to any order or final capital directive to meet and maintain a specific capital level for any capital measure; (ii) “adequately capitalized” if it has a total risk-based capital ratio of 8.0% or more, a Tier 1 risk-based capital ratio of 4.0% or more and a Tier 1 leverage capital ratio of 4.0% or more (3.0% under certain circumstances) and does not meet the definition of well capitalized; (iii) “undercapitalized” if it has a total risk-based capital ratio that is less than 8.0%, a tier 1 risk-based capital ratio that is less than 4.0% or a Tier 1 leverage capital ratio that is less than 4.0%

 

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(3.0% under certain circumstances); (iv) “significantly undercapitalized” if it has a total risk-based capital ratio that is less than 6.0%, a Tier 1 risk-based capital ratio that is less than 3.0% or a Tier 1 leverage capital ratio that is less than 3.0%; and (v) “critically undercapitalized” if it has a ratio of tangible equity to total assets that is equal to or less than 2.0%.

 

In certain situations, a federal banking agency may reclassify a well capitalized institution as adequately capitalized and may require an adequately capitalized or undercapitalized institution to comply with supervisory actions as if the institution were in the next lower category.

 

Under the prompt corrective action regulations, well capitalized institutions may generally operate without supervisory restriction. With respect to “adequately capitalized” institutions, such banks cannot normally pay dividends or make any capital contributions that would leave it undercapitalized; they cannot pay a management fee to a controlling person if, after paying the fee, it would be undercapitalized; and they cannot accept, renew or roll over any brokered deposit unless the bank has applied for and been granted a waiver by the FDIC. Once an adequately capitalized institution receives such a waiver, it may not pay an effective yield on any such deposit that exceeds by more than 75 basis points the local market rate or the national rate (which is determined and published by the FDIC and defined to be the “simple average of rates paid by all insured depository institutions and branches for which data are available”). As such, a less-than-well-capitalized institution that has received a waiver from the FDIC to accept, renew and rollover brokered deposits generally may not pay an interest rate on such brokered deposits in excess of the national rate plus 75 basis points.

 

The federal banking agencies are required to take action to restrict the activities of an “undercapitalized,” “significantly undercapitalized,” or “critically undercapitalized” insured depository institution. Any such bank must submit a capital restoration plan that is guaranteed by the parent holding company. Until such plan is approved, it may not increase its assets, acquire another institution, establish a branch or engage in any new activities, and generally may not make capital distributions.

 

Any institution that fails to comply with its capital plan or is “significantly undercapitalized” (i.e., Tier 1 risk-based or core capital ratios of less than 3% or a risk-based capital ratio of less than 6%) must be made subject to one or more of additional specified actions and operating restrictions mandated by the Federal Deposit Insurance Corporation Improvement Act of 1991. These actions and restrictions include requiring the issuance of additional voting securities, limitations on asset growth; mandated asset reduction; changes in senior management; divestiture, merger or acquisition of the association; restrictions on executive compensation; and any other action the appropriate federal banking agency deems appropriate. An institution that becomes “critically undercapitalized” is subject to further mandatory restrictions on its activities in addition to those applicable to significantly undercapitalized associations. In addition, the appropriate banking regulator must appoint a receiver (or conservator with the FDIC’s concurrence) for an institution, with certain limited exceptions, within 90 days after it becomes critically undercapitalized. Any undercapitalized institution is also subject to other possible enforcement actions, including the appointment of a receiver or conservator. The appropriate regulator is also generally authorized to reclassify an institution into a lower capital category and impose restrictions applicable to such category if the institution is engaged in unsafe or unsound practices or is in an unsafe or unsound condition.

 

Institutions must file a capital restoration plan with their regulators within 45 days of the date it receives a notice that it is “undercapitalized,” “significantly undercapitalized,” or “critically undercapitalized.” Compliance with a capital restoration plan must be guaranteed by a parent holding company. In addition, the IDFPR and Federal Reserve are permitted to take any one of a number of discretionary supervisory actions, including but not limited to the issuance of a capital directive and the replacement of senior executive officers and directors.

 

Finally, bank regulatory agencies have the ability to seek to impose higher than normal capital requirements known as individual minimum capital requirement (“IMCR”) for institutions with a high-risk profile.

 

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The Bank is considered to be “well-capitalized” under the prompt corrective regulations. The imposition of any of the measures described above for institutions that are less than “well capitalized” could have a substantial and material adverse effect on us and on our profitability and operations. Our Common stockholders do not have preemptive rights and, therefore, if we are directed by the IDFPR or the Federal Reserve to raise capital through the sale of additional shares of capital stock, such issuance may result in dilution in our stockholders’ percentage of ownership of the Company.

 

Standards for Safety and Soundness

 

The federal banking agencies have adopted the Interagency Guidelines for Establishing Standards for Safety and Soundness. The guidelines establish certain safety and soundness standards for all depository institutions. The operational and managerial standards in the guidelines relate to the following: (i) internal controls and information systems; (ii) internal audit systems; (iii) loan documentation; (iv) credit underwriting; (v) interest rate exposure; (vi) asset growth; (vii) compensation, fees and benefits; (viii) asset quality; and (ix) earnings. Rather than providing specific rules, the guidelines set forth basic compliance considerations and guidance with respect to a depository institution. Failure to meet the standards in the guidelines, however, could result in a request by the Bank’s regulators to provide a written compliance plan to demonstrate its efforts to come into compliance with such guidelines. Failure to provide a plan or to implement a provided plan requires the appropriate federal banking agency to issue an order to the institution requiring compliance.

 

Interstate Branching

 

Pursuant to the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (“Riegle-Neal Act”), an adequately capitalized and managed bank holding company may acquire banks in states other than its home state without regard to the permissibility of such acquisitions under state law, but remain subject to state requirements that a bank has been organized and operating for a period of time. Subject to certain other restrictions, the Riegle-Neal Act also authorizes banks to merge across state lines to create interstate branches. The Riegle-Neal Amendments Act of 1997 and the Regulatory Relief Act of 2006 provides further guidance on the application of host state laws to any branch located outside the host state.

 

Deposit Insurance Premiums

 

The Bank is a member of the DIF and pays an insurance premium to the fund based upon its assessable deposits on a quarterly basis. Deposits are insured up to applicable limits by the FDIC and such insurance is backed by the full faith and credit of the United States Government.

 

Under the Dodd-Frank Act, a permanent increase in deposit insurance was authorized to $250,000 (insurance coverage had previously been temporarily raised to that level until December 31, 2013). Generally, the coverage limit is per depositor, per insured depository institution.

 

The Dodd-Frank Act also set a new minimum DIF reserve ratio at 1.35% of estimated insured deposits. The FDIC is required to attain this ratio by September 30, 2020. In addition, the Dodd-Frank Act will have a significant impact on the calculation of deposit insurance assessment premiums going forward. Specifically, the Dodd-Frank Act generally requires the FDIC to define the deposit insurance assessment base for an insured depository institution as an amount equal to the institution’s average consolidated total assets during the assessment period minus average tangible equity. The FDIC has issued a proposed rulemaking notice that implements this change to the assessment calculation but has said that the new assessment rate schedule should result in the collection of assessment revenue that is approximately revenue neutral even though the new assessment based under the Dodd-Frank Act is larger than the current assessment base. Proposed assessment rates range from 2.5 basis points to 45 basis points.

 

The proposed FDIC rule also provides the FDIC’s board with the flexibility to adopt actual rates that are higher or lower than the total base assessment rates adopted without notice and comment if certain restrictions are met.

 

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The amount of the assessment is a function of the institution’s risk category, of which there are four, and assessment base. An institution’s risk category is determined according to its supervisory rating and capital level. The assessment rate for risk categories are calculated according to a formula, which relies on supervisory ratings and either certain financial ratios or long-term debt ratings. An insured bank’s assessment base is determined by the balance of its insured deposits. Because the system is risk-based, it allows banks to pay lower assessments to the FDIC as their capital level and supervisory ratings improve. By the same token, if these indicators deteriorate, the institution will have to pay higher assessments to the FDIC. Currently, deposit insurance premiums for FDIC-insured institutions range from 7 to 77.5 basis points per $100 of assessable deposits based upon assessment rates that are calculated based upon an institution’s levels of unsecured debt, secured liabilities and brokered deposits.

 

Under the FDIA, the FDIC Board has the authority to set the annual assessment rate range for the various risk categories within certain regulatory limits and to impose special assessments upon insured depository institutions when deemed necessary by the FDIC’s Board. The FDIC imposed an emergency special assessment on June 30, 2009, which was collected on September 30, 2009. In addition, in September 2009, the FDIC extended the Restoration Plan period to eight years. On November 12, 2009, the FDIC adopted a final rule requiring prepayment of 13 quarters of FDIC premiums.

 

FICO Assessments

 

DIF insured institutions pay a Financing Corporation (“FICO”) assessment in order to fund the interest on bonds issued in the 1980s in connection with the failures in the thrift industry. For the fourth quarter of 2010, the FICO assessment is equal to 1.04 basis points for each $100 in domestic deposits. These assessments will continue until the bonds mature in 2019.

 

The FDIC is authorized to conduct examinations of and require reporting by FDIC insured institutions. It is also authorized to terminate a depository bank’s deposit insurance upon a finding by the FDIC that the bank’s financial condition is unsafe or unsound or that the institution has engaged in unsafe or unsound practices or has violated any applicable rule, regulation, order or condition enacted or imposed by the bank’s regulatory agency.

 

Supervisory Assessments

 

All Illinois banks are required to pay supervisory assessments to the IDFPR to fund its operations. The amount of the assessment is calculated on the basis of the Bank’s total assets. During the year ended December 31, 2010, the Bank paid supervisory assessments to the IDFPR totaling $496,500.

 

Interagency Appraisal and Evaluation Guidelines

 

In December 2010, the federal banking agencies issued the Interagency Appraisal and Evaluation Guidelines. This guidance, which updated guidance originally issued in 1994, sets forth the minimum regulatory standards for appraisals. It incorporates previous regulatory issuances affecting appraisals, addresses advances in information technology used in collateral evaluation, and clarifies standards for use of analytical methods and technological tools in developing evaluations. This guidance also requires institutions to utilize strong internal controls to ensure reliable appraisals and evaluations and to monitor and periodically update valuations of collateral for existing real estate loans and transactions.

 

S.A.F.E. Act Registration Requirements

 

In connection with implementation of the Secure and Fair Enforcement for Mortgage Licensing Act of 2008, the federal banking agencies announced final rules in July 2010 to implement the provisions of the Act requiring employees of agency-related institutions to register with the Nationwide Mortgage Licensing System and Registry, a database created by the states to support the licensing of mortgage loan originators. Residential mortgage loan originators must register prior to originating residential mortgage loans.

 

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Community Reinvestment Act Requirements

 

The Bank is subject to periodic CRA review by our primary federal regulators. The CRA does not establish specific lending requirements or programs for financial institutions and does not limit the ability of such institutions to develop products and services believed best-suited for a particular community. Note that an institution’s CRA assessment can be used by its regulators in their evaluation of certain applications, including a merger or the establishment of a branch office. An unsatisfactory rating may be used as the basis for denial of such application.

 

The Bank underwent a CRA examination in January, 2010, for which it received an “outstanding” rating.

 

Transactions with Affiliates

 

The Bank must comply with Sections 23A and 23B of the Federal Reserve Act containing certain restrictions on its transactions with affiliates. In general terms, these provisions require that transactions between a banking institution or its subsidiaries and such institution’s affiliates be on terms as favorable to the institution as transactions with non-affiliates. In addition, these provisions contain certain restrictions on loans to affiliates, restricting such loans to a percentage of the institution’s capital. A covered “affiliate,” for purposes of these provisions, would include us and any other company that is under our common control.

 

The Dodd-Frank Act also included specific changes to the law related to the definition of “covered transaction” in Sections 23A and 23B and limitations on asset purchases from insiders. With respect to the definition of “covered transaction,” the Dodd-Frank Act now defines that term to include the acceptance of debt obligations issued by an affiliate as collateral for a bank’s loan or extension of credit to another person or company. In addition, a “derivative transaction” with an affiliate is now deemed to be a “covered transaction” to the extent that such a transaction causes a bank or its subsidiary to have a credit exposure to the affiliate. A separate provision of the Dodd-Frank Act states that an insured depository institution may not “purchase an asset from, or sell an asset to” a bank insider (or their related interests) unless (i) the transaction is conducted on market terms between the parties, and (ii) if the proposed transaction represents more than 10 percent of the capital stock and surplus of the insured institution, it has been approved in advance by a majority of the institution’s noninterested directors.

 

Additionally, certain transactions with our directors, officers or controlling persons are also subject to conflicts of interest regulations. Among other things, these regulations require that loans to such persons and their related interests be made on terms substantially the same as for loans to unaffiliated individuals and must not create an abnormal risk of repayment or other unfavorable features for the financial institution. See Notes to Consolidated Financial Statements, Note 4—Loans.

 

Government Monetary Policies and Economic Controls

 

Our earnings and growth, as well as the earnings and growth of the banking industry, are affected by the credit policies of monetary authorities, including the Federal Reserve. An important function of the Federal Reserve is to regulate the national supply of bank credit in order to combat recession and curb inflationary pressures. Among the instruments of monetary policy used by the Federal Reserve to implement these objectives are open market operations in U.S. government securities, changes in reserve requirements against member bank deposits, and changes in the Federal Reserve discount rate. These means are used in varying combinations to influence overall growth of bank loans, investments, and deposits, and may also affect interest rates charged on loans or paid for deposits. The monetary policies of the Federal Reserve authorities have had a significant effect on the operating results of commercial banks in the past and are expected to continue to have such an effect in the future.

 

In view of changing conditions in the national economy and in money markets, as well as the effect of credit policies by monetary and fiscal authorities, including the Federal Reserve, no prediction can be made as to

 

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possible future changes in interest rates, deposit levels, and loan demand, or their effect on our business and earnings or on the financial condition of our various customers.

 

Other Regulatory Authorities

 

In addition to regulation, supervision and examination by federal banking agencies, we and certain of our subsidiaries and affiliates are subject to other federal and state laws and regulations, and to supervision and examination by other regulatory and self governing authorities, including the SEC, the Financial Institution Regulatory Authority (FINRA), the NASDAQ Global Select Market and others.

 

Available Information

 

Our website is www.taylorcapitalgroup.com. We make available on our website under the caption “Stock Information,” free of charge, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports as soon as reasonably practicable after we electronically file or furnish such materials to the Securities and Exchange Commission (“SEC”). Materials that we file or furnish to the SEC may also be read and copied at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330. Also, the SEC maintains a website at www.sec.gov that contains reports, proxy and information statements, and other information that we file electronically with the SEC.

 

Item 1A. Risk Factors

 

You should read carefully and consider the following risks and uncertainties because they could materially and adversely affect our business, financial condition, results of operations and prospects.

 

Our business may be adversely affected by the highly regulated environment in which we operate.

 

We are subject to extensive federal and state regulation and supervision, which is primarily for the protection of depositors and customers rather than for the benefit of stockholders. As a bank holding company, we are subject to regulation and supervision primarily by the Federal Reserve. The Bank, as an Illinois-chartered member bank, is subject to regulation and supervision by the IDFPR and by the Federal Reserve. We undergo periodic examinations by our regulators, who have extensive discretion and power to prevent or remedy unsafe or unsound practices or violations of law by banks and bank holding companies. Our failure to comply with state and federal regulations can lead to, among other things, termination or suspension of our licenses, rights of rescission for borrowers, class action lawsuits and administrative enforcement actions. We cannot assure you that we will be able to fully satisfy the requirements imposed by the regulatory authorities that supervise us.

 

Further, we are significantly impacted by the policies of the Federal Reserve, whose monetary policies directly and indirectly influence the rate of interest earned on loans and paid on borrowings and interest-bearing deposits and can also affect the value of financial instruments we hold and the ability of borrowers to repay their loans, which could have a material adverse effect on our financial condition and results of operation.

 

We have not paid a dividend on our common stock since the second quarter of 2008. In addition, regulatory restrictions and liquidity constraints at the holding company level could impair our ability to make distributions on our outstanding securities.

 

Historically, our primary source of funds at the holding company level has been dividends received from the Bank. Currently, both we and the Bank have agreed to give notice to the Federal Reserve and the IDFPR prior to declaring a dividend on our common stock. In order to preserve capital, our Board of Directors suspended the payment of dividends on our common stock beginning in the second quarter of 2008. Current and future liquidity constraints at the holding company level could continue to impair our ability to declare and pay dividends or

 

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interest on our outstanding securities in the future. We also have agreed, consistent with our past practice, to continue to provide our regulators notice before we pay dividends and interest at the holding company.

 

The UST may also impose additional limitations on our ability to use funds we received from our participation in the Troubled Asset Relief Program (“TARP”) CPP, including the payment of dividends or interest on our outstanding securities. For example, we are currently prohibited from declaring or paying any dividends on our common stock without the UST’s consent until the earlier of November 21, 2012 or the date on which the UST no longer holds any shares of our Fixed Rate Cumulative Perpetual Preferred Stock, Series B, (“Series B Preferred”). If we are unable to pay dividends or interest on our outstanding securities in the future, the market value of such securities may be materially adversely affected.

