FMBI 09.30.2013 10-Q



 
 
 
 
 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
______________
 
FORM 10-Q
(Mark One)
[X]
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended September 30, 2013
 
 
 
or
 
 
[ ]
Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from _________ to __________.

Commission File Number 0-10967
_______________
 
FIRST MIDWEST BANCORP, INC.
(Exact name of registrant as specified in its charter)
Delaware
 
36-3161078
(State or other jurisdiction of incorporation or organization)
 
(IRS Employer Identification No.)
One Pierce Place, Suite 1500
Itasca, Illinois 60143-9768
(Address of principal executive offices) (zip code)
______________________
 
Registrant’s telephone number, including area code: (630) 875-7450
 
 
______________________

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 [X] No [ ].

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer [X]
 
Accelerated filer [ ]
Non-accelerated filer [ ]
 
Smaller reporting company [ ]
(Do not check if a smaller reporting company)
 
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X].

As of November 8, 2013, there were 75,071,717 shares of $.01 par value common stock outstanding.
 




FIRST MIDWEST BANCORP, INC.

FORM 10-Q

TABLE OF CONTENTS
 
 
Page
Part I.
FINANCIAL INFORMATION
 
 
Item 1.
Financial Statements (Unaudited)
 
 
 
 
 
 
 
 
 
Item 2.
 
 
Item 3.
 
Item 4.
 
Part II.
 
 
Item 1.
 
Item 1A.
 
Item 2.
 
Item 6.

2





PART I. FINANCIAL INFORMATION (Unaudited)

ITEM 1. FINANCIAL STATEMENTS

FIRST MIDWEST BANCORP, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Amounts in thousands, except per share data)
 
September 30,
2013
 
December 31,
2012
Assets
(Unaudited)
 
 
Cash and due from banks
$
155,075

 
$
149,420

Interest-bearing deposits in other banks
744,163

 
566,846

Trading securities, at fair value
16,443

 
14,162

Securities available-for-sale, at fair value
1,162,911

 
1,082,403

Securities held-to-maturity, at amortized cost
29,847

 
34,295

Federal Home Loan Bank (“FHLB”) and Federal Reserve Bank stock, at cost
35,161

 
47,232

Loans, excluding covered loans
5,448,929

 
5,189,676

Covered loans
153,305

 
197,894

Allowance for loan and covered loan losses
(90,828
)
 
(99,446
)
Net loans
5,511,406

 
5,288,124

Other real estate owned (“OREO”), excluding covered OREO
35,616

 
39,953

Covered OREO
10,477

 
13,123

Federal Deposit Insurance Corporation (“FDIC”) indemnification asset
18,078

 
37,051

Premises, furniture, and equipment
118,664

 
121,596

Accrued interest receivable
28,155

 
27,535

Investment in bank-owned life insurance (“BOLI”)
193,979

 
206,405

Goodwill and other intangible assets
277,187

 
281,059

Other assets
180,751

 
190,635

Total assets
$
8,517,913

 
$
8,099,839

Liabilities
 
 
 
Noninterest-bearing deposits
$
2,020,956

 
$
1,762,903

Interest-bearing deposits
4,982,252

 
4,909,352

Total deposits
7,003,208

 
6,672,255

Borrowed funds
212,058

 
185,984

Senior and subordinated debt
214,876

 
214,779

Accrued interest payable and other liabilities
101,046

 
85,928

Total liabilities
7,531,188

 
7,158,946

Stockholders’ Equity
 
 
 
Common stock
858

 
858

Additional paid-in capital
412,677

 
418,318

Retained earnings
839,835

 
786,453

Accumulated other comprehensive loss, net of tax
(26,057
)
 
(15,660
)
Treasury stock, at cost
(240,588
)
 
(249,076
)
Total stockholders’ equity
986,725

 
940,893

Total liabilities and stockholders’ equity
$
8,517,913

 
$
8,099,839

Per Common Share Data
 
 
 
Par Value
$
0.01

 
$
0.01

Shares authorized
100,000

 
100,000

Shares issued
85,787

 
85,787

Shares outstanding
75,074

 
74,840

Treasury shares
10,713

 
10,947

See accompanying notes to the unaudited condensed consolidated financial statements.

3





FIRST MIDWEST BANCORP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Amounts in thousands, except per share data)
(Unaudited)
 
Quarters Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2013
 
2012
 
2013
 
2012
Interest Income
 
 
 
 
 
 
 
Loans, excluding covered loans
$
60,614

 
$
63,672

 
$
179,156

 
$
187,156

Covered loans
3,142

 
3,223

 
10,742

 
11,898

Investment securities
7,742

 
8,058

 
22,755

 
25,406

Other short-term investments
831

 
631

 
2,474

 
1,910

Total interest income
72,329

 
75,584

 
215,127

 
226,370

Interest Expense
 
 
 
 
 
 
 
Deposits
2,837

 
4,126

 
9,160

 
14,317

Borrowed funds
390

 
507

 
1,217

 
1,512

Senior and subordinated debt
3,436

 
3,691

 
10,306

 
11,395

Total interest expense
6,663

 
8,324

 
20,683

 
27,224

Net interest income
65,666

 
67,260

 
194,444

 
199,146

Provision for loan and covered loan losses
4,770

 
111,791

 
16,257

 
152,459

Net interest income (expense) after provision for loan and
  covered loan losses
60,896

 
(44,531
)
 
178,187

 
46,687

Noninterest Income
 
 
 
 
 
 
 
Service charges on deposit accounts
9,472

 
9,502

 
27,267

 
27,010

Card-based fees
5,509

 
5,246

 
16,132

 
15,578

Wealth management fees
6,018

 
5,415

 
17,983

 
16,201

Mortgage banking income
1,273

 
196

 
4,251

 
360

Merchant servicing fees
2,915

 
2,849

 
8,368

 
8,079

Other service charges, commissions, and fees
2,617

 
1,142

 
5,569

 
3,365

Net securities gains (losses)
33,801

 
(217
)
 
34,017

 
(1,009
)
BOLI (loss) income
(13,028
)
 
300

 
(12,428
)
 
952

Gain on termination of FHLB forward commitments
7,829

 
—

 
7,829

 
—

Other income
1,682

 
4,701

 
4,116

 
7,324

Total noninterest income
58,088

 
29,134

 
113,104

 
77,860

Noninterest Expense
 
 
 
 
 
 
 
Salaries and wages
28,257

 
26,881

 
84,040

 
77,990

Retirement and other employee benefits
6,013

 
6,230

 
19,720

 
18,737

Net occupancy and equipment expense
7,982

 
8,108

 
23,922

 
23,952

Technology and related costs
2,984

 
2,906

 
8,351

 
8,615

Professional services
5,517

 
6,665

 
16,330

 
19,199

Net OREO expense
2,849

 
3,208

 
5,732

 
9,196

FDIC premiums
1,734

 
1,785

 
5,180

 
5,163

Other expenses
9,366

 
14,340

 
28,668

 
31,041

Total noninterest expense
64,702

 
70,123

 
191,943

 
193,893

Income (loss) before income tax expense (benefit)
54,282

 
(85,520
)
 
99,348

 
(69,346
)
Income tax expense (benefit)
24,959

 
(36,993
)
 
39,207

 
(35,076
)
Net income (loss)
29,323

 
(48,527
)
 
60,141

 
(34,270
)
Net (income) loss applicable to non-vested restricted shares
(416
)
 
715

 
(847
)
 
500

Net income (loss) applicable to common shares
$
28,907

 
$
(47,812
)
 
$
59,294

 
$
(33,770
)
Per Common Share Data
 
 
 
 
 
 
 
Basic earnings (loss) per common share
$
0.39

 
$
(0.65
)
 
$
0.80

 
$
(0.46
)
Diluted earnings (loss) per common share
$
0.39

 
$
(0.65
)
 
$
0.80

 
$
(0.46
)
Dividends declared per common share
$
0.04

 
$
0.01

 
$
0.09

 
$
0.03

Weighted-average common shares outstanding
74,023

 
73,742

 
73,969

 
73,636

Weighted-average diluted common shares outstanding
74,034

 
73,742

 
73,978

 
73,636

See accompanying notes to the unaudited condensed consolidated financial statements.

4





FIRST MIDWEST BANCORP, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Amounts in thousands)
(Unaudited)
 
Quarters Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2013
 
2012
 
2013
 
2012
Net income (loss)
$
29,323

 
$
(48,527
)
 
$
60,141

 
$
(34,270
)
Available-for-sale securities
 
 
 
 
 
 
 
Unrealized holding gains:
 
 
 
 
 
 
 
Before tax
6,211

 
4,065

 
5,359

 
5,555

Tax effect
(1,993
)
 
(1,574
)
 
(2,151
)
 
(2,123
)
Net of tax
4,218

 
2,491

 
3,208

 
3,432

Reclassification of net gains (losses) included in net income:
 
 
 
 
 
 
Before tax
33,801

 
(217
)
 
34,017

 
(1,009
)
Tax effect
(13,825
)
 
89

 
(13,913
)
 
413

Net of tax
19,976

 
(128
)
 
20,104

 
(596
)
Net unrealized holding (losses) gains
(15,758
)
 
2,619

 
(16,896
)
 
4,028

Unrecognized net pension costs
 
 
 
 
 
 
 
Unrealized holding gains:
 
 
 
 
 
 
 
Before tax
—

 
—

 
10,997

 
—

Tax effect
—

 
—

 
(4,498
)
 
—

Net of tax
—

 
—

 
6,499

 
—

Total other comprehensive (loss) income
(15,758
)
 
2,619

 
(10,397
)
 
4,028

Total comprehensive income (loss)
$
13,565

 
$
(45,908
)
 
$
49,744

 
$
(30,242
)


 
Accumulated
Unrealized
(Loss) Gain
on Securities
Available-
for-Sale
 
Unrecognized
Net Pension
Costs
 
Total
Accumulated
Other
Comprehensive
(Loss) Income
Balance at January 1, 2012
$
(354
)
 
$
(12,922
)
 
$
(13,276
)
Other comprehensive income
4,028

 
—

 
4,028

Balance at September 30, 2012
$
3,674

 
$
(12,922
)
 
$
(9,248
)
Balance at January 1, 2013
$
1,115

 
$
(16,775
)
 
$
(15,660
)
Other comprehensive (loss) income
(16,896
)
 
6,499

 
(10,397
)
Balance at September 30, 2013
$
(15,781
)
 
$
(10,276
)
 
$
(26,057
)
 
See accompanying notes to the unaudited condensed consolidated financial statements.


5





FIRST MIDWEST BANCORP, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(Amounts in thousands, except per share data)
(Unaudited)
 
Common
Shares
Outstanding
 
Common
Stock
 
Additional
Paid-in
Capital
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
(Loss) Income
 
Treasury
Stock
 
Total
Balance at January 1, 2012
74,435

 
$
858

 
$
428,001

 
$
810,487

 
$
(13,276
)
 
$
(263,483
)
 
$
962,587

Comprehensive income
—

 
—

 
—

 
(34,270
)
 
4,028

 
—

 
(30,242
)
Common dividends declared
($0.03 per common share)
—

 
—

 
—

 
(2,241
)
 
—

 
—

 
(2,241
)
Share-based compensation
  expense
—

 
—

 
4,568

 
—

 
—

 
—

 
4,568

Restricted stock activity
398

 
—

 
(15,256
)
 
—

 
—

 
13,980

 
(1,276
)
Treasury stock (purchased for)
  issued to benefit plans
(2
)
 
—

 
(68
)
 
—

 
—

 
107

 
39

Balance at September 30, 2012
74,831

 
$
858

 
$
417,245

 
$
773,976

 
$
(9,248
)
 
$
(249,396
)
 
$
933,435

Balance at January 1, 2013
74,840

 
$
858

 
$
418,318

 
$
786,453

 
$
(15,660
)
 
$
(249,076
)
 
$
940,893

Comprehensive income
—

 
—

 
—

 
60,141

 
(10,397
)
 
—

 
49,744

Common dividends declared
($0.09 per common share)
—

 
—

 
—

 
(6,759
)
 
—

 
—

 
(6,759
)
Share-based compensation
  expense
—

 
—

 
4,366

 
—

 
—

 
—

 
4,366

Restricted stock activity
236

 
—

 
(9,915
)
 
—

 
—

 
8,379

 
(1,536
)
Treasury stock (purchased for)
  issued to benefit plans
(2
)
 
—

 
(92
)
 
—

 
—

 
109

 
17

Balance at September 30, 2013
75,074

 
$
858

 
$
412,677

 
$
839,835

 
$
(26,057
)
 
$
(240,588
)
 
$
986,725


 
See accompanying notes to the unaudited condensed consolidated financial statements.

6





FIRST MIDWEST BANCORP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollar amounts in thousands)
(Unaudited)
 
Nine Months Ended 
 September 30,
 
2013
 
2012
Net cash provided by operating activities
$
104,383

 
$
125,225

Investing Activities
 
 
 
Proceeds from maturities, repayments, and calls of securities available-for-sale
178,256

 
289,839

Proceeds from sales of securities available-for-sale
69,428

 
50,633

Purchases of securities available-for-sale
(326,143
)
 
(515,064
)
Proceeds from maturities, repayments, and calls of securities held-to-maturity
7,084

 
52,107

Purchases of securities held-to-maturity
(2,636
)
 
(33,593
)
Proceeds from the redemption of FHLB stock
12,071

 
11,918

Net increase in loans
(233,844
)
 
(310,269
)
(Purchases) of BOLI, net of proceeds from claims
(2
)
 
1,144

Proceeds from sales of OREO
20,715

 
42,379

Proceeds from sales of premises, furniture, and equipment
1,425

 
3

Purchases of premises, furniture, and equipment
(6,586
)
 
(6,298
)
Proceeds received from the FDIC in an FDIC-assisted transaction
—

 
21,996

Other cash proceeds received in an FDIC-assisted transaction
—

 
4,984

Net cash used in investing activities
(280,232
)
 
(390,221
)
Financing Activities
 
 
 
Net increase in deposit accounts
330,953

 
197,162

Net increase (decrease) in borrowed funds
26,074

 
(31,636
)
Payments for the retirement of subordinated debt
—

 
(20,004
)
Proceeds received from the termination of FHLB forward commitments
7,829

 
—

Cash dividends paid
(4,502
)
 
(2,238
)
Restricted stock activity
(1,588
)
 
(1,414
)
Excess tax benefit (expense) related to share-based compensation
55

 
(30
)
Net cash provided by financing activities
358,821

 
141,840

Net increase (decrease) in cash and cash equivalents
182,972

 
(123,156
)
Cash and cash equivalents at beginning of period
716,266

 
641,530

Cash and cash equivalents at end of period
$
899,238

 
$
518,374

Supplemental Disclosures:
 
 
 
Non-cash transfers of loans to OREO
$
15,189

 
$
33,383

Non-cash transfer of loans held-for-investment to loans held-for-sale
1,275

 
92,292

Non-cash transfer of loans held-for-sale to loans held-for-investment
—

 
1,500

Non-cash transfer of an investment from other assets to securities available-for-sale
2,787

 
—

Dividends declared but unpaid
3,006

 
749

 
See accompanying notes to the unaudited condensed consolidated financial statements.

7





NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation – The accompanying unaudited condensed consolidated interim financial statements of First Midwest Bancorp, Inc. (the “Company”), a Delaware corporation, were prepared in accordance with the rules and regulations of the SEC for quarterly reports on Form 10-Q and reflect all adjustments that management deems necessary for the fair presentation of the financial position and results of operations for the periods presented. The results of operations for the quarter and nine-month periods ended September 30, 2013 are not necessarily indicative of the results that may be expected for the year ending December 31, 2013.

The accounting and reporting policies of the Company and its subsidiaries conform to U.S. generally accepted accounting principles (“GAAP”) and general practices within the banking industry. The accompanying quarterly statements do not include certain information and footnote disclosures required by GAAP for complete annual financial statements. Therefore, these financial statements should be read in conjunction with the Company’s 2012 Annual Report on Form 10-K (“2012 10-K”). The Company uses the accrual basis of accounting for financial reporting purposes. Certain reclassifications were made to prior year amounts to conform to the current year presentation.

Use of Estimates – The preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Although these estimates and assumptions are based on the best available information, actual results could differ from those estimates.

Principles of Consolidation – The accompanying consolidated financial statements include the financial position and results of operations of the Company and its subsidiaries after elimination of all significant intercompany accounts and transactions. Assets held in a fiduciary or agency capacity are not assets of the Company or its subsidiaries and are not included in the consolidated financial statements.

The Company owns interests in certain variable interest entities (“VIEs”) as described in Note 21, “Variable Interest Entities,” in the Company’s 2012 10-K. A VIE is a partnership, limited liability company, trust, or other legal entity that does not have sufficient equity to finance its activities without additional subordinated financial support from other parties, or whose investors lack the characteristics associated with owning a controlling financial interest. The VIEs are not consolidated in the Company’s financial statements since the Company is not the primary beneficiary of any of the VIEs.

The accounting policies related to loans, the allowance for credit losses, the FDIC indemnification asset, and derivative financial instruments are presented below. For a summary of all other significant accounting policies, please refer to Note 1, “Summary of Significant Accounting Policies,” in the Company’s 2012 10-K.

Loans – Loans held-for-investment are loans that the Company intends to hold until they are paid in full and are carried at the principal amount outstanding, including certain net deferred loan origination fees. Interest income on loans is accrued based on principal amounts outstanding. Loan origination fees, commitment fees, and certain direct loan origination costs are deferred, and the net amount is amortized as a yield adjustment over the contractual life of the related loans or commitments and included in interest income. Fees related to standby letters of credit are amortized into fee income over the contractual life of the commitment. Other credit-related fees are recognized as fee income when earned. Loans held-for-sale are carried at the lower of aggregate cost or fair value and included in other assets in the Consolidated Statements of Financial Condition.

Purchased Impaired Loans – Purchased impaired loans are recorded at fair value on the acquisition date and are accounted for prospectively based on estimates of expected cash flows. No allowance for credit losses is recorded on these loans at the acquisition date. To estimate the fair value, the Company generally aggregates purchased consumer loans and certain smaller balance commercial loans into pools of loans with common risk characteristics, such as delinquency status, credit score, and internal risk rating. The fair values of larger balance commercial loans are estimated on an individual basis. Expected future cash flows in excess of the fair value of loans at the purchase date (“accretable yield”) are recorded as interest income over the life of the loans if the timing and amount of the future cash flows can be reasonably estimated. The non-accretable yield represents the difference between contractually required payments and the cash flows expected to be collected at acquisition.

Subsequent increases in cash flows are recognized as interest income prospectively. The present value of any decreases in expected cash flows is recognized by recording a charge-off through the allowance for loan and covered loan losses or establishing an allowance for loan and covered loan losses.

8





Non-accrual Loans – Generally, corporate loans are placed on non-accrual status (i) when either principal or interest payments become 90 days or more past due based on contractual terms unless the loan is sufficiently collateralized such that full repayment of both principal and interest is expected and is in the process of collection within a reasonable period or (ii) when an individual analysis of a borrower’s creditworthiness indicates a credit should be placed on non-accrual status whether or not the loan is 90 days or more past due. When a loan is placed on non-accrual status, unpaid interest credited to income in the current year is reversed, and unpaid interest accrued in prior years is charged against the allowance for loan losses. After the loan is placed on non-accrual, all debt service payments are applied to the principal on the loan. Future interest income may only be recorded on a cash basis after recovery of principal is reasonably assured. Non-accrual loans are returned to accrual status when the financial position of the borrower and other relevant factors indicate that the Company will collect all principal and interest.

Commercial loans and loans secured by real estate are charged-off when deemed uncollectible. A loss is recorded if the net realizable value of the underlying collateral is less than the outstanding principal and interest. Consumer loans that are not secured by real estate are subject to mandatory charge-off at a specified delinquency date and are usually not classified as non-accrual prior to being charged-off. Closed-end consumer loans, which include installment, automobile, and single payment loans, are usually charged-off no later than the end of the month in which the loan becomes 120 days past due.

Purchased impaired loans are generally considered accruing loans unless reasonable estimates of the timing and amount of future cash flows cannot be determined. Loans without reasonable cash flow estimates are classified as non-accrual loans, and interest income is not recognized on those loans until the timing and amount of the future cash flows can be reasonably determined.

Troubled Debt Restructurings (“TDRs”) – A restructuring is considered a TDR when (i) the borrower is experiencing financial difficulties and (ii) the creditor grants a concession, such as forgiveness of principal, reduction of the interest rate, changes in payments, or extension of the maturity date. Loans are not classified as TDRs when the modification is short-term or results in an insignificant delay in payments. The Company’s TDRs are determined on a case-by-case basis.

The Company does not accrue interest on a TDR unless it believes collection of all principal and interest under the modified terms is reasonably assured. For a TDR to begin accruing interest, the borrower must demonstrate both some level of past performance and the future capacity to perform under the modified terms. Generally, six months of consecutive payment performance under the restructured terms is required before a TDR is returned to accrual status. However, the period could vary depending on the individual facts and circumstances of the loan. An evaluation of the borrower’s current creditworthiness is used to assess the borrower’s capacity to repay the loan under the modified terms. This evaluation includes an estimate of expected cash flows, evidence of strong financial position, and estimates of the value of collateral, if applicable. However, these TDRs continue to be separately reported as restructured until after the calendar year in which the restructuring occurred. If the loan was restructured at below market rates and terms, it continues to be separately reported as restructured until it is paid in full or charged-off.

Impaired Loans – Impaired loans consist of corporate non-accrual loans and TDRs.

A loan is considered impaired when it is probable that the Company will not collect all contractual principal and interest based on current information and events. Impaired loans are classified as non-accrual and are exclusive of smaller homogeneous loans, such as home equity, 1-4 family mortgages, and installment loans. After a loan is designated as impaired, all debt service payments are applied to the principal of the loan. Future interest income may only be recorded on a cash basis after recovery of principal is reasonably assured.

Impaired loans with balances under a specified threshold are not individually evaluated for impairment. For all other impaired loans, impairment is measured by comparing the estimated value of the loan to the recorded book value. The value of collateral-dependent loans is based on the fair value of the underlying collateral, less costs to sell. The value of other loans is measured using the present value of expected future cash flows discounted at the loan’s initial effective interest rate. All impaired loans are included in non-performing assets. Purchased impaired loans are not reported as impaired loans provided that estimates of the timing and amount of future cash flows can be reasonably determined.

90-Days Past Due Loans –The Company’s accrual of interest on loans is discontinued at the time the loan is 90 days past due unless the credit is sufficiently collateralized and in the process of renewal or collection.

Allowance for Credit Losses – The allowance for credit losses is comprised of the allowance for loan losses, the allowance for covered loan losses, and the reserve for unfunded commitments, and is maintained by management at a level believed adequate to absorb estimated losses inherent in the existing loan portfolio. Determination of the allowance for credit losses is subjective since it requires significant estimates and management judgment, including the amounts and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans, consideration of current economic trends, and other factors.


9





Loans deemed to be uncollectible are charged-off against the allowance for loan and covered loan losses, while recoveries of amounts previously charged-off are credited to the allowance for loan and covered loan losses. Additions to the allowance for loan and covered loan losses are charged to expense through the provision for loan and covered loan losses. The amount of provision depends on a number of factors, including net charge-off levels, loan growth, changes in the composition of the loan portfolio, and the Company’s assessment of the allowance for loan and covered loan losses based on the methodology discussed below.

Allowance for Loan Losses – The allowance for loan losses consists of (i) specific reserves established for probable losses on individual loans where the recorded investment exceeds the value, (ii) an allowance based on a loss migration analysis that uses historical credit loss experience for each loan category, and (iii) the impact of other internal and external qualitative factors.

The specific reserves component of the allowance for loan losses is based on a periodic analysis of impaired loans exceeding a fixed dollar amount. If the value of an impaired loan is less than the recorded book value, the Company either establishes a valuation allowance (i.e., a specific reserve) equal to the excess of the book value over the value of the loan as a component of the allowance for loan losses or charges off the amount if it is a confirmed loss.

The general reserve component is based on a loss migration analysis, which examines actual loss experience for a rolling 8-quarter period by loan category and the related internal risk rating for corporate loans. The loss migration analysis is updated quarterly using actual loss experience. This component is then adjusted based on management’s consideration of many internal and external qualitative factors, including:

•
Changes in the composition of the loan portfolio, trends in the volume of loans, and trends in delinquent and non-accrual loans that could indicate that historical trends do not reflect current conditions.
•
Changes in credit policies and procedures, such as underwriting standards and collection, charge-off, and recovery practices.
•
Changes in the experience, ability, and depth of credit management and other relevant staff.
•
Changes in the quality of the Company’s loan review system and Board of Directors oversight.
•
The effect of any concentration of credit and changes in the level of concentrations, such as loan type or risk rating.
•
Changes in the value of the underlying collateral for collateral-dependent loans.
•
Changes in the national and local economy that affect the collectability of various segments of the portfolio.
•
The effect of other external factors, such as competition and legal and regulatory requirements, on the Company’s loan portfolio.

Allowance for Covered Loan Losses – The Company’s allowance for covered loan losses reflects the difference between the carrying value and the discounted present value of the estimated cash flows of the covered purchased impaired loans. On a periodic basis, the adequacy of this allowance is determined through a re-estimation of cash flows on all of the outstanding covered purchased impaired loans using either a probability of default/loss given default (“PD/LGD”) methodology or a specific review methodology. The PD/LGD model is an expected loss model that estimates future cash flows using a probability of default curve and loss given default estimates.

Reserve for Unfunded Commitments – The Company also maintains a reserve for unfunded commitments, including letters of credit, for the risk of loss inherent in these arrangements. The reserve for unfunded commitments is estimated using the loss migration analysis from the allowance for loan losses, adjusted for probabilities of future funding requirements. The reserve for unfunded commitments is included in other liabilities in the Consolidated Statements of Financial Condition.

The establishment of the allowance for credit losses involves a high degree of judgment given the difficulty of assessing the factors impacting loan repayment and estimating the timing and amount of losses. While management utilizes its best judgment and information available, the adequacy of the allowance for credit losses depends on a variety of factors beyond the Company’s control, including the performance of its loan portfolio, the economy, changes in interest rates and property values, and the interpretation of loan risk classifications by regulatory authorities.

FDIC Indemnification Asset – The majority of loans and OREO acquired through FDIC-assisted transactions are covered by loss share agreements with the FDIC (the “FDIC Agreements”), under which the FDIC reimburses the Company for the majority of the losses and eligible expenses related to these assets. The FDIC indemnification asset represents the present value of future expected reimbursements from the FDIC. Since the indemnified items are covered loans and covered OREO, which are initially measured at fair value, the FDIC indemnification asset is also initially measured at fair value by discounting the cash flows expected to be received from the FDIC. These cash flows are estimated by multiplying estimated losses on purchased impaired loans and OREO by the reimbursement rates in the FDIC Agreements.


10





The balance of the FDIC indemnification asset is adjusted periodically to reflect changes in estimated cash flows. Decreases in expected cash flows on the indemnification asset are recorded prospectively through amortization and increases in estimated reimbursements from the FDIC are recognized by an increase in the carrying value of the indemnification asset. Payments from the FDIC for reimbursement of losses result in a reduction of the FDIC indemnification asset.

Derivative Financial Instruments – In the ordinary course of business, the Company enters into derivative transactions as part of its overall interest rate risk management strategy to minimize significant unplanned fluctuations in earnings and cash flows caused by interest rate volatility. All derivative instruments are recorded at fair value as either other assets or other liabilities in the Consolidated Statements of Financial Condition. Subsequent changes in a derivative’s fair value are recognized in earnings unless specific hedge accounting criteria are met.