 

Our regulators could require us to maintain additional regulatory capital.

 

At December 31, 2010, both we and our Bank were categorized as “well capitalized” under the regulatory capital framework. Our regulators have the ability to require us to maintain higher capital levels. If our regulators require the Bank to hold additional capital above the well capitalized level, we would either have to make an additional capital contribution to the Bank, have the Bank raise regulatory capital or reduce our asset levels. The inability to attract new capital investments or our ability to attract the capital on terms acceptable to us, could have a material adverse impact on our operations and financial position, including our ability to use net operating loss carry-forwards to reduce future income tax payments if we increase our capital levels and an ownership change is deemed to have occurred for income tax purposes.

 

Our allowance for loan losses may prove to be insufficient to absorb losses in our loan portfolio.

 

We maintain an allowance for loan losses to provide for loans in our portfolio that may not be repaid in their entirety. We believe that our allowance for loan losses is maintained at a level adequate to absorb probable losses inherent in our loan portfolio as of the corresponding balance sheet date. However, our allowance for loan losses may not be sufficient to cover actual loan losses, and future provisions for loan losses could materially adversely affect our operating results.

 

In evaluating the adequacy of our allowance for loan losses, we consider numerous quantitative factors, including our historical charge-off experience, growth of our loan portfolio, changes in the composition of our loan portfolio and the volume of delinquent and criticized loans. In addition, we use information about specific borrower situations, including their financial position and estimated collateral values under various liquidation scenarios, to estimate the risk and amount of loss for those borrowers. Finally, we also consider many qualitative factors, including general and economic business conditions, duration of the current business cycle, the impact of competition on our underwriting terms, current general market collateral valuations, trends apparent in any of the factors we take into account and other matters, which are by nature more subjective and fluid.

 

Our commercial loans and commercial real estate loans generally involve higher credit risk than residential real estate loans. Because payments on loans secured by commercial real estate or equipment are often dependent upon the successful operation and management of our customers’ businesses, repayment of such loans may be influenced to a great extent by the ability of our customers to execute on their business strategies and may be adversely impacted by adverse economic conditions in the markets we serve. If our customers are unable to successfully operate their businesses, our actual losses on our commercial loans may exceed our current estimates. Continued negative economic conditions also impacts our bank, bank holding company and lending institution clients with which we have commercial relationships, adversely impacting their ability to repay their loan obligations as agreed.

 

Our estimates of the risk of loss and amount of loss on any loan are exacerbated by the significant uncertainties surrounding not only our borrowers’ probability of default, but also the fair value of the underlying collateral. The current illiquidity in the real estate market has increased the uncertainty with respect to real estate

 

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values. Because of this degree of uncertainty and the sensitivity of any valuation to the underlying assumptions as to the method of collateral liquidation and the holding period until sale, our actual losses may significantly vary from our current estimates.

 

In addition, federal and state regulators periodically review the adequacy of our allowance for loan losses. Such regulators may require us to make additional provisions to the allowance, recognize additional loan charge-offs based upon their judgments about information available to them at the time of their examinations, or require us to reduce the level of nonperforming assets. Any such additional provisions for loan losses or charge-offs required by these regulatory agencies could have a material adverse effect on our financial condition and results of operations or result in decreased standing with our regulators, which may result in additional capital requirements.

 

We are subject to lending concentration risks.

 

We have focused on repositioning our portfolio to reduce our exposure to industries and sectors that we no longer consider economically desirable. As a business bank, our loan portfolio is comprised primarily of commercial loans to businesses. As of December 31, 2010, approximately 95% of our loan portfolio consisted of commercial loans of which approximately 40% are commercial real estate loans. Our commercial loans are typically larger in amount than loans to individual consumers and, therefore, have the potential for higher losses on an individual loan basis. Credit quality issues on larger commercial loans, if they were to occur, could cause greater volatility in reported credit quality performance measures, such as total impaired or nonperforming loans, and the amount of charge-offs and recoveries between periods. The deterioration of any one or a few of these loans may cause a significant increase in uncollectible loans, which would have a material adverse impact on our results of operations and financial condition.

 

New residential home sales continue to be at depressed levels, increasing financial stress on our real estate developer customers. Further deterioration in the credit quality of our Chicago real estate construction loans would have a material adverse effect on our financial condition and results of operations.

 

Our financial condition, results of operations and reputation would be materially adversely impacted if we are unable to respond effectively to unanticipated deposit volatility.

 

As a part of our liquidity management, we must ensure we can respond effectively to potential volatility in our customers’ deposit balances. Since 2008, we improved our liquidity position by increasing the amount of funding from our core customers in order to reduce reliance on brokered funding. We have customers that maintain significant deposit balances, the immediate withdrawal of which could have a material adverse affect on our daily liquidity management. In addition, the number of branches we maintain is small relative to our asset size, which could impact our ability to acquire deposits. We could encounter difficulty meeting a significant deposit outflow, in which case our capital position, reputation or profitability could be negatively affected. We primarily use advances from the Federal Home Loan Bank (“FHLB”) and Federal Reserve Bank (“FRB”), broker/dealer repurchase agreements and federal funds purchased to meet our immediate liquidity needs. If we fail to effectively manage the risk of deposit volatility, our business, financial condition and reputation could be materially adversely affected.

 

We must maintain our funding to support our operations and future growth and maintain appropriate levels of liquidity.

 

We must maintain access to sufficient funds to respond to the needs of our depositors and borrowers. As part of our liquidity management, we use a number of funding sources in addition to what is provided by in-market deposits and repayments and maturities of loans and investments. Although we have increased our funding from our core customers to reduce our reliance on wholesale funding, we continue to use brokered money market accounts and certificates of deposits, out-of-local-market certificates of deposit, broker/dealer repurchase agreements, federal funds purchased and FHLB and FRB advances as a source of liquidity.

 

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Under FDIC regulations, only “well-capitalized institutions” may issue brokered CDs without prior regulatory approval. The Bank is currently categorized as “well-capitalized” and, therefore, may continue to utilize this funding source. Brokered CD distributors may use other criteria in determining which banks to allow to issue brokered CDs through their distribution network. If our access to the brokered CD market were reduced in any material respect, it could lead to an inability to replace brokered deposits at maturity, which would result in higher costs to, or reduced asset levels at, the Bank.

 

Our holding company’s liquidity position is affected by the amount of cash and other liquid assets on hand, payment of interest and dividends on debt and equity instruments issued by the holding company, capital we inject into the Bank, redemption of debt issued by the holding company, proceeds we raise through the issuance of debt and equity instruments through the holding company, and dividends received from the Bank (if permitted). Our future liquidity position may be materially adversely affected if, in the future, one or a combination of the following events occur: the Bank reports net losses or its earnings are weak relative to our holding company’s cash flow needs; we deem it advisable or are required by our regulators to use cash at the holding company to support loan growth of the Bank or address other capital needs of the Bank through downstream capital injections; or we have difficulty raising cash at the holding company level through the issuance of debt or equity instruments or accessing additional sources of credit.

 

Given the losses recorded in 2009 and 2010 by the Bank and the resulting limitations imposed by our regulators on the ability of the Bank to pay dividends to our holding company, we are dependent upon our current cash position and cash proceeds generated by capital raises to meet our liquidity needs at the holding company level. If we foresee that the holding company will lack liquidity, we may, to the extent possible, seek to manage this risk by reducing the amount of capital we inject into the Bank. This may further reduce the capital position of the Bank and cause our growth to slow and may be subject to objection by our regulators.

 

Our participation in the TARP CPP may place significant restrictions on our operations.

 

Under the TARP CPP, our ability to declare or pay dividends on any of our shares is limited. Specifically, we are not permitted to pay dividends on our common stock without the UST’s approval until November 21, 2012, unless all of the outstanding shares of our Series B Preferred has been redeemed or transferred by the UST to unaffiliated third parties. In addition, our ability to repurchase our shares of our common stock and other securities is restricted. The consent of the UST generally is required for us to make any stock repurchases (other than in connection with the administration of any employee benefit plan in the ordinary course of business and consistent with past practice) until November 21, 2012, unless all of the outstanding shares of our Series B Preferred have been redeemed or transferred by the UST to unaffiliated third parties. Further, we may not repurchase shares of our common stock or shares of our 8.0% Non-Cumulative Convertible Perpetual Preferred Stock, Series C (“Series C Preferred”), Nonvoting Convertible Preferred Stock, Series D (“Series D Preferred”) and 8.0% Nonvoting, Non-Cumulative Convertible Perpetual Preferred Stock, Series E (“Series E Preferred”) if we are in arrears on the payment of Series B Preferred dividends.

 

Due to our participation in the TARP CPP, we are also subject to the UST’s current standards for executive compensation and corporate governance for the period during which the UST holds our Series B Preferred, as most recently set forth in the Interim Final Rule on TARP Standards for Compensation and Corporate Governance on June 10, 2009. The compensation standards apply to the five most highly compensated senior executive officers, including our Chief Executive Officer and our Chief Financial Officer, and the next 20 most highly compensated of our senior executive officers. The standards include (i) ensuring that incentive compensation plans and arrangements for senior executive officers do not encourage unnecessary and excessive risks that threaten our value or that encourage manipulation of reported earnings; (ii) a required clawback of any bonus or incentive compensation paid (or under a legally binding obligation to be paid) to a senior executive officer based on materially inaccurate financial statements, earnings, revenues, gains or other criteria; (iii) a prohibition on making “golden parachute payments” to senior executive officers and our next five most highly compensated employees; (iv) an agreement not to claim a deduction, for federal income tax purposes, for

 

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compensation paid to any of the senior executive officers in excess of $500,000 per year; (v) prohibitions on accruing and paying bonuses, retention awards and other incentive compensation to our five most highly paid employees other than restricted stock grants that do not fully vest during the TARP period, have a minimum 2-year vesting period and have a value of no more than one-third of the affected employee’s total annual compensation; (vi) retroactive review of bonuses, retention awards and other compensation paid to senior executive officers and our next 20 most highly compensated employees previously provided by TARP recipients if found by the UST to be inconsistent with the purposes of TARP or otherwise contrary to public interest; (vii) required establishment and posting of a company-wide policy regarding “excessive or luxury expenditures;” (viii) prohibitions on tax “gross ups” relating to severance, perquisites or other forms of compensation to the senior executive officers and our next 20 most highly compensated employees; (ix) disclosure of perquisites in excess of $25,000 that are paid to employees who are subject to bonus limitations; and (x) inclusion in a participant’s proxy statement for any annual stockholder meeting of a nonbinding “Say on Pay” stockholder vote on the compensation of executives. The restrictions on bonuses and incentive compensation in particular may result in us issuing additional shares of our common stock to compensate our executive officers that likely would result in dilution to our common stockholders, which would have an adverse impact on the market value of our common stock.

 

Fluctuations in interest rates could reduce our profitability.

 

We are subject to interest rate risk. We realize income primarily from the difference between interest earned on loans and investments and the interest incurred on deposits and borrowings. We expect that we will periodically experience imbalances in the interest rate sensitivities of our assets and liabilities and the relationships of various interest rates to each other. Over any period of time, our interest-earning assets may be more sensitive to changes in market interest rates than our interest-bearing liabilities, or vice versa. In addition, the individual market interest rates underlying our loan and deposit products (e.g., LIBOR and prime) may not change to the same degree over a given time period. If market interest rates should move contrary to our position, our earnings may be negatively affected. In addition, our loan volume and quality and deposit volume and mix can be affected by market interest rates. Changes in levels of market interest rates could materially adversely affect our net interest spread, asset quality, origination volume and overall profitability.

 

As part of our asset and liability management process, we perform sensitivity analysis to determine our exposure to changes in interest rate and develop strategies to mitigate this exposure. We attempt to mitigate our interest rate risk by managing the volume and mix of our earning assets and funding liabilities and using derivative financial instruments to hedge interest rate risk associated with specific hedged items. In a changing interest rate environment, we may not be able to manage this risk effectively. If we are unable to manage interest rate risk effectively or our hedge transactions are not effective in mitigating the intended risk, our business, financial condition and results of operations could be materially adversely affected.

 

Changes in our credit ratings could increase our financing costs or make it more difficult for us to obtain funding or capital on commercially acceptable terms.

 

We are rated by several different rating agencies, including Fitch, IDC, LACE and Bankrate.com. Adverse operating results and other factors may reduce our ratings with these agencies, which could subject us to negative publicity, adversely impact our ability to acquire or retain deposits and increase our cost of borrowing or limit our asset growth. Also, our credit ratings are an important factor to the institutions that provide our sources of liquidity, and reductions in our credit ratings could adversely affect our liquidity, increase our borrowing costs, limit our access to the capital markets or trigger unfavorable contractual obligations.

 

We may be adversely affected by the soundness of other financial institutions.

 

Financial services institutions are interrelated as a result of trading, clearing, counterparty, credit or other relationships. We regularly engage in transactions with counterparties in the financial services industry, including commercial banks, brokers and dealers, investment banks, and other institutional clients. These transactions may

 

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expose us to certain default risks. In certain circumstances, the collateral that we hold may be insufficient to cover such risks, resulting in losses that could have a material adverse affect on our business, financial condition and results of operations.

 

We are subject to certain operational risks, including, but not limited to, data processing system failures and errors and customer or employee fraud.

 

There have been a number of highly publicized cases involving fraud or other misconduct by employees of financial services firms in recent years. Misconduct by our employees could include hiding unauthorized activities from us, improper or unauthorized activities on behalf of our customers or improper use of confidential information. Employee fraud, errors and employee and customer misconduct could subject us to financial losses or regulatory sanctions and seriously harm our reputation. It is not always possible to prevent employee errors and misconduct, and the precautions we take to prevent and detect this activity may not be effective in all cases. Employee errors could also subject us to civil claims for negligence.

 

We maintain a system of internal controls and procedures designed to reduce the risk of loss from employee or customer fraud or misconduct and employee errors as well as insurance coverage to mitigate against operational risks, including data processing system failures and errors and customer or employee fraud. Should our internal controls fail to prevent or detect an occurrence, or if an occurrence is not insured or exceeds applicable insurance limits, it could have a material adverse effect on our business, financial condition or results of operations.

 

Our business is subject to the conditions of the local economy in which we operate and continued weakness in the local economy and the real estate markets may adversely affect our business.

 

Our success is dependent to a significant extent upon economic conditions in the Chicago area, where most of our loans are originated. The ongoing crisis caused by the current economic weakness in the Chicago area real estate market, unemployment, changes in housing market values, changes in securities markets or by inflation or other factors could continue to impact our customers and their ability to repay loans, the value of collateral securing our loans, and the stability of our deposits.

 

Our operating results have been negatively impacted by the continued historically high level of nonperforming loans in our commercial loan portfolio. Continued weakness in the Chicago area economy has had and may continue to have a material adverse affect on our business, financial condition and operating results, including higher provisions for loan losses and net loan charge-offs, lower net interest income caused by an increase in nonaccrual loans, and higher legal and collection costs. In addition, we may be required to continue to devote substantial additional attention and resources to nonperforming asset management rather than focusing on business growth activities. Continued adverse conditions in the local economy could also reduce demand for new loans and impair our ability to attract and retain deposits.

 

Our business is subject to domestic and international economic conditions and other factors, many of which are beyond our control and could adversely affect our business.

 

Our business is affected by domestic and international factors that are beyond our control, including economic, political and market conditions, broad trends in industry and finance, legislative and regulatory changes (including those as a result of the new Dodd-Frank Act), competition, changes in government monetary and fiscal policies, and consolidation within our customer base and within our industry. Because of uncertainty in the market, certain lenders and institutional investors have reduced and, in some cases, ceased to provide funding to borrowers, including to other financial institutions because of concern about the stability of the financial markets and the strength of counterparties. Any resulting lack of available credit or any lack of confidence in the banking and financial sector, decreased consumer confidence, increased volatility in the financial markets and reduced business activity could materially and adversely affect our business, financial condition and results of operations.

 

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Competition from financial institutions and other financial services providers may adversely affect our growth and profitability.

 

We operate in a highly competitive industry and experience intense competition from other financial institutions in our market. We compete with these institutions in making loans, attracting deposits and recruiting and retaining talented people. We have observed that the competition in our market for making commercial loans has resulted in more competitive pricing and credit structure, as well as intense competition for qualified commercial lending officers. We also may face a competitive disadvantage as a result of our smaller size, limited branch network, narrower product offerings and lack of geographic diversification. Although our competitive strategy is to provide a distinctly superior customer and employee experience, we can give no assurance that this strategy will be successful. Our growth and profitability depend on our continued ability to compete effectively within our market area.

 

Our business strategy is dependent on our continued ability to attract, develop and retain highly qualified and experienced personnel in senior management and customer relationship positions.

 

We believe our future success is dependent, in part, on our ability to attract and retain highly qualified and experienced personnel in key senior management and other positions. Our competitive strategy is to provide each of our commercial customers with a highly qualified relationship manager that will serve as the customer’s key point of contact with us. Achieving the status of a “trusted advisor” for our customers also requires that we minimize relationship manager turnover and provide stability to the customer relationship. Competition for experienced personnel is intense, and we may not be able to successfully retain and attract such personnel.