On the date the Company enters into a derivative contract, the derivative is designated as a fair value hedge, a cash flow hedge, or a non-hedge derivative instrument. Fair value hedges are designed to mitigate exposure to changes in the fair value of an asset or liability attributable to a particular risk, such as interest rate risk. Cash flow hedges are designed to mitigate exposure to variability in expected future cash flows to be received or paid related to an asset, liability, or other type of forecasted transaction. The Company formally documents all relationships between hedging instruments and hedged items, including its risk management objective and strategy for undertaking each hedge transaction.

At the hedge’s inception and quarterly thereafter, a formal assessment is performed to determine the effectiveness of the derivative in offsetting changes in the fair values or cash flows of the hedged items in the current period and prospectively. If a derivative instrument designated as a hedge is terminated or ceases to be highly effective, hedge accounting is discontinued prospectively, and the gain or loss is amortized into earnings. For fair value hedges, the gain or loss is amortized over the remaining life of the hedged asset or liability. For cash flow hedges, the gain or loss is amortized over the same period that the forecasted hedged transactions impact earnings. If the hedged item is disposed of, any fair value adjustments are included in the gain or loss from the disposition of the hedged item. If the forecasted transaction is no longer probable, the gain or loss is included in earnings immediately.

For effective fair value hedges, changes in the fair value of the derivative instruments, as well as changes in the fair value of the hedged item, are recognized in earnings. For cash flow hedges, the effective portion of the change in fair value of the derivative instrument is reported as a component of accumulated other comprehensive loss. The unrealized gain or loss is reclassified into earnings in the same period the hedged transaction affects earnings.

Ineffectiveness is calculated based on the change in fair value of the hedged item compared with the change in fair value of the hedging instrument. For all types of hedges, any ineffectiveness in the hedging relationship is recognized in earnings during the period the ineffectiveness occurs.

2.  RECENT ACCOUNTING PRONOUNCEMENTS

Balance Sheet – Disclosures about Offsetting Assets and Liabilities: In December of 2011, the FASB issued guidance on the presentation of offsetting assets and liabilities on the balance sheet, which was further clarified in January 2013. This guidance requires an entity to disclose both the gross information and net information regarding instruments and transactions eligible for offset, such as derivatives, sale and repurchase agreements, and securities borrowing and lending arrangements. The statement was effective for annual and interim periods beginning on or after January 1, 2013. The Company’s derivative assets and liabilities are presented gross, rather than net, in the Consolidated Statements of Financial Condition. The adoption of this guidance on January 1, 2013 did not impact the Company’s financial condition, results of operations, or liquidity.

Technical Corrections and Improvements: In October of 2012, the FASB issued guidance to update the Accounting Standards Codification (the “Codification”) on a variety of topics, which include source literature amendments, guidance clarification and reference corrections, and relocated guidance. In addition, the standard includes amendments to conform terminology and clarifies certain fair value guidance in the Codification. Amendments that do not have transition guidance were effective immediately, and amendments subject to transition guidance were effective for fiscal periods beginning after December 15, 2012. The adoption of this guidance on January 1, 2013 did not materially impact the Company’s financial condition, results of operations, or liquidity.

Reporting Amounts Reclassified Out of Accumulated Other Comprehensive Income: In February of 2013, the FASB issued guidance to improve the reporting of reclassifications out of accumulated other comprehensive income. The amendments require an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component on either the face of the income statement or as a separate disclosure in the notes to the financial statements. This guidance was effective for fiscal periods beginning after December 15, 2012. The Company provides disclosures related to amounts reclassified out of accumulated other comprehensive income in Note 3, “Securities.” Since this guidance only impacted the placement of

11





certain disclosures in the financial statements, the adoption of this guidance on January 1, 2013 did not impact the Company’s financial condition, results of operations, or liquidity.

3.  SECURITIES

Securities are generally classified as held-to-maturity, trading, or available-for-sale at the time of purchase. Securities classified as held-to-maturity are securities for which management has the positive intent and ability to hold to maturity and are stated at cost.

The Company’s trading securities consist of diversified investment securities reported at fair value that are held in a grantor trust under deferred compensation arrangements that allow plan participants to direct amounts into a variety of securities, including Company stock. Net trading gains represent changes in the fair value of the trading securities portfolio and are included in other noninterest income in the Condensed Consolidated Statements of Income.

All other securities are classified as available-for-sale and are carried at fair value with unrealized gains and losses, net of related deferred income taxes, recorded in stockholders’ equity as a separate component of accumulated other comprehensive loss.

Securities Portfolio
(Dollar amounts in thousands)
 
September 30, 2013
 
December 31, 2012
 
Amortized
 
Gross Unrealized
 
Fair
 
Amortized
 
Gross Unrealized
 
Fair
 
Cost
 
Gains
 
Losses
 
Value
 
Cost
 
Gains
 
Losses
 
Value
Securities Available-for-Sale
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. agency securities
$
501

 
$
—

 
$
—

 
$
501

 
$
508

 
$
—

 
$
—

 
$
508

Collateralized mortgage
    obligations (“CMOs”)
516,162

 
1,814

 
(11,940
)
 
506,036

 
397,146

 
3,752

 
(515
)
 
400,383

Other mortgage-backed
    securities (“MBSs”)
139,312

 
3,542

 
(1,552
)
 
141,302

 
117,785

 
5,183

 
(68
)
 
122,900

Municipal securities
464,176

 
11,787

 
(4,704
)
 
471,259

 
495,906

 
24,623

 
(486
)
 
520,043

Trust-preferred
    collateralized debt
    obligations (“CDOs”)
46,532

 
—

 
(29,536
)
 
16,996

 
46,533

 
—

 
(34,404
)
 
12,129

Corporate debt securities
13,000

 
1,993

 
—

 
14,993

 
13,006

 
2,333

 
—

 
15,339

Equity securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Hedge fund investment
1,208

 
1,642

 
—

 
2,850

 
1,231

 
385

 
—

 
1,616

Other equity securities
8,849

 
184

 
(59
)
 
8,974

 
8,459

 
1,026

 
—

 
9,485

Total equity securities
10,057

 
1,826

 
(59
)
 
11,824

 
9,690

 
1,411

 
—

 
11,101

Total available-for-
  sale securities
$
1,189,740

 
$
20,962

 
$
(47,791
)
 
$
1,162,911

 
$
1,080,574

 
$
37,302

 
$
(35,473
)
 
$
1,082,403

Securities Held-to-Maturity
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Municipal securities
$
29,847

 
$
—

 
$
(305
)
 
$
29,542

 
$
34,295

 
$
1,728

 
$
—

 
$
36,023

Trading Securities
 
 
 
 
 
 
$
16,443

 
 
 
 
 
 
 
$
14,162




12





Remaining Contractual Maturity of Securities
(Dollar amounts in thousands)
 
September 30, 2013
 
Available-for-Sale
 
Held-to-Maturity
 
Amortized
Cost
 
Fair Value
 
Amortized
Cost
 
Fair Value
One year or less
$
5,078

 
$
4,880

 
$
3,185

 
$
3,153

After one year to five years
293,418

 
281,966

 
6,540

 
6,473

After five years to ten years
121,548

 
116,804

 
10,274

 
10,169

After ten years
104,165

 
100,099

 
9,848

 
9,747

Securities that do not have a single contractual maturity
665,531

 
659,162

 
—

 
—

Total
$
1,189,740

 
$
1,162,911

 
$
29,847

 
$
29,542


The carrying value of securities available-for-sale that were pledged to secure deposits and for other purposes as permitted or required by law totaled $989.4 million at September 30, 2013 and $675.3 million at December 31, 2012. No securities held-to-maturity were pledged as of September 30, 2013 or December 31, 2012.

Purchases and sales of securities are recognized on a trade date basis. Realized securities gains or losses are reported in net securities gains (losses) in the Condensed Consolidated Statements of Income. The cost of securities sold is based on the specific identification method.
Securities Gains (Losses)
(Dollar amounts in thousands)
 
Quarters Ended
September 30,
 
Nine Months Ended
September 30,
 
2013
 
2012
 
2013
 
2012
Proceeds from sales
$
49,683

 
$
38,574

 
$
69,428

 
$
50,633

Gains (losses) on sales of securities:
 
 
 
 
 
 
 
Gross realized gains
34,205

 
131

 
34,421

 
1,734

Gross realized losses
—

 
(348
)
 
—

 
(601
)
Net realized gains (losses) on securities sales
34,205

 
(217
)
 
34,421

 
1,133

Non-cash impairment charges:
 
 
 
 
 
 
 
Other-than-temporary securities impairment (“OTTI”)
(404
)
 
—

 
(404
)
 
(2,328
)
 Portion of OTTI recognized in other comprehensive loss
—

 
—

 
—

 
186

Net non-cash impairment charges
(404
)
 
—

 
(404
)
 
(2,142
)
Net realized gains (losses)
33,801

 
(217
)
 
34,017

 
(1,009
)
Income tax expense (benefit) on net realized gains (losses)
13,825

 
(89
)
 
13,913

 
(413
)
Net amount reclassified from accumulated other
   comprehensive loss
$
19,976

 
$
(128
)
 
$
20,104

 
$
(596
)
Net trading gains (1)
$
882

 
$
685

 
$
2,132

 
$
1,511


(1) 
All net trading gains relate to trading securities still held as of September 30, 2013 and September 30, 2012.

Net gains realized on securities for the third quarter and nine months ended September 30, 2013 were $34.2 million and $34.4 million, respectively. During the third quarter of 2013, the Company sold its investment in an equity security which resulted in a $34.2 million gain.

The non-cash impairment charges in the table above relate to OTTI charges on municipal securities and CDOs. Accounting guidance requires that the credit portion of an OTTI charge be recognized through income. If a decline in fair value below carrying value is not attributable to credit deterioration and the Company does not intend to sell the security or believe it would not be more likely than not required to sell the security prior to recovery, the Company records the non-credit related portion of the decline in fair value in other comprehensive income. In deriving the credit component of the impairment on the CDOs, projected cash flows were discounted at the contractual rate and compared to the fair values computed by discounting future projected cash flows at the London Interbank Offered Rate (“LIBOR”) plus an adjustment to reflect the higher risk inherent in these securities given their complex structures and the impact of market factors.

13






OTTI on CDOs
(Dollar amounts in thousands)
 
 
Quarters Ended
September 30,
 
Nine Months Ended
September 30,
 
 
CDO Number
 
2013
 
2012
 
2013
 
2012
 
Life-to-Date
1
 
$
—

 
$
—

 
$
—

 
$
—

 
$
10,360

2
 
—

 
—

 
—

 
1,535

 
9,402

3
 
—

 
—

 
—

 
591

 
2,262

4
 
—

 
—

 
—

 
—

 
1,078

5
 
—

 
—

 
—

 
—

 
8,570

6
 
—

 
—

 
—

 
—

 
243

 
 
$
—

 
$
—

 
$
—

 
$
2,126

 
$
31,915


The following table presents a rollforward of life-to-date credit losses recognized in earnings attributable to available-for-sale debt securities held by the Company for the quarters and nine months ended September 30, 2013 and 2012.

Changes in Losses Recognized in Earnings
(Dollar amounts in thousands)
 
Quarters Ended
September 30,
 
Nine Months Ended
September 30,
 
2013
 
2012
 
2013
 
2012
Cumulative amount recognized at the beginning of the period
$
32,053

 
$
38,667

 
$
38,803

 
$
36,525

Credit losses included in earnings (1):
 
 
 
 
 
 
 
Losses recognized on securities that
  previously had credit losses
—

 
—

 
—

 
2,142

Losses recognized on securities that did not
   previously have credit losses
404

 
—

 
404

 
—

Reduction for securities sales (2)
(39
)
 
—

 
(6,789
)
 
—

Cumulative amount recognized at the end of the period
$
32,418

 
$
38,667

 
$
32,418

 
$
38,667


(1) 
Included in net securities gains (losses) in the Condensed Consolidated Statements of Income.
(2) 
During the nine months ended September 30, 2013, one CDO with a carrying value of zero was sold, resulting in a gain of $101,000. This CDO had OTTI of $6.8 million that was previously recognized in earnings.

The following table presents the aggregate amount of unrealized losses and the aggregate related fair values of securities with unrealized losses as of September 30, 2013 and December 31, 2012.


14





Securities in an Unrealized Loss Position
(Dollar amounts in thousands)
 
 
 
Less Than 12 Months
 
12 Months or Longer
 
Total
 
Number of
Securities
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
As of September 30, 2013
 
 
 
 
 
 
 
 
 
 
 
 
 
CMOs
63

 
$
300,791

 
$
9,666

 
$
93,536

 
$
2,274

 
$
394,327

 
$
11,940

Other MBSs
16

 
56,021

 
1,551

 
257

 
1

 
56,278

 
1,552

Municipal securities
146

 
84,725

 
4,544

 
3,136

 
160

 
87,861

 
4,704

CDOs
6

 
—

 
—

 
16,996

 
29,536

 
16,996

 
29,536

Equity securities
1

 
2,185

 
59

 
—

 
—

 
2,185

 
59

Total
232

 
$
443,722

 
$
15,820

 
$
113,925

 
$
31,971

 
$
557,647

 
$
47,791

As of December 31, 2012
 
 
 
 
 
 
 
 
 
 
 
 
 
CMOs
19

 
$
102,939

 
$
421

 
$
12,796

 
$
94

 
$
115,735

 
$
515

Other MBSs
6

 
7,210

 
55

 
176

 
13

 
7,386

 
68

Municipal securities
49

 
28,903

 
459

 
1,238

 
27

 
30,141

 
486

CDOs
6

 
—

 
—

 
12,129

 
34,404

 
12,129

 
34,404

Total
80

 
$
139,052

 
$
935

 
$
26,339

 
$
34,538

 
$
165,391

 
$
35,473


Substantially all of the Company’s CMOs and other MBSs are either backed by U.S. government-owned agencies or issued by U.S. government-sponsored enterprises. Municipal securities are issued by municipal authorities, and the majority are supported by third-party insurance or some other form of credit enhancement. Management does not believe any remaining individual unrealized loss as of September 30, 2013 represents an OTTI attributable to credit quality. In addition, the Company does not intend to sell the securities with unrealized losses, and it is not more likely than not that the Company will be required to sell them before recovery of their amortized cost basis, which may be at maturity.

The unrealized losses on CDOs as of September 30, 2013 reflect the illiquidity of these structured investment vehicles. Management does not believe these unrealized losses represent OTTI related to credit deterioration. In addition, the Company does not intend to sell the CDOs with unrealized losses within a short period of time, and the Company does not believe it is more likely than not that it will be required to sell them before recovery of their amortized cost basis, which may be at maturity.

Significant judgment is required to calculate the fair value of the CDOs, all of which are pooled. The Company estimates the fair value of these securities using a discounted cash flow analysis with the assistance of a structured credit valuation firm. For additional discussion of the CDO valuation methodology, refer to Note 12, “Fair Value.”


15





4.  LOANS

Loans Held-for-Investment

Loans that the Company intends to hold until they are paid in full or mature are classified as loans held-for-investment. The following table presents the Company’s loans held-for-investment by class.

Loan Portfolio
(Dollar amounts in thousands)
 
September 30,
2013
 
December 31,
2012
Commercial and industrial
$
1,792,561

 
$
1,631,474

Agricultural
318,659

 
268,618

Commercial real estate:
 
 
 
Office, retail, and industrial
1,336,864

 
1,333,191

Multi-family
332,749

 
285,481

Residential construction
46,424

 
61,462

Commercial construction
128,748

 
124,954

Other commercial real estate
790,114

 
773,121

Total commercial real estate
2,634,899

 
2,578,209

Total corporate loans
4,746,119

 
4,478,301

Home equity
377,015

 
390,033

1-4 family mortgages
286,333

 
282,948

Installment
39,462

 
38,394

Total consumer loans
702,810

 
711,375

Total loans, excluding covered loans
5,448,929

 
5,189,676

Covered loans (1)
153,305

 
197,894

Total loans
$
5,602,234

 
$
5,387,570

Deferred loan fees included in total loans
$
4,980

 
$
5,941

Overdrawn demand deposits included in total loans
2,409

 
4,451


(1) 
For information on covered loans, refer to Note 5, “Acquired Loans.”

The Company primarily lends to small and mid-sized businesses, commercial real estate customers, and consumers in the Company’s markets. Within these areas, the Company diversifies its loan portfolio by loan type, industry, and borrower.

It is the Company’s policy to review each prospective credit to determine the appropriateness and the adequacy of security or collateral prior to making a loan. In the event of borrower default, the Company seeks recovery in compliance with state lending laws, the Company’s lending standards, and credit monitoring and remediation procedures. A discussion of risk characteristics relevant to each portfolio segment is presented in Note 4, “Loans,” in the Company’s 2012 10-K.

Mortgage Loan Sales

During the quarter ended September 30, 2013, the Company sold $36.1 million of mortgage loans at a gain of $1.0 million, which is included in mortgage banking income in the Consolidated Statements of Income. For the nine months ended September 30, 2013, a gain of $4.0 million was recognized on $118.1 million of mortgage loans sold. The Company retained servicing responsibilities for the sold mortgages and collects servicing fees equal to a percentage of the outstanding principal balance.

The Company also retained limited recourse for credit losses on the sold loans. A description of the recourse obligation is presented in Note 11, “Commitments, Guarantees, and Contingent Liabilities.”


16





5.  ACQUIRED LOANS

Since 2009, the Company acquired the majority of the assets and assumed the deposits of four financial institutions in FDIC-assisted transactions. In three of those transactions, most loans and OREO acquired are covered by the FDIC Agreements. The significant accounting policies related to purchased impaired loans and the related FDIC indemnification asset are presented in Note 1, “Summary of Significant Accounting Policies.”

Acquired Loans
(Dollar amounts in thousands)
 
September 30, 2013
 
December 31, 2012
 
Covered
 
Non-Covered
 
Total
 
Covered
 
Non-Covered
 
Total
Purchased impaired loans
$
119,602

(1) 
$
15,964

 
$
135,566

 
$
154,762

(1) 
$
18,198

 
$
172,960

Other loans (2)
33,703

 
19,542

 
53,245

 
43,132

 
22,480

 
65,612

Total acquired loans
$
153,305

 
$
35,506

 
$
188,811

 
$
197,894

 
$
40,678

 
$
238,572


(1) 
At acquisition, the Company made an election to account for certain covered loans as purchased impaired loans. These loans totaled $25.5 million at September 30, 2013 and $28.1 million at December 31, 2012.
(2) 
These loans did not meet the criteria to be accounted for as purchased impaired loans at acquisition.

Except for leases and revolving loans, management determined that a significant portion of the acquired loans had evidence of credit deterioration since origination (“purchased impaired loans”), and it was probable at the date of acquisition that the Company would not collect all contractually required principal and interest payments. Evidence of credit quality deterioration was evaluated using various indicators, such as past due and non-accrual status. Other key considerations and indicators included the past performance of the troubled institutions’ credit underwriting standards, completeness and accuracy of credit files, maintenance of risk ratings, and age of appraisals.

In connection with the FDIC Agreements, the Company recorded an indemnification asset. To maintain eligibility for the loss share reimbursement, the Company is required to follow certain servicing procedures as specified in the FDIC Agreements. The Company is in compliance with those requirements as of September 30, 2013 and December 31, 2012.

Changes in the FDIC Indemnification Asset
(Dollar amounts in thousands)
 
Quarters Ended
September 30,
 
Nine Months Ended
September 30,
 
2013
 
2012
 
2013
 
2012
Beginning balance
$
23,158

 
$
58,302

 
$
37,051

 
$
65,609

Amortization
(116
)
 
(6,146
)
 
(2,348
)
 
(10,642
)
Expected reimbursements from the FDIC for changes
  in expected credit losses
(999
)
 
250

 
(3,453
)
 
10,022

Payments received from the FDIC
(3,965
)
 
(5,215
)
 
(13,172
)
 
(17,798
)
Ending balance
$
18,078

 
$
47,191

 
$
18,078

 
$
47,191



17





Changes in the accretable yield for purchased impaired loans were as follows.

Changes in Accretable Yield
(Dollar amounts in thousands)
 
Quarters Ended
September 30,
 
Nine Months Ended
September 30,
 
2013
 
2012
 
2013
 
2012
Beginning balance
$
47,104

 
$
48,980

 
$
51,498

 
$
52,147

Accretion
(3,410
)
 
(4,689
)
 
(11,752
)
 
(15,870
)
Other (1)
(3,128
)
 
(6,348
)
 
820

 
1,666

Ending balance
$
40,566

 
$
37,943

 
$
40,566

 
$
37,943


(1) 
Decreases result from the resolution of certain loans occurring earlier than anticipated while increases represent an increase in the estimated cash flows to be collected over the remaining estimated life of the underlying portfolio.

6.  PAST DUE LOANS, ALLOWANCE FOR CREDIT LOSSES, IMPAIRED LOANS, AND TDRS

Past Due and Non-accrual Loans

The following table presents an aging analysis of the Company’s past due loans as of September 30, 2013 and December 31, 2012. The aging is determined without regard to accrual status. The table also presents non-performing loans, consisting of non-accrual loans (the majority of which are past due) and loans 90 days or more past due and still accruing interest, as of each balance sheet date.

18





Aging Analysis of Past Due Loans and Non-Performing Loans by Class
(Dollar amounts in thousands)
 
Aging Analysis (Accruing and Non-accrual)
 
 
Non-performing Loans
 
Current
 
30-89 Days
Past Due
 
90 Days or
More Past
Due
 
Total
Past Due
 
Total
Loans
 
 
Non-
accrual
Loans
 
90 Day Past Due Loans, Still Accruing Interest
September 30, 2013
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial and industrial
$
1,772,525

 
$
5,344

 
$
14,692

 
$
20,036

 
$
1,792,561

 
 
$
13,835

 
$
3,927

Agricultural
318,125

 
—

 
534

 
534

 
318,659

 
 
642

 
—

Commercial real estate:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Office, retail, and industrial
1,318,709

 
802

 
17,353

 
18,155

 
1,336,864

 
 
19,855

 
12

Multi-family
330,069

 
1,347

 
1,333

 
2,680

 
332,749

 
 
2,068

 
—

Residential construction
44,286

 
—

 
2,138

 
2,138

 
46,424

 
 
2,356

 
—

Commercial construction
124,867

 
—

 
3,881

 
3,881

 
128,748

 
 
3,881

 
—

Other commercial real estate
778,929

 
1,519

 
9,666

 
11,185

 
790,114

 
 
11,620

 
173

Total commercial real
 estate
2,596,860

 
3,668

 
34,371

 
38,039

 
2,634,899

 
 
39,780

 
185

Total corporate loans
4,687,510

 
9,012

 
49,597

 
58,609

 
4,746,119

 
 
54,257

 
4,112

Home equity
365,888

 
4,622

 
6,505

 
11,127

 
377,015

 
 
6,779

 
973

1-4 family mortgages
279,271

 
2,154

 
4,908

 
7,062

 
286,333

 
 
5,055

 
519

Installment
36,884

 
485

 
2,093

 
2,578

 
39,462

 
 
2,079

 
38

Total consumer loans
682,043

 
7,261

 
13,506

 
20,767

 
702,810

 
 
13,913

 
1,530

Total loans, excluding
  covered loans
5,369,553

 
16,273

 
63,103

 
79,376

 
5,448,929

 
 
68,170

 
5,642

Covered loans
103,382

 
8,223

 
41,700

 
49,923

 
153,305

 
 
30,856

 
20,235

Total loans
$
5,472,935

 
$
24,496

 
$
104,803

 
$
129,299

 
$
5,602,234

 
 
$
99,026

 
$
25,877

December 31, 2012
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial and industrial
$
1,614,167

 
$
4,883

 
$
12,424

 
$
17,307

 
$
1,631,474

 
 
$
25,941

 
$
2,138

Agricultural
267,077

 
79

 
1,462

 
1,541

 
268,618

 
 
1,173

 
375

Commercial real estate:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Office, retail, and industrial
1,306,526

 
4,130

 
22,535

 
26,665

 
1,333,191

 
 
23,224

 
823

Multi-family
283,634

 
761

 
1,086

 
1,847

 
285,481

 
 
1,434

 
153

Residential construction
57,009

 
—

 
4,453

 
4,453

 
61,462

 
 
4,612

 
—

Commercial construction
124,081

 
—

 
873

 
873

 
124,954

 
 
873

 
—

Other commercial real estate
755,103

 
1,053

 
16,965

 
18,018

 
773,121

 
 
16,214

 
1,534

Total commercial real
 estate
2,526,353

 
5,944

 
45,912

 
51,856

 
2,578,209

 
 
46,357

 
2,510

Total corporate loans
4,407,597

 
10,906

 
59,798

 
70,704

 
4,478,301

 
 
73,471

 
5,023

Home equity
376,801

 
6,482

 
6,750

 
13,232

 
390,033

 
 
6,189

 
1,651

1-4 family mortgages
272,270

 
4,472

 
6,206

 
10,678

 
282,948

 
 
4,874

 
1,947

Installment
35,936

 
2,390

 
68

 
2,458

 
38,394

 
 
—

 
68

Total consumer loans
685,007

 
13,344

 
13,024

 
26,368

 
711,375

 
 
11,063

 
3,666

Total loans, excluding
  covered loans
5,092,604

 
24,250

 
72,822

 
97,072

 
5,189,676

 
 
84,534

 
8,689

Covered loans
147,462

 
6,517

 
43,915

 
50,432

 
197,894

 
 
14,182

 
31,447

Total loans
$
5,240,066

 
$
30,767

 
$
116,737

 
$
147,504

 
$
5,387,570

 
 
$
98,716

 
$
40,136


Allowance for Credit Losses

The Company maintains an allowance for credit losses at a level deemed adequate by management to absorb probable losses inherent in the loan portfolio. Refer to Note 1, “Summary of Significant Accounting Policies,” for the accounting policy for the allowance for credit losses.


19





Allowance for Credit Losses by Portfolio Segment
(Dollar amounts in thousands)
 
Commercial,
Industrial,
and
Agricultural
 
Office,
Retail, and
Industrial
 
Multi-
Family
 
Residential
Construction
 
Other
Commercial
Real Estate
 
Consumer
 
Covered
Loans
 
Reserve for
Unfunded
Commitments
 
Total
Allowance
Quarter ended September 30, 2013
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
31,742

 
$
11,857

 
$
3,424

 
$
4,170

 
$
16,169

 
$
12,367

 
$
14,381

 
$
2,866

 
$
96,976

Charge-offs
(2,719
)
 
(987
)
 
(112
)
 
(470
)
 
(889
)
 
(2,482
)
 
(1,636
)
 
—

 
(9,295
)
Recoveries
521

 
31

 
—

 
57

 
253

 
374

 
7

 
—

 
1,243

Net charge-offs
(2,198
)
 
(956
)
 
(112
)
 
(413
)
 
(636
)
 
(2,108
)
 
(1,629
)
 
—

 
(8,052
)
Provision for loan
  and covered loan
  losses and other
2,452

 
938

 
(31
)
 
(100
)
 
(1,218
)
 
2,425

 
304

 
(480
)
 
4,290

Ending balance
$
31,996

 
$
11,839

 
$
3,281

 
$
3,657

 
$
14,315

 
$
12,684

 
$
13,056

 
$
2,386

 
$
93,214

Quarter ended September 30, 2012
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
43,410

 
$
18,353

 
$
4,789

 
$
12,732

 
$
23,233

 
$
12,683

 
$
982

 
$
2,500

 
$
118,682

Charge-offs
(47,630
)
 
(29,370
)
 
(2,758
)
 
(9,368
)
 
(34,510
)
 
(3,042
)
 
(442
)
 
—

 
(127,120
)
Recoveries
1,318

 
2

 
3

 
126

 
21

 
122

 
—

 
—

 
1,592

Net charge-offs
(46,312
)
 
(29,368
)
 
(2,755
)
 
(9,242
)
 
(34,489
)
 
(2,920
)
 
(442
)
 
—

 
(125,528
)
Provision for loan
  and covered loan
  losses and other
40,546

 
22,989

 
1,939

 
4,297

 
30,896

 
2,267

 
8,857

 
—

 
111,791

Ending balance
$
37,644

 
$
11,974

 
$
3,973

 
$
7,787

 
$
19,640

 
$
12,030

 
$
9,397

 
$
2,500

 
$
104,945

Nine months ended September 30, 2013
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
36,761

 
$
11,432

 
$
3,575

 
$
5,242

 
$
17,512

 
$
12,862

 
$
12,062

 
$
3,366

 
$
102,812

Charge-offs
(9,010
)
 
(3,702
)
 
(490
)
 
(1,885
)
 
(3,971
)
 
(7,369
)
 
(4,322
)
 
—

 
(30,749
)
Recoveries
3,183

 
68

 
35

 
62

 
1,614

 
894

 
18

 
—

 
5,874

Net charge-offs
(5,827
)
 
(3,634
)
 
(455
)
 
(1,823
)
 
(2,357
)
 
(6,475
)
 
(4,304
)
 
—

 
(24,875
)
Provision for loan
  and covered loan
  losses and other
1,062

 
4,041

 
161

 
238

 
(840
)
 
6,297

 
5,298

 
(980
)
 
15,277

Ending balance
$
31,996

 
$
11,839

 
$
3,281

 
$
3,657

 
$
14,315

 
$
12,684

 
$
13,056

 
$
2,386

 
$
93,214

Nine months ended September 30, 2012
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
46,017

 
$
16,012

 
$
5,067

 
$
14,423

 
$
22,823

 
$
14,131

 
$
989

 
$
2,500

 
$
121,962

Charge-offs
(62,243
)
 
(34,607
)
 
(3,242
)
 
(13,649
)
 
(48,432
)
 
(8,164
)
 
(3,150
)
 
—

 
(173,487
)
Recoveries
2,569

 
311

 
165

 
346

 
46

 
574

 
—

 
—

 
4,011

Net charge-offs
(59,674
)
 
(34,296
)
 
(3,077
)
 
(13,303
)
 
(48,386
)
 
(7,590
)
 
(3,150
)
 
—

 
(169,476
)
Provision for loan
  and covered loan
  losses and other
51,301

 
30,258

 
1,983

 
6,667

 
45,203

 
5,489

 
11,558

 
—

 
152,459

Ending balance
$
37,644

 
$
11,974

 
$
3,973

 
$
7,787

 
$
19,640

 
$
12,030

 
$
9,397

 
$
2,500

 
$
104,945


 

20





The table below provides a breakdown of loans and the related allowance for credit losses by portfolio segment.

Loans and Related Allowance for Credit Losses by Portfolio Segment
(Dollar amounts in thousands)
 
Loans
 
Allowance for Credit Losses
 
Individually
Evaluated
for
Impairment
 
Collectively
Evaluated
for
Impairment
 
Acquired
with
Deteriorated
Credit
Quality
 
Total
 
Individually
Evaluated
for
Impairment
 
Collectively
Evaluated
for
Impairment
 
Acquired
with
Deteriorated
Credit
Quality
 
Total
September 30, 2013
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial, industrial, and
  agricultural
$
16,202

 
$
2,093,220

 
$
1,798

 
$
2,111,220

 
$
3,424

 
$
28,572

 
$
—

 
$
31,996

Commercial real estate:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Office, retail, and industrial
28,600

 
1,308,264

 
—

 
1,336,864

 
818

 
11,021

 
—

 
11,839

Multi-family
1,624

 
330,998

 
127

 
332,749

 
120

 
3,161

 
—

 
3,281

Residential construction
2,357

 
44,067

 
—

 
46,424

 
99

 
3,558

 
—

 
3,657

Other commercial real estate
17,481

 
897,407

 
3,974

 
918,862

 
358

 
13,957

 
—

 
14,315

Total commercial
  real estate
50,062

 
2,580,736

 
4,101

 
2,634,899

 
1,395

 
31,697

 
—

 
33,092

Total corporate loans
66,264

 
4,673,956

 
5,899

 
4,746,119

 
4,819

 
60,269

 
—

 
65,088

Consumer
—

 
692,745

 
10,065

 
702,810

 
—

 
12,684

 
—

 
12,684

Total loans, excluding
  covered loans
66,264

 
5,366,701

 
15,964

 
5,448,929

 
4,819

 
72,953

 
—

 
77,772

Covered loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Purchased impaired loans
—

 
—

 
119,602

 
119,602

 
—

 
—

 
12,280

 
12,280

Other loans
—

 
33,703

 
—

 
33,703

 
—

 
776

 
—

 
776

Total covered loans
—

 
33,703

 
119,602

 
153,305

 
—

 
776

 
12,280

 
13,056

Reserve for unfunded
  commitments
—

 
—

 
—

 
—

 
—

 
2,386

 
—

 
2,386

Total loans
$
66,264

 
$
5,400,404

 
$
135,566

 
$
5,602,234

 
$
4,819

 
$
76,115

 
$
12,280

 
$
93,214

December 31, 2012
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial, industrial, and
  agricultural
$
23,731

 
$
1,874,464

 
$
1,897

 
$
1,900,092

 
$
9,404

 
$
27,357

 
$
—

 
$
36,761

Commercial real estate:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Office, retail, and industrial
21,736

 
1,311,455

 
—

 
1,333,191

 
971

 
10,461

 
—

 
11,432

Multi-family
642

 
284,718

 
121

 
285,481

 
—

 
3,575

 
—

 
3,575

Residential construction
4,040

 
57,422

 
—

 
61,462

 
—

 
5,242

 
—

 
5,242

Other commercial real estate
16,160

 
877,749

 
4,166

 
898,075

 
1,247

 
16,265

 
—

 
17,512

Total commercial
  real estate
42,578

 
2,531,344

 
4,287

 
2,578,209

 
2,218

 
35,543

 
—

 
37,761

Total corporate loans
66,309

 
4,405,808

 
6,184

 
4,478,301

 
11,622

 
62,900

 
—

 
74,522

Consumer
—

 
699,361

 
12,014

 
711,375

 
—

 
12,862

 
—

 
12,862

Total loans, excluding
  covered loans
66,309

 
5,105,169

 
18,198

 
5,189,676

 
11,622

 
75,762

 
—

 
87,384

Covered loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Purchased impaired loans
—

 
—

 
154,762

 
154,762

 
—

 
—

 
11,134

 
11,134

Other loans
—

 
43,132

 
—

 
43,132

 
—

 
928

 
—

 
928

Total covered loans
—

 
43,132

 
154,762

 
197,894

 
—

 
928

 
11,134

 
12,062

Reserve for unfunded
  commitments
—

 
—

 
—

 
—

 
—

 
3,366

 
—

 
3,366

Total loans
$
66,309

 
$
5,148,301

 
$
172,960

 
$
5,387,570

 
$
11,622

 
$
80,056

 
$
11,134

 
$
102,812



21





Loans Individually Evaluated for Impairment

Corporate non-accrual loans exceeding a fixed dollar amount are individually evaluated for impairment when the internal risk rating is at or below a certain level. The following table presents loans individually evaluated for impairment by class of loan as of September 30, 2013 and December 31, 2012. Loans acquired with deteriorated credit quality are excluded from this disclosure.

Impaired Loans Individually Evaluated by Class
(Dollar amounts in thousands)
 
September 30, 2013
 
 
December 31, 2012
 
Recorded Investment In
 
 
 
 
Recorded Investment In
 
 
 
Loans with
No Specific
Reserve
 
Loans with
a Specific
Reserve
 
Unpaid
Principal
Balance
 
Specific
Reserve
 
 
Loans with
No Specific
Reserve
 
Loans with
a Specific
Reserve
 
Unpaid
Principal
Balance
 
Specific
Reserve
Commercial and industrial
$
12,130

 
$
4,072

 
$
28,685

 
$
3,424

 
 
$
5,636

 
$
18,095

 
$
39,834

 
$
9,404

Agricultural
—

 
—

 
—

 
—

 
 
—

 
—

 
—

 
—

Commercial real estate:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Office, retail, and industrial
24,934

 
3,666

 
37,466

 
818

 
 
14,504

 
7,232

 
29,631

 
971

Multi-family
1,264

 
360

 
3,523

 
120

 
 
642

 
—

 
2,406

 
—

Residential construction
1,523

 
834

 
6,286

 
99

 
 
4,040

 
—

 
10,741

 
—

Commercial construction
3,881

 
—

 
4,247

 
—

 
 
—

 
876

 
1,242

 
90

Other commercial real estate
12,146

 
1,454

 
17,624

 
358

 
 
5,218

 
10,066

 
23,907

 
1,157

Total commercial real
  estate
43,748

 
6,314

 
69,146

 
1,395

 
 
24,404

 
18,174

 
67,927

 
2,218

 Total impaired loans
   individually evaluated
   for impairment
$
55,878

 
$
10,386

 
$
97,831

 
$
4,819

 
 
$
30,040

 
$
36,269

 
$
107,761

 
$
11,622



22





Average Recorded Investment and Interest Income Recognized on Impaired Loans by Class
(Dollar amounts in thousands)
 
Quarters Ended September 30,
 
2013
 
2012
 
Average
Recorded
Balance
 
Interest
Income
Recognized (1)
 
Average
Recorded
Balance
 
Interest
Income
Recognized (1)
Commercial and industrial
$
20,665

 
$
195

 
$
51,073

 
$
85

Agricultural
—

 
—

 
1,494

 
—

Commercial real estate:
 
 
 
 
 
 
 

Office, retail, and industrial
25,747

 
5

 
43,506

 
2

Multi-family
1,337

 
—

 
7,095

 
—

Residential construction
2,630

 
—

 
16,007

 
1

Commercial construction
3,881

 
—

 
21,086

 
—

Other commercial real estate
12,511

 
16

 
31,392

 
32

Total commercial real estate
46,106

 
21

 
119,086

 
35

Total impaired loans
$
66,771

 
$
216

 
$
171,653

 
$
120


 
Nine Months Ended September 30,
 
2013
 
2012
 
Average
Recorded
Balance
 
Interest
Income
Recognized (1)
 
Average
Recorded
Balance
 
Interest
Income
Recognized (1)
Commercial and industrial
$
22,862

 
$
198

 
$
50,777

 
$
94

Agricultural
—

 
—

 
1,117

 
—

Commercial real estate:
 
 
 
 
 
 
 
Office, retail, and industrial
24,415

 
15

 
35,874

 
2

Multi-family
1,071

 
—

 
7,680

 
—

Residential construction
3,608

 
—

 
17,658

 
1

Commercial construction
2,379

 
—

 
21,397

 
—

Other commercial real estate
14,102

 
24

 
41,085

 
38

Total commercial real estate
45,575

 
39

 
123,694

 
41

Total impaired loans
$
68,437

 
$
237

 
$
175,588

 
$
135


(1) 
Recorded using the cash basis of accounting.


23





TDRs

TDRs are generally performed at the request of the individual borrower and may include forgiveness of principal, reduction in interest rates, changes in payments, and maturity date extensions. A discussion of our accounting policies for TDRs can be found in Note 1, “Summary of Significant Accounting Policies.”

TDRs by Class
(Dollar amounts in thousands)
 
As of September 30, 2013
 
As of December 31, 2012
 
Accruing
 
Non-accrual (1)
 
Total
 
Accruing
 
Non-accrual (1)
 
Total
Commercial and industrial
$
6,804

 
$
2,225

 
$
9,029

 
$
519

 
$
2,545

 
$
3,064

Agricultural
—

 
—

 
—

 
—

 
—

 
—

Commercial real estate:
 
 
 
 
 
 
 
 
 
 
 
Office, retail, and industrial
10,346

 
363

 
10,709

 
—

 
2,407

 
2,407

Multi-family
1,045

 
259

 
1,304

 
—

 
150

 
150

Residential construction
495

 
—

 
495

 
—

 
—

 
—

Commercial construction
—

 
—

 
—

 
—

 
—

 
—

Other commercial real estate
4,273

 
453

 
4,726

 
5,206

 
4,649

 
9,855

Total commercial real estate
16,159

 
1,075

 
17,234

 
5,206

 
7,206

 
12,412

Total corporate loans
22,963

 
3,300

 
26,263

 
5,725

 
9,751

 
15,476

Home equity
550

 
518

 
1,068

 
40

 
234

 
274

1-4 family mortgages
816

 
919

 
1,735

 
1,102

 
939

 
2,041

Installment
—

 
—

 
—

 
—

 
—

 
—

Total consumer loans
1,366

 
1,437

 
2,803

 
1,142

 
1,173

 
2,315

Total loans
$
24,329

 
$
4,737

 
$
29,066

 
$
6,867

 
$
10,924

 
$
17,791


(1) 
These loans are included in non-accrual loans in the preceding tables.

TDRs are included in the calculation of the allowance for credit losses in the same manner as impaired loans. TDRs had related specific reserves totaling $2.0 million as of September 30, 2013 and $2.8 million as of December 31, 2012.




24





TDRs Restructured During the Period
(Dollar amounts in thousands)
 
Number
of
Loans
 
Pre-
Modification
Recorded
Investment
 
Funds
Disbursed
 
Interest
and Escrow
Capitalized
 
Charge-offs
 
Post-
Modification
Recorded
Investment
Quarter ended September 30, 2013
 
 
 
 
 
 
 
 
 
 
Commercial and industrial
3

 
$
369

 
$
—

 
$
—

 
$
—

 
$
369

Office, retail, and industrial
2

 
1,674

 
—

 
—

 
—

 
1,674

Other commercial real estate
1

 
10

 
—

 
—

 
—

 
10

Home equity
8

 
822

 
—

 
—

 
—

 
822

Total TDRs restructured during the period
14

 
$
2,875

 
$
—

 
$
—

 
$
—

 
$
2,875

Quarter ended September 30, 2012
 
 
 
 
 
 
 
 
 
 
Commercial and industrial
2

 
$
2,541

 
$
—

 
$
—

 
$
—

 
$
2,541

Office, retail, and industrial
1

 
1,791

 
—

 
—

 
—

 
1,791

Total TDRs restructured during the period
3

 
$
4,332

 
$
—

 
$
—

 
$
—

 
$
4,332

Nine months ended September 30, 2013
 
 
 
 
 
 
 
 
 
 
Commercial and industrial
7

 
$
14,439

 
$
—

 
$
2

 
$
—

 
$
14,441

Office, retail, and industrial
6

 
2,275

 
30

 
—

 
—

 
2,305

Multi-family
5

 
1,275

 
—

 
57

 
—

 
1,332

Residential construction
2

 
508

 
—

 
—

 
—

 
508

Other commercial real estate
5

 
526

 
—

 
—

 
—

 
526

Home equity
9

 
947

 
—

 
—

 
—

 
947

1-4 family mortgages
1

 
132

 
—

 
4

 
—

 
136

Total TDRs restructured during the period
35

 
$
20,102

 
$
30

 
$
63

 
$
—

 
$
20,195

Nine months ended September 30, 2012
 
 
 
 
 
 
 
 
 
 
Commercial and industrial
3

 
$
2,850

 
$
—

 
$
—

 
$
170

 
$
2,680

Office, retail, and industrial
2

 
2,416

 
—

 
—

 
—

 
2,416

Other commercial real estate
3

 
913

 
—

 
—

 
125

 
788

1-4 family mortgages
4

 
563

 
—

 
4

 
—

 
567

Total TDRs restructured during the period
12

 
$
6,742

 
$
—

 
$
4

 
$
295

 
$
6,451


Accruing TDRs that have payment defaults and do not perform in accordance with their modified terms are transferred to non-accrual. The following table presents TDRs that had payment defaults during the nine months ended September 30, 2013 and 2012 where the default occurred within twelve months of the restructure date.


25





TDRs That Defaulted Within Twelve Months of the Restructure Date
(Dollar amounts in thousands)
 
Quarters Ended
 
Nine Months Ended
 
September 30, 2013
 
September 30, 2012
 
September 30, 2013
 
September 30, 2012
 
Number
of
Loans
 
Recorded
Investment
 
Number
of
Loans
 
Recorded
Investment
 
Number
of
Loans
 
Recorded
Investment
 
Number
of
Loans
 
Recorded
Investment
Commercial and industrial
—

 
$
—

 
—

 
$
—

 
1

 
$
350

 
—

 
$
—

Office, retail, and industrial
—

 
—

 
1

 
617

 
—

 
—

 
2

 
837

Other commercial real estate
—

 
—

 
2

 
717

 
3

 
354

 
2

 
717

1-4 family mortgages
—

 
—

 
—

 
—

 
—

 
—

 
1

 
62

Total
—

 
$
—

 
3

 
$
1,334

 
4

 
$
704

 
5

 
$
1,616


A rollforward of the carrying value of TDRs for the quarters and nine months ended September 30, 2013 and 2012 is presented in the following table.

TDR Rollforward
(Dollar amounts in thousands)
 
 
Quarters Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2013
 
2012
 
2013
 
2012
Accruing
 
 
 
 
 
 
 
 
Beginning balance
 
$
8,287

 
$
7,811

 
$
6,867

 
$
17,864

Additions
 
1,128

 
—

 
4,606

 
1,978

Net payments received
 
(248
)
 
(86
)
 
(415
)
 
(155
)
Returned to performing status
 
—

 
—

 
(5,037
)
 
(16,619
)
Transfers from (to) non-accrual
 
15,162

 
(1,334
)
 
18,308

 
3,323

Ending balance
 
24,329

 
6,391

 
24,329

 
6,391

Non-accrual
 
 
 
 
 
 
 
 
Beginning balance
 
18,450

 
24,861

 
10,924

 
29,842

Additions
 
1,747

 
4,332

 
15,589

 
4,473

Net payments received
 
(201
)
 
(954
)
 
(735
)
 
(892
)
Charge-offs
 
(62
)
 
(9,147
)
 
(1,850
)
 
(9,674
)
Transfers to OREO
 
(35
)
 
(6,437
)
 
(77
)
 
(6,437
)
Loans sold
 
—

 
(1,602
)
 
(806
)
 
(1,602
)
Transfers (to) from accruing
 
(15,162
)
 
1,334

 
(18,308
)
 
(3,323
)
Ending balance
 
4,737

 
12,387

 
4,737

 
12,387

Total TDRs
 
$
29,066

 
$
18,778

 
$
29,066

 
$
18,778


For TDRs to be removed from TDR status, the loans must (i) have an interest rate and terms that reflect market conditions at the time of restructuring and (ii) be in compliance with the modified loan terms. TDRs that were returned to performing status totaled $5.0 million and $16.6 million for the nine months ended September 30, 2013 and 2012, respectively. No TDRs were returned to performing status for the quarters ended September 30, 2013 and 2012. Loans that were not restructured at market rates and terms, that are not in compliance with the modified terms, or for which there is a concern about the future ability of the borrower to meet its obligations under the modified terms, continue to be separately reported as restructured until paid in full or charged-off.

There were no commitments to lend additional funds to borrowers with TDRs as of September 30, 2013 or December 31, 2012.


26





Credit Quality Indicators

Corporate loans and commitments are assessed for credit risk and assigned ratings based on various characteristics, such as the borrower’s cash flow, leverage, and collateral. Ratings for commercial credits are reviewed periodically. On a quarterly basis, consumer loans are assessed for credit quality based on the accrual status of the loan.

Corporate Credit Quality Indicators by Class, Excluding Covered Loans
(Dollar amounts in thousands)
 
Pass
 
Special
Mention (1) (4)
 
Substandard (2) (4)
 
Non-accrual (3)
 
Total
 
 
 
 
 
 
 
 
 
 
September 30, 2013
 
 
 
 
 
 
 
 
 
Commercial and industrial
$
1,725,474

 
$
42,627

 
$
10,625

 
$
13,835

 
$
1,792,561

Agricultural
318,017

 
—

 
—

 
642

 
318,659

Commercial real estate:
 
 
 
 
 
 
 
 
 
Office, retail, and industrial
1,230,963

 
63,172

 
22,874

 
19,855

 
1,336,864

Multi-family
326,547

 
3,212

 
922

 
2,068

 
332,749

Residential construction
33,138

 
3,705

 
7,225

 
2,356

 
46,424

Commercial construction
107,972

 
6,524

 
10,371

 
3,881

 
128,748

Other commercial real estate
743,885

 
13,017

 
21,592

 
11,620

 
790,114

Total commercial real estate
2,442,505

 
89,630

 
62,984

 
39,780

 
2,634,899

Total corporate loans
$
4,485,996

 
$
132,257

 
$
73,609

 
$
54,257

 
$
4,746,119

December 31, 2012
 
 
 
 
 
 
 
 
 
Commercial and industrial
$
1,558,932

 
$
37,833

 
$
8,768

 
$
25,941

 
$
1,631,474

Agricultural
267,114

 
331

 
—

 
1,173

 
268,618

Commercial real estate:
 
 
 
 
 
 
 
 

Office, retail, and industrial
1,235,950

 
57,271

 
16,746

 
23,224

 
1,333,191

Multi-family
282,126

 
1,921

 
—

 
1,434

 
285,481

Residential construction
33,392

 
11,870

 
11,588

 
4,612

 
61,462

Commercial construction
95,567

 
14,340

 
14,174

 
873

 
124,954

Other commercial real estate
712,702

 
14,056

 
30,149

 
16,214

 
773,121

Total commercial real estate
2,359,737

 
99,458

 
72,657

 
46,357

 
2,578,209

Total corporate loans
$
4,185,783

 
$
137,622

 
$
81,425

 
$
73,471

 
$
4,478,301


(1) 
Loans categorized as special mention exhibit potential weaknesses that require the close attention of management since these potential weaknesses may result in the deterioration of repayment prospects in the future.
(2) 
Loans categorized as substandard exhibit a well-defined weakness or weaknesses that may jeopardize the liquidation of the debt. These loans continue to accrue interest because they are well secured and collection of principal and interest is expected within a reasonable time.
(3) 
Loans categorized as non-accrual exhibit a well-defined weakness or weaknesses that may jeopardize the liquidation of the debt or result in a loss if the deficiencies are not corrected.
(4) 
Total special mention and substandard loans include $18.6 million of accruing TDRs as of September 30, 2013 and $448,000 of accruing TDRs as of December 31, 2012.


27





Consumer Credit Quality Indicators by Class, Excluding Covered Loans
(Dollar amounts in thousands)
 
Performing
 
Non-accrual
 
Total
September 30, 2013
 
 
 
 
 
Home equity
$
370,236

 
$
6,779

 
$
377,015

1-4 family mortgages
281,278

 
5,055

 
286,333

Installment
37,383

 
2,079

 
39,462

Total consumer loans
$
688,897

 
$
13,913

 
$
702,810

December 31, 2012
 
 
 
 
 
Home equity
$
383,844

 
$
6,189

 
$
390,033

1-4 family mortgages
278,074

 
4,874

 
282,948

Installment
38,394

 
—

 
38,394

Total consumer loans
$
700,312

 
$
11,063

 
$
711,375


7. EARNINGS PER COMMON SHARE

Basic and Diluted Earnings per Common Share
(Amounts in thousands, except per share data)
 
Quarters Ended
September 30,
 
Nine Months Ended
September 30,
 
2013
 
2012
 
2013
 
2012
Net income (loss)
$
29,323

 
$
(48,527
)
 
$
60,141

 
$
(34,270
)
Net (income) loss applicable to non-vested restricted shares
(416
)
 
715

 
(847
)
 
500

Net income (loss) applicable to common shares
$
28,907

 
$
(47,812
)
 
$
59,294

 
$
(33,770
)
Weighted-average common shares outstanding:
 
 
 
 
 
 
 
Weighted-average common shares outstanding
74,023

 
73,742

 
73,969

 
73,636

Dilutive effect of common stock equivalents
11

 
—

 
9

 
—

Weighted-average diluted common shares
  outstanding
74,034

 
73,742

 
73,978

 
73,636

Basic earnings (loss) per common share
$
0.39

 
$
(0.65
)
 
$
0.80

 
$
(0.46
)
Diluted earnings (loss) per common share
$
0.39

 
$
(0.65
)
 
$
0.80

 
$
(0.46
)
Anti-dilutive shares not included in the computation of
  diluted earnings per common share (1)
1,411,643

 
1,739,697

 
1,483,394

 
1,785,959


(1) 
This amount represents outstanding stock options for which the exercise price is greater than the average market price of the Company’s common stock.


28





8.  INCOME TAXES

Income Tax Expense
(Dollar amounts in thousands)
 
Quarters Ended
September 30,
 
Nine Months Ended
September 30,
 
2013
 
2012
 
2013
 
2012
Income (loss) before income tax expense (benefit)
$
54,282

 
$
(85,520
)
 
$
99,348

 
$
(69,346
)
Income tax expense (benefit):
 
 
 
 
 
 
 
Federal income tax expense (benefit)
$
19,145

 
$
(29,391
)
 
$
29,058

 
$
(28,420
)
State income tax expense (benefit)
5,814

 
(7,602
)
 
10,149

 
(6,656
)
Total income tax expense (benefit)
$
24,959

 
$
(36,993
)
 
$
39,207

 
$
(35,076
)
Effective income tax rate
46.0
%
 
43.3
%
 
39.5
%
 
50.6
%

Federal income tax expense and the related effective income tax rate are influenced primarily by the amount of tax-exempt income derived from investment securities and bank-owned life insurance in relation to pre-tax income and state income taxes. State income tax expense and the related effective income tax rate are driven by the amount of state tax-exempt income in relation to pre-tax income and state tax rules related to consolidated/combined reporting and sourcing of income and expense.

Income tax expense was $25.0 million and $39.2 million for the third quarter and nine months ended September 30, 2013, respectively, compared to an income tax benefit of $37.0 million and $35.1 million for the same periods in 2012. The rise in income tax expense in 2013 was driven primarily by higher levels of income during 2013, which are subject to tax at statutory rates, and to a non-deductible BOLI modification loss recorded during the third quarter of 2013. Excluding the BOLI modification loss, the effective tax rate would have been 36.9% and 34.8% for the third quarter and nine months ended September 30, 2013, respectively.

The Company’s accounting policies for income taxes are included in Note 1, “Summary of Significant Accounting Policies,” and Note 14, “Income Taxes,” in the Company’s 2012 10-K.


29





9.  EMPLOYEE BENEFIT PLANS

The Company sponsors a defined contribution retirement savings plan (the “Profit Sharing Plan”) and a noncontributory defined benefit retirement plan (the “Pension Plan”) that cover eligible employees. Additional information regarding the Profit Sharing Plan and Pension Plan can be found in Note 15, “Employee Benefit Plans,” in the Company’s 2012 10-K.

The Pension Plan covers employees who met certain eligibility requirements and were hired before April 1, 2007, the date it was amended to eliminate enrollment of new participants. During the second quarter of 2013, the Board of Directors approved an amendment to freeze benefit accruals under the Pension Plan effective on January 1, 2014. As a result of the Pension Plan amendment, the Company recorded an immaterial curtailment loss and remeasured the Pension Plan obligations and assets as of June 30, 2013. The remeasurement decreased the projected pension obligation by $11.0 million and increased other comprehensive income by $6.5 million, after tax. Depending on various factors, these actions could reduce 2013 pension expense by approximately $1.0 million.

Components of Net Periodic Benefit Cost
(Dollar amounts in thousands)
 
Quarters Ended
September 30,
 
Nine Months Ended
September 30,
 
2013
 
2012
 
2013
 
2012
Service cost
$
218

 
$
1,109

 
$
2,135

 
$
2,191

Interest cost
203

 
1,054

 
1,981

 
2,082

Expected return on plan assets
(361
)
 
(1,727
)
 
(3,528
)
 
(3,411
)
Recognized net actuarial loss
—

 
653

 
—

 
1,289

Amortization of prior service cost
122

 
1

 
1,192

 
2

Net periodic cost
$
182

 
$
1,090

 
$
1,780

 
$
2,153


The Company’s policy is to amortize the Pension Plan’s net actuarial losses into income over the average remaining life expectancy of the Pension Plan participants.