 

Our recent operating losses have reduced our cash-based incentive awards. In addition, our participation in the TARP CPP program places limits on executive compensation. While we have not recently experienced significant employee turnover, the inability to retain and attract key personnel could negatively impact our operations.

 

New lines of business or new products and services may subject us to certain additional risks.

 

From time to time, we will consider and may enter into new lines of business or offer new products or services. These activities can involve a number of uncertainties, risks and expenses, including the investment of significant time and resources, and we can give no assurance that our projected price and profitability targets will be attainable or that our efforts will be successful. These initiatives could also require us to enter geographical markets that are new to us. In addition, new lines of business and new products and services could significantly impact the effectiveness of our system of internal controls, and present requirements for legal compliance with which we were previously unfamiliar. Failure to successfully manage these risks could have a material adverse affect on our business, results of operations and financial condition.

 

We may experience difficulties in managing our growth.

 

Our future success depends on our achieving growth in commercial banking relationships that result in increased commercial loans outstanding at yields that are profitable to us. Achieving our growth targets requires us to attract customers who currently bank at other financial institutions in our market, thereby increasing our share of the market. Our strategy is to provide a local, high-touch relationship servicing experience that we believe is attractive to customers in our marketplace. In addition, we actively pursue high quality relationship managers to extend our reach in the market place. Although we believe that we have the necessary resources in place to successfully manage our future growth, our growth strategy exposes us to certain risks and expenses, and we cannot assure you that we will be able to expand our market presence or that any such expansion will not adversely affect our results of operations.

 

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Our strategy for future growth also may place a significant strain on our management, personnel, systems and resources. Maintaining credit quality while growing our loan portfolio is critical to achieving and sustaining profitable growth. We may not be able to manage our growth effectively. If we fail to do so, our business would be materially harmed.

 

In furtherance of our growth strategy, we may also seek to acquire other financial institutions or parts of those institutions in the future, and we may engage in banking center expansion. In connection with future acquisitions, we may issue equity securities which could cause ownership and economic dilution to our current stockholders. Moreover, we cannot assure you that our regulators will permit us to implement an acquisition strategy. Furthermore, there is no assurance that, following any future mergers or acquisitions, our integration efforts will be successful or that, after giving effect to the acquisition, we will achieve a level of profitability that will justify the investment that we made in any such acquisition.

 

We are subject to security risks relating to our internet banking activities that could damage our reputation and our business.

 

Security breaches in our internet banking activities could expose us to possible liability and damage our reputation. Any compromise of our security also could deter customers from using our internet banking services that involve the transmission of confidential information. We rely on standard internet security systems to provide the security and authentication necessary to effect secure transmission of data. These precautions may not protect our systems from compromises or breaches of our security measures that could result in damage to our reputation and our business.

 

Our reputation could be damaged by negative publicity.

 

Reputational risk, or the risk to our business, earnings and capital from negative publicity, is inherent in our business. Negative publicity can result from actual or alleged conduct in a number of areas, including legal and regulatory compliance, lending practices, corporate governance, litigation, inadequate protection of customer data, ethical behavior of our employees, and from actions taken by regulators, ratings agencies and others as a result of that conduct. Damage to our reputation could impact our ability to attract new or maintain existing loan and deposit customers, employees, and business relationships.

 

Item 2. Properties

 

Our principal offices are located at our Corporate Center at 9550 West Higgins Road, Rosemont, Illinois. We lease approximately 112,000 square feet for our Corporate Center under an operating lease that expires on August 31, 2014, with two five-year renewal options which could extend the lease to 2024. We also have an approximately 4,000 square foot banking center on the first floor of our Corporate Center.

 

We also maintain approximately 36,000 square feet of general office space for our administrative offices in downtown Chicago at 225 West Washington under an operating lease with a 15-year term and two five-year renewal options which could extend the lease to 2032.

 

We currently have nine banking centers located in the Chicago area. Of the nine banking center locations, we own five of the buildings from which the banking centers are operated, including our Ashland, Skokie, Yorktown, Old Orchard, and Milwaukee locations. We lease the land under the buildings at Yorktown, Old Orchard and Milwaukee. We lease the buildings for our Wheeling (term to February 2015), Burbank (term to June 2014), Rosemont (term to August 2014), and South Clark (term to June 2018) banking facilities.

 

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The following is a list of our administrative and customer banking locations:

 

Facility

  

Address

   Square
Feet
 

Corporate Center

   9550 West Higgins Road, Rosemont, Illinois      112,212   

West Washington

   225 West Washington, Chicago, Illinois      35,931   

Milwaukee

   1965 North Milwaukee, Chicago, Illinois      27,394   

Burbank

   5501 West 79th Street, Burbank, Illinois      14,807   

Skokie

   4400 West Oakton, Skokie, Illinois      15,800   

Old Orchard

   Golf Road and Skokie Boulevard, Skokie, Illinois      10,000   

Wheeling

   350 East Dundee Road, Wheeling, Illinois      8,274   

Ashland

   1542 W. 47th Street, Chicago, Illinois      6,000   

Yorktown

   Three Yorktown Center, Lombard, Illinois      5,966   

South Clark

   20 South Clark, Chicago, Illinois      2,700   

 

We have expanded our asset-based lending services and opened offices in geographical areas outside the Chicago area. Currently, we maintain offices in Kansas City, Missouri; Brookfield, Wisconsin; Baltimore, Maryland; Irvine, California; Stamford, Connecticut; New York, New York and Atlanta, Georgia. Each of these offices operates under short-term operating leases.

 

The principal administrative offices of our new residential mortgage loan originations line of business are located in two facilities located across the street from each other in Hamburg, Michigan. The first is an 8,000 square foot facility which has a lease expiring in November 2014, but can be terminated at any time with four month notice. The second is an 8,000 square foot facility which has a lease expiring in July 2014, but can be terminated in July 2012 with four months notice. The mortgage division also has smaller retail offices located in Ann Arbor and Northville, Michigan; Louisville and Lexington, Kentucky; Lancaster and Maple Glen, Pennsylvania; Champaign, Illinois and Long Island, New York. These spaces are subleased by Cole Taylor Bank and cancellable with 30 days notice.

 

Item 3. Legal Proceedings

 

We are a party to litigation from time to time arising in the normal course of business. As of the date of this annual report, management knows of no threatened or pending legal action against us that is likely to have a material adverse effect on our business, financial condition or results of operations.

 

Item 4. Reserved

 

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TAYLOR CAPITAL GROUP, INC.

 

PART II

 

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

 

Our common stock trades on the Nasdaq Global Select Market under the symbol “TAYC”. The high and low sales price per share of our common stock for the periods indicated is set forth below:

 

     High      Low  

2010

     

Quarter Ended March 31

   $ 13.23       $ 7.82   

Quarter Ended June 30

     18.05         11.00   

Quarter Ended September 30

     13.50         9.36   

Quarter Ended December 31

     13.38         11.19   

2009

     

Quarter Ended March 31

   $ 8.69       $ 2.82   

Quarter Ended June 30

     7.65         2.64   

Quarter Ended September 30

     7.48         6.24   

Quarter Ended December 31

     11.50         5.19   

 

As of March 15, 2011, the closing price per share of our common stock as reported on the Nasdaq was $10.09.

 

As of March 15, 2011, there were 174 stockholders of record of the common stock, based upon securities position listings furnished to us by our transfer agent. We believe the number of beneficial owners is greater than the number of record holders because a large portion of our common stock is held of record through brokerage firms in “street name”.

 

There have been no dividends declared on our common stock for any quarter in 2010 and 2009. Holders of our common stock are entitled to receive any cash dividends that may be declared by our Board of Directors. In connection with our participation in TARP CPP and the issuance of our Series B Preferred, we need the consent of the UST before we can pay any dividends on our common stock. Subject to such restrictions, the declaration and payment of future dividends to holders of our common stock will be at the discretion of our Board of Directors and will depend upon our earnings and financial condition, the capital requirements of the Company and our subsidiaries, regulatory conditions and considerations and other factors as our Board of Directors may deem relevant. We also have agreed, consistent with our past practice, to continue to provide our regulators notice before we pay dividends and interest at the holding company.

 

As a bank holding company, we are ultimately dependent upon the Bank to provide funding for our operating expenses, debt service and dividends. Various banking laws applicable to the Bank limit the payment of dividends, management fees and other distributions by the Bank to us, and may, therefore, limit our ability to pay dividends on our common stock. Because of recent operating losses, our Bank does not have the ability to pay us dividends without regulatory approval, and we do not expect that our Bank will be able to pay dividends to us in the near-term. We will also be prohibited from paying dividends on our common stock if we fail to make distributions or required payments on the trust preferred securities and our outstanding preferred stock. See “Management’s Discussion and Analysis of Financial Condition and Results of Operation–Liquidity” for additional details of restrictions on our ability to pay dividends and the ability of the Bank to pay dividends to us.

 

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Stock Performance Graph

 

The graph below compares our cumulative stockholder return on our common stock from December 31, 2005 through December 31, 2010, with the composite index for all U.S. companies included in the Nasdaq Stock Market and the SNL Nasdaq Stock Market Bank Index. The source for the information below is SNL Financial LC, Charlottesville, VA.

 

LOGO

 

This graph is not deemed to be “soliciting material” or to be “filed” with the SEC or subject to the SEC’s proxy rules or to the liabilities of Section 18 of the Exchange Act, and the graph shall not be deemed to be incorporated by reference into any prior or subsequent filing by us under the Securities Act or the Exchange Act.

 

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Item 6. Selected Financial Data

 

The selected consolidated financial data presented below under the caption “Taylor Capital Group, Inc.” as of and for the five years ended December 31, 2010 is derived from our historical financial statements. The selected financial information presented below under the caption of “Cole Taylor Bank” is derived from unaudited financial statements of the Bank or from the audited consolidated financial statements of Taylor Capital Group, Inc. You should read this information in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the related notes included elsewhere in this annual report. Results from past periods are not necessarily indicative of results that may be expected for any future period.

 

    Year Ended December 31,  
    2010     2009     2008     2007     2006  
    (dollars in thousands, except per share data)  

TAYLOR CAPITAL GROUP, INC. (consolidated):

         

Statements of Operations Data:

         

Net interest income

  $ 136,074      $ 122,911      $ 92,351      $ 104,705      $ 111,192   

Provision for loan losses

    143,127        89,611        144,158        31,900        6,000   
                                       

Net interest income (loss) after provision for loan losses

    (7,053     33,300        (51,807     72,805        105,192   

Noninterest income:

         

Service charges

    11,282        11,306        9,136        7,709        7,738   

Trust and investment management fees

    768        1,697        3,578        3,864        4,155   

Mortgage origination revenue

    14,261        —          —          —          —     

Gain (loss) on investment securities

    41,376        17,595        (2,399     —          —     

Other noninterest income

    4,996        2,993        2,122        5,138        4,372   
                                       

Total noninterest income

    72,683        33,591        12,437        16,711        16,265   

Noninterest expense:

         

Salaries and employee benefits

    54,073        42,914        47,855        37,771        40,652   

Goodwill impairment

    —          —          —          23,237        —     

Other noninterest expense

    64,163        54,693        45,515        33,517        32,607   
                                       

Total noninterest expense

    118,236        97,607        93,370        94,525        73,259   
                                       

Income (loss) before income taxes

    (52,606     (30,716     (132,740     (5,009     48,198   

Income tax expense (benefit)

    1,217        834        (8,212     4,561        2,035   
                                       

Net income (loss)

    (53,823     (31,550     (124,528     (9,570     46,163   

Preferred dividends and discounts

    (25,455     (11,483     (18,830     —          —     
                                       

Net income (loss) applicable to common stockholders

  $ (79,278   $ (43,033   $ (143,358   $ (9,570   $ 46,163   
                                       

Common Share Data:

         

Basic earnings (loss) per share

  $ (5.27   $ (4.10   $ (13.72   $ (0.89   $ 4.17   

Diluted earnings (loss) per share

    (5.27     (4.10     (13.72     (0.89     4.12   

Cash dividends per common share

    —          —          0.10        0.40        0.28   

Book value per common share

    3.97        9.02        13.47        24.10        24.36   

Dividend payout ratio

    NM        N.M.        N.M.        N.M.        6.75

Weighted average shares – basic earnings per share

    15,049,868        10,492,911        10,450,177        10,782,316        10,940,162   

Weighted average shares – diluted earnings per share

    15,049,868        10,492,911        10,450,177        10,782,316        11,118,818   

Shares outstanding – end of year

    17,877,708        11,076,707        11,115,936        10,551,994        11,131,059   

 

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     Year Ended December 31,  
     2010     2009     2008     2007     2006  
     (dollars in thousands, except per share data)  

TAYLOR CAPITAL GROUP, INC. (consolidated):

          

Balance Sheet Data (at end of year):

          

Total assets

   $ 4,483,854      $ 4,403,502      $ 4,388,889      $ 3,556,463      $ 3,379,667   

Investment securities

     1,254,477        1,271,271        1,094,594        892,371        669,085   

Total loans

     3,094,358        3,035,328        3,233,261        2,533,333        2,500,685   

Allowance for loan losses

     124,568        106,185        128,548        54,681        37,516   

Goodwill

     —          —          —          —          23,237   

Total deposits

     3,026,906        2,976,800        3,131,046        2,580,192        2,639,927   

Other borrowings

     511,008        337,669        275,560        389,054        262,319   

Notes payable and other advances

     505,000        627,000        462,000        205,000        80,000   

Junior subordinated debentures

     86,607        86,607        86,607        86,607        86,607   

Subordinated notes, net

     88,835        55,695        55,303        —          —     

Preferred stock

     137,893        158,844        157,314        —          —     

Common stockholders’ equity

     70,908        99,962        149,773        254,256        271,192   

Total stockholders’ equity

     208,801        258,806        307,087        254,256        271,192   

Earnings Performance Data:

          

Return (loss) on average assets

     (1.20 )%      (0.70 )%      (3.27 )%      (0.28 )%      1.40

Return (loss) on average stockholders’ equity

     (19.54     (10.74     (51.01     (3.47     19.55   

Net interest margin (non tax-equivalent) (1)

     3.12        2.77        2.46        3.22        3.49   

Noninterest income to revenues

     25.85        13.24        5.73        6.86        6.86   

Efficiency ratio (2)

     70.64        70.27        87.11        77.85        57.48   

Loans to deposits

     102.23        101.97        103.26        98.18        94.72   

Average interest-earning assets to average interest-bearing liabilities

     122.59        125.32        120.66        122.78        122.42   

Ratio of earnings to fixed charges: (3)

          

Including interest on deposits

     0.25     0.59     (0.16 )x      0.96     1.43

Excluding interest on deposits

     (0.47 )x      (0.00 )x      (3.63 )x      0.82     2.92

Asset Quality Ratios:

          

Allowance for loan losses to total loans (excluding loans held for sale)

     4.39     3.60     3.98     2.16     1.50

Allowance for loan losses to nonperforming loans (4)

     77.98        75.06        64.15        72.27        113.15   

Net loan charge-offs to average total loans

     4.11        3.53        2.52        0.59        0.25   

Nonperforming assets to total loans plus repossessed property (5)

     6.12        5.48        6.58        3.09        1.34   

Capital Ratios:

          

Total stockholders’ equity to assets – end of year

     4.66     5.88     7.00     7.15     8.02

Average stockholders’ equity to average assets

     6.13        6.55        6.41        8.21        7.18   

Leverage ratio

     6.89        7.60        8.73        9.40        10.17   

Tier 1 Capital ratio

     8.93        9.79        10.22        11.44        12.10   

Total Capital ratio

     12.98        12.72        13.02        12.74        13.35   

COLE TAYLOR BANK:

          

Net income (loss)

   $ (44,721   $ (23,977 )   $ (117,196 )   $ (2,971 )   $ 40,247   

Return (loss) on average assets

     (.10 )%      (0.54 )%      (3.08 )%      (0.09 )%      1.22

Stockholder’s equity to assets – end of year

     6.53        6.95        7.36        8.82        9.38   

Leverage ratio

     7.05        6.77        7.11        8.74        9.04   

Tier 1 Capital ratio

     9.13        8.73        8.32        10.62        10.76   

Total Capital ratio

     12.04        11.64        11.12        11.88        12.01   

 

N.M. Not Meaningful
(1) Net interest margin is determined by dividing net interest income, as reported, by average interest-earning assets.
(2) The efficiency ratio is determined by dividing noninterest expense by an amount equal to net interest income plus noninterest income, adjusted for gains or losses on investment securities.
(3) For purposes of calculating the ratio of earnings to fixed charges, earnings consist of earnings (loss) before income taxes plus interest and rent expense. Fixed charges consist of interest expense, rent expense and preferred stock dividend requirements.
(4) Nonperforming loans consist of nonaccrual loans and loans contractually past due 90 days or more but still accruing interest.
(5) Nonperforming assets consist of nonperforming loans and other real estate owned and other repossessed assets.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Introduction

 

We are a bank holding company headquartered in Rosemont, Illinois, a suburb of Chicago, and we derive substantially all of our revenue from our wholly-owned subsidiary, Cole Taylor Bank. We provide a range of products and services primarily to closely-held commercial businesses and their owner operators in the Chicago area. We also provide asset-based lending and residential mortgage origination services through offices both in Chicago and in other geographic markets. At December 31, 2010, we had assets of approximately $4.5 billion, deposits of approximately $3.0 billion and stockholders equity of $208.8 million.