10.  DERIVATIVE FINANCIAL INSTRUMENTS

The Company hedges the fair value of fixed rate commercial real estate loans using interest rate swaps through which the Company pays fixed amounts and receives variable amounts. These derivative contracts are designated as fair value hedges.

Fair Value Hedges
(Dollar amounts in thousands)
 
September 30,
2013
 
December 31,
2012
Notional amount outstanding
$
15,017

 
$
15,860

Derivative liability fair value
(1,647
)
 
(2,270
)
Weighted-average interest rate received
2.09
%
 
2.12
%
Weighted-average interest rate paid
6.39
%
 
6.39
%
Weighted-average maturity (in years)
4.02

 
4.76

Cash pledged to collateralize net unrealized losses with counterparties (1)
$
1,583

 
$
2,516

Fair value of assets needed to settle derivative transactions (2)
1,676

 
2,301


(1) 
No other collateral was required to be pledged.
(2) 
This amount represents the fair value of assets needed to settle derivative transactions if credit risk related contingent factors were triggered.


Hedge ineffectiveness is recognized in other noninterest income in the Consolidated Statements of Income. For the quarters and nine months ended September 30, 2013 and 2012, gains or losses relating to fair value hedge ineffectiveness were not material.

The Company also enters into derivative transactions with its commercial customers and simultaneously enters into an offsetting interest rate derivative transaction with a third-party. This transaction allows the Company’s customers to effectively convert a variable rate loan into a fixed rate loan. Due to the offsetting nature of these transactions, the Company does not apply hedge

30





accounting treatment. Transaction fees related to commercial customer derivative instruments of $1.4 million and $2.0 million were recorded in noninterest income for the quarter and nine months ended September 30, 2013, respectively. There were no transaction fees recorded for the quarter and nine months ended September 30, 2012.

Other Derivative Instruments
(Dollar amounts in thousands)
 
September 30,
2013
 
December 31,
2012
Notional amount outstanding
$
98,763

 
$
—

Derivative asset fair value
2,258

 
—

Derivative liability fair value
(2,258
)
 
—

Cash pledged to collateralize net unrealized losses with counterparties (1)
1,800

 
—

Fair value of assets needed to settle derivative transactions (2)
1,953

 
—


(1) 
No other collateral was required to be pledged.
(2) 
This amount represents the fair value if credit risk related contingent factors were triggered.

Derivative instruments are inherently subject to credit risk, which represents the Company’s risk of loss when the counterparty to a derivative contract fails to perform according to the terms of the agreement. Credit risk is managed by limiting and collateralizing the aggregate amount of net unrealized losses by transaction, monitoring the size and the maturity structure of the derivatives, and applying uniform credit standards. Company policy establishes limits on credit exposure to any single counterparty. In addition, the Company established bilateral collateral agreements with derivative counterparties that provide for exchanges of marketable securities or cash to collateralize either party’s net losses above a stated minimum threshold. At September 30, 2013, these collateral agreements covered 100% of the fair value of the Company’s outstanding fair value hedges. Derivative assets and liabilities are presented gross, rather than net, of pledged collateral amounts.

As of September 30, 2013 and December 31, 2012, the Company’s derivative instruments generally contained provisions that require the Company’s debt to remain above a certain credit rating by each of the major credit rating agencies or that the Company maintain certain capital levels. If the Company’s debt were to fall below that credit rating or the Company's capital were to fall below the required levels, it would be in violation of those provisions, and the counterparties to the derivative instruments could terminate the swap transaction and demand cash settlement of the derivative instrument in an amount equal to the derivative liability fair value. As of September 30, 2013 and December 31, 2012, the Company was not in violation of these provisions.

The Company’s derivative portfolio also includes other derivative instruments that do not receive hedge accounting treatment consisting of commitments to originate 1-4 family mortgage loans and foreign exchange contracts. In addition, the Company occasionally enters into risk participation agreements with counterparty banks to transfer or assume a portion of the credit risk related to customer transactions. The amounts of these instruments were not material for any period presented. The Company had no other derivative instruments as of September 30, 2013 or December 31, 2012. The Company does not enter into derivative transactions for purely speculative purposes.

11.  COMMITMENTS, GUARANTEES, AND CONTINGENT LIABILITIES

Credit Commitments and Guarantees

In the normal course of business, the Company enters into a variety of financial instruments with off-balance sheet risk to meet the financing needs of its customers and to conduct lending activities, including commitments to extend credit and standby and commercial letters of credit. These instruments involve elements of credit and interest rate risk in excess of the amount recognized in the Consolidated Statements of Financial Condition.


31





Contractual or Notional Amounts of Financial Instruments
(Dollar amounts in thousands)
 
September 30,
2013
 
December 31,
2012
Commitments to extend credit:
 
 
 
Commercial and industrial
$
877,470

 
$
737,973

Commercial real estate
194,095

 
168,105

Residential construction
12,133

 
18,986

Home equity lines
262,244

 
258,156

Credit card lines
27,565

 
25,459

Overdraft protection program (1)
172,610

 
176,328

All other commitments
91,797

 
105,344

Total commitments
$
1,637,914

 
$
1,490,351

Letters of credit:
 
 
 
Commercial real estate
$
40,459

 
$
52,145

Residential construction
5,141

 
5,696

All other
70,701

 
57,996

Total letters of credit
$
116,301

 
$
115,837

Unamortized fees associated with letters of credit (2)(3)
$
659

 
$
740

Remaining weighted-average term, in months
9.71

 
13.20

Remaining lives, in years
0.1 to 10.8

 
0.1 to 11.6

Recourse on assets sold:
 
 
 
Unpaid principal balance of loans sold
$
155,514

 
$
50,110

Carrying value of recourse obligation (2)
142

 
55


(1) 
Federal regulations regarding electronic fund transfers require customers to affirmatively consent to the institution’s overdraft service for automated teller machine and one-time debit card transactions before overdraft fees may be assessed on the account. Customers are provided a specific line for the amount they may overdraw.
(2) 
Included in other liabilities in the Consolidated Statements of Financial Condition.
(3) 
The Company amortizes these amounts into income over the commitment period.

Commitments to extend credit are agreements to lend funds to a customer, subject to contractual terms and covenants. Commitments generally have fixed expiration dates or other termination clauses, variable interest rates, and fee requirements, when applicable. Since many of the commitments are expected to expire without being drawn, the total commitment amounts do not necessarily represent future cash flow requirements.

In the event of a customer’s non-performance, the Company’s credit loss exposure is equal to the contractual amount of the commitments. The credit risk is essentially the same as extending loans to customers. The Company uses the same credit policies for credit commitments and its loans and minimizes exposure to credit loss through various collateral requirements.

Letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Standby letters of credit generally are contingent on the failure of the customer to perform according to the terms of the contract with the third party and are often issued in favor of a municipality where construction is taking place to ensure the borrower adequately completes the construction.

The maximum potential future payments guaranteed by the Company under standby letters of credit arrangements are equal to the contractual amount of the commitment. If a commitment is funded, the Company may seek recourse through the liquidation of the underlying collateral including real estate, production plants and property, marketable securities, or receipt of cash.

As a result of the sale of certain 1-4 family mortgage loans, the Company is contractually obligated to repurchase any non-performing loans or loans that do not meet underwriting requirements at recorded value. In accordance with the sales agreements, there is no limitation on the maximum potential future payments or expiration of the Company’s recourse obligation. No loans were required to be repurchased during the quarters and nine months ended September 30, 2013 or 2012.


32





During 2012, the Company entered into two forward commitments with the FHLB of Chicago to borrow $250 million for a five year period beginning in 2014 at a weighted average interest rate of 2.0%. The Company terminated these forward commitments during the third quarter of 2013, resulting in a gain of $7.8 million recorded in noninterest income in the Condensed Consolidated Statement of Income.

Legal Proceedings

In 2011, the Bank was named in a purported class action lawsuit filed in the Circuit Court of Cook County, Illinois on behalf of certain of the Bank’s customers who incurred overdraft fees. The lawsuit is based on the Bank’s practices relating to debit card transactions, and alleges that these practices resulted in customers being assessed excessive overdraft fees. The plaintiffs seek an unspecified amount of damages and other relief, including restitution. No class has been certified. The Bank filed a motion to dismiss the plaintiffs’ complaint and, on January 23, 2013, the Circuit Court entered an order granting the Bank’s motion and dismissed the complaint with prejudice. The plaintiffs have appealed the Circuit Court’s ruling, and the appeal is currently pending with the Appellate Court of Illinois. The Company continues to believe that the Bank has meritorious defenses to the claims made by the plaintiffs.

There are certain other legal proceedings pending against the Company and its subsidiaries in the ordinary course of business. The Company does not believe that liabilities, individually or in the aggregate, arising from any legal proceedings, if any, would have a material adverse effect on the consolidated financial condition of the Company as of September 30, 2013.

12.  FAIR VALUE

Fair value represents the amount received to sell an asset or paid to transfer a liability in its principal or most advantageous market in an orderly transaction between market participants at the measurement date. In accordance with fair value accounting guidance, the Company measures, records, and reports various types of assets and liabilities at fair value on either a recurring or non-recurring basis in the Consolidated Statements of Financial Condition. Those assets and liabilities are presented below in the sections titled “Assets and Liabilities Required to be Measured at Fair Value on a Recurring Basis” and “Assets and Liabilities Required to be Measured at Fair Value on a Non-Recurring Basis.”

Other assets and liabilities are not required to be measured at fair value in the Consolidated Statements of Financial Condition, but must be disclosed at fair value. Refer to the “Fair Value Measurements of Other Financial Instruments” section of this footnote. Any aggregation of the estimated fair values presented in this footnote does not represent the value of the Company.

Depending on the nature of the asset or liability, the Company uses various valuation methodologies and assumptions to estimate fair value. GAAP provides a three-tiered fair value hierarchy based on the inputs used to measure fair value. The hierarchy is defined as follows:

•
Level 1 – Quoted prices in active markets for identical assets or liabilities.
•
Level 2 – Observable inputs other than level 1 prices, such as quoted prices for similar instruments, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data.
•
Level 3 – Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. These inputs require significant management judgment or estimation, some of which use model-based techniques and may be internally developed.
Assets and liabilities are assigned to a level within the fair value hierarchy based on the lowest level of significant input used to measure fair value. Assets and liabilities may change levels within the fair value hierarchy due to market conditions or other circumstances. Those transfers are recognized on the date of the event that prompted the transfer. There were no transfers of assets or liabilities between levels of the fair value hierarchy during the periods presented.


33





Assets and Liabilities Required to be Measured at Fair Value on a Recurring Basis

The following table provides the fair value for assets and liabilities required to be measured at fair value on a recurring basis in the Consolidated Statements of Financial Condition by level in the fair value hierarchy.

Recurring Fair Value Measurements
(Dollar amounts in thousands)
 
September 30, 2013
 
December 31, 2012
 
Level 1
 
Level 2
 
Level 3
 
Level 1
 
Level 2
 
Level 3
Assets:
 
 
 
 
 
 
 
 
 
 
 
Trading securities:
 
 
 
 
 
 
 
 
 
 
 
Money market funds
$
1,256

 
$
—

 
$
—

 
$
1,554

 
$
—

 
$
—

Mutual funds
15,187

 
—

 
—

 
12,608

 
—

 
—

Total trading securities
16,443

 
—

 
—

 
14,162

 
—

 
—

Securities available-for-sale:
 
 
 
 
 
 
 
 
 
 
 
U.S. agency securities
—

 
501

 
—

 
—

 
508

 
—

CMOs
—

 
506,036

 
—

 
—

 
400,383

 
—

Other MBSs
—

 
141,302

 
—

 
—

 
122,900

 
—

Municipal securities
—

 
471,259

 
—

 
—

 
520,043

 
—

CDOs
—

 
—

 
16,996

 
—

 
—

 
12,129

Corporate debt securities
—

 
14,993

 
—

 
—

 
15,339

 
—

Hedge fund investment
—

 
2,850

 
—

 
—

 
1,616

 
—

Other equity securities
43

 
8,931

 
—

 
43

 
9,442

 
—

Total securities
  available-for-sale
43

 
1,145,872

 
16,996

 
43

 
1,070,231

 
12,129

Mortgage servicing rights (1)
—

 
—

 
1,726

 
—

 
—

 
985

Derivative assets (1)
—

 
2,258

 
—

 
—

 
—

 
—

Liabilities:
 
 
 
 
 
 
 
 
 
 
 
Derivative liabilities (2)
$
—

 
$
3,905

 
$
—

 
$
—

 
$
2,270

 
$
—


(1) 
Included in other assets in the Consolidated Statements of Financial Condition.
(2) 
Included in other liabilities in the Consolidated Statements of Financial Condition.

The following sections describe the specific valuation techniques and inputs used to measure financial assets and liabilities at fair value.

Trading Securities

The Company’s trading securities consist of diversified investment securities held in a grantor trust and are invested in money market and mutual funds. The fair value of these money market and mutual funds is based on quoted market prices in active exchange markets and is classified in level 1 of the fair value hierarchy. Changes in the fair value of trading securities are included in other noninterest income in the Condensed Consolidated Statements of Income.

Securities Available-for-Sale

Where quoted prices are available in an active market, securities are classified in level 1 of the fair value hierarchy. The Company’s available-for-sale securities are primarily fixed income instruments that are not quoted on an exchange, but may be traded in active markets. The fair values are based on quoted prices in active markets or market prices for similar securities obtained from external pricing services or dealer market participants and are classified in level 2 of the fair value hierarchy. Quarterly, the Company evaluates the methodologies used by its external pricing services to develop the fair values to determine whether the results of the valuations are representative of an exit price in the Company’s principal markets and an appropriate representation of fair value.

The Company’s hedge fund investment is classified in level 2 of the fair value hierarchy. The fair value is derived from monthly and annual financial statements provided by hedge fund management. The majority of the hedge fund’s investment portfolio is held in securities that are freely tradable and are listed on national securities exchanges.

34






CDOs are classified in level 3 of the fair value hierarchy. The Company estimates the fair values for each CDO using discounted cash flow analyses with the assistance of a structured credit valuation firm. This methodology relies on credit analysis and review of historical financial data for each of the issuers of the securities underlying the individual CDO (the “Issuers”) to estimate the cash flows. These estimates are highly subjective and sensitive to several significant, unobservable inputs, including prepayment assumptions, default probabilities, loss given default assumptions, and deferral cure probabilities. The cash flows for each Issuer are then discounted to present values using LIBOR plus an adjustment to reflect the higher risk inherent in these securities given their complex structures and the impact of market factors. Finally, the discounted cash flows for each Issuer are aggregated to derive the estimated fair value for the specific CDO. Information for each CDO, as well as the significant unobservable assumptions, is presented in the following table.

Characteristics of CDOs and Significant Unobservable Inputs
Used in the Valuation of CDOs as of September 30, 2013
(Dollar amounts in thousands)
 
CDO Number
 
1
 
2
 
3
 
4
 
5
 
6
Characteristics:
 
 
 
 
 
 
 
 
 
 
 
Class
C-1

 
C-1

 
C-1

 
B1

 
C

 
C

Original par
$
17,500

 
$
15,000

 
$
15,000

 
$
15,000

 
$
10,000

 
$
6,500

Amortized cost
7,140

 
5,598

 
12,377

 
13,922

 
1,317

 
6,178

Fair value
4,034

 
373

 
4,196

 
5,340

 
1,017

 
2,036

Lowest credit rating (Moody’s)
 Ca

 
 Ca

 
 Ca

 
 Ca

 
 C

 
 Ca

Number of underlying Issuers
43

 
55

 
60

 
59

 
55

 
77

Percent of Issuers currently performing
79.1
%
 
76.4
%
 
78.3
%
 
54.2
%
 
63.6
%
 
66.2
%
Current deferral and default
  percent (1)
14.6
%
 
16.6
%
 
11.3
%
 
34.8
%
 
40.1
%
 
28.7
%
Expected future deferral and
  default percent (2)
17.2
%
 
16.2
%
 
15.3
%
 
28.6
%
 
25.3
%
 
14.8
%
Excess subordination percent (3)
—
%
 
—
%
 
—
%
 
—
%
 
—
%
 
1.2
%
Discount rate risk adjustment (4)
14.0
%
 
15.0
%
 
14.0
%
 
13.0
%
 
14.0
%
 
12.5
%
Significant unobservable inputs, weighted average of Issuers:
 
 
 
 
 
 
 
 
Probability of prepayment
15.3
%
 
7.6
%
 
4.8
%
 
6.0
%
 
5.3
%
 
1.8
%
Probability of default
21.7
%
 
25.4
%
 
21.9
%
 
28.0
%
 
39.7
%
 
31.2
%
Loss given default
88.0
%
 
89.3
%
 
89.3
%
 
92.9
%
 
92.7
%
 
95.3
%
Probability of deferral cure
40.3
%
 
38.1
%
 
26.3
%
 
53.4
%
 
35.9
%
 
45.2
%

(1) 
Represents actual deferrals and defaults, net of recoveries, as a percent of the original collateral.
(2) 
Represents expected future net deferrals and defaults, net of recoveries, as a percent of the remaining performing collateral. The probability of future defaults is derived for each Issuer based on a credit analysis. The associated assumed loss given default is based on historical default and recovery information provided by a nationally recognized credit rating agency and is assumed to be 90% for banks, 85% for insurance companies, and 100% for Issuers that have already defaulted.
(3) 
Represents additional defaults that the CDO can absorb before the security experiences any credit impairment. The excess subordination percentage is calculated by dividing the amount of potential additional loss that can be absorbed (before the receipt of all expected future principal and interest payments is affected) by the total balance of performing collateral.
(4) 
Cash flows are discounted at LIBOR plus this adjustment to reflect the higher risk inherent in these securities.

Most Issuers have the right to prepay its securities on the fifth anniversary of issuance and under other limited circumstances. To estimate prepayments, a credit analysis of each Issuer is performed to estimate its ability and likelihood to fund a prepayment. If a prepayment occurs, the Company receives cash equal to the par value for the portion of the CDO associated with that Issuer.

The likelihood that an Issuer who is currently deferring payment on its securities will pay all deferred amounts and remain current thereafter is based on an analysis of the Issuer’s asset quality, leverage ratios, and other measures of financial viability.


35





The impact of changes in these key inputs could result in a significantly higher or lower fair value measurement for each CDO. The timing of the default, the magnitude of the default, and the timing and magnitude of the cure probability are directly interrelated. Defaults that occur sooner and/or are greater than anticipated have a negative impact on the valuation. In addition, a high cure probability assumption has a positive effect on the fair value, and, if a cure event takes place sooner than anticipated, the impact on the valuation is also favorable.

Management monitors the valuation results of each CDO on a quarterly basis, which includes an analysis of historical pricing trends for these types of securities, overall economic conditions (such as tracking LIBOR curves), and the performance of the Issuers’ industries. Management also reviews market activity for the same or similar tranches of the CDOs, when available. Annually, management validates significant assumptions by reviewing detailed back-testing performed by the structured credit valuation firm.

A rollforward of the carrying value of CDOs for the quarters and nine months ended September 30, 2013 and 2012 is presented in the following table.

Rollforward of the Carrying Value of CDOs
(Dollar amounts in thousands)
 
Quarters Ended
September 30,
 
Nine Months Ended
September 30,
 
2013
 
2012
 
2013
 
2012
Beginning balance
$
14,917

 
$
11,082

 
$
12,129

 
$
13,394

Total income (loss):
 
 
 
 
 
 
 
OTTI included in earnings (1)
—

 
—

 
—

 
(2,126
)
Included in other comprehensive income (2)
2,079

 
464

 
4,867

 
278

Ending balance (3)
$
16,996

 
$
11,546

 
$
16,996

 
$
11,546

Change in unrealized losses recognized in earnings
  related to securities still held at end of period
$
—

 
$
—

 
$
—

 
$
(2,126
)

(1) 
Included in net securities gains (losses) in the Condensed Consolidated Statements of Income and related to securities still held at the end of the period.
(2) 
Included in unrealized holding gains (losses) in the Consolidated Statements of Comprehensive Income.
(3) 
There were no purchases, issuances, or settlements of CDOs during the periods presented. One CDO with a carrying value of zero was sold during the nine months ended September 30, 2013, resulting in a gain of $101,000.

Mortgage Servicing Rights

The Company services loans for others totaling $202.5 million as of September 30, 2013 and $109.7 million as of December 31, 2012. These loans are owned by third parties and are not included in the Consolidated Statements of Condition. The Company estimates the fair value of mortgage servicing rights by using a discounted cash flow analysis and classifies them in level 3 of the fair value hierarchy. Additional information regarding the Company’s mortgage servicing rights can be found in Note 22, “Fair Value,” in the Company’s 2012 10-K.

Derivative Assets and Derivative Liabilities

The Company enters into interest rate swaps that are executed in the dealer market, and pricing is based on market quotes obtained from the counterparty. The market quotes were developed using market observable inputs, which primarily include LIBOR. Therefore, derivatives are classified in level 2 of the fair value hierarchy. For its derivative assets and liabilities, the Company also considers non-performance risk, including the likelihood of default by itself and its counterparties, when evaluating whether the market quotes from the counterparty are representative of an exit price. The Company also enters into derivative transactions with commercial customers and simultaneously enters into an offsetting interest rate derivative transaction with a third party, which are valued using market consensus prices.

Pension Plan Assets

Although pension plan assets are not consolidated in the Company’s Consolidated Statements of Financial Condition, the fair value of pension plan assets is required to be measured on an annual basis. Additionally, pension plan assets were remeasured as of June 30, 2013 as a result of the amendment to freeze the benefit accruals under the Pension Plan. Refer to Note 9, “Employee

36





Benefit Plans” for additional discussion regarding this change. The fair value of pension plan assets is presented in the following table by level in the fair value hierarchy.

Fair Value Measurements for Pension Plan Assets
(Dollar amounts in thousands)
 
September 30, 2013
 
December 31, 2012
 
Level 1
 
Level 2
 
Total
 
Level 1
 
Level 2
 
Total
Pension plan assets:
 
 
 
 
 
 
 
 
 
 
 
Mutual funds (1)
$
24,761

 
$
—

 
$
24,761

 
$
16,009

 
$
—

 
$
16,009

U.S. government and government
  agency securities
9,797

 
7,425

 
17,222

 
6,510

 
7,295

 
13,805

Corporate bonds
—

 
6,110

 
6,110

 
—

 
8,653

 
8,653

Common stocks
14,861

 
—

 
14,861

 
15,001

 
—

 
15,001

Common trust funds
—

 
10,030

 
10,030

 
—

 
10,033

 
10,033

Total pension plan assets
$
49,419

 
$
23,565

 
$
72,984

 
$
37,520

 
$
25,981

 
$
63,501


(1) 
Includes mutual funds, money market funds, cash, cash equivalents, and accrued interest.

Mutual funds, certain U.S. government agency securities, and common stocks are based on quoted market prices in active exchange markets and classified in level 1 of the fair value hierarchy. Corporate bonds, certain U.S. government agency, and U.S. Treasury securities are valued at quoted prices from independent sources that are based on observable market trades or observable prices for similar bonds where a price for the identical bond is not observable and, therefore, are classified as level 2 of the fair value hierarchy. Common trust funds are valued at quoted redemption values on the last business day of the Plan’s year end and are classified as level 2 in the fair value hierarchy.

Assets and Liabilities Required to be Measured at Fair Value on a Non-Recurring Basis

The following table provides the fair value for each class of assets and liabilities required to be measured at fair value on a non-recurring basis in the Consolidated Statements of Financial Condition by level in the fair value hierarchy.

Non-Recurring Fair Value Measurements
(Dollar amounts in thousands)
 
September 30, 2013
 
December 31, 2012
 
Level 1
 
Level 2
 
Level 3
 
Level 1
 
Level 2
 
Level 3
Collateral-dependent impaired
  loans
$
—

 
$
—

 
$
11,996

 
$
—

 
$
—

 
$
61,454

OREO (1)
—

 
—

 
10,252

 
—

 
—

 
11,956

Loans held-for-sale (2)
—

 
—

 
1,191

 
—

 
—

 
—

Assets held-for-sale (3)
—

 
—

 
4,000

 
—

 
—

 
1,668


(1) 
Includes OREO and covered OREO with fair value adjustments subsequent to initial transfer.
(2) 
Included in other assets in the Consolidated Statements of Financial Condition.
(3) 
Included in premises, furniture, and equipment in the Consolidated Statements of Financial Condition.

Collateral-Dependent Impaired Loans

Certain collateral-dependent impaired loans are subject to fair value adjustments to reflect the difference between the carrying value of the loans and the value of the underlying collateral. The fair values of collateral-dependent impaired loans are primarily determined by current appraised values of the underlying collateral. Based on the age and/or type, appraisals may be adjusted in the range of 0% -20%. In certain cases, an internal valuation may be used when the underlying collateral is located in areas where comparable sales data is limited or unavailable. Accordingly, collateral-dependent impaired loans are classified in level 3 of the fair value hierarchy.

Collateral-dependent impaired loans for which the fair value is greater than the recorded investment are not measured at fair value in the Consolidated Statements of Financial Condition and are not included in this disclosure.

37






OREO

The fair value of OREO is measured using the current appraised value of the properties. In certain circumstances, a current appraisal may not be available or may not represent an accurate measurement of the property’s fair value due to outdated market information or other factors. In these cases, the fair value is determined based on the lower of the (i) most recent appraised value, (ii) broker price opinion, (iii) current listing price, or (iv) signed sales contract. Given these valuation methods, OREO is classified in level 3 of the fair value hierarchy. Any valuation adjustments for reductions in the fair value of OREO are recognized in the Company’s operating results in the period in which they occur.

Loans Held-for-Sale

As of September 30, 2013, loans held-for-sale consisted of 1-4 family mortgage loans. The Company had no loans held-for-sale as of December 31, 2012.

Assets Held-for-Sale

As of September 30, 2013, assets held-for-sale consisted of three former bank branches that are no longer in operation, which were transferred into the held-for-sale category at their recorded investment as an approximation of fair value. Therefore, they are classified in level 3 of the fair value hierarchy.

Valuation Adjustments Recorded for
Assets Measured at Fair Value on a Non-Recurring Basis
(Dollar amounts in thousands)
 
Quarters Ended
September 30,
 
Nine Months Ended
September 30,
 
2013
 
2012
 
2013
 
2012
Charged to allowance for loan and covered loan losses:
 
 
 
 
 
 
 
Collateral-dependent impaired loans
$
4,604

 
$
43,414

 
$
15,812

 
$
79,828

Loans held-for-sale
—

 
80,260

 
1,560

 
82,647

Charged to earnings:
 
 
 
 
 
 
 
OREO
243

 
1,410

 
829

 
3,924

Assets held-for-sale
—

 
1,255

 
—

 
1,255



38





Financial Instruments Not Required to be Measured at Fair Value

For certain financial instruments that are not required to be measured at fair value in the Consolidated Statements of Financial Condition, the Company must disclose the estimated fair values and the level within the fair value hierarchy as shown in the following table.