 

The following discussion and analysis presents our consolidated financial condition at December 31, 2010 and December 31, 2009 and the results of operations for the years ended December 31, 2010, December 31, 2009, and December 31, 2008. This discussion should be read together with the “Selected Consolidated Financial Data,” our audited consolidated financial statements and the notes thereto and other financial data contained elsewhere in this annual report. In addition to the historical information provided below, we have made certain estimates and forward-looking statements that involve risks and uncertainties. Our actual results could differ significantly from those anticipated in these estimates and forward-looking statements as a result of certain factors, including those discussed in the section captioned “Risk Factors” and elsewhere in this Annual Report on Form 10-K.

 

Application of Critical Accounting Policies

 

Our accounting and reporting policies conform to accounting principles generally accepted in the United States of America and general reporting practices within the financial services industry. For additional details, see “Notes to Consolidated Financial Statements—Summary of Significant Accounting and Reporting Policies” from our audited financial statements contained elsewhere in this Annual Report.

 

The preparation of financial statements in conformity with these accounting principles requires management to make estimates, assumptions and judgments that affect the amounts reported in the consolidated financial statements and accompanying notes. These estimates, assumptions and judgments are based on information available to us as of the date of the consolidated financial statements and, accordingly, as this information changes, actual results could differ from the estimates, assumptions and judgments reflected in the financial statements. The estimates, assumptions and judgments made by us are based upon historical experience or other factors that we believe to be reasonable under the circumstances. Certain accounting policies inherently have 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. We consider our policies for the allowance for loan losses, the realizability of deferred tax assets, derivatives used in hedging and the valuation of financial instruments such as investment securities and derivatives to be critical accounting policies.

 

The following accounting policies materially affect our reported earnings and financial condition and require significant estimates, assumptions and judgments.

 

Allowance for Loan Losses

 

We have established an allowance for loan losses to provide for loans in our portfolio that may not be repaid in their entirety. The allowance is based on our regular, quarterly assessments of the probable estimated losses inherent in our loan portfolio. Our methodology for measuring the appropriate level of the allowance relies on several key elements, which include a general allowance computed by applying loss factors to categories of loans outstanding in the portfolio and specific allowances for identified problem loans and portfolio categories. We maintain our allowance for loan losses at a level that we consider sufficient to absorb probable losses inherent in our portfolio as of the balance sheet date. In evaluating the adequacy of our allowance for loan losses, we consider numerous quantitative factors, including historical charge-off experience, changes in the size of our loan

 

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portfolio, changes in the composition of our loan portfolio and the volume of delinquent and criticized loans. In addition, we use information about specific borrower situations, including their financial position, work-out plans and estimated collateral values under various liquidation scenarios to estimate the risk and amount of loss on loans to those borrowers. Finally, we also consider many qualitative factors, including general and economic business conditions, duration of the current business cycle, the impact of competition on our underwriting terms, current general market collateral valuations, trends apparent in any of the factors we take into account and other matters, which are by nature more subjective and fluid. Our estimates of risk of loss and amount of loss on any loan are complicated by the uncertainties surrounding not only our borrowers’ probability of default, but also the fair value of the underlying collateral. The current illiquidity in the Chicago area real estate market has increased the uncertainty with respect to real estate values. Because of the degree of uncertainty and the sensitivity of valuations to the underlying assumptions regarding holding period until sale and the collateral liquidation method, our actual losses may materially vary from our current estimates.

 

Our loan portfolio is comprised primarily of commercial loans to businesses. These loans are inherently larger in amount than loans to individual consumers and, therefore, have the potential for higher losses for each loan. These larger loans can cause greater volatility in our reported credit quality performance measures, such as total impaired or nonperforming loans. Our current credit risk rating and loss estimate for any one loan may have a material impact on our reported impaired loans and related loss estimates. Because our loan portfolio contains a significant number of commercial loans with relatively large balances, the deterioration of any one or a few of these loans can cause an increase in uncollectible loans and, therefore, our allowance for loan losses. We review our estimates on a quarterly basis and, as we identify changes in estimates, our allowance for loan losses is adjusted through the recording of a provision for loan losses.

 

Income Taxes

 

We maintained net deferred tax assets for deductible temporary differences between book and taxable income, the largest of which relates to the allowance for loan losses. For income tax return purposes, only net charge-offs are deductible, not the provision for loan losses. Under GAAP, a deferred tax asset valuation allowance is required to be recognized if it is “more likely than not” that the deferred tax asset will not be realized. The determination of the realizability of the deferred tax assets is highly subjective and dependent upon judgment concerning management’s evaluation of both positive and negative evidence, the forecasts of future taxable income, applicable tax planning strategies, and assessments of current and future economic and business conditions. We consider both positive and negative evidence regarding the ultimate realizability of our deferred tax assets. Examples of positive evidence may include the existence, if any, of taxes paid in available carry-back years and the likelihood that taxable income will be generated in future periods. Examples of negative evidence may include a cumulative loss in the current year and prior two years and negative general business and economic trends. We currently maintain a valuation allowance against substantially all of our net deferred tax assets because it is more likely than not that all of these deferred tax assets will not be realized. This determination was based, largely, on the negative evidence of a cumulative loss in the most recent three year period caused primarily by the loan loss provisions made during those periods. In addition, general uncertainty surrounding future economic and business conditions has increased the likelihood of fluctuations in our future earnings.

 

Derivative Financial Instruments

 

We use derivative financial instruments (“derivatives”), including interest rate exchange and corridor agreements, as well as interest rate lock and forward loan sale commitments to either accommodate individual customer needs or to assist in our interest rate risk management. All derivatives are measured and reported at fair value on our Consolidated Balance Sheets as either an asset or a liability. For derivatives that are designated and qualify as a fair value hedge, the gain or loss on the derivative, as well as the offsetting loss or gain on the hedged item attributable to the effective portion of the hedged risk, are recognized in current earnings during the period of the change in the fair values. For derivatives that are designated and qualify as a cash flow hedge, the

 

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effective portion of the gain or loss on the derivative is reported as a component of other comprehensive income and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. For all hedging relationships, derivative gains and losses that are not effective in hedging the changes in fair value or expected cash flows of the hedged item are recognized immediately in current earnings during the period of the change in fair value. Similarly, the changes in the fair value of derivatives that do not qualify for hedge accounting or are not designated as an accounting hedge are also reported currently in earnings.

 

At the inception of a formally designated hedge and quarterly thereafter, an assessment is made to determine whether changes in the fair values or cash flows of the derivatives have been highly effective in offsetting the changes in the fair values or cash flows of the hedged item and whether they are expected to be highly effective in the future. If it is determined that derivatives are not highly effective as a hedge, hedge accounting is discontinued for the period. Once hedge accounting is terminated, all changes in fair value of the derivatives flow through the consolidated statements of operations in other noninterest income, which results in greater volatility in our earnings.

 

The estimates of fair values of certain of our derivative instruments, such as interest rate swaps and corridors, are calculated using independent valuation models to estimate market-based valuations. The valuations are determined using widely accepted valuation techniques, including discounted cash flow analysis of the expected cash flow of each derivative. This analysis reflects the contractual terms of the derivative and uses observable market-based inputs, including interest rate curves and implied volatilities. In addition, the fair value estimate also incorporates a credit valuation adjustment to reflect the risk of nonperformance by both us and our counterparties in the fair value measurement. The resulting fair values produced by these proprietary valuation models are in part theoretical and, therefore, can vary between derivative dealers and are not necessarily reflective of the actual price at which the derivative contract could be traded. Small changes in assumptions can result in significant changes in valuation. The risks inherent in the determination of the fair value of a derivative may result in volatility in our earnings.

 

Valuation of Investment Securities

 

The fair value of our investment securities portfolio is determined in accordance with GAAP, which requires that we classify financial assets and liabilities measured at fair value into a three-level fair value hierarchy. The determination of fair value is highly subjective and requires management to rely on estimates, assumptions, and judgments that can affect amounts reported in our financial statements. We obtain the fair value of investment securities from an independent pricing service. We review the pricing methodology for each significant class of assets used by this third party pricing service to assess the compliance with accounting standards for fair value measurement and classification in the fair value measurement hierarchy. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information, including credit spreads and current rating from credit rating agencies, and the bond’s terms and conditions, among other things. While we use an independent pricing service to obtain the fair values of our investment portfolio, we do employ certain control procedures to determine the reasonableness of the valuations. We validate the overall reasonableness of the fair values by comparing information obtained from our independent pricing service to other third party valuation sources for selected assets and review the valuations and any differences in valuations with members of management who have the relevant technical expertise to assess the results. However, we do not alter the fair values provided by our independent pricing service.

 

Each quarter we review our investment securities portfolio to determine whether unrealized losses are temporary or other than temporary, based on an evaluation of the creditworthiness of the issuers/guarantors, as well as the underlying collateral, if applicable. Our analysis includes an evaluation of the type of security, the length of time and extent to which the fair value has been less than the security’s carrying value, the characteristics of the underlying collateral, the degree of credit support provided by subordinate tranches within the total issuance, independent credit ratings, changes in credit ratings and a cash flow analysis, considering

 

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default rates, loss severities based upon the location of the collateral, and estimated prepayments. Those securities with unrealized losses for more than 12 months and for more than 10% of their carrying value are subjected to further analysis to determine if we expect to receive all the contractual cash flows. We use other independent pricing sources to obtain fair value estimates and perform discounted cash flow analysis for selected securities. When the discounted cash flow analysis obtained from those independent pricing sources indicates that we expect all future principal and interest payments will be received in accordance with their original contractual terms, we do not intend to sell the security, and we more-likely-than-not will not be required to sell the security before recovery, the unrealized loss is deemed temporary. If such analysis shows that we do not expect to be able to recover our entire investment, then an other-than-temporary impairment charge will be recorded in current earnings for the amount of the credit loss component. The amount of impairment that related to factors other than the credit loss is recognized in other comprehensive income. Our assessments of creditworthiness and the resultant expected cash flows are complicated by the uncertainties surrounding not only the specific security and its underlying collateral but also the severity of the current overall economic downturn. Our cash flow estimates for mortgage related securities are based on estimates of mortgage default rates, severity of loss, and prepayments, which are difficult to predict. Changes in assumptions can result in material changes in expected cash flows. Therefore, unrealized losses that we have determined to be temporary may at a later date be determined to be other-than-temporary and have a material impact on our statement of operations.

 

Outlook

 

Since 2008, we have pursued a two pronged strategy of asset quality remediation and earnings growth and diversification, which we call our “fix and grow” strategy. The “fix” component refers to our continuing efforts to improve asset quality issues largely caused by the downturn in the Chicago area economy, and the resulting impact on real estate prices and liquidity. The “grow” component of our strategy seeks to increase and diversify our pre-tax, pre-provision earnings by repositioning our commercial banking business to provide middle-market lending across a wide array of industries. In addition, “grow” also encompasses our two new businesses lines—Cole Taylor Business Capital, our asset-based lending arm, and Cole Taylor Mortgage, our mortgage origination business.

 

We plan to continue pursuing our “fix and grow” strategy in 2011. Regarding our “fix” strategy, we expect to continue to remediate asset quality and to reduce lending concentrations in areas of higher risk. Improvement in asset quality will in part depend on a sustained improvement in the economy and in particular the Chicago area real estate market and may continue for some time.

 

We also expect to maintain focus on the growth component of our strategy emphasizing our commercial banking and mortgage origination businesses. Cole Taylor Business Capital and Cole Taylor Mortgage are relatively new businesses and we believe that each have meaningful potential for continued growth. Cole Taylor Mortgage’s geographic expansion and growth, however, will be limited until the Dodd-Frank mandates surrounding mortgage origination sales incentives are fully understood and implemented. See “Supervision and Regulation—Changes to Mortgage Loan Originator Compensation” for additional details. We will also look for additional opportunities for strategic, measured expansion provided it increases stockholder value, especially in the areas of deposit franchise enhancement.

 

Results of Operations

 

We reported a net loss applicable to common stockholders of $79.3 million, or ($5.27) per diluted common share outstanding for the year ended December 31, 2010, compared to a net loss applicable to common stockholders of $43.0 million, or ($4.10) per diluted common share, for the year ended December 31, 2009. The higher net loss applicable to common stockholders in 2010 was due to a $53.5 million increase in the provision for loan losses, an implied non-cash dividend of $15.8 million representing an inducement to the holders of our 8% non-cumulative convertible perpetual Series A Preferred to convert their Series A Preferred shares into common stock, higher noninterest expense of $20.6 million, which was offset by higher net interest income of $13.2 million and higher noninterest income of $39.1 million.

 

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2010 Highlights

 

   

Pre-tax, pre-provision earnings from core operations (defined as loss before income taxes plus provision for loan losses plus nonperforming asset expense less gains on the sales of investment securities) were $68.9 million, up 30.0% from $53.0 million for the full year 2009.

 

   

Revenue (defined as net interest income plus noninterest income less gains on the sales of investment securities) was $167.4 million, up 20.5% from $138.9 million in 2009.

 

   

Net interest income increased 10.7% from $122.9 million for the year ended December 31, 2009 to $136.1 million for the year ended December 31, 2010.

 

   

Nonperforming loans were $159.7 million and 5.16% of total loans at December 31, 2010, compared to $141.5 million and 4.66% of total loans at December 31, 2009.

 

   

The allowance for loan losses was $124.6 million and 77.98% of nonperforming loans at December 31, 2010, compared to $106.2 million and 75.06% at December 31, 2009.

 

   

At December 31, 2010, commercial criticized and classified loans totaled $303.9 million down 25.2% from $406.3 million at December 31, 2009.

 

   

In May 2010, we completed a $75 million private offering. This provided additional liquidity for us to continue to act as a source of strength for the Bank, to better align our capital position to our peers and to support our future growth plans.

 

In 2010, we also completed an exchange offer in which we issued an aggregate of 7.2 million shares of our common stock in exchange for all of the outstanding shares of our Series A Preferred. The Series A Preferred had an aggregate liquidation preference of $60 million and a non-cumulative preferred dividend that accrued at 8% per annum. By its terms, the Series A Preferred was convertible into 6.0 million shares of common stock. As an inducement to convert, holders of our Series A Preferred were offered, in the aggregate, an additional 1.2 million shares of common stock.

 

In the first quarter of 2011, we announced the sale of $25 million of a new series of preferred stock in a private placement to existing investors. Subject to stockholder approval, which we expect to receive at a special meeting on March 29, 2011, these shares of preferred stock will convert automatically into 2.5 million shares of common stock, or in the case of certain investors, non-voting common stock equivalents. We intend to use the proceeds to provide additional capital to the Bank. As we continue to grow our business as well as manage our loan portfolio, we may require additional capital, either from earnings retention or external sources. We continue to review and evaluate our capital plan in conjunction with our business strategy as well as the heightened focus on capital requirements by regulatory authorities and the investment community. The timing, amount and form of any such capital raise will depend on a number of factors, including the amount of earnings generated by the Bank, the opportunities for future growth, further loan losses, regulatory requirements and the state of the capital markets.

 

2009 Highlights

 

We reported a net loss applicable to common stockholders of $43.0 million, or ($4.10) per diluted common share outstanding for the year ended December 31, 2009, compared to a net loss applicable to common stockholders of $143.4 million, or ($13.72) per diluted common share, during 2008. The lower net loss applicable to common stockholders in 2009 was due to a $54.5 million decrease in the provision for loan losses and increases in net interest income of $30.6 million and noninterest income of $21.2 million. These decreases to the net loss in 2009 were partly offset by a $9.0 million increase in income tax expense and a $4.2 million increase in noninterest expense. In addition, preferred stock dividends and discounts decreased to $11.5 million during 2009 from $18.8 million during 2008. The decrease was primarily due to a $16.7 million charge in 2008 for an implied non-cash dividend to the holders of our 8% non-cumulative convertible perpetual Series A preferred stock to

 

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reflect the beneficial conversion feature upon issuance of this preferred stock. This decrease was partly offset by higher dividends and discounts as 2009 had the full year’s impact of the preferred stock issued in September and November 2008.

 

Noninterest income, without considering the gains and losses from the investment securities portfolio, also increased in 2009 as compared to 2008, as an increase in service charge revenue and other income were partly offset by lower trust and investment management fees and losses from our mortgage banking activities. Total noninterest expense increased by $4.2 million, or 4.5%, during 2009 as compared to 2008. This increase included $7.7 million of higher assessments from the FDIC and an increase of $7.0 million in expenses related to our nonperforming assets. Without the increases in deposit insurance premiums and nonperforming asset expense, our overall noninterest expense would have declined by over $10 million.