Fair Value Measurements of Other Financial Instruments
(Dollar amounts in thousands)
 
 
September 30, 2013
 
December 31, 2012
 
Fair Value Hierarchy
Level
 
Carrying
Amount
 
Fair Value
 
Carrying
Amount
 
Fair Value
Assets:
 
 
 
 
 
 
 
 
 
Cash and due from banks
1
 
$
155,075

 
$
155,075

 
$
149,420

 
$
149,420

Interest-bearing deposits in other banks
2
 
744,163

 
744,163

 
566,846

 
566,846

Securities held-to-maturity
2
 
29,847

 
29,542

 
34,295

 
36,023

FHLB and Federal Reserve Bank stock
2
 
35,161

 
35,161

 
47,232

 
47,232

Net loans
3
 
5,511,406

 
5,440,441

 
5,288,124

 
5,305,286

FDIC indemnification asset
3
 
18,078

 
11,902

 
37,051

 
27,040

Accrued interest receivable
3
 
28,155

 
28,155

 
27,535

 
27,535

Investment in BOLI
3
 
193,979

 
193,979

 
206,405

 
206,405

Other interest earning assets
3
 
7,374

 
8,475

 
9,923

 
10,640

Liabilities:
 
 
 
 
 
 
 
 
 
Deposits
2
 
$
7,003,208

 
$
6,999,214

 
$
6,672,255

 
$
6,674,510

Borrowed funds
2
 
212,058

 
213,995

 
185,984

 
189,074

Senior and  subordinated debt
1
 
214,876

 
222,755

 
214,779

 
216,686

Accrued interest payable
2
 
5,852

 
5,852

 
2,884

 
2,884

Standby letters of credit
2
 
659

 
659

 
740

 
740


Management uses various methodologies and assumptions to determine the estimated fair values of the financial instruments in the table above. The fair value estimates are made at a discrete point in time based on relevant market information and consider management’s judgments regarding future expected economic conditions, loss experience, and specific risk characteristics of the financial instruments.

Short-Term Financial Assets and Liabilities - For financial instruments with a shorter-term or with no stated maturity, prevailing market rates, and limited credit risk, the carrying amounts approximate fair value. Those financial instruments include cash and due from banks, interest-bearing deposits in other banks, and other short-term investments, accrued interest receivable, and accrued interest payable.

Securities Held-to-Maturity - The fair value of securities held-to-maturity is based on quoted market prices or dealer quotes. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.

FHLB and Federal Reserve Bank Stock - The carrying amounts approximate fair value.

Net Loans - Net loans includes loans, covered loans, and the allowance for loans and covered loan losses. The fair value of loans is estimated using the present value of the future cash flows of the remaining maturities of the loans. Prepayment assumptions that consider the Company’s historical experience and current economic and lending conditions were included. The discount rate was based on the LIBOR yield curve with adjustments for liquidity and credit risk. The primary impact of credit risk on the fair value of the loan portfolio was accommodated through the use of the allowance for loan and covered loan losses, which is believed to represent the current fair value of estimated inherent losses for purposes of the fair value calculation.

The fair value of the covered loan portfolio is determined by discounting the estimated cash flows at a market interest rate, which is derived from LIBOR swap rates over the life of those loans. The estimated cash flows are determined using the contractual terms of the covered loans, net of any projected credit losses. For valuation purposes, these loans are placed into groups with similar characteristics and risk factors, where appropriate. The timing and amount of credit losses for each group are estimated

39





using historical default and loss experience, current collateral valuations, borrower credit scores, and internal risk ratings. For individually significant loans or credit relationships, the estimated fair value is determined by a specific loan level review utilizing appraised values for collateral and projections of the timing and amount of cash flows.

FDIC Indemnification Asset - The fair value of the FDIC indemnification asset is calculated by discounting the cash flows expected to be received from the FDIC. The future cash flows are estimated by multiplying expected losses on covered loans and covered OREO by the reimbursement rates in the FDIC Agreements.

Investment in BOLI - The fair value of BOLI approximates the carrying amount as both are based on each policy’s respective CSV, which is the amount the Company would receive upon liquidation of these investments. The CSV is derived from monthly reports provided by the managing brokers and is determined using the Company’s initial insurance premium and earnings of the underlying assets, offset by management fees.

Other Interest-Earning Assets - The fair value of other interest-earning assets is estimated using the present value of the future cash flows of the remaining maturities of the assets.

Deposits - The fair values disclosed for demand deposits, savings deposits, NOW accounts, and money market deposits are equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). The fair value for fixed-rate time deposits was estimated using the future cash flows discounted based on the LIBOR yield curve, plus or minus the spread associated with current pricing.

Borrowed Funds - The fair value of FHLB advances is estimated by discounting the agreements based on maturities using the rates currently offered for repurchase agreements of similar remaining maturities adjusted for prepayment penalties that would be incurred if the borrowings were paid off on the measurement date. The carrying amounts of federal funds purchased, repurchase agreements, federal term auction facilities, and other borrowed funds approximate their fair value due to their short-term nature.

Senior and Subordinated Debt - The fair value of senior and subordinated debt was determined using quoted market prices.

Standby Letters of Credit - The fair value of standby letters of credit represents deferred fees arising from the related off-balance sheet financial instruments. These deferred fees approximate the fair value of these instruments and are based on several factors, including the remaining terms of the agreements and the credit standing of the customers.

Commitments - The Company estimated the fair value of commitments outstanding to be immaterial based on the following factors: (i) the limited interest rate exposure of the commitments outstanding due to their variable nature, (ii) the short-term nature of the commitment periods, (iii) termination clauses provided in the agreements, and (iv) the market rate of fees charged.


40





ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

INTRODUCTION

First Midwest Bancorp, Inc. (the “Company”) is a bank holding company headquartered in the Chicago suburb of Itasca, Illinois with operations throughout the greater Chicago metropolitan area as well as northwest Indiana, central and western Illinois, and eastern Iowa. Our principal subsidiary is First Midwest Bank (the “Bank”), which provides a broad range of commercial and retail banking and wealth management services to consumer, commercial and industrial, commercial real estate, and municipal customers through approximately 90 banking offices. We are committed to meeting the financial needs of the people and businesses in the communities where we live and work by providing customized banking solutions, quality products, and innovative services that fulfill those financial needs.

The following discussion and analysis is intended to address the significant factors affecting our results of operations and financial condition for the quarters and nine months ended September 30, 2013 and 2012. When we use the terms “First Midwest,” the “Company,” “we,” “us,” and “our,” we mean First Midwest Bancorp, Inc., a Delaware Corporation, and its consolidated subsidiaries. When we use the term “Bank,” we are referring to our wholly owned banking subsidiary, First Midwest Bank. Management’s discussion and analysis should be read in conjunction with the consolidated financial statements and accompanying notes presented elsewhere in this report, as well as in our 2012 Annual Report on Form 10-K (“2012 10-K”). The results of operations for the quarter and nine months ended September 30, 2013 are not necessarily indicative of future results.

Our primary sources of revenue are net interest income and fees from financial services provided to our customers. Our largest expenses include interest expense, compensation expense, and various other noninterest expense items.

Our results of operations are affected by various factors, many of which are beyond our control, including interest rates, local and national economic conditions, business spending, consumer confidence, certain seasonal factors, legislative and regulatory changes, and changes in real estate and securities markets. Our management evaluates performance using a variety of qualitative and quantitative metrics. The primary quantitative metrics used by management include:

•
Pre-Tax, Pre-Provision Operating Earnings - Pre-tax, pre-provision operating earnings, a non-GAAP financial measure, reflects our operating performance before the effects of credit-related charges, securities gains, losses, and impairments, and certain unusual, infrequent, or non-recurring revenues and expenses. We believe this metric is useful because it helps investors to assess the Company’s operating performance. A reconciliation of pre-tax, pre-provision operating earnings to GAAP can be found in Table 1.
•
Net Interest Income - Net interest income, our primary source of revenue, equals the difference between interest income and fees earned on interest-earning assets and interest expense incurred on interest-bearing liabilities.
•
Net Interest Margin - Net interest margin equals net interest income divided by total average interest-earning assets.
•
Noninterest Income - Noninterest income is the income we earn from fee-based revenues, BOLI and other income, and non-operating revenues.
•
Asset Quality - Asset quality represents an estimation of the quality of our loan portfolio, including an assessment of the credit risk related to existing and potential loss exposure, and can be evaluated using a number of quantitative measures, such as non-performing loans to total loans.
•
Regulatory Capital - Our regulatory capital is classified in one of the following two tiers: (i) Tier 1 capital consists of common equity, retained earnings, and qualifying trust-preferred securities, less goodwill and most intangible assets and (ii) Tier 2 capital includes qualifying subordinated debt and the allowance for credit losses, subject to limitations.

Unless otherwise stated, all earnings per common share data included in this section and throughout the remainder of this discussion are presented on a diluted basis.

CAUTIONARY STATEMENT PURSUANT TO THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995

We include or incorporate by reference in this Quarterly Report on Form 10-Q, and from time to time our management may make, statements that may constitute “forward-looking statements” within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are not historical facts, but instead represent only management’s beliefs regarding future events, many of which, by their nature, are inherently uncertain and outside our control. Although we believe the expectations reflected in any forward-looking statements are reasonable, it is possible that our actual results and financial condition may differ, possibly materially, from the anticipated results and financial condition indicated in such statements. In some cases, you can identify these statements by forward-looking words such as “may,” “might,” “will,” “should,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “probable,” “potential,” or “continue,” and the negative of these terms and other

41





comparable terminology. We caution you not to place undue reliance on forward-looking statements, which speak only as of the date of this report or when made. We do not undertake any obligation to update any forward-looking statements to reflect circumstances or events that occur after the date of this quarterly report or the date on which the forward-looking statement is made.

Forward-looking statements are subject to known and unknown risks, uncertainties, and assumptions and may contain projections relating to our future financial performance including our growth strategies and anticipated trends in our business. For a detailed discussion of these and other risks and uncertainties that could cause actual results and events to differ materially from such forward-looking statements, you should refer to the sections entitled “Risk Factors” and “Management’s Discussion and Analysis of Results of Operations” in this report and in our 2012 Annual Report on Form 10-K as well as our subsequent periodic and current reports filed with the U.S. Securities and Exchange Commission (“SEC”). However, these risks and uncertainties are not exhaustive. Other sections of this report describe additional factors that could adversely impact our business and financial performance.

CRITICAL ACCOUNTING POLICIES

Our consolidated financial statements are prepared in accordance with GAAP and are consistent with general practices in the banking industry. Critical accounting policies are policies that management believes are the most important to our financial position and results of operations. Application of critical accounting policies requires management to make estimates, assumptions, and judgments based on information available as of the date of the financial statements that affect the amounts reported in the financial statements and accompanying notes. Future changes in information may affect these estimates, assumptions, and judgments, which may affect amounts reported in the financial statements.

For additional information regarding critical accounting policies, refer to “Summary of Significant Accounting Policies,” presented in Note 1 to the Consolidated Financial Statements and the section titled “Critical Accounting Policies” in Management’s Discussion and Analysis of Financial Condition and Results of Operations included in the Company’s 2012 10-K. There have been no significant changes in the Company’s application of critical accounting policies related to the allowance for credit losses, valuation of securities, and income taxes since December 31, 2012.


42





PERFORMANCE OVERVIEW

Table 1
Selected Financial Data
(Dollar and share amounts in thousands, except per share data)
 
Quarters Ended
September 30,
 
Nine Months Ended
September 30,
 
2013
 
2012
 
2013
 
2012
Operating Results
 
 
 
 
 
 
 
Interest income
$
72,329

 
$
75,584

 
$
215,127

 
$
226,370

Interest expense
(6,663
)
 
(8,324
)
 
(20,683
)
 
(27,224
)
Net interest income
65,666

 
67,260

 
194,444

 
199,146

Fee-based revenues
27,804

 
24,350

 
79,570

 
70,593

Other noninterest income (1)
1,966

 
1,712

 
5,000

 
4,731

Noninterest expense (1)
(62,817
)
 
(61,788
)
 
(186,574
)
 
(182,413
)
Pre-tax, pre-provision operating earnings (2)
32,619

 
31,534

 
92,440

 
92,057

Provision for loan and covered loan losses
(4,770
)
 
(111,791
)
 
(16,257
)
 
(152,459
)
Net securities gains (losses)
33,801

 
(217
)
 
34,017

 
(1,009
)
BOLI modification loss
(13,312
)
 
—

 
(13,312
)
 
—

Gain on termination of FHLB forward commitments
7,829

 
—

 
7,829

 
—

Net losses on OREO sales
(1,409
)
 
(615
)
 
(1,316
)
 
(931
)
OREO valuation adjustments
(243
)
 
(1,410
)
 
(829
)
 
(3,924
)
Severance-related costs
(233
)
 
(840
)
 
(1,724
)
 
(1,155
)
Gain on FDIC-assisted transaction, net of integration costs
—

 
3,074

 
—

 
3,074

Adjusted amortization of FDIC indemnification asset
—

 
(4,000
)
 
(1,500
)
 
(4,000
)
Valuation adjustments on assets held-for-sale
—

 
(1,255
)
 
—

 
(1,255
)
Gain on early extinguishment of debt
—

 
—

 
—

 
256

Income (loss) before income tax
54,282

 
(85,520
)
 
99,348


(69,346
)
Income tax expense (benefit)
24,959

 
(36,993
)
 
39,207

 
(35,076
)
Net income (loss)
29,323

 
(48,527
)
 
60,141

 
(34,270
)
Net (income) loss applicable to non-vested restricted shares
(416
)
 
715

 
(847
)
 
500

Net income (loss) applicable to common shares
$
28,907

 
$
(47,812
)
 
$
59,294

 
$
(33,770
)
Weighted average diluted common shares outstanding
74,034

 
73,742

 
73,978

 
73,636

Diluted earnings (loss) per common share
$
0.39

 
$
(0.65
)
 
$
0.80

 
$
(0.46
)
Performance Ratios (3)
 
 
 
 
 
 
 
Return on average common equity
11.66
%
 
(19.36
)%
 
8.22
%
 
(4.62
)%
Return on average assets
1.38
%
 
(2.35
)%
 
0.98
%
 
(0.57
)%
Net interest margin – tax equivalent
3.63
%
 
3.83
 %
 
3.70
%
 
3.86
 %
Efficiency ratio (4)
62.70
%
 
69.04
 %
 
64.46
%
 
64.78
 %


(1) 
Excludes certain non-operating noninterest items.
(2) 
Our accounting and reporting policies conform to GAAP and general practices within the banking industry. As a supplement to GAAP, we provided this non-GAAP performance result, which we believe is useful because it assists investors in evaluating our operating performance. This non-GAAP financial measure should not be considered an alternative to GAAP and may not be comparable to similar non-GAAP measures used by other companies.
(3) 
All ratios are presented on an annualized basis.
(4) 
The efficiency ratio expresses noninterest expense, excluding OREO expense, as a percentage of tax-equivalent net interest income plus total fee-based revenues, other income, trading gains (losses), and the tax-equivalent adjustment on BOLI income. The $7.8 million gain on termination of FHLB forward commitments and the $13.3 million BOLI modification loss are non-recurring items excluded from the efficiency ratio for the third quarter and nine months ended September 30, 2013.

43





 
September 30,
2013
 
December 31,
2012
 
September 30,
2012
 
September 30, 2013
Change From
December 31,
2012
 
September 30,
2012
Balance Sheet Highlights
 
 
 
 
 
 
 
 
 
Total assets
$
8,517,913

 
$
8,099,839

 
$
8,167,176

 
$
418,074

 
$
350,737

Total loans, excluding covered loans
5,448,929

 
5,189,676

 
5,218,345

 
259,253

 
230,584

Total loans, including covered loans
5,602,234

 
5,387,570

 
5,434,955

 
214,664

 
167,279

Total deposits
7,003,208

 
6,672,255

 
6,749,055

 
330,953

 
254,153

Transactional deposits
5,745,047

 
5,272,307

 
5,253,658

 
472,740

 
491,389

Loans-to-deposits ratio
80.0
%
 
80.7
%
 
80.5
%
 
 
 
 
Transactional deposits to total deposits
82.0
%
 
79.0
%
 
77.8
%
 
 
 
 

 
September 30,
2013
 
December 31,
2012
 
September 30,
2012
 
September 30, 2013
Change From
December 31,
2012
 
September 30,
2012
Asset Quality Highlights (1)
 
 
 
 
 
 
 
 
 
Non-accrual loans
$
68,170

 
$
84,534

 
$
99,579

 
$
(16,364
)
 
$
(31,409
)
90 days or more past due loans
  (still accruing interest)
5,642

 
8,689

 
12,582

 
(3,047
)
 
(6,940
)
Total non-performing loans
73,812

 
93,223

 
112,161

 
(19,411
)
 
(38,349
)
Accruing TDRs
24,329

 
6,867

 
6,391

 
17,462

 
17,938

OREO
35,616

 
39,953

 
36,487

 
(4,337
)
 
(871
)
Total non-performing assets
$
133,757

 
$
140,043

 
$
155,039

 
$
(6,286
)
 
$
(21,282
)
30-89 days past due loans
  (still accruing interest)
$
15,111

 
$
22,666

 
$
20,088

 
$
(7,555
)
 
$
(4,977
)
Allowance for credit losses
80,158

 
90,750

 
95,548

 
(10,592
)
 
(15,390
)
Allowance for credit losses as a
   percent of loans
1.47
%
 
1.75
%
 
1.83
%
 
 
 
 
Allowance for credit losses to
  non-accrual loans
117.59
%
 
107.35
%
 
95.95
%
 
 
 
 

(1) 
Excludes covered loans and covered OREO. For a discussion of covered loans and covered OREO, refer to Note 5 of “Notes to Condensed Consolidated Financial Statements” in Part I, Item 1 of this Form 10-Q. Asset quality, including covered loans and covered OREO, is included in the “Loan Portfolio and Credit Quality” section below.

Net income applicable to common shares for the third quarter of 2013 was $28.9 million, or $0.39 per share, compared to a net loss applicable to common shares of $47.8 million, or $0.65 per share, for the third quarter of 2012. For the first nine months of 2013, net income applicable to common shares was $59.3 million, or $0.80 per share, compared to a net loss applicable to common shares of $33.8 million, or $0.46 per share, for the same period in 2012.

Pre-tax, pre-provision operating earnings of $32.6 million for the third quarter of 2013 increased by 3.4% compared to the third quarter of 2012. For the first nine months of 2013, pre-tax, pre-provision operating earnings was $92.4 million, increasing from $92.1 million for the first nine months of 2012. The rise from both prior periods resulted from growth in our core businesses, specifically mortgage banking, wealth management, and sales of capital market products to our commercial clients, which more than offset a reduction in net interest income and increase in noninterest expense. A discussion of noninterest income and noninterest expense is presented in the following section titled “Earnings Performance.”

Non-performing loans, excluding covered loans, were $73.8 million at September 30, 2013, decreasing significantly from $93.2 million at December 31, 2012 and $112.2 million at September 30, 2012. Compared to December 31, 2012, the decline primarily resulted from the reclassification of $19.4 million of corporate loans from non-accrual to accruing TDR status. Compared to both prior periods presented, the decline in non-performing assets, excluding covered loans and covered OREO, was driven by management's continued focus on credit remediation. Refer to the “Loan Portfolio and Credit Quality” section below for further discussion of non-accrual loans, 90 days past due loans, TDRs, and OREO.

44






Significant Third Quarter Events

During the third quarter of 2013, certain balance sheet repositioning activities, which primarily impacted the securities and bank-owned life insurance ("BOLI") portfolios, were executed to take advantage of changing market conditions, strengthen capital, and better position the Company to benefit from a higher interest rate environment. These activities included:

•
Sale of our $4.0 million equity investment in Textura Corporation ("Textura") for $38.2 million, resulting in a realized gain of $34.2 million. Textura completed an initial public offering ("IPO") of common stock during the second quarter of 2013. At June 30, 2013, we classified our investment in Textura's common stock as available-for-sale and valued it using the closing stock price of Textura on that date reported by the New York Stock Exchange, resulting in an unrealized gain as of that date. Initially, we were restricted from selling any of our shares for six months following the completion of the IPO. During the third quarter of 2013, Textura completed a secondary offering and certain stockholders, including the Company, were allowed to sell their shares. Therefore, we sold substantially all of our equity investment in Textura in the secondary offering. The Company has no other similar equity investments.

•
Terminated two forward commitments with the Federal Home Loan Bank of Chicago ("FHLB") to borrow a total of $250 million for a 5-year period beginning in 2014 at a weighted average interest rate of approximately 2.0%, at a gain of $7.8 million. This termination was executed to take advantage of a temporary rise in interest rates and an anticipation that future liquidity needs could be better managed through maturities of securities, continued growth in our deposit base, and other similar low rate borrowings.

•
Crediting rate terms and the underlying cash surrender value ("CSV") of approximately $100 million of lower yielding BOLI policies were voluntarily modified, resulting in a $13.3 million write-down. This write-down represents the difference between the book value and the fair value of the underlying investments and was previously being amortized in other noninterest income, offsetting BOLI income and any insurance proceeds received. This action gives the Company the flexibility to reinvest these assets in longer duration securities at higher yields to enhance BOLI income.


EARNINGS PERFORMANCE

Net Interest Income

Net interest income is our primary source of revenue and is impacted by interest rates and the volume and mix of interest-earning assets and interest-bearing liabilities. The accounting policies for the recognition of interest income on loans, securities, and other interest-earning assets are presented in Note 1 to the Consolidated Financial Statements of our 2012 10-K.

Our accounting and reporting policies conform to GAAP and general practices within the banking industry. For purposes of this discussion, both net interest income and net interest margin have been adjusted to a fully tax-equivalent basis to more appropriately compare the returns on certain tax-exempt loans and securities to returns on taxable interest-earning assets. Although we believe that these non-GAAP financial measures enhance investors’ understanding of our business and performance, they should not be considered an alternative to GAAP. The effect of this adjustment is at the bottom of Tables 2 and 3.

Table 2 summarizes our average interest-earning assets and interest-bearing liabilities for the quarters ended September 30, 2013 and 2012, the related interest income and interest expense for each earning asset category and funding source, and the average interest rates earned and paid. Table 2 also details differences in interest income and expense from the prior year and the extent to which any changes are attributable to volume and rate fluctuations. Table 3 presents this same information for the nine months ended September 30, 2013 and 2012.

45





Table 2
Net Interest Income and Margin Analysis
(Dollar amounts in thousands)
 
Quarter Ended September 30,
 
 
Attribution of Change
in Net Interest Income (1)
 
2013
 
 
2012
 
 
 
Average
Balance
 
Interest
 
Yield/
Rate (%)
 
 
Average
Balance
 
Interest
 
Yield/
Rate (%)
 
 
Volume
 
Yield/
Rate
 
Total
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other interest-earning assets
$
661,779

 
$
469

 
0.28
 
 
$
435,528

 
$
265

 
0.24
 
 
$
155

 
$
49

 
$
204

Trading securities
15,543

 
29

 
0.75
 
 
15,389

 
25

 
0.65
 
 
—

 
4

 
4

Investment securities (2)
1,250,158

 
10,199

 
3.26
 
 
1,220,654

 
10,841

 
3.55
 
 
271

 
(913
)
 
(642
)
FHLB and Federal Reserve
  Bank stock
35,162

 
333

 
3.79
 
 
47,111

 
341

 
2.90
 
 
(113
)
 
105

 
(8
)
Loans (2)(3)
5,559,932

 
64,326

 
4.59
 
 
5,630,091

 
67,512

 
4.77
 
 
139

 
(3,325
)
 
(3,186
)
Total interest-earning assets (2)
7,522,574

 
75,356

 
3.98
 
 
7,348,773

 
78,984

 
4.28
 
 
452

 
(4,080
)
 
(3,628
)
Cash and due from banks
127,847

 
 
 
 
 
 
128,714

 
 
 
 
 
 
 
 
 
 
 
Allowance for loan and
  covered loan losses
(93,940
)
 
 
 
 
 
 
(118,925
)
 
 
 
 
 
 
 
 
 
 
 
Other assets
847,304

 
 
 
 
 
 
868,551

 
 
 
 
 
 
 
 
 
 
 
Total assets
$
8,403,785

 
 
 
 
 
 
$
8,227,113

 
 
 
 
 
 
 
 
 
 
 
Liabilities and Stockholders’ Equity:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Savings deposits
$
1,127,970

 
192

 
0.07
 
 
$
1,048,430

 
260

 
0.10
 
 
22

 
(90
)
 
(68
)
NOW accounts
1,175,926

 
162

 
0.05
 
 
1,111,412

 
170

 
0.06
 
 
11

 
(19
)
 
(8
)
Money market deposits
1,343,263

 
411

 
0.12
 
 
1,234,833

 
468

 
0.15
 
 
48

 
(105
)
 
(57
)
Time deposits
1,288,746

 
2,072

 
0.64
 
 
1,498,993

 
3,228

 
0.86
 
 
(412
)
 
(744
)
 
(1,156
)
Borrowed funds
203,613

 
390

 
0.76
 
 
189,835

 
507

 
1.06
 
 
41

 
(158
)
 
(117
)
Senior and subordinated debt
214,860

 
3,436

 
6.34
 
 
231,156

 
3,691

 
6.35
 
 
(261
)
 
6

 
(255
)
Total interest-bearing
  liabilities
5,354,378

 
6,663

 
0.49
 
 
5,314,659

 
8,324

 
0.62
 
 
(551
)
 
(1,110
)
 
(1,661
)
Demand deposits
1,975,797

 
 
 
 
 
 
1,852,810

 
 
 
 
 
 
 
 
 
 
 
Other liabilities
90,154

 
 
 
 
 
 
77,062

 
 
 
 
 
 
 
 
 
 
 
Stockholders’ equity - common
983,456

 
 
 
 
 
 
982,582

 
 
 
 
 
 
 
 
 
 
 
Total liabilities and
  stockholders’ equity
$
8,403,785

 
 
 
 
 
 
$
8,227,113

 
 
 
 
 
 
 
 
 
 
 
Net interest income/margin (2)
 
 
$
68,693

 
3.63
 
 
 
 
$
70,660

 
3.83
 
 
$
1,003

 
$
(2,970
)
 
$
(1,967
)
Net interest income (GAAP)
 
 
$
65,666

 
 
 
 
 
 
$
67,260

 
 
 
 
 
 
 
 
 
Tax equivalent adjustment
 
 
3,027

 
 
 
 
 
 
3,400

 
 
 
 
 
 
 
 
 
Tax-equivalent net interest
  income
 
 
$
68,693

 
 
 
 
 
 
$
70,660

 
 
 
 
 
 
 
 
 

(1) 
For purposes of this table, changes which are not due solely to volume changes or rate changes are allocated to these categories on the basis of the percentage relationship of each to the sum of the two.
(2) 
Interest income and yields are presented on a tax-equivalent basis, assuming a federal income tax rate of 35%.
(3) 
This item includes covered interest-earning assets consisting of loans acquired through the Company’s Federal Deposit Insurance Corporation (“FDIC”)-assisted transactions with loss share agreements and the related FDIC indemnification asset. For additional discussion, please refer to Note 5 of “Notes to the Condensed Consolidated Financial Statements” in Part I, Item 1 of this Form 10-Q.