 

Net Interest Income

 

Net interest income is the difference between total interest income and fees generated by interest-earning assets and total interest expense incurred on interest-bearing liabilities. Net interest income is our principal source of earnings. The amount of net interest income is affected by changes in the volume and mix of interest-earning assets and interest-bearing liabilities, and the level of rates earned or incurred on those assets and liabilities.

 

Year Ended December 31, 2010 as Compared to Year Ended December 31, 2009

 

Net interest income increased by $13.2 million, or 10.7%, to $136.1 million in 2010, compared to $122.9 million in 2009, that was driven largely by a 33 basis point increase in net interest margin.

 

Net interest margin increased to 3.17% in 2010, compared to 2.84% in 2009, as our funding costs continued to decrease by more than the yield on our interest-earning assets. The low interest rate environment enabled our portfolio of term deposits to continue to reprice to the current market rates coupled with increasing noninterest-bearing deposit balances from customers, and taking advantage of low cost short-term funding opportunities drove funding costs lower.

 

In contrast, the interest-earning asset yield declined to 4.83% in 2010 from 5.03% in 2009. The yield earned on loans increased slightly to 5.07% during 2010 from 5.04% in 2009. However, this was more than offset by a drop in the yield on our investment securities portfolio, which decreased to 4.28% in 2010 from 5.01% in 2009.

 

Our average interest-earning assets during 2010 were $4.37 billion, a decrease of $66.2 million, or 1.5%, as compared to the $4.43 billion of average interest-earning assets during 2009. The decrease was driven by lower loan balances largely offset by higher investment portfolio balances. Average loan balances fell due to the continued downward pressure from the current economic environment.

 

Average interest–bearing deposit balances decreased to $2.39 billion in 2010, compared to $2.52 billion during 2009. The decrease was offset by increases in average noninterest-bearing deposit balances, which increased $18.3 million to $602.8 million during 2010, as compared to $584.5 million in 2009, and by short-term borrowings, which increased $163.1 million from $366.8 million during 2009 to $529.9 million during 2010.

 

With an adjustment for tax-exempt income, our consolidated net interest income for 2010 was $138.6 million, compared to $126.0 million for 2009. This non-GAAP presentation is discussed below. See “Tax-Equivalent Adjustments to Yields and Margins”.

 

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Year Ended December 31, 2009 as Compared to Year Ended December 31, 2008

 

Net interest income increased to $122.9 million in 2009, compared to $92.4 million in 2008, up $30.6 million, or 33.1%. With an adjustment for tax-exempt income, our consolidated net interest income for 2009 was $126.0 million, compared to $95.6 million for 2008. This non-GAAP presentation is discussed below. See “Tax-Equivalent Adjustments to Yields and Margins”. During 2009, net interest income benefited from both a $683.0 million increase in average interest-earning assets and a 29 basis point increase in the net interest margin.

 

Our net interest margin increased to 2.84% in 2009 as compared to 2.55% in 2008. The net interest margin increased in 2009 as our funding costs decreased by more than the yield on our interest-earning assets. Market interest rates declined during 2008 and remained at historically low levels throughout 2009. Since approximately 71% of the loan portfolio is tied to floating or variable indexes, the declining market rates had an immediate impact on our earning asset yields in 2008, which continued in 2009 as higher rate assets were repaid and replaced at lower current market rates. Because of our portfolio of term deposits, our cost of funds can lag changes in market interest rates. Our net interest margin increased in 2009, as the low interest rate environment enabled our portfolio of term deposits to continue to reprice to the current market rates. In addition, our cost of funds decreased in 2009 as we improved our funding mix by reducing reliance on more costly out-of-market funding, increased noninterest-bearing deposit balances from customers, and took advantage of low cost short-term funding opportunities from the FHLB and the FRB’s Term Auction Facility.

 

During 2009, the interest-earning asset yield declined to 5.03% from 5.54% during 2008, a decrease of 51 basis points. The yield earned on loans decreased to 5.04% during 2009 from 5.69% in 2008, while the yield on our investment securities portfolio decreased to 5.01% in 2009 from 5.32% in 2008. We took additional steps during 2009 to increase net interest income and maintain our earning asset yields by improving loan pricing, including the use of interest rate floors, and increasing the size and duration of our investment portfolio to take advantage of higher yields. Over the same time period, the cost of funds decreased 86 basis points, from 3.61% during 2008 to 2.75% during 2009. The cost of our deposits decreased 76 basis points to 2.75% during 2009 from 3.51% during 2008. In addition, overall borrowing costs benefited from our increased use of attractively priced short-term borrowings.

 

Our average interest-earning assets during 2009 were $4.43 billion, an increase of $683.0 million, or 18.2%, as compared to the $3.75 billion of average interest-earning assets during 2008. Both an increase in average loans and investment balances produced the overall increase in interest earning assets. The growth strategy implemented in 2008 caused the $380.7 million, or 13.6%, increase in average loan balances between the two annual periods. Average loan balances were $3.17 billion during 2009, compared to $2.79 billion during 2008. We also increased the size of the investment portfolio in an effort to increase average earning assets and enhance net interest margin. Average investment balances increased to $1.26 billion during 2009 from $895.4 million during 2008, an increase of $364.7 million or 40.7%.

 

The increase in average earning assets was largely funded with short-term borrowings and an increase in noninterest-bearing deposits. Average interest-bearing deposit balances remained relatively unchanged at $2.52 billion during 2009, compared to $2.51 billion during 2008. Our average noninterest-bearing deposit balances increased $175.2 million, or 42.8%, to $584.5 million during 2009, as compared to $409.3 million in 2008. In addition, average notes payable and other advances increased $327.1 million and other borrowings increased by $53.4 million during 2009, as compared to 2008.

 

Tax-Equivalent Adjustments to Yields and Margins

 

As part of our evaluation of net interest income, we review our consolidated average balances, our yield on average interest-earning assets, and the costs of average interest-bearing liabilities. Such yields and costs are derived by dividing income or expense by the average balance of assets or liabilities. Because management reviews net interest income on a taxable equivalent basis, the analysis contains certain non-GAAP financial

 

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measures. In these non-GAAP financial measures, interest income and net interest income are adjusted to reflect tax-exempt interest income on an equivalent before-tax basis assuming a tax rate of 35%. This assumed rate may differ from our actual effective income tax rate. In addition, we adjusted the interest-earning asset yield, net interest margin, and the net interest rate spread to a fully taxable equivalent basis. We believe that these measures and ratios present a more meaningful measure of the performance of interest-earning assets because they provide a better basis for comparison of net interest income regardless of the mix of taxable and tax-exempt instruments.

 

The following table reconciles the tax-equivalent net interest income to net interest income as reported in our Consolidated Statements of Operations. In addition, the interest-earning asset yield, net interest margin and net interest spread are shown with and without the tax equivalent adjustment.

 

     For the Year Ended December 31,  
     2010     2009     2008  
     (dollars in thousands)  

Net interest income as reported

   $ 136,074      $ 122,911      $ 92,351   

Tax equivalent adjustment-investments

     2,393        2,944        3,140   

Tax equivalent adjustment-loans

     100        115        126   
                        

Tax equivalent net interest income

   $ 138,567      $ 125,970      $ 95,617   
                        

Yield on interest-earning assets without tax adjustment

     4.77     4.96     5.45

Yield on interest-earning assets – tax equivalent

     4.83     5.03     5.54

Net interest margin without tax adjustment

     3.12     2.77     2.46

Net interest margin – tax equivalent

     3.17     2.84     2.55

Net interest spread – without tax adjustment

     2.74     2.21     1.84

Net interest spread – tax equivalent

     2.80     2.28     1.93

 

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The following table presents, for the periods indicated, certain information relating to our consolidated average balances and reflects our yield on average interest-earning assets and costs of average interest-bearing liabilities. The table contains certain non-GAAP financial measures to adjust tax-exempt interest income on an equivalent before-tax basis assuming a tax rate of 35%.

 

    Year Ended December 31,  
    2010     2009     2008  
    AVERAGE
BALANCE
    INTEREST     YIELD/
RATE
(%)
    AVERAGE
BALANCE
    INTEREST     YIELD/
RATE
(%)
    AVERAGE
BALANCE
    INTEREST     YIELD/
RATE
(%)
 
    (dollars in thousands)  

INTEREST-EARNING ASSETS:

                 

Investment securities (1):

                 

Taxable

  $ 1,222,785      $ 50,162        4.10   $ 1,127,899      $ 54,694        4.85   $ 754,811      $ 38,633        5.12

Tax-exempt (tax equivalent) (2)

    108,353        6,837        6.31        132,184        8,412        6.36        140,550        8,970        6.38   
                                                     

Total investment securities

    1,331,138        56,999        4.28        1,260,083        63,106        5.01        895,361        47,603        5.32   
                                                     

Cash Equivalents

    939        11        1.16        1,688        20        1.17        64,025        1,421        2.18   
                                                     

Loans (2) (3):

                 

Commercial and commercial real estate

    2,775,085        141,778        5.04        2,982,534        150,021        4.96        2,627,905        147,727        5.53   

Residential real estate mortgages

    166,818        7,304        4.38        87,483        4,485        5.13        56,660        3,150        5.56   

Home equity and consumer

    92,995        3,912        4.21        101,356        4,266        4.21        106,158        5,770        5.44   

Fees on loans

      1,005            1,191            2,043     
                                                     

Net loans (tax equivalent) (2)

    3,034,898        153,999        5.07        3,171,373        159,963        5.04        2,790,723        158,690        5.69   
                                                     

Total interest earning assets (2)

    4,366,975        211,009        4.83        4,433,144        223,089        5.03        3,750,109        207,714        5.54   
                                                     

NON-EARNING ASSETS:

                 

Allowance for loan losses

    (108,347         (131,131         (88,046    

Cash and due from banks

    81,774            65,674            57,269       

Accrued interest and other assets

    153,011            116,888            91,655       
                                   

TOTAL ASSETS

  $ 4,493,413          $ 4,484,575          $ 3,810,987       
                                   

INTEREST-BEARING LIABILITIES:

                 

Interest-bearing deposits:

                 

Interest-bearing demand deposits

  $ 812,253      $ 8,344        1.03      $ 661,403      $ 7,610        1.15      $ 748,001      $ 13,114        1.75   

Savings deposits

    40,616        32        0.08        41,848        35        0.08        45,247        58        0.13   

Time deposits

    1,533,939        35,910        2.34        1,816,169        61,519        3.39        1,718,572        75,107        4.37   
                                                     

Total interest-bearing deposits

    2,386,808        44,286        1.86        2,519,420        69,164        2.75        2,511,820        88,279        3.51   
                                                     

Other borrowings

    529,900        8,648        1.61        366,844        8,844        2.38        313,430        9,648        3.03   

Notes payable and other advances

    484,789        5,289        1.08        509,049        6,557        1.27        181,986        5,511        2.98   

Junior subordinated debentures

    86,607        5,804        6.70        86,607        6,066        7.00        86,607        7,013        8.10   

Subordinated notes

    74,154        8,415        11.35        55,499        6,488        11.69        14,192        1,646        11.60   
                                                     

Total interest-bearing liabilities

    3,562,258        72,442        2.03        3,537,419        97,119        2.75        3,108,035        112,097        3.61   
                                                     

NONINTEREST-BEARING LIABILITIES:

                 

Noninterest-bearing deposits

    602,757            584,512            409,322       

Accrued interest, taxes and other liabilities

    52,904            68,801            49,483       
                                   

Total noninterest-bearing liabilities

    655,661            653,313            458,805       
                                   

STOCKHOLDERS’ EQUITY

    275,494            293,843            244,147       
                                   

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY

  $ 4,493,413          $ 4,484,575          $ 3,810,987       
                                   

Net interest income (tax equivalent) (2)

    $ 138,567          $ 125,970          $ 95,617     
                                   

Net interest spread (2) (4)

        2.80         2.28         1.93
                                   

Net interest margin (2) (5)

        3.17         2.84         2.55
                                   

 

(1) Investment securities average balances are based on amortized cost.
(2) Calculations are computed on a taxable-equivalent basis using a tax rate of 35%.
(3) Nonaccrual loans are included in the above stated average balances.
(4) Net interest spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities.
(5) Net interest margin is determined by dividing taxable equivalent net interest income by average interest-earning assets.

 

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The following table presents, for the periods indicated, a summary of the changes in interest earned and interest expense incurred resulting from changes in volume and rates for the major components of interest-earning assets and interest-bearing liabilities on a tax-equivalent basis assuming a tax rate of 35%. The change due to both rate and volume has been allocated in proportion to the dollar amount of the change in each. The impact of changes in the mix of interest-earning assets and interest-bearing liabilities is reflected in net interest income.

 

    2010 over 2009
INCREASE/(DECREASE)
    2009 over 2008
INCREASE/(DECREASE)
 
    Volume     Rate     Net     Volume     Rate     Day (1)     Net  

INTEREST EARNED ON:

             

Investment securities:

             

Taxable

  $ 4,364      $ (8,896   $ (4,532   $ 18,196      $ (2,135   $ —        $ 16,061   

Tax-exempt

    (1,509     (66     (1,575     (530     (28     —          (558

Cash equivalents

    (9     —          (9     (947     (450     (4     (1,401

Loans

    (6,911     947        (5,964     20,673        (18,966     (434     1,273   
                                                       

Total interest-earning assets

    (4,065     (8,015     (12,080     37,392        (21,579     (438     15,375   

INTEREST PAID ON:

             

Interest-bearing demand deposits

    1,593        (859     734        (1,380     (4,088     (36     (5,504

Savings deposits

    (3     —          (3     (4     (19     —          (23

Time deposits

    (8,556     (17,053     (25,609     4,102        (17,485     (205     (13,588

Other borrowings

    3,156        (3,352     (196     1,460        (2,238     (26     (804

Notes payable and other advances

    (306     (962     (1,268     5,522        (4,461     (15     1,046   

Junior subordinated debentures

    —          (262     (262     —          (928     (19     (947

Subordinated debt

    2,121        (194     1,927        4,833        13        (4     4,842   
                                                       

Total interest-bearing liabilities

    (1,995     (22,682     (24,677     14,533        (29,206     (305     (14,978
                                                       

Net interest income, tax-equivalent

  $ (2,070   $ 14,667      $ 12,597      $ 22,859      $ 7,627      $ (133   $ 30,353   
                                                       

 

(1) The year ended December 31, 2008 had 366 days compared to 365 days for the years ended December 31, 2010 and 2009.

 

Provision for Loan Losses

 

We determine a provision for loan losses that we consider sufficient to maintain an allowance to absorb probable losses inherent in our portfolio as of the balance sheet date. For additional information concerning this determination, see “Application of Critical Accounting Policies—Allowance for Loan Losses,” “Nonperforming Assets”, “Impaired Loans” and “Allowance for Loan Losses.”

 

Our provision for loan losses totaled $143.1 million during 2010, an increase of $53.5 million, or 59.7%, as compared to the $89.6 million provision for loan losses recorded in 2009. The provision for loan losses in 2010 reflects the continued weakness in the Chicago area real estate market, deterioration in our bank and bank holding company loans, the rise in nonperforming and impaired loans, and the increase in the severity of the estimated losses associated with these loans.

 

Nonperforming loans and impaired loans remain at elevated levels, increasing slightly in 2010. Nonperforming loans totaled $159.7 million at December 31, 2010, compared to $141.5 million at year-end 2009, an increase of $18.2 million, or 12.9%. As we address our problem assets, the level of gross charge-offs has increased to $128.9 million during 2010 as compared to $116.2 million in 2009. However, because the provision for loan losses exceeded net charge-offs in 2010, the total allowance for loan losses increased from $106.2 million at December 31, 2009 to $124.6 million at December 31, 2010. See “Nonperforming Assets” and “Allowance for Loan Losses” for further discussion of the credit quality of our loan portfolio and our allowance for loan losses.

 

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The provision for loan losses of $89.6 million during 2009 was $54.5 million lower than the $144.2 million provision for loan losses during 2008. The provision in 2008 reflected the rapid rise in nonperforming and impaired loans and the increase in the severity of the estimated loss associated with these loans. Lower nonperforming loans, impaired loans, and net charge-offs caused us to decrease our allowance for loan losses in 2009.

 

Noninterest Income

 

The following table presents the composition of our noninterest income for the periods indicated:

 

     Year Ended December 31,  
     2010     2009     2008  
     (in thousands)  

Service charges

   $ 11,282      $ 11,306      $ 9,136   

Trust and investment management fees

     768        1,697        3,578   

Mortgage origination revenue

     14,261        —          —     

Losses relating to bulk purchased mortgage loans

     (2,418     (1,961     —     

Gain (loss) on sales of investment securities

     41,376        17,595        (2,399

Other derivative income

     1,963        1,399        1,936   

Letter of credit and other loan fees

     4,041        2,186        376   

Change in market value of employee deferred compensation plan

     161        478        (1,354

Other noninterest income

     1,249        891        1,164   
                        

Total noninterest income

   $ 72,683      $ 33,591      $ 12,437   
                        

 

Year Ended December 31, 2010 as Compared to Year Ended December 31, 2009

 

Total noninterest income during 2010 totaled $72.7 million, up from $33.6 million during 2009, an increase of $39.1 million or 116.4%. Increases in the gains on the sale of investment securities in 2010 of $23.8 million, mortgage origination revenue of $14.3 million from Cole Taylor Mortgage and letters of credit fees of $1.9 million drove the increase.