46





Table 3
Net Interest Income and Margin Analysis
(Dollar amounts in thousands)
 
Nine Months Ended September 30,
 
 
Attribution of Change
in Net Interest Income (1)
 
2013
 
 
2012
 
 
 
Average
Balance
 
 
Interest
 
Yield/
Rate (%)
 
 
Average
Balance
 
 
Interest
 
Yield/
Rate (%)
 
 
Volume
 
Yield/
Rate
 
Total
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other interest-earning assets
$
640,551

 
$
1,371

 
0.29
 
 
$
439,104

 
$
798

 
0.24
 
 
$
413

 
$
160

 
$
573

Trading securities
15,174

 
89

 
0.78
 
 
15,355

 
87

 
0.76
 
 
(1
)
 
3

 
2

Investment securities (2)
1,227,619

 
30,303

 
3.29
 
 
1,207,634

 
33,747

 
3.73
 
 
569

 
(4,013
)
 
(3,444
)
FHLB and Federal Reserve
Bank stock
41,086

 
1,014

 
3.29
 
 
48,792

 
1,025

 
2.80
 
 
105

 
(116
)
 
(11
)
Loans (2)(3)
5,439,308

 
191,605

 
4.71
 
 
5,516,758

 
200,729

 
4.86
 
 
51,817

 
(60,941
)
 
(9,124
)
Total interest-earning assets (2)
7,363,738

 
224,382

 
4.07
 
 
7,227,643

 
236,386

 
4.37
 
 
52,903

 
(64,907
)
 
(12,004
)
Cash and due from banks
121,037

 
 
 
 
 
 
120,230

 
 
 
 
 
 
 
 
 
 
 
Allowance for loan and
covered loan losses
(96,991
)
 
 
 
 
 
 
(121,762
)
 
 
 
 
 
 
 
 
 
 
 
Other assets
858,347

 
 
 
 
 
 
873,704

 
 
 
 
 
 
 
 
 
 
 
Total assets
$
8,246,131

 
 
 
 
 
 
$
8,099,815

 
 
 
 
 
 
 
 
 
 
 
Liabilities and Stockholders’ Equity:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Savings deposits
$
1,126,501

 
647

 
0.08
 
 
$
1,028,900

 
812

 
0.11
 
 
88

 
(253
)
 
(165
)
NOW accounts
1,162,657

 
505

 
0.06
 
 
1,075,908

 
567

 
0.07
 
 
53

 
(115
)
 
(62
)
Money market deposits
1,289,857

 
1,315

 
0.14
 
 
1,198,756

 
1,454

 
0.16
 
 
125

 
(264
)
 
(139
)
Time deposits
1,331,277

 
6,693

 
0.67
 
 
1,556,234

 
11,484

 
0.99
 
 
(1,495
)
 
(3,296
)
 
(4,791
)
Borrowed funds
202,664

 
1,217

 
0.80
 
 
196,415

 
1,512

 
1.03
 
 
50

 
(345
)
 
(295
)
Senior and subordinated debt
214,829

 
10,306

 
6.41
 
 
236,816

 
11,395

 
6.43
 
 
(1,055
)
 
(34
)
 
(1,089
)
Total interest-bearing
  liabilities
5,327,785

 
20,683

 
0.52
 
 
5,293,029

 
27,224

 
0.69
 
 
(2,234
)
 
(4,307
)
 
(6,541
)
Demand deposits
1,866,560

 
 
 
 
 
 
1,747,672

 
 
 
 
 
 
 
 
 
 
 
Other liabilities
87,651

 
 
 
 
 
 
82,424

 
 
 
 
 
 
 
 
 
 
 
Stockholders’ equity - common
964,135

 
 
 
 
 
 
976,690

 
 
 
 
 
 
 
 
 
 
 
Total liabilities and
  stockholders’ equity
$
8,246,131

 
 
 
 
 
 
$
8,099,815

 
 
 
 
 
 
 
 
 
 
 
Net interest income/margin (2)
 
 
$
203,699

 
3.70
 
 
 
 
$
209,162

 
3.86
 
 
$
55,137

 
$
(60,600
)
 
$
(5,463
)
Net interest income (GAAP)
 
 
$
194,444

 
 
 
 
 
 
$
199,146

 
 
 
 
 
 
 
 
 
Tax equivalent adjustment
 
 
9,255

 
 
 
 
 
 
10,016

 
 
 
 
 
 
 
 
 
Tax-equivalent net interest
  income
 
 
$
203,699

 
 
 
 
 
 
$
209,162

 
 
 
 
 
 
 
 
 

(1) 
For purposes of this table, changes which are not due solely to volume changes or rate changes are allocated to these categories on the basis of the percentage relationship of each to the sum of the two.
(2) 
Interest income and yields are presented on a tax-equivalent basis, assuming a federal income tax rate of 35%.
(3) 
This item includes covered interest-earning assets consisting of loans acquired through FDIC-assisted transactions with loss share agreements and the related FDIC indemnification asset. For additional discussion, please refer to Note 5 of “Notes to the Condensed Consolidated Financial Statements” in Part I, Item 1 of this Form 10-Q.

Total interest-earning assets for the third quarter of 2013 increased by $173.8 million from the third quarter of 2012 and $136.1 million for the first nine months of 2013 compared to the same period in 2012. This growth was driven primarily by an increase in other interest-earning assets, partially offset by a decrease in loans. The completion of the bulk loan sales in the fourth quarter of 2012 funded a significant portion of the rise in other interest-earning assets and accounted for the decline in average loans.


47





For the third quarter of 2013, total interest-bearing liabilities increased by $39.7 million from the third quarter of 2012 and $34.8 million for the first nine months of 2013 compared to the same period in 2012 driven by higher levels of interest-bearing transaction deposits, which more than offset the decline in time deposits.

Tax-equivalent net interest margin for the third quarter and first nine months of 2013 was 3.63% and 3.70%, respectively, a decline of 20 basis points from the third quarter of 2012 and 16 basis points from the first nine months of 2012. These decreases resulted primarily from an overall lower yield earned on loans due to a decline in the yield for new and renewing loans and a greater preference for floating rate loans given the current low interest rate environment. Additionally, the reinvestment of maturing investment securities at lower rates also contributed to the decrease. An improved funding mix and lower rates paid on time deposits and borrowed funds mitigated the decline in the loan and securities yields.

Noninterest Income

A summary of noninterest income for the quarters and nine months ended September 30, 2013 and 2012 is presented in the following table.

Table 4
Noninterest Income Analysis
(Dollar amounts in thousands)
 
Quarters Ended
September 30,
 
 
 
Nine Months Ended
September 30,
 
 
 
2013
 
2012
 
% Change
 
2013
 
2012
 
% Change
Service charges on deposit accounts
$
9,472

 
$
9,502

 
(0.3
)
 
$
27,267

 
$
27,010

 
1.0

Card-based fees (1)
5,509

 
5,246

 
5.0

 
16,132

 
15,578

 
3.6

Wealth management fees
6,018

 
5,415

 
11.1

 
17,983

 
16,201

 
11.0

Mortgage banking income
1,273

 
196

 
N/M

 
4,251

 
360

 
N/M

Merchant servicing fees
2,915

 
2,849

 
2.3

 
8,368

 
8,079

 
3.6

Other service charges, commissions,
  and fees
2,617

 
1,142

 
N/M

 
5,569

 
3,365

 
65.5

Total fee-based revenues
27,804

 
24,350

 
14.2

 
79,570

 
70,593

 
12.7

Net gains (losses) on securities sales (2)
33,801

 
(217
)
 
N/M

 
34,017

 
(1,009
)
 
N/M

BOLI (loss) income
(13,028
)
 
300

 
N/M

 
(12,428
)
 
952

 
N/M

Gain on termination of FHLB forward
commitments
7,829

 
—

 
N/M

 
7,829

 
—

 
N/M

Other income (3)(5)
800

 
727

 
10.0

 
1,984

 
2,268

 
(12.5
)
Net trading gains (4)(5)
882

 
685

 
28.8

 
2,132

 
1,511

 
41.1

Gain on FDIC-assisted transaction (5)
—

 
3,289

 
N/M

 
—

 
3,289

 
N/M

Gain on early extinguishment
  of debt (5)
—

 
—

 
—

 
—

 
256

 
N/M

Total noninterest income
$
58,088

 
$
29,134

 
99.4

 
$
113,104

 
$
77,860

 
45.3


N/M – Not meaningful.

(1) 
Card-based fees consist of debit and credit card interchange fees for processing transactions as well as various fees on both customer and non-customer automated teller machine (“ATM”) and point-of-sale transactions processed through the ATM and point-of-sale networks.
(2) 
For a discussion of these items, see the “Investment Portfolio Management” section below. These line items are included in net securities gains (losses) in the Condensed Consolidated Statements of Income.
(3) 
Other income consists of various items, including safe deposit box rentals, miscellaneous recoveries, and gains on the sales of various assets.
(4) 
Net trading gains result from changes in the fair value of diversified investment securities held in a grantor trust under deferred compensation arrangements and are substantially offset by nonqualified plan expense for each period presented.
(5) 
These line items are included in other income in the Condensed Consolidated Statements of Income.


Total noninterest income for the third quarter of 2013 increased by $29.0 million, or 99.4%, compared to the third quarter of 2012. For the first nine months of 2013, total noninterest income rose $35.2 million, or 45.3%, from the same period in 2012. Compared to both prior periods presented, the increase resulted primarily from the $34.2 million gain on the sale of our $4.0 million equity investment in Textura. In addition, the $7.8 million gain on the termination of two FHLB forward commitments contributed to

48





the variance. These gains were partially offset by the modification of approximately $100 million of certain lower yielding BOLI policies, which resulted in a $13.3 million write-down of the CSV. These actions helped strengthen capital and provide greater flexibility to redeploy assets to benefit from the rising interest rate environment.

Fee-based revenues increased 14.2% from the third quarter of 2012 and 12.7% from the first nine months of 2012, driven by growth in core business services, specifically mortgage banking, wealth management, and sales of capital market products to commercial clients.

Wealth management fees increased by approximately 11.0% from both prior periods presented due to higher levels of assets under management driven by new customer relationships and improved market performance.

During the third quarter and first nine months of 2013, we sold $36.1 million and $118.1 million respectively, of 1-4 family mortgage loans in the secondary market, respectively, which accounted for the growth in mortgage banking income. Growth in mortgage banking income reflects market conditions and the expansion of our mortgage lending sales force.

The increases in other service charges, commissions, and fees compared to the third quarter and first nine months of 2012 resulted primarily from sales of capital market products to our commercial clients.


49





Noninterest Expense

The following table presents the components of noninterest expense for the quarters and nine months ended September 30, 2013 and 2012.

Table 5
Noninterest Expense Analysis
(Dollar amounts in thousands)
 
Quarters Ended
September 30,
 
 
 
Nine Months Ended
September 30,
 
 
 
2013
 
2012
 
% Change
 
2013
 
2012
 
% Change
Compensation expense:
 
 
 
 
 
 
 
 
 
 
 
Salaries and wages (1)
$
27,254

 
$
26,064

 
4.6

 
$
81,646

 
$
76,209

 
7.1

Nonqualified plan expense (1)
1,003

 
817

 
22.8

 
2,394

 
1,781

 
34.4

Retirement and other employee
  benefits
6,013

 
6,230

 
(3.5
)
 
19,720

 
18,737

 
5.2

Total compensation expense
34,270

 
33,111

 
3.5

 
103,760

 
96,727

 
7.3

Net OREO expense:
 
 
 
 
 
 
 
 
 
 
 
OREO valuation adjustments
243

 
1,410

 
(82.8
)
 
829

 
3,924

 
(78.9
)
Net losses on OREO sales
1,409

 
615

 
N/M

 
1,316

 
931

 
41.4

Net OREO operating expense
1,197

 
1,183

 
1.2

 
3,587

 
4,341

 
(17.4
)
Net OREO expense
2,849

 
3,208

 
(11.2
)
 
5,732

 
9,196

 
(37.7
)
Professional services:
 
 
 
 
 
 
 
 
 
 
 
Loan remediation costs
1,893

 
3,206

 
(41.0
)
 
6,579

 
9,588

 
(31.4
)
Other professional services
3,624

 
3,459

 
4.8

 
9,751

 
9,611

 
1.5

Total professional services
5,517

 
6,665

 
(17.2
)
 
16,330

 
19,199

 
(14.9
)
Net occupancy expense (2)
5,576

 
5,864

 
(4.9
)
 
17,154

 
17,369

 
(1.2
)
Equipment expense (2)
2,406

 
2,244

 
7.2

 
6,768

 
6,583

 
2.8

Technology and related costs
2,984

 
2,906

 
2.7

 
8,351

 
8,615

 
(3.1
)
FDIC premiums
1,734

 
1,785

 
(2.9
)
 
5,180

 
5,163

 
0.3

Advertising and promotions (3)
2,167

 
1,427

 
51.9

 
5,609

 
3,329

 
68.5

Merchant card expense (3)
2,339

 
2,272

 
2.9

 
6,704

 
6,392

 
4.9

Cardholder expenses (3)
1,030

 
982

 
4.9

 
3,003

 
3,004

 
—

Other expenses (3)
3,830

 
4,404

 
(13.0
)
 
11,852

 
13,061

 
(9.3
)
Adjusted amortization of FDIC
  indemnification asset
—

 
4,000

 
N/M

 
1,500

 
4,000

 
(62.5
)
Valuation adjustments of assets
  held-for-sale (3)
—

 
1,255

 
N/M

 
—

 
1,255

 
N/M

Total noninterest expense
$
64,702

 
$
70,123

 
(7.7
)
 
$
191,943

 
$
193,893

 
(1.0
)

N/M – Not meaningful.

(1) 
These expenses are included in salaries and wages in the Condensed Consolidated Statements of Income. Nonqualified plan expense results from changes in the Company’s obligation to participants under deferred compensation agreements.
(2) 
These line items are included in net occupancy and equipment expense in the Condensed Consolidated Statements of Income.
(3) 
These line items are included in other expenses in the Condensed Consolidated Statements of Income.

Total noninterest expense for the third quarter of 2013 decreased 7.7% from the third quarter of 2012. For the first nine months of 2013, noninterest expense declined 1.0% compared to the same period in 2012.

The increase in salaries and wages from the third quarter and first nine months of 2012 was driven primarily by lower levels of deferred salaries and the timing of certain incentive compensation accruals. A rise in commissions related to the increase in wealth management activities previously discussed, the focused expansion of sales personnel into specialized lending areas, and the growth of our mortgage lending sales force also contributed to the variance compared to both prior periods presented.


50





Retirement and other employee benefits increased during the nine months ended September 30, 2013 compared to the same period in 2012 from a rise in profit sharing contributions and insurance costs.

Net OREO expense decreased 11.2% from the third quarter of 2012 and 37.7% from the first nine months of 2012, primarily from lower valuation adjustments. This progress was partially offset by higher net losses, including a $1.2 million loss on the sale of a special-purpose, foreclosed property, during the third quarter of 2013.

Loan remediation costs decreased 41.0% and 31.4% compared to the quarter and nine months ended September 30, 2012 as a result of improved credit quality driven by management’s accelerated credit remediation actions in the third and fourth quarters of 2012, including the bulk loan sales and lower servicing costs for our covered loan portfolio.

The rise in other professional services from the third quarter of 2012 was driven mainly by consulting expenses related to sales of capital market products to commercial clients and legal costs related to the sale of our equity investment in Textura discussed earlier.

The rise in advertising and promotions expense compared to both prior periods presented was driven by our "Bank with Momentum" branding campaign launched in the second quarter of 2013, and reflects the return to a more normalized level of expense.

A reduction in the reserve for unfunded commitments for the quarter and nine months ended September 30, 2013 of $480,000 and $980,000, respectively, resulted in lower other expenses compared to both prior periods presented.

Based on management's current estimates of future cash flows on covered loans and OREO and expected reimbursements from the FDIC for covered losses, adjusted amortization of the FDIC indemnification asset decreased for the third quarter and nine months ended September 30, 2013 compared to both prior periods presented.

Income Taxes

Our provision for income taxes includes both federal and state income tax expense. An analysis of the provision for income taxes is detailed in the following table.

Table 6
Income Tax Expense Analysis
(Dollar amounts in thousands)
 
Quarters Ended
September 30,
 
Nine Months Ended
September 30,
 
2013
 
2012
 
2013
 
2012
Income (loss) before income tax expense (benefit)
$
54,282

 
$
(85,520
)
 
$
99,348

 
$
(69,346
)
Income tax expense (benefit):
 
 
 
 
 
 
 
Federal income tax expense (benefit)
$
19,145

 
$
(29,391
)
 
$
29,058

 
$
(28,420
)
State income tax expense (benefit)
5,814

 
(7,602
)
 
10,149

 
(6,656
)
Total income tax expense (benefit)
$
24,959

 
$
(36,993
)
 
$
39,207

 
$
(35,076
)
Effective income tax rate
46.0
%
 
43.3
%
 
39.5
%
 
50.6
%

Federal income tax expense and the related effective income tax rate are influenced by the amount of tax-exempt income derived from investment securities and bank-owned life insurance in relation to pre-tax income and state income taxes. State income tax expense and the related effective tax rate are driven by the amount of state tax-exempt income in relation to pre-tax income and state tax rules related to consolidated/combined reporting and sourcing of income and expense.

Income tax expense was $25.0 million and $39.2 million for the third quarter and first nine months of 2013 compared to an income tax benefit of $37.0 million and $35.1 million for the same periods in 2012. The rise in income tax expense in 2013 was driven primarily by higher levels of income during 2013 which are subject to tax at statutory rates, and to a non-deductible BOLI modification loss recorded during the third quarter of 2013. Excluding the BOLI modification loss, the effective tax rate would have been 36.9% and 34.8% for the quarter and nine months ended September 30, 2013, respectively.

Our accounting policies for the recognition of income taxes in the Consolidated Statements of Financial Condition and Income are included in Notes 1 and 14 to the Consolidated Financial Statements of our 2012 10-K.

51






FINANCIAL CONDITION

Investment Portfolio Management

Securities that we have the positive intent and ability to hold until maturity are classified as securities held-to-maturity and are accounted for using historical cost, adjusted for amortization of premiums and accretion of discounts. Trading securities are carried at fair value with changes in fair value included in other noninterest income. Our trading securities consist of securities held in a grantor trust for our nonqualified deferred compensation plan and are not considered part of the traditional investment portfolio. All other securities are classified as securities available-for-sale and are carried at fair value with unrealized gains and losses, net of related deferred income taxes, recorded in stockholders’ equity as a separate component of accumulated other comprehensive loss.

We manage our investment portfolio to maximize the return on invested funds within acceptable risk guidelines, to meet pledging and liquidity requirements, and to adjust balance sheet interest rate sensitivity to mitigate the impact of changes in interest rates on net interest income.

From time to time, we adjust the size and composition of our securities portfolio based on a number of factors, including expected loan growth, anticipated changes in collateralized public funds on account, the interest rate environment, and the related value of various segments of the securities markets. The following table provides a valuation summary of our investment portfolio.

Table 7
Investment Portfolio Valuation Summary
(Dollar amounts in thousands)
 
September 30, 2013
 
December 31, 2012
 
Fair
Value
 
Net
Unrealized
Gains
(Losses)
 
Amortized
Cost
 
% of Total
Amortized
Cost
 
Fair
Value
 
Net
Unrealized
Gains
(Losses)
 
Amortized
Cost
 
% of Total
Amortized
Cost
Securities Available-for-Sale
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. agency securities
$
501

 
$
—

 
$
501

 
—
 
$
508

 
$
—

 
$
508

 
—
CMOs
506,036

 
(10,126
)
 
516,162

 
42.3
 
400,383

 
3,237

 
397,146

 
35.6
Other MBSs
141,302

 
1,990

 
139,312

 
11.4
 
122,900

 
5,115

 
117,785

 
10.6
Municipal securities
471,259

 
7,083

 
464,176

 
38.1
 
520,043

 
24,137

 
495,906

 
44.5
CDOs
16,996

 
(29,536
)
 
46,532

 
3.9
 
12,129

 
(34,404
)
 
46,533

 
4.2
Corporate debt
  securities
14,993

 
1,993

 
13,000

 
1.1
 
15,339

 
2,333

 
13,006

 
1.2
Equity securities
11,824

 
1,767

 
10,057

 
0.8
 
11,101

 
1,411

 
9,690

 
0.8
Total available-for-
  sale securities
1,162,911

 
(26,829
)
 
1,189,740

 
97.6
 
1,082,403

 
1,829

 
1,080,574

 
96.9
Securities Held-to-Maturity
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Municipal securities
29,542

 
(305
)
 
29,847

 
2.4
 
36,023

 
1,728

 
34,295

 
3.1
Total securities
$
1,192,453

 
$
(27,134
)
 
$
1,219,587

 
100.0
 
$
1,118,426

 
$
3,557

 
$
1,114,869

 
100.0



52





 
September 30, 2013
 
December 31, 2012
 
Effective
 
Average
 
Yield to
 
Effective
 
Average
 
Yield to
 
Duration (1)
 
Life (2)
 
Maturity (3)
 
Duration (1)
 
Life (2)
 
Maturity (3)
Securities Available-for-Sale
 
 
 
 
 
 
 
 
 
 
 
U.S. agency securities
0.08
%
 
0.08

 
0.20
%
 
0.90
%
 
0.92

 
0.20
%
CMOs
4.24
%
 
4.14

 
1.35
%
 
2.22
%
 
2.93

 
1.19
%
Other MBSs
3.74
%
 
4.65

 
2.30
%
 
1.97
%
 
3.62

 
2.79
%
Municipal securities
5.18
%
 
3.40

 
5.54
%
 
4.49
%
 
3.69

 
5.56
%
CDOs
0.25
%
 
10.00

 
N/A

 
0.25
%
 
8.36

 
N/A

Corporate debt securities
5.04
%
 
7.37

 
6.38
%
 
5.51
%
 
8.09

 
6.37
%
Equity securities
N/A

 
N/A

 
N/A

 
N/A

 
N/A

 
N/A

Total available-for-sale securities
4.40
%
 
4.18

 
3.09
%
 
3.20
%
 
3.65

 
3.37
%
Securities Held-to-Maturity
 
 
 
 
 
 
 
 
 
 
 
Municipal securities
5.54
%
 
8.78

 
4.54
%
 
6.30
%
 
10.53

 
5.26
%
Total securities
4.43
%
 
4.29

 
3.12
%
 
3.29
%
 
3.86

 
3.43
%

(1) 
The effective duration represents the estimated percentage change in the fair value of the securities portfolio given a 100 basis point increase or decrease in interest rates. This measure is used to evaluate the portfolio’s price volatility at a single point in time and is not intended to be a precise predictor of future fair values since those values will be influenced by a number of factors.
(2) 
Average life is presented in years and represents the weighted-average time to receive all future cash flows using the dollar amount of principal paydowns, including estimated principal prepayments, as the weighting factor.
(3) 
Yields on municipal securities are reflected on a tax-equivalent basis, assuming a federal income tax rate of 35%.

Portfolio Composition

As of September 30, 2013, our securities portfolio totaled $1.2 billion, an increase of 6.6% compared to December 31, 2012. The growth in CMOs during the first nine months of 2013 resulted from the redeployment of cash and cash equivalents into these securities. During the first nine months of 2013, available-for-sale securities purchases of $326.1 million more than offset $178.3 million in maturities and $7.5 million in premium amortization. Our available-for-sale securities portfolio is comprised primarily of municipal securities, CMOs, and other MBSs. The remainder of the portfolio consists of six CDOs with a total fair value of $17.0 million and miscellaneous other securities with fair values equaling $27.3 million.

Investments in municipal securities comprised 40.5%, or $471.3 million, of the total available-for-sale securities portfolio at September 30, 2013 and declined 9.4% from $520.0 million at December 31, 2012. The majority consists of general obligations of local municipalities, compared to state issued debt. Our municipal securities portfolio has historically experienced very low default rates and provides a predictable cash flow.

The average life and effective duration of our available-for-sale securities portfolio as of September 30, 2013 are elevated from the December 31, 2012 metrics due primarily to purchases of CMOs and other MBSs during the nine months ended September 30, 2013. The decline in the yield to maturity from December 31, 2012 was impacted by purchases and repricing of securities in the CMO and other MBS portfolios.

Securities Gains and Losses

Net securities gains for the third quarter and first nine months of 2013 were $33.8 million and $34.0 million, respectively, and resulted primarily from the sale of our equity investment in Textura. During the third quarter of 2013, Textura completed a secondary offering and certain stockholders, including the Company, were allowed to sell their shares. In addition, net securities gains for the quarter include other-than-temporary securities impairment ("OTTI") charges of $404,000 on four municipal securities.

Net securities losses were $217,000 for the third quarter of 2012 and $1.0 million for the nine months ended September 30, 2012. Net securities losses for the nine months ended September 30, 2012 included an OTTI charge of $2.1 million associated with two CDOs and net gains of $1.4 million from the sale of $50.6 million in CMOs, municipal securities, and corporate bonds.


53





Unrealized Gains and Losses

Unrealized gains and losses on securities available-for-sale represent the difference between the aggregate cost and fair value of the portfolio. These amounts are presented in the Consolidated Statements of Comprehensive Income and reported as a separate component of stockholders’ equity in accumulated other comprehensive loss on an after-tax basis. This balance sheet component will fluctuate as current market interest rates and conditions change and affect the aggregate fair value of the portfolio. The rise in interest rates caused a decrease in the fair value of fixed rate securities resulting in net unrealized losses at September 30, 2013 of $26.8 million compared to net unrealized gains of $1.8 million at December 31, 2012.

Net unrealized losses in the CMO portfolio totaled $10.1 million at September 30, 2013, compared to net unrealized gains of $3.2 million at December 31, 2012. CMOs are either backed by U.S. government-owned agencies or issued by U.S. government-sponsored enterprises. We do not believe any individual unrealized loss on these types of securities as of September 30, 2013 represents OTTI since the unrealized losses are not attributed to credit quality.

As of September 30, 2013, net unrealized gains in the available-for-sale municipal securities portfolio totaled $7.1 million compared to $24.1 million as of December 31, 2012. Net unrealized gains on municipal securities include unrealized losses of $4.7 million at September 30, 2013. Substantially all of these securities carry investment grade ratings with the majority supported by the general revenues of the issuing governmental entity and supported by third-party bond insurance or other types of credit enhancement. We do not believe the unrealized loss on any of these securities represents an OTTI.

Our investments in CDOs are supported by the credit of the underlying banks and insurance companies. The unrealized loss on these securities declined from $34.4 million at December 31, 2012 to $29.5 million at September 30, 2013. The unrealized loss reflects the difference between amortized cost and fair value that we determined did not relate to credit and reflects the illiquid nature of these particular investments. We do not believe the unrealized losses on the CDOs as of September 30, 2013 represent OTTI related to credit deterioration. In addition, we do not intend to sell the CDOs with unrealized losses within a short period of time, and we do not believe it is more likely than not that we will be required to sell them before recovery of their amortized cost basis, which may be at maturity. Our estimation of fair values for the CDOs is based on discounted cash flow analyses as described in Note 12 of “Notes to the Condensed Consolidated Financial Statements,” in Part I, Item 1 of this Form 10-Q.




54





LOAN PORTFOLIO AND CREDIT QUALITY

Loans Held-for-Investment

Our loan portfolio is comprised of both corporate and consumer loans with corporate loans representing 87.1% of total loans, excluding covered loans, at September 30, 2013. Consistent with our emphasis on relationship banking, the majority of our loans are made to our multi-relationship customers.

Table 8
Loan Portfolio
(Dollar amounts in thousands)
 
September 30,
2013
 
% of
Total
 
December 31,
2012
 
% of
Total
 
Annualized
% Change
Commercial and industrial
$
1,792,561

 
32.9
 
$
1,631,474

 
31.5
 
13.2

Agricultural
318,659

 
5.8
 
268,618

 
5.2
 
24.8

Commercial real estate:
 
 
 
 
 
 
 
 
 
Office
449,067

 
8.2
 
474,717

 
9.1
 
(7.2
)
Retail
384,787

 
7.1
 
368,796

 
7.1
 
5.8

Industrial
503,010

 
9.2
 
489,678

 
9.4
 
3.6

Multi-family
332,749

 
6.1
 
285,481

 
5.5
 
22.1

Residential construction
46,424

 
0.9
 
61,462

 
1.2
 
(32.6
)
Commercial construction
128,748

 
2.4
 
124,954

 
2.4
 
4.0

Other commercial real estate
790,114

 
14.5
 
773,121

 
14.9
 
2.9

Total commercial real estate
2,634,899

 
48.4
 
2,578,209

 
49.6
 
2.9

Total corporate loans
4,746,119

 
87.1
 
4,478,301

 
86.3
 
8.0

Home equity
377,015

 
6.9
 
390,033

 
7.5
 
(4.5
)
1-4 family mortgages
286,333

 
5.3
 
282,948

 
5.5
 
1.6

Installment
39,462

 
0.7
 
38,394

 
0.7
 
3.7

Total consumer loans
702,810

 
12.9
 
711,375

 
13.7
 
(1.6
)
Total loans, excluding covered
  loans
5,448,929

 
100.0
 
5,189,676

 
100.0
 
6.7

Covered loans
153,305

 
 
 
197,894

 
 
 
(30.0
)
Total loans
$
5,602,234

 
 
 
$
5,387,570

 
 
 
5.3


Total loans, excluding covered loans, of $5.4 billion grew by $259.3 million from December 31, 2012. Strong annualized growth in the commercial and industrial, agricultural, and multi-family loan categories continues to reflect our targeted repositioning of the loan portfolio. In addition, greater resource investments and expansion into specialized lending areas, such as agribusiness and asset-based lending, contributed to the increases. This growth was offset by declines in the office, residential construction, and home equity portfolios. Overall, the loan portfolio continues to benefit from well balanced growth reflecting credits of varying size and diverse geographic locations within our markets.