 

In 2010, we recorded gains on the sale of available-for-sale investment securities of $41.4 million from the sale of approximately $965 million of investment securities, mostly mortgage-related securities. We realized gains when we sold mortgage-backed securities that had been experiencing higher than anticipated prepayments and to take advantage of the low level of interest rates and tightening spreads in the market later in the year. See “Investment Securities” below for a further discussion

 

We principally derive service charges from deposit accounts. Service charges stayed flat in 2010 at $11.3 million. Service charge income is affected by a number of factors, such as the volume of deposit accounts and service transactions, the price established for each deposit service, the earnings credit rate and the collected balances customers maintain in their commercial checking accounts.

 

Other derivative income totaled $2.0 million in 2010, compared to $1.4 million in 2009. The increase was almost entirely due to an increase in the number and the size of fees collected on customer related swaps. See “Derivative Financial Instruments” following for further discussion of our derivative instruments.

 

Standby letters of credit and other loan fees totaled $4.0 million in 2010, compared to $2.2 million in 2009. The increase in fees during 2010 was primarily due to our expanded asset based lending operations.

 

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Year Ended December 31, 2009 as Compared to Year Ended December 31, 2008

 

Noninterest income during 2009 totaled $33.6 million, up from $12.4 million during 2008. The gain on the sale of investment securities in 2009 of $17.6 million and a $2.4 million loss due to other-than-temporary impairment of an investment security in 2008 accounted for most of this increase. Higher service charges and letter of credit and other fees, partly offset by a decrease in trust and investment management fees and losses from mortgage banking activities, also contributed to this increase.

 

Service charges increased $2.2 million, or 23.8%, in 2009 to $11.3 million as compared to $9.1 million in 2008. The increase in service charge revenue in 2009 was largely due to increased customer accounts and activity that resulted from the commercial banking growth initiative that we began in 2008. In addition, a decrease in the earnings credit rate given to customers on their collected account balances also contributed to the higher service charge revenue.

 

Trust and investment management fees declined to $1.7 million during 2009 from $3.6 million during 2008, a decrease of $1.9 million or 52.6%. Trust fees totaled $968,000 during 2009, compared to $2.4 million during 2008. Trust fees were earned in connection with our offering of corporate trust services, primarily our paying agent and escrow services. Trust fees declined during 2009 because of a reduced volume of business and a decrease in the spread income we earned on invested trust funds. During the first quarter of 2010, we entered into an agreement to sell our trust business to a third party. This transaction closed during 2010.

 

Investment management fees in 2009 declined to $729,000 from $1.2 million during 2008 due to fewer assets being under management. During the second quarter of 2009, the third-party investment management firm that had been providing sub-advisory services to the Bank’s clients became the primary investment advisor and assumed all portfolio management responsibilities for our wealth management customers.

 

The $2.0 million loss during 2009 related to bulk purchased mortgage loans was primarily due to economic hedges associated with our residential mortgage loans held for sale. In order to mitigate interest rate risk associated with these loans held for sale, we entered into forward loan sale commitments. The loss resulted from a realized settlement loss on matured forward loan sale commitments and an unrealized gain of $540,000 on the unsettled outstanding forward loan sales as of December 31, 2009. In addition, during the fourth quarter we sold approximately $10.5 million of mortgage loans held for sale and recorded a small gain.

 

During 2009, we recorded gains on the sale of available-for-sale investment securities of $17.6 million from the sale of approximately $500 million of investment securities, mostly mortgage-related securities. We realized gains when we sold mortgage-backed securities that had been experiencing higher than anticipated prepayments and to take advantage of the low level of interest rates and tightening spreads in the market later in the year. The $2.4 million loss recorded in 2008 was an other-than-temporary impairment of one private label mortgage-backed security. See “Investment Securities” below for a further discussion.

 

Other derivative income totaled $1.4 million during 2009, compared to $1.9 million during 2008. The income in 2009 was primarily attributable to recording the initial fair value from the offering of derivative instruments to our customers. Other derivative income in 2008 was comprised of $712,000 from customer derivatives and $1.2 million from changes in the fair value of derivatives that are not designated as accounting hedges. See “Derivative Financial Instruments” following for further discussion of our derivative instruments.

 

Standby letters of credit and other loan fees totaled $2.2 million during 2009, compared to $376,000 during 2008. The increase in fees during 2009 was primarily due to our expanded asset based lending operations.

 

Our employees’ deferred compensation plan allows the participants to direct the investments of their deferred compensation in selected mutual funds. The investment in these mutual funds are assets of the Company and carried at fair value, while an equal and offsetting liability is recorded to reflect the obligation of the

 

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Company to the plan participants. The change in the fair value of assets in our employees’ deferred compensation plan is reported in noninterest income and the offsetting change in our liability to deferred compensation plan participants is included in salary expense and, therefore, has no net impact on the Company’s operating results. During 2009, the fair value of these assets increased by $478,000 compared to a decline in the fair value of $1.4 million in 2008.

 

Other noninterest income includes fees from automated teller machines, safe deposit box rentals, fees from insurance and financial planning services, and gains or losses from investments in limited partnerships. Total other noninterest income was $891,000 during 2009 as compared to $1.2 million in 2008.

 

Noninterest Expense

 

The following table presents the composition of our noninterest expense for the periods indicated:

 

     Year Ended December 31,  
     2010     2009     2008  
     (dollars in thousands)  

Salaries and employee benefits:

      

Salaries, employment taxes and medical insurance

   $ 44,796      $ 38,440      $ 36,406   

Sign-on bonuses and severance

     375        386        6,088   

Incentives, commissions and retirement benefits

     8,902        4,088        5,361   
                        

Total salaries and employee benefits

     54,073        42,914        47,855   

Occupancy of premises

     8,328        8,146        7,812   

Furniture and equipment

     2,284        2,230        3,094   

Nonperforming asset expense

     19,790        11,726        4,711   

FDIC assessment

     8,238        10,380        2,687   

Legal fees, net

     4,922        5,961        5,016   

Early extinguishment of debt

     378        527        2,500   

Other professional services

     1,761        1,518        2,311   

Computer processing

     2,171        1,858        1,995   

Other noninterest expense

     16,291        12,347        15,389   
                        

Total noninterest expense

   $ 118,236      $ 97,607      $ 93,370   
                        

Efficiency Ratio (1)

     70.64     70.27     87.11
                        

 

(1) The efficiency ratio is determined by dividing noninterest expense by an amount equal to net interest income plus noninterest income, excluding gains or losses on investment securities.

 

Year Ended December 31, 2010 as Compared to Year Ended December 31, 2009

 

Total noninterest expense was $118.2 million during 2010, an increase of $20.6 million, or 21.1%, as compared to noninterest expense of $97.6 million during 2009. The increase in expense was primarily due to higher salaries and employee benefits expense of $11.2 million and nonperforming asset expense of $8.1 million. These increases were partly offset by lower FDIC assessments of $2.1 million.

 

Total salaries and employee benefits expense in 2010 was $54.1 million, compared to $42.9 million during 2009, an increase of $11.2 million, or 26.0%. The increase in expense in 2010 was largely due to the higher base salaries and sales incentives at Cole Taylor Mortgage as that business added 150 new employees during 2010. The total number of employees at the Company was 607 at December 31, 2010, compared to 443 at December 31, 2009.

 

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Nonperforming asset expense increased to $19.8 million during 2010 as compared to $11.7 million during 2009. The increase was primarily associated with additional write-downs on other real estate owned during 2010. The amount of nonperforming asset expense is impacted by the complexity and number of nonperforming loans and other real estate owned and could continue to be significant in future periods.

 

Our FDIC insurance premium decreased in 2010 from 2009, primarily due to the nonrecurring FDIC special assessment in the second quarter of 2009 of $2.1 million.

 

Other noninterest expense was $20.2 million for the year ended December 31, 2010, compared to $15.7 for the year ended December 31, 2009. Other noninterest expense includes costs for certain consulting fees, advertising and public relations, business meals and travel, board of directors fees, operational losses and other operating expenses such as telephone, postage, office supplies and printing.

 

Our efficiency ratio was 70.64% in 2010, compared to 70.27% in 2009. The impact of higher nonperforming asset expense was mostly offset by higher net interest and noninterest income.

 

Year Ended December 31, 2009 as Compared to Year Ended December 31, 2008

 

Total noninterest expense was $97.6 million during 2009, an increase of $4.2 million, or 4.5%, as compared to noninterest expense of $93.4 million during 2008. The increase in expense was primarily due to higher FDIC assessments of $7.7 million and higher nonperforming asset expense of $7.0 million. These increases were partly offset by lower salaries and employee benefits expense of $4.9 million, a $2.0 million decrease in losses on early extinguishment of debt, and general decreases in other categories of expense.

 

Total salaries and employee benefits expense in 2009 was $42.9 million, compared to $47.9 million during 2008, a reduction of $4.9 million, or 10.3%. The decline in 2009 was largely due to higher sign-on bonuses and severance we incurred in 2008 as part of the implementation of our growth strategy. In addition, lower incentives, commissions, and retirement benefits during 2009, partly offset by an increase in base salaries, also contributed to the decrease in expense. During 2009, we put in place certain expense control measures to reduce salaries and benefits costs, which included reducing staffing levels, eliminating annual cash-based incentive awards and suspending the annual merit increase.

 

Salaries, employment taxes, and medical insurance expenses increased $2.0 million, or 5.6%, to $38.4 million during 2009, compared to $36.4 million for 2008. Most of the increase in salaries was associated with an increase in the liability to our deferred compensation plan participants caused by an increase in the fair value of assets held in the plan. During 2009, the market value of these assets increased by $478,000, compared to a decline in the market value of $1.4 million in 2008. The change in the market value of assets in our employees’ deferred compensation plan is reported in noninterest income, and the offsetting change in our liability to these participants is reported in salary expense and has no net impact on the Company’s operating results. The remainder of the increase was due to higher base salaries associated with our growth strategy and the additional hiring that took place in 2008. These increases were partly offset by a decrease in employment taxes and medical insurance. As part of our expense control measures, we reduced the number of full time equivalent employees by eliminating certain positions in the first quarter of 2009. The number of full-time employees was 434 at December 31, 2009, compared to 451 at December 31, 2008.

 

Sign-on bonuses and severance expense was $386,000 in 2009 and consisted primarily of severance costs. Sign-on bonuses and severance expense was $6.1 million in 2008, and consisted of severance expense of $4.1 million and sign-on bonuses of $2.0 million. The higher expense in 2008 was associated with severance related to changes in senior management and certain of our supporting staff and signing bonuses to attract new employees.

 

Incentives, commissions, and retirement benefits also decreased during 2009 to $4.1 million, as compared to $5.4 million during 2008. The decrease was largely due to expenses in 2008 for guaranteed bonuses, primarily as a result of our recruiting activities. In addition, lower sales incentives also contributed to the decrease in expense in 2009.

 

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Occupancy of premises expense increased to $8.1 million during 2009, compared to $7.8 million during 2008, an increase of $334,000 or 4.3%. Most of the increase was due to the opening of leased asset-based lending offices in other states.

 

Furniture and equipment expense decreased to $2.2 million during 2009, as compared to $3.1 million in 2008, a decrease of $864,000, or 27.9%. Most of the decrease was associated with lower depreciation expense at our corporate offices in Rosemont, Illinois as the furniture and equipment purchased when the facility opened in late 2003, became fully depreciated in 2008.

 

Nonperforming asset expense increased to $11.7 million during 2009 as compared to $4.7 million during 2008. The increase was primarily associated with $5.8 million of additional write-downs recorded in the fourth quarter of 2009 on certain nonaccrual commercial loans held for sale. Additional write-downs and higher losses on the disposition of other real estate owned during 2009 also contributed to the increase in expense. The amount of nonperforming asset expense is impacted by the complexity and number of nonperforming loans and other real estate owned and could continue to be significant in future periods.

 

FDIC assessments increased in 2009, compared to 2008, because the FDIC imposed an industry-wide special assessment and a general increase in premiums for all financial institutions. In addition, our election to participate in the FDIC’s Transaction Account Guarantee Program also increased our expense. FDIC assessments were $10.4 million for 2009, compared to $2.7 million for 2008, an increase of $7.7 million. FDIC assessments in 2009 included an industry-wide special assessment to help recapitalize the FDIC’s Deposit Insurance Fund, which amounted to $2.1 million. The remainder of the increase was primarily due to higher insurance assessments that went into effect for all financial institutions. In addition, in an effort to increase the balance of its DIF, during the fourth quarter of 2009, the FDIC required all banks to prepay the estimated amount of the next three years’ premium payments. At December 31, 2009, the Bank’s prepaid FDIC premiums totaled $29.1 million and were included in other assets on our Consolidated Balance Sheets.

 

Legal fees were $6.0 million in 2009, as compared to $5.0 million in 2008, an increase of $945,000, or 18.8%. Legal fees are reported net of reimbursements received from customers. The increase was primarily due to legal fees incurred in our efforts to deal with the greater amount of nonperforming assets.

 

During 2009, we incurred $527,000 of expense for the early redemption of approximately $29.0 million of above market rate brokered certificates of deposits, compared to $2.5 million of expense for the early redemption of approximately $190 million of above market rate brokered certificates of deposits in 2008. The unamortized issuance costs and other discounts on these deposits were written off at the time of redemption. As of December 31, 2009, we did not have additional brokered CDs that we can call at our option.

 

Other professional fees totaled $1.5 million in 2009, as compared to $2.3 million in 2008, a decrease of $793,000, or 34.3%. Most of the decrease was associated with lower third-party asset management fees paid to the sub-advisor for our investment management clients. During 2009, we expanded the relationship with this third party to become the primary investment advisor going forward. As part of this arrangement, we were no longer obligated to pay the sub-advisor fee.

 

Other noninterest expense was $12.3 million in 2009, compared to $15.4 million in 2008. Other noninterest expense principally includes costs for certain consulting and professional fees, advertising and public relations, business meals and travel, board of directors’ fees, operational losses and other operating expenses such as telephone, postage, office supplies, and printing. During 2009, as part of our cost control measures, we reduced costs in many areas of other expenses, such as advertising, business meals and travel, consulting and other professional fees, and directors’ fees.

 

Our efficiency ratio was 70.27% in 2009, compared to 87.11% in 2008. The improvement in our efficiency ratio in 2009 was primarily the result of the increase in net interest income and noninterest income, excluding the gains and losses from investment securities.

 

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Income Taxes

 

During 2010, despite a pre-tax loss of $52.6 million, we recorded total income tax expense of $1.2 million. A current income tax benefit that would normally result from a pre-tax loss was offset by additional deferred tax expense due to an increase in the required valuation allowance. The tax expense recorded in 2010 was largely due to the release of the residual tax effects of changes in the beginning of the year valuation allowance previously allocated to other comprehensive income. These residual tax effects resulted from changes in the deferred tax liability associated with deferred gains on terminated cash flow hedges recorded in other comprehensive income. We expect additional income tax expense of $500,000 during 2011 as a result of the release of the residual tax effects.

 

Since the third quarter of 2008, we have maintained a valuation allowance on our deferred tax assets because we concluded that, based upon the weight of all available evidence, it was “more likely than not” that not all of the deferred tax assets would be realized. The valuation allowance increased $30.6 million during 2010 to $92.7 million at December 31, 2010, compared to $62.1 million at December 31, 2009. The increase in the required valuation allowance was largely due to the increase in our net deferred tax assets and changes in the beginning of the year valuation allowance solely attributable to identifiable events recorded in other comprehensive income, primarily changes in unrealized gains and losses on available-for-sale investment securities, the tax effects of which were allocated to other comprehensive income. At December 31, 2010, the net deferred tax asset, after considering the $92.7 million valuation allowance, was $11.6 million, which was supported by available tax planning strategies. We evaluate the valuation allowance each quarter taking into account our inventory of deferred tax assets and liabilities, including those recorded on items included in equity as other comprehensive income, which are recorded net of tax.

 

During 2009, we reported income tax expense of $834,000 for the year on a pre-tax loss of $30.7 million. Because of the valuation allowance on our deferred tax asset, we were not able to record an income tax benefit related to the pre-tax loss incurred. A current income tax benefit that would normally result from a pre-tax loss was offset by additional deferred tax expense due to an increase in the required valuation allowance. The tax expense recorded in 2009 was largely due to the release of the residual tax effects of changes in the beginning of the year valuation allowance previously allocated to other comprehensive income. These residual tax effects resulted from changes in the deferred tax liability associated with deferred gains on terminated cash flow hedges recorded in other comprehensive income. At December 31, 2009, the net deferred tax asset, after considering the $62.1 million valuation allowance, was $4.6 million, which was supported by available tax planning strategies.