During the first nine months of 2013, we sold $118.1 million of 1-4 family mortgage loans in the secondary market, which contributed to the decrease in the consumer portfolio. We continue to generate solid new mortgage volume, reflecting the expansion of our mortgage lending sales force.

Commercial, Industrial, and Agricultural Loans

Commercial, industrial, and agricultural loans represent 38.7% of total loans, excluding covered loans, and totaled $2.1 billion at September 30, 2013, an increase of $211.1 million, or 14.8% annualized, from December 31, 2012. Our commercial and industrial loans are a diverse group of loans to middle market businesses generally located in the Chicago metropolitan area with purposes that range from supporting seasonal working capital needs to term financing of equipment. The underwriting for these loans is primarily based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower.

55





Most commercial and industrial loans are secured by the assets being financed or other business assets, such as accounts receivable or inventory, and may incorporate a personal guarantee. As part of our targeted portfolio distribution strategy, we are developing and growing specialized lending platforms, such as healthcare, agribusiness, and asset-based lending. Agricultural loans generally provide seasonal support and are secured by facilities and equipment in addition to crop production, which is usually covered by crop insurance.

Commercial Real Estate Loans

All commercial real estate loans are subject to underwriting standards and processes similar to commercial and industrial loans, in addition to those standards specific to real estate loans. The repayment of commercial real estate loans depends on the successful operation of the property securing the loan or the business conducted on the property securing the loan. This category of loans may be more adversely affected by conditions in the real estate market. Management monitors and evaluates commercial real estate loans based on cash flow, collateral, geography, and risk rating criteria. The mix of properties securing the loans in our commercial real estate portfolio are balanced between owner-occupied and investor categories and are diverse in terms of type and geographic location within the Company's markets.


56





The following table presents commercial real estate loans by owner-occupied or investor status and category.

Table 9
Commercial Real Estate Loans
(Dollar amounts in thousands)
 
September 30, 2013
 
December 31, 2012
 
Owner-
Occupied
 
Investor
 
Total
 
Owner-
Occupied
 
Investor
 
Total
Office, retail, and industrial:
 
 
 
 
 
 
 
 
 
 
 
Office
$
161,421

 
$
287,646

 
$
449,067

 
$
167,221

 
$
307,496

 
$
474,717

Retail
118,338

 
266,449

 
384,787

 
115,570

 
253,226

 
368,796

Industrial
262,211

 
240,799

 
503,010

 
270,484

 
219,194

 
489,678

Total office, retail, and industrial
541,970

 
794,894

 
1,336,864

 
553,275

 
779,916

 
1,333,191

Multi-family
—

 
332,749

 
332,749

 
—

 
285,481

 
285,481

Residential construction
—

 
46,424

 
46,424

 
—

 
61,462

 
61,462

Commercial construction
—

 
128,748

 
128,748

 
—

 
124,954

 
124,954

Other commercial real estate:
 
 
 
 
 
 
 
 
 
 
 
Rental properties (1)
32,004

 
84,178

 
116,182

 
26,902

 
94,272

 
121,174

Service stations and truck stops
76,408

 
19,486

 
95,894

 
95,794

 
18,727

 
114,521

Warehouses and storage
65,830

 
54,165

 
119,995

 
77,290

 
33,077

 
110,367

Hotels
—

 
62,937

 
62,937

 
—

 
73,347

 
73,347

Restaurants
62,106

 
18,893

 
80,999

 
62,921

 
17,509

 
80,430

Automobile dealers
33,914

 
7,728

 
41,642

 
39,392

 
5,729

 
45,121

Mobile home parks
—

 
26,943

 
26,943

 
—

 
27,147

 
27,147

Recreational
47,652

 
10,639

 
58,291

 
32,804

 
8,254

 
41,058

Religious
32,484

 
873

 
33,357

 
28,301

 
895

 
29,196

Medical
—

 
797

 
797

 
—

 
816

 
816

Multi-use properties
15,382

 
69,670

 
85,052

 
14,295

 
48,825

 
63,120

Other
32,721

 
35,304

 
68,025

 
32,401

 
34,423

 
66,824

Total other commercial real estate
398,501

 
391,613

 
790,114

 
410,100

 
363,021

 
773,121

Total commercial real estate
$
940,471

 
$
1,694,428

 
$
2,634,899

 
$
963,375

 
$
1,614,834

 
$
2,578,209

Commercial real estate loans, excluding
   multi-family and construction loans
$
940,471

 
$
1,186,507

 
$
2,126,978

 
$
963,375

 
$
1,142,937

 
$
2,106,312

Percent of total (2)
44.2
%
 
55.8
%
 
 
 
45.7
%
 
54.3
%
 
 

(1) 
Owner-occupied rental properties primarily represent home-based businesses.
(2) 
The percent reported does not include multi-family or construction loans since the owner-occupied classification is not relevant to these categories.

Commercial real estate loans represent 48.4% of total loans, excluding covered loans, and totaled $2.6 billion at September 30, 2013, an increase of $56.7 million from December 31, 2012, due primarily to an increase in the multi-family portfolio. Over half of our commercial real estate loans consist of loans for industrial buildings, office buildings, and retail shopping centers.

Consumer Loans

Our consumer loan portfolio consists mainly of loans or lines of credit to individuals for residential or other personal expenditures. Home equity loans and lines of credit and 1-4 family mortgages are primarily secured by senior or junior liens on the borrower’s personal residence. Underwriting standards for these loans are heavily influenced by statutory requirements, which include loan-to-value and affordability ratios, risk-based pricing strategies, and documentation requirements. Loan-to-value ratios on home equity and 1-4 family mortgages are based on the current value of the appraised collateral.


57





Non-performing Assets and Potential Problem Loans

The following table presents our loan portfolio by performing and non-performing status. A discussion of our accounting policies for non-accrual loans, TDRs, and loans 90 days or more past due can be found in Note 1 of “Notes to the Condensed Consolidated Financial Statements” in Part 1, Item 1 of this Form 10-Q.


58





Table 10
Loan Portfolio by Performing/Non-Performing Status
(Dollar amounts in thousands)
 
 
 
 
 
Accruing
 
 
 
 
 
Total
Loans
 
Current
 
30-89 Days
Past Due
 
90 Days
Past Due
 
TDRs
 
Non-accrual
As of September 30, 2013
 
 
 
 
 
 
 
 
 
 
 
Commercial and industrial
$
1,792,561

 
$
1,762,727

 
$
5,268

 
$
3,927

 
$
6,804

 
$
13,835

Agricultural
318,659

 
318,017

 
—

 
—

 
—

 
642

Commercial real estate:
 
 
 
 
 
 
 
 
 
 
 
Office
449,067

 
446,306

 
638

 
—

 
—

 
2,123

Retail
384,787

 
377,399

 
29

 
12

 
626

 
6,721

Industrial
503,010

 
482,184

 
95

 
—

 
9,720

 
11,011

Multi-family
332,749

 
328,765

 
871

 
—

 
1,045

 
2,068

Residential construction
46,424

 
43,573

 
—

 
—

 
495

 
2,356

Commercial construction
128,748

 
124,867

 
—

 
—

 
—

 
3,881

Other commercial real estate
790,114

 
772,793

 
1,255

 
173

 
4,273

 
11,620

Total commercial real estate
2,634,899

 
2,575,887

 
2,888

 
185

 
16,159

 
39,780

Total corporate loans
4,746,119

 
4,656,631

 
8,156

 
4,112

 
22,963

 
54,257

Home equity
377,015

 
364,158

 
4,555

 
973

 
550

 
6,779

1-4 family mortgages
286,333

 
278,028

 
1,915

 
519

 
816

 
5,055

Installment
39,462

 
36,860

 
485

 
38

 
—

 
2,079

Total consumer loans
702,810

 
679,046

 
6,955

 
1,530

 
1,366

 
13,913

Total loans, excluding covered loans
5,448,929

 
5,335,677

 
15,111

 
5,642

 
24,329

 
68,170

Covered loans
153,305

 
94,333

 
7,881

 
20,235

 
—

 
30,856

Total loans
$
5,602,234

 
$
5,430,010

 
$
22,992

 
$
25,877

 
$
24,329

 
$
99,026

As of December 31, 2012
 
 
 
 
 
 
 
 
 
 
 
Commercial and industrial
$
1,631,474

 
$
1,598,342

 
$
4,534

 
$
2,138

 
$
519

 
$
25,941

Agricultural
268,618

 
266,991

 
79

 
375

 
—

 
1,173

Commercial real estate:

 
 
 
 
 
 
 
 
 
 
Office
474,717

 
471,242

 
871

 
197

 
—

 
2,407

Retail
368,796

 
358,945

 
2,415

 
626

 
—

 
6,810

Industrial
489,678

 
475,416

 
255

 
—

 
—

 
14,007

Multi-family
285,481

 
283,415

 
479

 
153

 
—

 
1,434

Residential construction
61,462

 
56,850

 
—

 
—

 
—

 
4,612

Commercial construction
124,954

 
124,081

 
—

 
—

 
—

 
873

Other commercial real estate
773,121

 
749,114

 
1,053

 
1,534

 
5,206

 
16,214

Total commercial real estate
2,578,209

 
2,519,063

 
5,073

 
2,510

 
5,206

 
46,357

Total corporate loans
4,478,301

 
4,384,396

 
9,686

 
5,023

 
5,725

 
73,471

Home equity
390,033

 
375,804

 
6,349

 
1,651

 
40

 
6,189

1-4 family mortgages
282,948

 
270,784

 
4,241

 
1,947

 
1,102

 
4,874

Installment
38,394

 
35,936

 
2,390

 
68

 
—

 
—

Total consumer loans
711,375

 
682,524

 
12,980

 
3,666

 
1,142

 
11,063

Total loans, excluding covered loans
5,189,676

 
5,066,920

 
22,666

 
8,689

 
6,867

 
84,534

Covered loans
197,894

 
145,751

 
6,514

 
31,447

 
—

 
14,182

Total loans
$
5,387,570

 
$
5,212,671

 
$
29,180

 
$
40,136

 
$
6,867

 
$
98,716


The following table provides a comparison of our non-performing assets and past due loans to prior periods.


59





Table 11
Non-Performing Assets and Past Due Loans
(Dollar amounts in thousands)
 
2013
 
2012
 
September 30
 
June 30
 
March 31
 
December 31
 
September 30
Non-performing assets, excluding covered loans and covered OREO
 
 
 
 
 
 
Non-accrual loans
$
68,170

 
$
89,193

 
$
95,397

 
$
84,534

 
$
99,579

90 days or more past due loans
5,642

 
3,832

 
5,552

 
8,689

 
12,582

Total non-performing loans
73,812

 
93,025

 
100,949

 
93,223

 
112,161

Accruing TDRs
24,329

 
8,287

 
2,587

 
6,867

 
6,391

OREO
35,616

 
39,497

 
39,994

 
39,953

 
36,487

Total non-performing assets
$
133,757

 
$
140,809

 
$
143,530

 
$
140,043

 
$
155,039

30-89 days past due loans
$
15,111

 
$
21,756

 
$
22,222

 
$
22,666

 
$
20,088

Non-accrual loans to total loans
1.25
%
 
1.69
%
 
1.84
%
 
1.63
%
 
1.91
%
Non-performing loans to total loans
1.35
%
 
1.76
%
 
1.95
%
 
1.80
%
 
2.15
%
Non-performing assets to loans plus
  OREO
2.44
%
 
2.64
%
 
2.75
%
 
2.68
%
 
2.95
%
Non-performing covered loans and covered OREO (1)
 
 
 
 
 
 
 
 
Non-accrual loans
$
30,856

 
$
28,468

 
$
20,912

 
$
14,182

 
$
16,372

90 days or more past due loans
20,235

 
27,700

 
24,934

 
31,447

 
34,554

Total non-performing loans
51,091

 
56,168

 
45,846

 
45,629

 
50,926

Accruing TDRs
—

 
—

 
—

 
—

 
—

OREO
10,477

 
13,681

 
14,774

 
13,123

 
8,729

Total non-performing assets
$
61,568

 
$
69,849

 
$
60,620

 
$
58,752

 
$
59,655

30-89 days past due loans
$
7,881

 
$
5,650

 
$
10,655

 
$
6,514

 
$
9,241

Non-performing assets, including covered loans and covered OREO
 
 
 
 
 
 
Non-accrual loans
$
99,026

 
$
117,661

 
$
116,309

 
$
98,716

 
$
115,951

90 days or more past due loans
25,877

 
31,532

 
30,486

 
40,136

 
47,136

Total non-performing loans
124,903

 
149,193

 
146,795

 
138,852

 
163,087

Accruing TDRs
24,329

 
8,287

 
2,587

 
6,867

 
6,391

OREO
46,093

 
53,178

 
54,768

 
53,076

 
45,216

Total non-performing assets
$
195,325

 
$
210,658

 
$
204,150

 
$
198,795

 
$
214,694

30-89 days past due loans
$
22,992

 
$
27,406

 
$
32,877

 
$
29,180

 
$
29,329

Non-accrual loans to total loans
1.77
%
 
2.16
%
 
2.17
%
 
1.83
%
 
2.13
%
Non-performing loans to total loans
2.23
%
 
2.73
%
 
2.74
%
 
2.58
%
 
3.00
%
Non-performing assets to loans plus
  OREO
3.46
%
 
3.82
%
 
3.77
%
 
3.65
%
 
3.92
%

(1) 
Covered loans and covered OREO are covered by FDIC Agreements that substantially mitigate the risk of loss. Past due covered loans in the tables above are determined by borrower performance compared to contractual terms, but are generally considered accruing loans since they continue to perform in accordance with our expectations of cash flows. For a discussion of covered loans and covered OREO, refer to Note 5 of “Notes to the Condensed Consolidated Financial Statements” in Part I,  Item 1 of this Form 10-Q.

Non-performing loans, excluding covered loans, were $73.8 million at September 30, 2013, decreasing $19.4 million, or 20.8%, from December 31, 2012. The improvement in non-performing loans was driven primarily by the reclassification of $19.4 million of corporate loans from non-accrual to accruing TDR status. These loans continue to perform in accordance with contractual terms, which are at market rates, and are expected to move to the performing loan portfolio in the first quarter of 2014. This reclassification resulted in a more favorable asset quality mix. Refer to the "TDRs" section below for further discussion.


60





Compared to December 31, 2012, non-performing assets, excluding covered loans and covered OREO, declined by 4.5% due to management's continued focus on credit remediation.

Loans 30-89 days past due decreased to $15.1 million as of September 30, 2013, the lowest level in over a decade.

TDRs

Loan modifications may be performed at the request of the individual borrower and may include reductions in interest rates, changes in payments, or maturity date extensions. We occasionally restructure loans at other than market rates or terms to enable the borrower to work through financial difficulties for a period of time, and these restructures remain classified as TDRs for the remaining terms of the loans.

Table 12
TDRs by Type
(Dollar amounts in thousands)
 
September 30, 2013
 
December 31, 2012
 
September 30, 2012
 
Number
of Loans
 
Amount
 
Number
of Loans
 
Amount
 
Number
of Loans
 
Amount
Commercial and industrial
12

 
$
9,029

 
6

 
$
3,064

 
12

 
$
2,999

Commercial real estate:
 
 
 
 
 
 
 
 
 
 
 
Office
—

 
—

 
—

 
—

 
—

 
—

Retail
2

 
626

 
—

 
—

 
—

 
—

Industrial
4

 
10,083

 
2

 
2,407

 
2

 
2,407

Multi-family
5

 
1,304

 
1

 
150

 
1

 
150

Residential construction
2

 
495

 
—

 
—

 
—

 
—

Commercial construction
—

 
—

 
—

 
—

 
—

 
—

Other commercial real estate
7

 
4,726

 
7

 
9,855

 
7

 
10,797

Total commercial real estate loans
20

 
17,234

 
10

 
12,412

 
10

 
13,354

Total corporate loans
32

 
26,263

 
16

 
15,476

 
22

 
16,353

Home equity
14

 
1,068

 
7

 
274

 
6

 
259

1-4 family mortgages
14

 
1,735

 
16

 
2,041

 
18

 
2,166

Installment
—

 
—

 
—

 
—

 
—

 
—

Total consumer loans
28

 
2,803

 
23

 
2,315

 
24

 
2,425

Total TDRs
60

 
$
29,066

 
39

 
$
17,791

 
46

 
$
18,778

Accruing TDRs
37

 
$
24,329

 
19

 
$
6,867

 
15

 
$
6,391

Non-accrual TDRs
23

 
4,737

 
20

 
10,924

 
31

 
12,387

Total TDRs
60

 
$
29,066

 
39


$
17,791

 
46

 
$
18,778

Year-to-date charge-offs on TDRs
 
 
$
1,850

 
 
 
$
10,003

 
 
 
$
9,674

Specific reserves related to TDRs
 
 
$
2,024

 
 
 
$
2,794

 
 
 
$
3,035


TDRs totaled $29.1 million at September 30, 2013, increasing $11.3 million from December 31, 2012.

Accruing TDRs rose $17.5 million from December 31, 2012, driven primarily by the reclassification of $18.3 million of corporate loans from non-accrual TDR to accruing TDR status based on restructuring actions and continued performance of these loans in accordance with their modified terms. In addition, $4.6 million of new accruing loan restructures also contributed to the variance. These increases were offset by the return of $5.0 million of accruing TDRs to performing status due to sustained payment performance in accordance with the modified terms, which are at market rates.

At September 30, 2013, non-accrual TDRs totaled $4.7 million compared to $10.9 million at December 31, 2012. TDRs are reported as non-accrual because they are not yet performing in accordance with their modified terms or they have not yet exhibited sufficient performance under their modified terms. The decrease in non-accrual TDRs from December 31, 2012 was driven by the reclassification of non-accrual TDRs to accruing TDR status discussed above, which was offset by $15.6 million of new non-accrual loan restructures during the first nine months of 2013.

61






Performing Potential Problem Loans

Performing potential problem loans consist of special mention loans and substandard loans. These loans are performing in accordance with contractual terms, but we have concerns about the ability of the borrower to continue to comply with loan terms due to the borrower’s potential operating or financial difficulties.
  
Table 13
Performing Potential Problem Loans
(Dollar amounts in thousands)
 
September 30, 2013
 
December 31, 2012
 
Special
Mention (1) (3)
 
Substandard (2) (3)
 
Total (3)
 
Special
Mention (1) (3)
 
Substandard (2) (3)
 
Total (3)
Commercial and industrial
$
36,738

 
$
9,869

 
$
46,607

 
$
37,833

 
$
8,418

 
$
46,251

Agricultural
—

 
—

 
—

 
331

 
—

 
331

Commercial real estate:
 
 
 
 
 
 
 
 
 
 
 
Office, retail, and industrial
52,826

 
22,874

 
75,700

 
57,271

 
16,746

 
74,017

Multi-family
2,791

 
508

 
3,299

 
1,921

 
—

 
1,921

Residential construction
3,209

 
7,225

 
10,434

 
11,870

 
11,588

 
23,458

Commercial construction
6,524

 
10,371

 
16,895

 
14,340

 
14,174

 
28,514

Other commercial real estate
12,700

 
21,592

 
34,292

 
14,056

 
30,051

 
44,107

Total commercial real estate
78,050

 
62,570

 
140,620

 
99,458

 
72,559

 
172,017

Total performing potential 
  problem corporate loans
$
114,788

 
$
72,439

 
$
187,227

 
$
137,622

 
$
80,977

 
$
218,599


(1) 
Loans categorized as special mention exhibit potential weaknesses that require the close attention of management since these potential weaknesses may result in the deterioration of repayment prospects in the future.
(2) 
Loans categorized as substandard exhibit a well-defined weakness or weaknesses that may jeopardize the liquidation of the debt. These loans continue to accrue interest because they are well secured and collection of principal and interest is expected within a reasonable time.
(3) 
Total special mention and substandard loans exclude $18.6 million of accruing TDRs as of September 30, 2013 and $448,000 thousand of accruing TDRs as of December 31, 2012.

Performing potential problem loans totaled $187.2 million as of September 30, 2013, down $31.4 million, or 14.4%, from December 31, 2012, reflecting management's proactive focus on credit remediation. As of September 30, 2013, approximately 53.0% of performing potential problem loans was comprised of 10 corporate loan relationships each having balances greater than $5.0 million. Management has specific monitoring plans for these corporate loan relationships.


62





OREO Activity

OREO consists of properties acquired as the result of borrower defaults on loans. OREO, excluding covered OREO, was $35.6 million at September 30, 2013, comparable to September 30, 2012, and decreasing $4.3 million from December 31, 2012.

Table 14
OREO Properties by Type
(Dollar amounts in thousands)
 
September 30, 2013
 
December 31, 2012
 
September 30, 2012
 
Number of
Properties
 
Amount
 
Number of
Properties
 
Amount
 
Number of
Properties
 
Amount
Single family homes
30

 
$
3,028

 
15

 
$
2,054

 
22

 
$
3,267

Land parcels:
 
 
 
 
 
 
 
 
 
 
 
Raw land
6

 
4,540

 
5

 
3,244

 
5

 
3,244

Farmland
—

 
—

 
1

 
207

 
1

 
207

Commercial lots
18

 
11,955

 
22

 
12,355

 
21

 
12,157

Single-family lots
23

 
3,105

 
29

 
4,970

 
33

 
5,619

Total land parcels
47

 
19,600

 
57

 
20,776

 
60

 
21,227

Multi-family units
10

 
845

 
10

 
796

 
7

 
811

Commercial properties
23

 
12,143

 
32

 
16,327

 
23

 
11,182

Total OREO, excluding covered OREO
110

 
35,616

 
114

 
39,953

 
112

 
36,487

Covered OREO
54

 
10,477

 
62

 
13,123

 
49

 
8,729

Total OREO properties
164

 
$
46,093

 
176

 
$
53,076

 
161

 
$
45,216


Table 15
OREO Disposals and Write-Downs
(Dollar amounts in thousands)
 
Nine Months Ended
 
September 30, 2013
 
September 30, 2012
 
OREO
 
Covered
OREO
 
Total
 
OREO
 
Covered
OREO
 
Total
OREO sales
 
 
 
 
 
 
 
 
 
 
 
Proceeds from sales
$
17,023

 
$
3,692

 
$
20,715

 
$
23,656

 
$
18,723

 
$
42,379

Less: Basis of properties sold
(18,356
)
 
(3,675
)
 
(22,031
)
 
(24,713
)
 
(18,597
)
 
(43,310
)
Net losses (gains) on sales of OREO
$
1,333

 
$
(17
)
 
$
1,316

 
$
1,057

 
$
(126
)
 
$
931

OREO valuation adjustments
$
628

 
$
201

 
$
829

 
$
3,713

 
$
211

 
$
3,924


For the nine months ended September 30, 2013, we sold $18.4 million of OREO, excluding covered OREO. These sales consisted of 54 properties with the majority classified as single-family homes and commercial properties. Net losses on sales of OREO were primarily impacted by a $1.2 million loss on the sale of a special-purpose, foreclosed property during the third quarter of 2013.

OREO sales, excluding covered OREO, consisted of 77 properties for the nine months ended September 30, 2012, with the majority classified as single family homes and lots.

Allowance for Credit Losses

Methodology for the Allowance for Credit Losses

The allowance for credit losses is comprised of the allowance for loan and covered loan losses and the reserve for unfunded commitments and is maintained by management at a level believed adequate to absorb estimated losses inherent in the existing loan portfolio. Determination of the allowance for credit losses is inherently subjective since it requires significant estimates and management judgment, including the amounts and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans, and consideration of current economic trends.

63





While management utilizes its best judgment and information available, the ultimate adequacy of the allowance for credit losses depends on a variety of factors beyond the Company’s control, including the performance of its loan portfolio, the economy, changes in interest rates and property values, and the interpretation of loan risk classifications by regulatory authorities. Management believes that the allowance for credit losses is an appropriate estimate of credit losses inherent in the loan portfolio as of September 30, 2013.

The accounting policy for the allowance for credit losses is discussed in Note 1 of “Notes to the Condensed Consolidated Financial Statements” in Part I, Item 1 of this Form 10-Q.


64





Table 16
Allowance for Credit Losses
and Summary of Loan Loss Experience
(Dollar amounts in thousands)
 
Quarters Ended
 
2013
 
2012
 
September 30
 
June 30
 
March 31
 
December 31
 
September 30
Change in allowance for credit losses
 
 
 
 
 
 
 
 
 
Beginning balance
$
96,976

 
$
100,457

 
$
102,812

 
$
104,945

 
$
118,682

Loan charge-offs:
 
 
 
 
 
 
 
 
 
Commercial and industrial
2,578

 
3,021

 
3,085

 
2,425

 
43,099

Agricultural
141

 
95

 
90

 
—

 
4,531

Office, retail, and industrial
987

 
1,453

 
1,262

 
361

 
29,370

Multi-family
112

 
213

 
165

 
119

 
2,758

Residential construction
470

 
850

 
565

 
239

 
9,368

Commercial construction
—

 
—

 
—

 
100

 
11,037

Other commercial real estate
889

 
547

 
2,535

 
1,865

 
23,473

Home equity and installment
2,123

 
2,254

 
1,966

 
1,915

 
2,470

1-4 family mortgages
359

 
269

 
398

 
831

 
572

Total loan charge-offs
7,659

 
8,702

 
10,066

 
7,855

 
126,678

Recoveries of loan charge-offs:
 
 
 
 
 
 
 
 
 
Commercial and industrial
521

 
573

 
2,089

 
647

 
1,318

Agricultural
—

 
—

 
—

 
177

 
—

Office, retail, and industrial
31

 
35

 
2

 
266

 
2

Multi-family
—

 
30

 
5

 
110

 
3

Residential construction
57

 
5

 
—

 
105

 
126

Commercial construction
3

 
—

 
2

 
—

 
—

Other commercial real estate
250

 
329

 
1,030

 
79

 
21

Home equity and installment
305

 
169

 
105

 
205

 
119

1-4 family mortgages
69

 
244

 
2

 
5

 
3

Total recoveries of loan charge-offs
1,236

 
1,385

 
3,235

 
1,594

 
1,592

Net loan charge-offs, excluding
  covered loans
6,423

 
7,317

 
6,831

 
6,261

 
125,086

Net covered loan charge-offs
1,629

 
1,977

 
698

 
1,465

 
442

Net loan and covered loan charge-offs
8,052

 
9,294

 
7,529

 
7,726

 
125,528

Provision for loan and covered loan losses:
 
 
 
 
 
 
 
 
 
Provision for loan losses
4,466

 
1,682

 
4,811

 
1,463

 
102,934

Provision for covered loan losses
304

 
4,131

 
1,014

 
4,131

 
9,212

Less: expected reimbursement from the
  FDIC
—

 
—

 
(151
)
 
(1
)
 
(355
)
Net provision for covered loan losses
304

 
4,131

 
863

 
4,130

 
8,857

Provision for loan and covered loan losses
4,770

 
5,813

 
5,674

 
5,593

 
111,791

Reduction in reserve for unfunded
  commitments (1)
(480
)
 
—

 
(500
)
 
—

 
—

Total provision for loan and
  covered loan losses and other
4,290

 
5,813

 
5,174

 
5,593

 
111,791

Ending balance
$
93,214

 
$
96,976

 
$
100,457

 
$
102,812

 
$
104,945


(1) 
Included in other noninterest expense in the Consolidated Statements of Income.