 

During 2008, we reported an income tax benefit of $8.2 million for the year on a pre-tax loss of $132.7 million. We recorded an income tax benefit in 2008 because of our ability to carry back the 2008 pre-tax loss to recover taxes paid in prior years. This benefit was partly offset by the recording of an after-tax, non-cash charge of $46.4 million to establish a valuation allowance against our deferred tax asset. After considering the valuation allowance, at December 31, 2008, we had a net deferred tax asset of $6.9 million which was supported by available carry backs of operating losses to taxes paid in previous years and available tax planning strategies.

 

Impact of Inflation and Changing Prices

 

The consolidated financial statements and notes thereto presented herein have been prepared in accordance with generally accepted accounting principles, which require the measurement of our financial position and operating results in terms of historical amounts without considering the changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the cost of our operations. Unlike industrial companies, nearly all of our assets and liabilities are monetary in nature. As a result, interest rates have a greater impact on our performance than do the effects of the general levels of inflation. Interest rates do not necessarily move in the same direction or, to the same extent, as the price of goods and services.

 

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Financial Condition

 

Total assets increased by $80.4 million, or 1.8%, to $4.48 billion at December 31, 2010, compared to $4.40 billion at December 31, 2009. During 2010, total loan balances increased $59.0 million, or 1.9%, to $3.09 billion at December 31, 2010, compared to $3.04 billion at year-end 2009. Offsetting this increase was a decrease in investment securities, which totaled $1.25 billion at December 31, 2010, compared to $1.27 billion as of December 31, 2009. In addition, other real estate and repossessed assets increased by $5.3 million, or 20.0%, to $31.5 million at December 31, 2010, compared to $26.2 million at December 31, 2009.

 

Total liabilities increased from $4.14 billion as of December 31, 2009 to $4.28 billion as of December 31, 2010. Other borrowings increased $173.3 million, or 51.3%, to $511.0 million at December 31, 2010, compared to $337.7 at December 31, 2009. Total deposits increased $50.1 million, or 1.7%, to $3.03 billion at December 31, 2010, from $2.98 billion at December 31, 2009. However, notes payable and other advances decreased $122.0 million, or 19.5%, in 2010 to $505.0 million at December 31, 2010, compared to $627.0 million at December 31, 2009. Our total stockholders’ equity decreased $50.0 million during 2010 to $208.8 million at December 31, 2010, from $258.8 million at December 31, 2009, primarily due to the net loss incurred during 2010 and partially offset by additional capital raised in 2010.

 

Interest-bearing Cash Equivalents

 

Interest-bearing cash equivalents consist of interest-bearing deposits with banks or other financial institutions, federal funds sold and securities purchased under agreements to resell with original maturities of less than 30 days. All federal funds are sold overnight with daily settlement required.

 

Investment Securities

 

Our investment portfolio is designed to provide a source of income with minimal risk of loss, a source of liquidity and interest rate risk management opportunities. In managing our investment portfolio within the composition of the entire balance sheet, we balance our earnings, credit, interest rate risk, and liquidity considerations, with a goal of maximizing longer-term overall profitability.

 

The following table presents the composition of our investment portfolio by major category as of the dates indicated

 

    AVAILABLE-FOR-SALE     HELD-TO-MATURITY     TOTAL  
    Amortized
cost
    Estimated
fair value
    Amortized
cost
    Estimated
fair value
    Amortized
cost
    Estimated
fair value
 
    (in thousands)  

December 31, 2010:

           

U.S. government sponsored agency securities

  $ 22,994      $ 22,019      $ —        $ —        $ 22,994      $ 22,019   

Mortgage-backed securities:

           

Residential

    863,353        842,386        100,990        101,751        964,343        944,137   

Commercial

    145,529        149,722        —          —          145,529        149,722   

Collateralized mortgage obligations

    66,022        61,902        —          —          66,022        61,902   

State and municipal obligations

    76,873        77,458        —          —          76,873        77,458   
                                               

Total

  $ 1,174,771      $ 1,153,487      $ 100,990      $ 101,751      $ 1,275,761      $ 1,255,238   
                                               

 

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     AVAILABLE-FOR-SALE      HELD-TO-MATURITY      TOTAL  
     Amortized
cost
     Estimated
fair value
     Amortized
cost
     Estimated
fair value
     Amortized
cost
     Estimated
fair value
 
     (in thousands)  

December 31, 2009:

                 

U.S. government sponsored agency securities

   $ 44,956       $ 45,094       $ —         $ —         $ 44,956       $ 45,094   

Mortgage-backed securities:

                 

Residential

     803,516         810,032         —           —           803,516         810,032   

Commercial

     159,688         161,393         —           —           159,688         161,393   

Collateralized mortgage obligations

     127,641         130,098         —           —           127,641         130,098   

State and municipal obligations

     120,716         122,307         —           —           120,716         122,307   

Other debt securities

     2,220         2,347         —           —           2,220         2,347   
                                                     

Total

   $ 1,258,737       $ 1,271,271       $ —         $ —         $ 1,258,737       $ 1,271,271   
                                                     

December 31, 2008:

                 

U.S. government sponsored agency securities

   $ 64,993       $ 66,985       $ —         $ —         $ 64,993       $ 66,985   

Residential mortgage-backed securities

     704,684         722,933         —           —           704,684         722,933   

Collateralized mortgage obligations

     152,198         151,703         —           —           152,198         151,703   

State and municipal obligations

     137,958         138,175         —           —           137,958         138,175   

Other debt securities

     14,563         14,773         25         25         14,588         14,798   
                                                     

Total

   $ 1,074,396       $ 1,094,569       $ 25       $ 25       $ 1,074,421       $ 1,094,594   
                                                     

 

Investment securities do not include investments in FHLB and FRB stock of $40.0 million, $31.2 million, and $29.6 million, at December 31, 2010, 2009, and 2008, respectively. These investments are stated at cost.

 

Our total investment portfolio decreased $16.0 million, or 1.3%, to $1.25 billion at December 31, 2010 as compared to $1.27 billion at December 31, 2009, a decrease of $16.8 million, or 1.3%. During 2010, we decreased the size of our investment portfolio to capture gains on mortgage-backed securities that had higher refinancing risk. During the year, we received $929.4 million of proceeds from the sale of primarily mortgage-backed securities and collateralized mortgage obligations issued by Ginnie Mae, Fannie Mae and Freddie Mac and recorded gains of $41.4 million. We realized gains when we sold mortgage-backed securities that had been experiencing higher than anticipated prepayments and to take advantage of the low level of interest rates and tightening spreads in the market later in the year to reposition our portfolio. Offsetting these sales were purchases of $1.11 billion of mortgage-backed securities and collateralized mortgage obligations. The overall weighted-average life of our investment portfolio at December 31, 2010 was approximately 8.3 years, compared to approximately 6.9 years at December 31, 2009.

 

Mortgage-related securities include residential and commercial mortgage-backed securities and collateralized mortgage obligations, and comprised 92.1% of our investment portfolio at December 31, 2010, compared to 86.6% at December 31, 2009. As of December 31, 2010, over 99% of mortgage-related securities that we held were securities issued by government and government-sponsored enterprises, such as Ginnie Mae, Fannie Mae, and Freddie Mac. We do not hold subprime loans in our mortgage-related investment securities portfolio. While the fair value of these securities has been impacted by market illiquidity, we do not modify the fair value determined by an independent pricing service, but take additional steps to review for other-than-temporary impairment.

 

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The following table shows the composition of our mortgage-related securities as of December 31, 2010 by type of issuer.

 

     Amortized Cost      Fair Value  
     Pass Thru
Securities
     CMOs      Total      Pass Thru
Securities
     CMOs      Total  

Ginnie Mae, Fannie Mae,
Freddie Mac

   $ 1,101,594       $ 66,022       $ 1,167,616       $ 1,087,318       $ 61,902       $ 1,149,220   

Private issuers

     8,278         —           8,278         6,541         —           6,541   
                                                     

Total

   $ 1,109,872       $ 66,022       $ 1,175,894       $ 1,093,859       $ 61,902       $ 1,155,761   
                                                     

 

At December 31, 2010, we had a net unrealized loss on the available-for-sale securities of $21.3 million, or 1.8% of amortized cost, compared to a net unrealized gain on the available for sale securities of $12.5 million, or 1.0% of amortized cost, at December 31, 2009. At December 31, 2010, we held 94 investment securities with a carrying value of $873.3 million that were in a gross unrealized loss position of $29.8 million. We analyzed each of these securities to determine if other-than-temporary impairment has occurred. Our analysis included an evaluation of the type of security; the length of time and extent to which the fair value has been less than the security’s carrying value; the characteristics of the underlying collateral; the degree of credit support provided by subordinate tranches within the total issuance; independent credit ratings; changes in credit ratings; and a cash flow analysis, considering default rates, loss severities based on the location of the collateral and estimated prepayments. Those securities with unrealized losses for more than 12 months and for more than 10% of their carrying value are subjected to further analysis to determine if we expect to receive all the contractual cash flows. We obtained fair value estimates from additional independent sources and performed cash flow analysis to determine if other-than-temporary impairment has occurred. Of the 94 securities with gross unrealized losses at December 31, 2010, only three securities have been in a loss position for 12 months or more, including one security for which we recognized other-than-temporary impairment during the fourth quarter of 2008. Our analysis at December 31, 2010, indicated that these three securities did not have other-than-temporary impairment or did not have any additional other-than-temporary impairment. For additional details, see “Notes to Consolidated Financial Statements–Investment Securities” from our audited financial statements contained elsewhere in this annual report.

 

The other-than-temporary impairment charge that the Company recorded in 2008 was adjusted effective April 1, 2009 when the Company adopted amended accounting guidance on investments in debt and equity securities which modified the requirements for recognizing other-than-temporary impairment and changed the model used to determine the amount of impairment. Under the revised guidance, declines in fair value of investment securities below their amortized costs basis that are deemed to be other-than-temporary are reflected in earnings as a realized loss to the extent the impairment is related to credit loss. The amount of impairment related to other factors is recognized in other comprehensive income. We recorded the cumulative effect of initial application as an adjustment to the opening balance of retained earnings with a corresponding adjustment to other comprehensive income for one private label mortgage-related security for which an other-than-temporary impairment was recognized in the fourth quarter of 2008 through earnings. The amount of the anticipated credit loss on this investment security was $488,000 upon adoption and no additional credit loss has been recorded since the adoption.

 

At December 31, 2010, we held no securities of any single issuer that exceeds 10% of stockholders’ equity, other than U.S. government agencies. Although we hold securities issued by municipalities within the State of Illinois that, in the aggregate, exceed 10% of stockholders’ equity, none of the holdings from any individual municipal issuer exceed this threshold.

 

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As a member, we are required to hold stock in the FHLBC and the FRB, which as of December 31, 2010 and 2009 consisted of the following:

 

     December 31,
2010
     December 31,
2009
 
     (in thousands)  

Federal Home Loan Bank of Chicago (FHLBC)

   $ 29,500       $ 22,250   

Federal Reserve Bank (“FRB”)

     10,532         8,960   
                 
   $ 40,032       $ 31,210   
                 

 

The amount of FHLBC stock required to be held is based on the Bank’s asset size and the amount of borrowings from the FHLBC. After increasing our investment in FHLBC stock earlier in 2009, we sold $5.0 million of stock at par during the fourth quarter of 2009 in response to a decrease in borrowings from the FHLBC. Based on our assessment at December 31, 2010 of the ultimate recoverability of our FHLBC stock, we believe no impairment has occurred. For additional details of these investments, see the “Notes to Consolidated Financial Statements—Investment Securities” from our audited financial statements contained elsewhere in this annual report. We did not hold any FHLBC debt securities in our investment portfolio as of December 31, 2010.

 

The amount of FRB stock required to be held is based on the Bank’s common stock and surplus. The Bank’s surplus increased during 2010 primarily due to the conversion of our Series A Preferred to common stock, which caused the Bank to increase its holdings of FRB stock by $1.6 million.

 

Investment securities with an approximate book value of $892 million and $674 million at December 31, 2010 and 2009, respectively, were pledged to collateralize certain deposits, securities sold under agreements to repurchase, FHLB advances, and for other purposes as required or permitted by law.

 

Investment Portfolio – Maturity and Yields

 

The following table summarizes the contractual maturity of investment securities and their weighted-average yields:

 

    AS OF DECEMBER 31, 2010  
    WITHIN ONE
YEAR
    AFTER ONE
BUT WITHIN
FIVE YEARS
    AFTER FIVE
BUT WITHIN
TEN YEARS
    AFTER TEN
YEARS
    TOTAL  
    AMOUNT     YIELD     AMOUNT     YIELD     AMOUNT     YIELD     AMOUNT     YIELD     AMOUNT     YIELD  
    (dollars in thousands)  

Available-for-sale securities (1):

                   

U.S. government sponsored agency securities

  $ —          —     $ 12,468        2.66   $ 9,551        3.00   $ —          —     $ 22,019        2.81

Mortgage-backed securities (2):

                   

Residential

    116,819        3.51        481,761        3.47        191,433        3.67        52,373        4.14        842,386        3.46   

Commercial

    2,778        4.67        12,501        4.67        91,583        4.63        42,860        4.79        149,722        4.68   

Collateralized mortgage obligations (2)

    9,168        2.75        24,888        2.85        27,846        2.97        —          —          61,902        2.89   

States and municipal obligations (3)

    826        7.03        1,832        7.22        27,840        6.25        46,960        6.18        77,458        6.24   
                                                                               

Total available-for-sale

  $ 129,591        3.51   $ 533,450        3.47   $ 348,253        4.05   $ 142,193        5.01   $ 1,153,487        3.76
                                                                               

Held-to-maturity securities:

                   

Mortgage-backed securities:

                   

Residential

    13,117        4.53        53,322        4.48        29,368        4.54        5,183        4.52        100,990        4.51   
                                                                               

Total held-to-maturity

  $ 13,117        4.53   $ 53,322        4.48   $ 29,368        4.54   $ 5,183        4.52   $ 100,990        4.51
                                                                               

 

(1) Based on estimated fair value.
(2) Maturities of mortgage-backed securities and collateralized mortgage obligations (“CMOs”) are based on anticipated lives of the underlying mortgages, not contractual maturities. CMO maturities are based on cash flow (or payment) windows derived from broker market consensus.
(3) Rates on obligations of states and political subdivisions have been adjusted to tax equivalent yields using a 35% income tax rate.

 

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Loan Portfolio

 

Our primary source of income is interest on loans. The following table presents the composition of our loan portfolio by type of loan as of the dates indicated:

 

     As of December 31,  
     2010     2009     2008     2007     2006  
     (in thousands)  

Loans Held for Portfolio:

          

Commercial and industrial

   $ 1,351,862      $ 1,264,369      $ 1,485,673      $ 850,196      $ 770,863   

Commercial real estate secured

     1,120,361        1,171,777        1,058,930        839,629        791,962   

Residential construction and land

     104,036        221,859        349,998        492,780        605,133   

Commercial construction and land

     106,423        142,584        181,454        178,898        139,184   
                                        

Total commercial loans

     2,682,682        2,800,589        3,076,055        2,361,503        2,307,142   

Residential real estate – mortgages

     71,103        57,887        53,859        60,195        62,453   

Home equity loans and lines of credit

     73,316        86,227        92,085        99,696        116,516   

Consumer loans

     6,384        8,221        9,163        10,551        13,237   

Other loans

     1,854        557        2,115        1,421        1,396   
                                        

Gross loans

     2,835,339        2,953,481        3,233,277        2,533,366        2,500,744   

Less: Unearned discount

     (1     (6     (16     (33     (59
                                        

Total loans

     2,835,338        2,953,475        3,233,261        2,533,333        2,500,685   

Less: Allowance for loan losses

     (124,568     (106,185     (128,548     (54,681     (37,516
                                        

Loans, net

   $ 2,710,770      $ 2,847,290      $ 3,104,713      $ 2,478,652      $ 2,463,169   
                                        

Loans Held for Sale

   $ 259,020      $ 81,853      $ —        $ —        $ —     
                                        

 

Loans Held for Portfolio

 

Our portfolio loans at December 31, 2010 of $2.84 billion represented a decrease of $118.1 million, or 4.0%, as compared to portfolio loans at December 31, 2009 of $2.95 billion and a decrease of $397.9 million, or 12.3%, from $3.23 billion at December 31, 2008. Approximately 95% of our loan portfolio was comprised of commercial loans, which include commercial and industrial, commercial real estate secured, and real estate-construction loans. Total commercial loans decreased to $2.68 billion at year-end, compared to $2.80 billion at December 31, 2009 and $3.08 billion at December 31, 2008. Although we originated new loans during 2010, including the funding of approximately $390.9 million of new commercial loans, this growth was more than offset as we repositioned our portfolio to reduce our exposure in industries and sectors that we no longer consider desirable. In addition, loan charge-offs and low line usage by our customers combined to produce lower commercial loan balances in 2010.

 

Commercial and industrial (“C&I”) loans are loans to businesses or for business purposes that are either unsecured or secured by collateral other than commercial real estate. Total C&I loans increased $87.5 million, or 6.9%, to $1.35 billion at December 31, 2010, compared to $1.26 billion at December 31, 2009. These loans are generally made to operating companies in a variety of businesses, but do not include commercial real estate investment loans. We continue to develop new customer relationships and originate C&I loans as part of our strategy. This realignment resulted in a net increase in our C&I loans during 2010.

 

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Loans secured by commercial real estate consist of commercial owner-occupied properties, as well as investment properties. At December 31, 2010, December 31, 2009 and December 31, 2008, the composition of our commercial real estate secured portfolio by type of collateral was as follows:

 

    December 31, 2010     December 31, 2009     December 31, 2008  
    Balance     Percentage
of Total
Commercial
Real Estate

Loans
    Balance     Percentage
of Total
Commercial
Real Estate

Loans
    Balance     Percentage
of Total
Commercial
Real Estate

Loans
 
    (dollars in thousands)  

Commercial non-owner occupied:

           

Retail strip centers or malls

  $ 198,527        18   $ 211,817        18   $ 206,637        20

Office/mix use property

    126,624        11        149,951        13        145,978        13   

Commercial properties

    153,482        14        144,745        12        130,227        12   

Specialized – other

    123,102        11        121,530        10        92,193        9   

Other commercial properties

    49,857        4        64,602        6        61,478        6   
                                               

Subtotal commercial non-owner occupied

    651,592        58        692,645        59        636,513        60   

Commercial owner occupied

    349,028        31        334,744        29        270,346        26   

Multi-family properties

    119,741        11        144,388        12        152,071        14   
                                               

Total commercial real estate secured

  $ 1,120,361        100   $ 1,171,777        100   $ 1,058,930        100
                                               

 

Total commercial real estate loans were $1.12 billion at December 31, 2010 as compared to $1.17 billion at December 31, 2009, a decrease of $51.4 million, or 4.4%. During 2010, loans secured by commercial owner occupied properties increased by $14.3 million, while loans on commercial non-owner occupied properties decreased by $41.1 million and multi-family property related loans decreased $24.6 million.

 

Total commercial real estate loans were $1.17 billion at December 31, 2009 as compared to $1.06 billion at December 31, 2008, an increase of $112.8 million, or 10.7%. During 2009, loans secured by commercial owner occupied properties increased by $64.4 million, while loans on commercial non-owner occupied properties increased by $56.1 million. Most of the increase in non-owner occupied was in the specialized-other category, which includes loans on properties such as nursing homes, gas stations and convenience stores, churches, and hotels/motels.

 

Real estate construction and land loans consist primarily of loans to professional real estate developers for the construction of single-family homes, town-homes, and condominium conversions. Our residential real estate construction and loan portfolio decreased $117.8 million, or 53.1%, during 2010 to $104.0 million at December 31, 2010, as compared to $221.9 million at December 31, 2009 and $350.0 million at December 31, 2008. Because of the continued slow down in the residential real estate markets and reduced real estate valuations, we have been actively reducing our exposure to this portion of the loan portfolio.

 

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At the dates indicated, the composition of our residential real estate construction and land portfolio by type of collateral was as follows:

 

    December 31, 2010     December 31, 2009     December 31, 2008  
    Balance     Percentage
of Total
Residential
Construction

Loans
    Balance     Percentage
of Total
Residential
Construction

Loans
    Balance     Percentage
of Total
Residential
Construction

Loans
 
    (dollars in thousands)  

Residential construction:

           

Single family attached and detached housing

  $ 13,585        13   $ 55,849        25   $ 105,526        30

Condo (new & conversions)

    39,994        38        54,424        25        95,705        27   

Multi-family

    18,159        18        51,191        23        57,495        17   

Completed for sale

    8,947        9        11,968        5        16,830        5   
                                               

Total residential construction

    80,685        78        173,432        78        275,556        79   

Residential land:

           

Land – unimproved & farmland

    14,049        14        37,317        17        52,321        15   

Land – improved & entitled

    1,871        1        2,271        1        3,921        1   

Land – under development

    7,431        7        8,839        4        18,200        5   
                                               

Total land

    23,351        22        48,427        22        74,442        21   
                                               

Total residential construction and land

  $ 104,036        100   $ 221,859        100   $ 349,998        100
                                               

 

We continue to reduce our commercial construction and land portfolio, which declined $36.2 million, or 25.4%, to $106.4 million at December 31, 2010, as compared to $142.6 million at December 31, 2009, and $181.5 million at December 31, 2008.

 

Our portfolio of residential real estate mortgages totaled $71.1 million at December 31, 2010, as compared to $57.9 million at December 31, 2009 and $53.9 million at December 31, 2008. While these are not loans that we actively marketed in 2010, we do continue to offer these products to our current customers and are not part of Cole Taylor Mortgage.

 

Our portfolio of home equity loans and lines of credit also continues to decline as a result of our decision to discontinue the origination of third-party sourced home equity products in 2002. At December 31, 2010, this portfolio totaled $73.3 million, compared to $86.2 million at December 31, 2009 and $92.1 million at December 31, 2008. This portfolio as a percentage of total loans decreased to 2.6% at year-end 2010.

 

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The following table shows our maturity distribution of loans as of the dates indicated:

 

     As of December 31, 2010(1)  
     ONE YEAR
OR LESS
     OVER 1 YEAR THROUGH
5 YEARS
     OVER 5 YEARS         
            FIXED RATE      FLOATING
OR
ADJUSTABLE
RATE
     FIXED
RATE
     FLOATING
OR
ADJUSTABLE
RATE
     TOTAL  
     (in thousands)  

Commercial and commercial real estate

   $ 919,840       $ 531,384       $ 986,123       $ 13,280       $ 21,596       $ 2,472,223   

Residential construction and land

     101,605         199         2,232         —           —           104,036   

Commercial construction and land

     66,838         11,315         28,270         —           —           106,423   

Residential real estate – mortgages

     9,586         7,373         4,775         26,365         23,004         71,103   

Home equity loans and lines of credit

     10,249         4,172         40,556         156         18,183         73,316   

Consumer

     718         1,626         —           3,743         296         6,383   

Other loans

     1,854         —           —           —           —           1,854   
                                                     

Total loans (excluding loans held for sale)

   $ 1,110,690       $ 556,069       $ 1,061,956       $ 43,544       $ 63,079       $ 2,835,338   
                                                     

 

(1) Maturities are based upon contractual dates. Demand loans are included in the one year or less category and totaled $1.1 million as of December 31, 2010.

 

Loans Held for Sale

 

At December 31, 2010, we held $259.0 million of residential mortgage loans classified as held for sale as compared to $81.9 million of commercial and residential mortgage loans classified as held for sale at December 31, 2009.

 

Loans held for sale at December 31, 2010 are entirely derived from Cole Taylor Mortgage. This business sources mortgages through both retail offices and brokers throughout the United States, as well as through the Chicago based banking centers. Currently, we sell the all the loans originated by this unit to institutional investors rather than hold the loans for portfolio.

 

In 2009, in an effort to reduce the level of nonperforming loans, we decided to sell certain of our commercial nonaccrual loans. In connection with this decision, during the third quarter of 2009, we completed the sale of a group of loans. We also transferred certain other nonaccrual commercial loans into the held for sale category as we actively marketed these loans for sale. Upon transfer into the held for sale category, we recorded a charge-off to reduce the loans to their estimated net fair value.

 

We also had residential mortgage loans classified as held for sale at December 31, 2009, which we intended to sell to third party institutional investors. During the third quarter of 2009, we purchased a participation interest in 20 pools of residential single family mortgages totaling approximately $100 million. These loans were to have been pooled into pass-through certificates to be issued by a mortgage originator and guaranteed by the Government National Mortgage Association, otherwise known as Ginnie Mae, and sold to third party investors. The mortgage originator completed the securitization of a portion of these loans in early August and we received payment for the sale of these loans. However, the mortgage loan originator was not able to securitize the remaining single family loans because Ginnie Mae removed the originator from its list of eligible issuers, so we

 

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took possession of the underlying collateral. During 2010, we sold approximately $40.9 million of these loans for a loss of $2.8 million, compared to sales of approximately $10.5 million of these loans in the fourth quarter of 2009 at a small gain. Any remaining loans were transferred to the loan portfolio by the end of 2010.

 

Nonperforming Assets

 

Our lending officers and their managers are responsible for the ongoing review of present and projected future performance of the loans within their assigned portfolio and for risk rating such loans in accordance with the Bank’s risk rating system. In addition, a loan review function independently risk rates loans to monitor and confirm the reasonableness of the lending officer’s risk rating conclusion. Delinquency reports are reviewed monthly by the lending officers, their managers and credit administration. The responsible lending officer reports to a loan committee about the current status of loans past due or current but graded below a designated level. The committee evaluates whether the loan is appropriately risk rated and determines if the loan should be placed on nonaccrual, the need for a specific allowance for loan loss, or, if appropriate, a partial or full charge-off. Most loans rated substandard or below are transferred to a separate loan work-out department, staffed by collection professionals. We have increased the size of our loan work-out department to effectively handle the increased volume of nonperforming assets. When the loan is transferred to work-out, an independent legal review of the loan documents is performed and current appraisals are obtained for loans secured by real estate.

 

The following table sets forth the amounts of nonperforming loans and nonperforming assets as of the dates indicated:

 

     As of December 31,  
     2010     2009     2008     2007     2006  
     (dollars in thousands)  

Loans contractually past due 90 days or more but still accruing interest

   $ 55      $ 59      $ 153      $ 4,253      $ 10,046   

Nonaccrual loans

     159,685        141,403        200,227        71,412        23,111   
                                        

Total nonperforming loans

     159,740        141,462        200,380        75,665        33,157   

Other real estate owned and repossessed assets

     31,490        26,231        13,179        2,606        412   
                                        

Total nonperforming assets

   $ 191,230      $ 167,693      $ 213,559      $ 78,271      $ 33,569   
                                        

Restructured loans not included in nonperforming assets

   $ 29,786      $ 1,196      $ —        $ —        $ —     

Nonperforming loans to total loans

     5.16     4.66     6.20     2.99     1.33

Nonperforming assets to total loans plus other real estate owned and repossessed assets

     6.12     5.48     6.58     3.09     1.34

Nonperforming assets to total assets

     4.26     3.81     4.87     2.20     0.99

 

The following table presents loans past due 30 to 89 days and still accruing interest as of the dates indicated:

 

     As of December 31,  
     2010     2009     2008     2007     2006  
     (dollars in thousands)  

Loans contractually past due 30 through 89 days and still accruing interest

   $ 11,948      $ 13,206      $ 25,272      $ 63,553      $ 59,199   

30 – 89 days past due to total loans

     0.39 %     0.44     0.78 %     2.51 %     2.37 %

 

Nonperforming Loans

 

Nonperforming loans include nonaccrual loans and interest-accruing loans contractually past due 90 days or more. We evaluate all loans on which principal or interest is contractually past due 90 days or more to determine if they are adequately secured and in the process of collection. If sufficient doubt exists as to the full collection of

 

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principal and interest on a loan, we place it on nonaccrual and we discontinue recognizing interest income. After a loan is placed on nonaccrual status, any current period interest previously accrued but not yet collected is reversed against current income. Interest is included in income subsequent to the date the loan is placed on nonaccrual status only as interest is received and so long as management is satisfied that there is a high probability that principal will be collected in full. The loan is returned to accrual status only when the borrower has made required payments for a minimum length of time and demonstrates the ability to make future payments of principal and interest as scheduled.

 

The following table presents the composition of nonaccrual loans as of the dates indicated:

 

     As of December 31,  

Loan Category

   2010      2009      2008  

Commercial and industrial

   $ 71,438       $ 26,687       $ 42,263   

Commercial real estate secured

     42,221         36,420         23,068   

Residential construction and land

     20,660         62,795         114,160   

Commercial construction and land

     12,734         4,245         14,934   
                          

Total commercial loans

     147,053         130,147         194,425   

Consumer loans

     12,632         11,256         5,802   
                          

Total nonaccrual loans

   $ 159,685       $ 141,403       $ 200,227   
                          

 

After decreasing in 2009, nonaccrual loans increased during 2010 to $159.7 million at December 31, 2010 as compared to $141.4 million at December 31, 2009, an increase of $18.3 million, or 12.9%. Nonaccrual loans at December 31, 2008 were $200.2 million. The increase in total nonaccrual loans during 2010 was due primarily to the deterioration of loans to banks and bank holding companies largely offset by loan charge-offs. The decrease in total nonaccrual loans during 2009 was largely due to $116.2 million of gross loan charge-offs during the year, transfers into other real estate owned of $29.1 million and repayments and other resolutions of certain assets partially offset by new nonaccrual loans.

 

Commercial and industrial is our largest category of nonaccrual loans and comprises approximately 45% of all nonaccrual loans at December 31, 2010. Nonaccrual commercial and industrial loans were $71.4 million at December 31, 2010, as compared to $26.7 million at December 31, 2009 and $42.3 million at December 31, 2008. This increase was primarily due to the deterioration of loans to bank and bank holding companies.

 

Commercial real estate secured loans were our second largest category of nonaccrual loans. This category increased to $42.2 million at December 31, 2010, from $36.4 million at December 31 2009 and $23.1 million at December 31, 2008. New nonaccrual loans, partly offset by charge-offs, resulted in the increase in this category.

 

Residential construction and land loans had previously been our largest category of nonaccrual loans, but were only 12.9% of all nonaccrual loans at December 31, 2010. Residential construction and land nonaccrual loans decreased to $20.7 million at December 31, 2010 as compared to $62.8 million at December 31, 2009 and $114.2 million at December 31, 2008. The decrease in these nonperforming loans during 2010 was due to loan sales, net charge-offs and transfers to other real estate owned.

 

The level of nonaccrual loans in our consumer portfolio increased to $12.6 million at December 31, 2010 from $11.3 million at December 31, 2009 and $5.8 million at December 31, 2008. Approximately 95% of the consumer nonaccrual loans are from our portfolio of home equity loans and lines of credit.

 

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Other Real Estate Owned and Repossessed Assets

 

Other real estate owned and repossessed assets increased from $26.2 million at December 31, 2009 to $31.5 million at December 31, 2010. The following table provides a rollforward, for the periods indicated, of other real estate owned and repossessed assets:

 

     For the Period Ended December 31,  
     2010     2009     2008  

Balance at beginning of period

   $ 26,231      $ 13,179      $ 2,606   

Transfers from loans

     34,725        29,076        14,478   

Additional investment in foreclosed properties

     —          342        1,625   

Dispositions

     (15,957     (14,310     (4,673

Additional impairment

     (13,509     (2,056     (857
                        

Balance at end of period

   $ 31,490      $ 26,231      $ 13,179   
                        

 

During 2010, we transferred $34.7 million from loans into other real estate and repossessed assets. Of the amount transferred, $18.6 million was from our residential construction and land portfolio, $10.7 million was from our commercial real estate secured portfolio, $3.9 million was from our commercial construction and land portfolio. We received proceeds of $16.8 million on assets that had a carrying value of $16.0 million, resulting in a net loss of $800,000, which was included as additional nonperforming asset expense in noninterest expense. We also wrote down the carrying value of certain other real estate owned and repossessed assets by $13.5 million during 2010 to reflect a decrease in the estimated fair value of those assets. During 2009, we transferred $29.1 million from loans into other real estate and repossessed assets. We received net proceeds of $13.6 million on the sale of other real estate owned that had a carrying value of $14.3 million. This resulted in a net loss of $758,000, which was included as additional nonperforming asset expense in noninterest expense. We also wrote down the carrying value of certain other real estate owned and repossessed assets by $2.1 million during 2009 to reflect a decrease in the estimated fair value of those assets. The level of other real estate owned and repossessed assets increased during 2010, and we expect that these assets may continue to increase in the future as we work through the elevated level of nonperforming assets.

 

Impaired Loans

 

After decreasing in 2009, the level of impaired loans also increased during 2010. At December 31, 2010, impaired loans totaled $181.1 million, compared to $141.7 million at December 31, 2009, an increase of $39.4 million, or 27.8%. Total impaired loans were $206.7 million at December 31, 2008.

 

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The balance of impaired loans and the related allowance for loan losses for impaired loans are as follows:

 

     Dec. 31,
2010
     Dec. 31,
2009
     Dec. 31,
2008
 
     (in thousands)  

Impaired loans:

  

Commercial and industrial

   $ 78,804       $ 31,447       $ 54,543   

Commercial real estate secured

     63,831         36,420         23,068   

Residential construction and land

     24,190         68,389         114,160   

Commercial construction and land

     12,734         4,245         14,934   

Consumer-oriented

     1,522         1,196         —     
                          

Total impaired loans

   $ 181,081       $ 141,697       $ 206,705   
                          

Recorded balance of impaired loans:

        

With related allowance for loan losses

   $ 136,404       $ 95,936       $ 120,973   

With no related allowance for loan losses

     44,677         45,761         85,732   
                          

Total impaired loans

   $ 181,081       $ 141,697       $ 206,705   
                          

Allowance for losses on impaired loans:

        

Commercial and industrial