65





 
Quarters Ended
 
2013
 
2012
 
September 30
 
June 30
 
March 31
 
December 31
 
September 30
Allowance for credit losses
 
 
 
 
 
 
 
 
 
Allowance for loan losses
$
77,772

 
$
79,729

 
$
85,364

 
$
87,384

 
$
93,048

Allowance for covered loan losses
13,056

 
14,381

 
12,227

 
12,062

 
9,397

Total allowance for loan and
  covered loan losses
90,828

 
94,110

 
97,591

 
99,446

 
102,445

Reserve for unfunded commitments
2,386

 
2,866

 
2,866

 
3,366

 
2,500

Total allowance for credit losses
$
93,214

 
$
96,976

 
$
100,457

 
$
102,812

 
$
104,945

Amounts and ratios, excluding covered loans
 
 
 
 
 
 
 
 
Average loans
$
5,379,435

 
$
5,180,608

 
$
5,148,343

 
$
5,160,576

 
$
5,353,911

Net loan charge-offs to average loans,
  annualized
0.47
%
 
0.57
%
 
0.54
%
 
0.48
%
 
9.29
%
Allowance for credit losses at end of
  period as a percent of:
 
 
 
 
 
 
 
 
 
Total loans
1.47
%
 
1.56
%
 
1.70
%
 
1.75
%
 
1.83
%
Non-accrual loans
117.59
%
 
92.60
%
 
92.49
%
 
107.35
%
 
95.95
%
Non-performing loans
108.60
%
 
88.79
%
 
87.40
%
 
97.35
%
 
85.19
%
Amounts and ratios, including covered loans
 
 
 
 
 
 
 
 
Average loans
$
5,539,776

 
$
5,357,945

 
$
5,339,749

 
$
5,367,121

 
$
5,575,406

Net loan charge-offs to average loans
  annualized
0.58
%
 
0.70
%
 
0.57
%
 
0.57
%
 
8.96
%
Allowance for credit losses at end of
  period as a percent of:
 
 
 
 
 
 
 
 
 
Total loans
1.66
%
 
1.78
%
 
1.87
%
 
1.91
%
 
1.93
%
Non-accrual loans
94.13
%
 
82.42
%
 
86.37
%
 
104.15
%
 
90.51
%
Non-performing loans
74.63
%
 
65.00
%
 
68.43
%
 
74.04
%
 
64.35
%

Activity in the Allowance for Credit Losses

The allowance for credit losses was $93.2 million as of September 30, 2013, a decline of $9.6 million from December 31, 2012 and $11.7 million from September 30, 2012. The allowance for credit losses was 1.66% of total loans at September 30, 2013 compared to 1.91% at December 31, 2012 and 1.93% at September 30, 2012.

The provision for loan and covered loan losses was $4.8 million for the quarter ended September 30, 2013, decreasing by $107.0 million compared to the quarter ended September 30, 2012 and remaining stable compared to the other prior periods presented. The provision for loan and covered loan losses was elevated for the quarter ended September 30, 2012 due primarily to the additional provision of $62.3 million recorded as a result of moving $171.1 million of loans to held for sale status in anticipation of the bulk loan sales, which were completed during the fourth quarter of 2012.

Net loan charge-offs, excluding covered loan charge-offs, during the third quarter of 2013 remained stable or decreased compared to the prior periods presented. The decline in charge-offs from the third quarter of 2012 reflected improved credit quality due to management’s accelerated credit remediation actions that occurred during the third and fourth quarters of 2012, including the bulk loan sales. Net loan charge-offs, excluding covered loan charge-offs, of $6.4 million at September 30, 2013 are at the lowest level in the last five years.

Covered loan charge-offs reflect the decline in estimated cash flows of certain acquired loans. Management re-estimates cash flows periodically, and the present value of any decreases in expected cash flows from the FDIC is recorded as either a charge-off or an allowance for covered loan losses is established. Any increases in expected cash flows are recorded through prospective yield adjustments over the remaining lives of the specific loans.


66





FUNDING AND LIQUIDITY MANAGEMENT

The following table provides a comparison of average funding sources for the quarters ended September 30, 2013, December 31, 2012, and September 30, 2012. We believe that average balances, rather than period-end balances, are more meaningful in analyzing funding sources because of the inherent fluctuations that may occur on a monthly basis within most funding categories.

Table 17
Funding Sources – Average Balances
(Dollar amounts in thousands)
 
Quarters Ended
 
 
Third Quarter 2013
% Change From
 
September 30,
2013
 
December 31,
2012
 
September 30,
2012
 
 
Fourth
Quarter
2012
 
Third
Quarter
2012
Demand deposits
$
1,975,797

 
$
1,808,522

 
$
1,852,810

 
 
9.2
 %
 
6.6
 %
Savings deposits
1,127,970

 
1,066,611

 
1,048,430

 
 
5.8
 %
 
7.6
 %
NOW accounts
1,175,926

 
1,133,740

 
1,111,412

 
 
3.7
 %
 
5.8
 %
Money market accounts
1,343,263

 
1,268,046

 
1,234,833

 
 
5.9
 %
 
8.8
 %
Transactional deposits
5,622,956

 
5,276,919

 
5,247,485

 
 
6.6
 %
 
7.2
 %
Time deposits
1,272,670

 
1,418,689

 
1,470,041

 
 
(10.3
)%
 
(13.4
)%
Brokered deposits
16,076

 
29,229

 
28,952

 
 
(45.0
)%
 
(44.5
)%
Total time deposits
1,288,746

 
1,447,918

 
1,498,993

 
 
(11.0
)%
 
(14.0
)%
Total deposits
6,911,702

 
6,724,837

 
6,746,478

 
 
2.8
 %
 
2.4
 %
Securities sold under agreements to
   repurchase
89,029

 
70,805

 
74,570

 
 
25.7
 %
 
19.4
 %
Funds purchased
22

 
—

 
—

 
 
N/M

 
N/M

FHLB advances
114,562

 
114,585

 
115,265

 
 
—

 
(0.6
)%
Total borrowed funds
203,613

 
185,390

 
189,835

 
 
9.8
 %
 
7.3
 %
Senior and subordinated debt
214,860

 
214,764

 
231,156

 
 
—

 
(7.0
)%
Total funding sources
$
7,330,175

 
$
7,124,991

 
$
7,167,469

 
 
2.9
 %
 
2.3
 %
Average interest rate paid on
  borrowed funds
0.76
%
 
1.07
%
 
1.06
%
 
 
 
 
 
Weighted-average maturity of FHLB
  advances
32.6 months

 
20.8 months

 
23.2 months

 
 
 
 
 
Weighted-average interest rate of
  FHLB advances
1.34
%
 
1.72
%
 
1.68
%
 
 
 
 
 

Average funding sources for the third quarter of 2013 increased $205.2 million from the fourth quarter of 2012 and $162.7 million from the third quarter of 2012. Compared to the prior year periods, growth across transactional deposit products more than offset the decline in time deposits.

The reduction in average senior and subordinated debt compared to third quarter of 2012 was attributed to the repurchase and retirement of $4.3 million of junior subordinated debentures and $12.0 million of subordinated notes during the fourth quarter of 2012.

67





Table 18
Borrowed Funds
(Dollar amounts in thousands)
 
September 30, 2013
 
 
September 30, 2012
 
Amount
 
Weighted-
Average
Rate (%)
 
 
Amount
 
Weighted-
Average
Rate (%)
At period-end:
 
 
 
 
 
 
 
 
Securities sold under agreements to repurchase
$
97,500

 
0.03
 
 
$
69,103

 
0.01
FHLB advances
114,558

 
1.34
 
 
114,588

 
1.68
Total borrowed funds
$
212,058

 
0.74
 
 
$
183,691

 
1.05
Average for the year-to-date period:
 
 
 
 
 
 
 
 
Securities sold under agreements to repurchase
$
88,088

 
0.03
 
 
$
82,987

 
0.01
Fed funds purchased
7

 
—
 
 
—

 
—
FHLB advances
114,569

 
1.40
 
 
113,428

 
1.74
Total borrowed funds
$
202,664

 
0.80
 
 
$
196,415

 
1.03
Maximum amount outstanding at the end of any day
  during the period:
 
 
 
 
 
 
 
 
Securities sold under agreements to repurchase
$
106,170

 
 
 
 
$
103,591

 
 
FHLB advances
114,581

 
 
 
 
114,593

 
 

Average borrowed funds totaled $202.7 million for the first nine months of 2013, consistent with $196.4 million for the same period in 2012.

Securities sold under agreements to repurchase generally mature within 1 to 90 days from the transaction date.


68





MANAGEMENT OF CAPITAL

Capital Measurements

A strong capital structure is required under applicable banking regulations and is crucial in maintaining investor confidence, accessing capital markets, and enabling us to take advantage of future profitable growth opportunities. Our capital policy requires that the Company and the Bank maintain capital ratios in excess of the minimum regulatory guidelines. It serves as an internal discipline in analyzing business risks and internal growth opportunities and sets targeted levels of return on equity. Under regulatory capital adequacy guidelines, the Company and the Bank are subject to various capital requirements set by the federal banking agencies. These requirements specify minimum capital ratios, defined as Tier 1 and total capital as a percentage of assets and off-balance sheet items that were weighted according to broad risk categories and a leverage ratio calculated as Tier 1 capital as a percentage of adjusted average assets. We manage our capital ratios for both the Company and the Bank to consistently maintain these measurements in excess of the Federal Reserve’s minimum levels to be “well-capitalized,” which is the highest capital category established.

The following table presents our consolidated measures of capital as of the dates presented and the capital guidelines established by the Federal Reserve to be categorized as “well-capitalized.” All regulatory mandated ratios for characterization as “well-capitalized” were exceeded as of September 30, 2013 and December 31, 2012.

All other ratios presented in the table below are capital adequacy metrics used and relied on by investors and industry analysts; however, they are non-GAAP financial measures for SEC purposes. These non-GAAP measures are valuable indicators of a financial institution’s capital strength since they eliminate intangible assets from stockholders’ equity and retain the effect of accumulated other comprehensive loss in stockholders’ equity. Reconciliations of the components of those ratios to GAAP are also presented in the table below.


69





Table 19
Capital Measurements
(Dollar amounts in thousands)
 
September 30,
2013
 
December 31,
2012
 
Regulatory
Minimum
For
“Well-
Capitalized”
 
Excess Over
Required Minimums
at September 30, 2013
Reconciliation of capital components to regulatory requirements:
 
 
 
 
 
 
Total regulatory capital, as defined in federal regulations
$
843,675

 
$
755,264

 
 
 
 
 
 
Tier 1 capital, as defined in federal regulations
$
744,468

 
$
652,480

 
 
 
 
 
 
Trust preferred securities included in Tier 1 capital
(59,965
)
 
(59,965
)
 
 
 
 
 
 
Tier 1 common capital
$
684,503

 
$
592,515

 
 
 
 
 
 
Risk-weighted assets, as defined in federal regulations
$
6,694,123

 
$
6,348,523

 
 
 
 
 
 
Average assets, as defined in federal regulations
8,082,881

 
7,768,967

 
 
 
 
 
 
Regulatory capital ratios:
 
 
 
 
 
 
 
 
 
Total capital to risk-weighted assets
12.60
%
 
11.90
%
 
10.00
%
 
26
%
 
$
174,263

Tier 1 capital to risk-weighted assets
11.12
%
 
10.28
%
 
6.00
%
 
85
%
 
$
342,821

Tier 1 leverage to average assets
9.21
%
 
8.40
%
 
5.00
%
 
84
%
 
$
340,324

Tier 1 common capital to risk-weighted assets (1)
10.23
%
 
9.33
%
 
N/A(2)

 
N/A(2)

 
N/A(2)

Reconciliation of capital components to GAAP:
 
 
 
 
 
 
 
 
Total stockholder’s equity
$
986,725

 
$
940,893

 
 
 
 
 
 
Goodwill and other intangible assets
(277,187
)
 
(281,059
)
 
 
 
 
 
 
Tangible common equity
709,538

 
659,834

 
 
 
 
 
 
Accumulated other comprehensive income
26,057

 
15,660

 
 
 
 
 
 
Tangible common equity, excluding accumulated
  other comprehensive income
$
735,595

 
$
675,494

 
 
 
 
 
 
Total assets
$
8,517,913

 
$
8,099,839

 
 
 
 
 
 
Goodwill and other intangible assets
(277,187
)
 
(281,059
)
 
 
 
 
 
 
Tangible assets
$
8,240,726

 
$
7,818,780

 
 
 
 
 
 
Tangible common equity ratios:
 
 
 
 
 
 
 
 
 
Tangible common equity to tangible
  assets
8.61
%
 
8.44
%
 
N/A(2)

 
N/A(2)

 
N/A(2)

Tangible common equity, excluding
  other accumulated comprehensive
  income, to tangible assets
8.93
%
 
8.64
%
 
N/A(2)

 
N/A(2)

 
N/A(2)

Tangible common equity to
  risk-weighted assets
10.60
%
 
10.39
%
 
N/A(2)

 
N/A(2)

 
N/A(2)


(1) 
Excludes the impact of trust-preferred securities.
(2) 
Ratio is not subject to formal Federal Reserve regulatory requirements.

Regulatory capital ratios improved 70 to 84 basis points compared to December 31, 2012. This improvement resulted from strong earnings and the continued increase in allowable deferred tax assets, more than offsetting the impact of loan growth and the increase in dividends paid.

The Board of Directors reviews the Company’s capital plan each quarter, considering the current and expected operating environment as well as an evaluation of various capital alternatives.


70





Basel III Capital Rules

In July 2013, the Federal Reserve, the primary federal regulator of the Company and the Bank, published final rules (the “Basel III Capital Rules”) establishing a new comprehensive capital framework for U.S. banking organizations. The rules implement the Basel Committee’s December 2010 framework commonly known as “Basel III” for strengthening international capital standards as well as certain provisions of the Dodd-Frank Act. The Basel III Capital Rules substantially revise the risk-based capital requirements applicable to bank holding companies and depository institutions, including the Company and the Bank, compared to the current U.S. risk-based capital rules. The Basel III Capital Rules define the components of capital and address other issues affecting the numerator in banks’ regulatory capital ratios. The Basel III Capital Rules also address risk weights and other issues affecting the denominator in regulatory capital ratios and replace the existing risk-weighting approach with a more risk-sensitive approach. In addition, the Basel III Capital Rules implement the requirements of Section 939A of the Dodd-Frank Act to remove references to credit ratings from the federal banking agencies’ rules. The Basel III Capital Rules are effective for the Company and the Bank on January 1, 2015 (subject to a phase-in period).

The Basel III Capital Rules, among other things, (i) introduce a new capital measure called “Common Equity Tier 1” (“CET1”), (ii) specify that Tier 1 capital consist of CET1 and “Additional Tier 1 capital” instruments meeting specified requirements, (iii) narrowly define CET1 by requiring that most deductions/adjustments to regulatory capital measures be made to CET1 and not to the other components of capital, and (iv) expand the scope of the deductions/adjustments compared to existing regulations. Bank holding companies with less than $15 billion in consolidated assets as of December 31, 2009, such as the Company, are permitted to include trust-preferred securities in Additional Tier 1 Capital on a permanent basis and without any phase-out. As of September 30, 2013, the Company had $61.8 million of trust-preferred securities.

When fully phased in on January 1, 2019, the Basel III Capital Rules will require the Company and the Bank to maintain (i) a minimum ratio of CET1 to risk-weighted assets of at least 4.5%, plus a 2.5% “capital conservation buffer” (resulting in a minimum ratio of CET1 to risk-weighted assets of at least 7% upon full implementation), (ii) a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the capital conservation buffer (resulting in a minimum Tier 1 capital ratio of 8.5% upon full implementation), (iii) a minimum ratio of Total capital (that is, Tier 1 plus Tier 2) to risk-weighted assets of at least 8.0%, plus the capital conservation buffer (resulting in a minimum total capital ratio of 10.5% upon full implementation) and (iv) a minimum leverage ratio of 4%, calculated as the ratio of Tier 1 capital to average assets.

The capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a ratio of CET1 to risk-weighted assets above the minimum, but below the conservation buffer will face constraints on dividends, equity repurchases, and compensation based on the amount of the shortfall. The implementation of the capital conservation buffer will begin on January 1, 2016 at the 0.625% level and be phased in over a four-year period (increasing by that amount on each subsequent January 1 until it reaches 2.5% on January 1, 2019).

The Basel III Capital Rules provide for a number of deductions from and adjustments to CET1 beginning on January 1, 2015 and will be phased-in over a four-year period (beginning at 40% on January 1, 2015 and an additional 20% per year thereafter). Examples of these include the requirement that mortgage servicing rights, deferred tax assets depending on future taxable income, and significant investments in non-consolidated financial entities be deducted from CET1 to the extent that any one such category exceeds 10% of CET1 or all such categories in the aggregate exceed 15% of CET1. Under current capital standards, the effects of accumulated other comprehensive income items included in capital are excluded for the purposes of determining regulatory capital ratios. Under the Basel III Capital Rules, the effects of certain accumulated other comprehensive items are not excluded; however, non-advanced approaches banking organizations, including the Company and the Bank, may make a one-time permanent election to continue to exclude these items.

The Basel III Capital Rules prescribe a standardized approach for risk weightings that expand the risk-weighting categories from the current four Basel I-derived categories (0%, 20%, 50%, and 100%) to a much larger and more risk-sensitive number of categories depending on the nature of the assets, generally ranging from 0% for U.S. government and agency securities to 600% for certain equity exposures, resulting in higher risk weights for a variety of asset categories.

We are currently evaluating the impact of the capital adequacy requirements under the Basel III Capital Rules on the Company and the Bank.

The Basel III Capital Rules adopted in July 2013 do not address the proposed Liquidity Coverage Ratio Test and Net Stable Funding Ratio Test called for by the proposed Basel III framework. The bank regulatory agencies recently issued for public comment a proposed Liquidity Coverage Ratio Test that would not apply to banking organizations with less than $50 billion in assets. See “Item 1. Business – Supervision and Regulation – Liquidity Requirements” in the Company’s 2012 10-K for more information on these proposed requirements.

71






ITEM 3. QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK

Market risk is the risk of loss arising from adverse changes in the fair value of financial instruments due to changes in interest rates, exchange rates, and equity prices. Interest rate risk is our primary market risk and is the result of repricing, basis, and option risk. A description and analysis of our interest rate risk management policies is included in Part II, Item 7A, “Quantitative and Qualitative Disclosures about Market Risk,” in our 2012 10-K.

We seek to achieve consistent growth in net interest income and net income while managing volatility that arises from shifts in interest rates. The Bank’s Asset and Liability Committee (“ALCO”) oversees financial risk management by developing programs to measure and manage interest rate risks within authorized limits set by the Bank’s Board of Directors. ALCO also approves the Bank’s asset and liability management policies, oversees the formulation and implementation of strategies to improve balance sheet positioning and earnings, and reviews the Bank’s interest rate sensitivity position. Management uses net interest income and economic value of equity simulation modeling tools to analyze and capture short-term and long-term interest rate exposures.

Net Interest Income Sensitivity

The analysis of net interest income sensitivities assesses the magnitude of changes in net interest income resulting from changes in interest rates over a 12-month horizon using multiple rate scenarios. These scenarios include, but are not limited to, a most likely forecast, a flat or unchanged rate environment, a gradual increase and decrease of 200 basis points that occur in equal steps over a six-month time horizon, and immediate increases of 200 and 300 basis points and decreases of 100 and 200 basis points.

This simulation analysis is based on actual cash flows and repricing characteristics for balance sheet and off-balance sheet instruments and incorporates market-based assumptions regarding the effect of changing interest rates on the prepayment rates of certain assets and liabilities. This simulation analysis includes management’s projections for activity levels in each of the product lines we offer. The analysis also incorporates assumptions based on the historical behavior of deposit rates and balances in relation to interest rates. Because these assumptions are inherently uncertain, the simulation analysis cannot definitively measure net interest income or predict the impact of the fluctuation in interest rates on net interest income. Actual results may differ from simulated results due to timing, magnitude, and frequency of interest rate changes as well as changes in market conditions and management strategies.

We monitor and manage interest rate risk within approved policy limits. Our current interest rate risk policy limits are determined by measuring the change in net interest income over a 12-month horizon.

Analysis of Net Interest Income Sensitivity
(Dollar amounts in thousands)
 
Gradual Change in Rates (1)
 
Immediate Change in Rates
 
-200
 
+200
 
-200
 
-100
 
+200
 
+300
September 30, 2013:
 
 
 
 
 
 
 
 
 
 
 
Dollar change
$
(13,535
)
 
$
17,708

 
$
(18,194
)
 
$
(11,908
)
 
$
24,362

 
$
39,762

Percent change
(5.17
)%
 
6.77
%
 
(6.95
)%
 
(4.55
)%
 
9.31
%
 
15.20
%
December 31, 2012:
 
 
 
 
 
 
 
 
 
 
 
Dollar change
$
(10,678
)
 
$
12,933

 
$
(19,173
)
 
$
(13,502
)
 
$
19,766

 
$
33,786

Percent change
(4.05
)%
 
4.93
%
 
(7.27
)%
 
(5.12
)%
 
7.49
%
 
12.81
%
 
(1) 
Reflects an assumed uniform change in interest rates across all terms that occurs in equal steps over a six-month horizon.

Overall, in rising interest rate scenarios, interest rate risk volatility is more positive at September 30, 2013 compared to December 31, 2012 and, in declining interest rate scenarios, interest rate risk volatility is generally less negative at September 30, 2013 compared to December 31, 2012. In rising interest rate scenarios the increase in short-term investments and variable rate loans positively impact net interest income sensitivity.


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Economic Value of Equity

In addition to the simulation analysis, management uses an economic value of equity sensitivity technique to understand the risk in both shorter-term and longer-term positions and to study the impact of longer-term cash flows on earnings and capital. In determining the economic value of equity, we discount present values of expected cash flows on all assets, liabilities, and off-balance sheet contracts under different interest rate scenarios. The discounted present value of all cash flows represents our economic value of equity. Economic value of equity does not represent the true fair value of asset, liability, or derivative positions because certain factors are not considered, such as credit risk, liquidity risk, and the impact of future changes to the balance sheet.

Analysis of Economic Value of Equity
(Dollar amounts in thousands)
 
Immediate Change in Rates
 
-200
 
-100
 
+200
 
+300
September 30, 2013:
 
 
 
 
 
 
 
Dollar change
$
(68,559
)
 
$
(22,425
)
 
$
70,656

 
$
99,209

Percent change
(5.26
)%
 
(1.72
)%
 
5.42
%
 
7.61
%
December 31, 2012:
 
 
 
 
 
 
 
Dollar change
$
(134,704
)
 
$
(86,090
)
 
$
130,148

 
$
181,210

Percent change
(10.96
)%
 
(7.00
)%
 
10.59
%
 
14.74
%

As of September 30, 2013, the estimated sensitivity of the economic value of equity to rising interest rates is less positive compared to December 31, 2012, and the estimated sensitivity to falling rates is less negative compared to December 31, 2012. The change from December 31, 2012 is due to lower loan prepayment speeds which lengthened the duration on fixed rate loans. In addition, during the second and third quarters of 2013, the yield curve steepened, resulting in duration extension on the loan and securities portfolios.

ITEM 4. CONTROLS AND PROCEDURES

At the end of the period covered by this report, (the “Evaluation Date”), the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s President and Chief Executive Officer and its Executive Vice President and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rules 13a-15(e) and 15d-15 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based on that evaluation, the President and Chief Executive Officer and Executive Vice President and Chief Financial Officer concluded that as of the Evaluation Date, the Company’s disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in Securities and Exchange Commission rules and forms. There were no changes in the Company’s internal control over financial reporting during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

The nature of the business of the Bank and the Company’s other subsidiaries ordinarily results in a certain amount of claims, litigation, investigations, and legal and administrative cases and proceedings, that are considered incidental to the normal conduct of business. In managing such matters, management considers the merits and feasibility of all options and strategies available to the Company, including litigation prosecution, arbitration, insurance coverage, and settlement. Generally, if the Company determines it has meritorious defenses to a matter, it vigorously defends itself.

In August of 2011, the Bank was named in a purported class action lawsuit filed in the Circuit Court of Cook County, Illinois on behalf of certain of the Bank’s customers who incurred overdraft fees. The lawsuit is based on the Bank’s practices relating to debit card transactions, and alleges that these practices resulted in customers being assessed excessive overdraft fees. The plaintiffs seek an unspecified amount of damages and other relief, including restitution. No class has been certified. The Bank filed a motion to dismiss the plaintiffs’ complaint and, on January 23, 2013, the Circuit Court entered an order granting the Bank’s motion and dismissed the complaint with prejudice. The plaintiffs have appealed the Circuit Court’s ruling, and the appeal is currently pending with the Appellate Court of Illinois. The Company continues to believe that the Bank has meritorious defenses to the claims made by the plaintiffs.

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ITEM 1A. RISK FACTORS

The Company provided a discussion of certain risks and uncertainties faced by the Company in its Annual Report on Form 10-K for 2012. However, these factors may not be the only risks or uncertainties the Company faces.

Based on currently available information, the Company has not identified any additional material changes in the Company’s risk factors as previously disclosed, except as discussed above.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

The following table summarizes the Company’s monthly common stock purchases during the third quarter of 2013. The Board approved a stock repurchase program on November 27, 2007. Up to 2.5 million shares of the Company’s common stock may be repurchased, and the total remaining authorization under the program was 2,494,747 shares as of September 30, 2013. The repurchase program has no set expiration or termination date.

Issuer Purchases of Equity Securities
(Number of shares in thousands)
 
Total
Number of
Shares
Purchased (1)
 
Average
Price
Paid per
Share
 
Total Number
of Shares
Purchased as
Part of a
Publicly
Announced
Plan or
Program
 
Maximum
Number of
Shares that
May Yet Be
Purchased
Under the
Plan or
Program
July 1 – July 31, 2013
—

 
$
—

 
—

 
2,494,747

August 1 – August 31, 2013
—

 
—

 
—

 
2,494,747

September 1 – September 30, 2013
—

 
—

 
—

 
2,494,747

Total
—

 
$
—

 
—

 
 

(1) 
Consists of shares acquired pursuant to the Company’s share-based compensation plans and not the Company’s repurchase program. Under the terms of these plans, the Company accepts shares of common stock from option holders if they elect to surrender previously owned shares upon exercise to cover the exercise price of the stock options or, in the case of restricted shares of common stock, the withholding of shares to satisfy tax withholding obligations associated with the vesting of restricted shares.


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ITEM 6. EXHIBITS
Exhibit
Number
 
Description of Documents
 
3.1

Restated Certificate of Incorporation of First Midwest Bancorp, Inc. is herein incorporated by reference to Exhibit 3.1 to the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on February 27, 2009.
3.2

Restated By-laws of First Midwest Bancorp, Inc. is herein incorporated by reference to Exhibit 3.2 to the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on February 28, 2012.
11

Statement re: Computation of Per Share Earnings - The computation of basic and diluted earnings per common share is included in Note 7 of the Company’s Notes to the Condensed Consolidated Financial Statements included in “ITEM 1. FINANCIAL STATEMENTS” of this document.
15

Acknowledgment of Independent Registered Public Accounting Firm.
31.1

Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2

Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 (1)

Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 (1)

Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
99

Report of Independent Registered Public Accounting Firm.
101

Interactive Data File.

(1) 
Furnished, not filed.

75





SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

                      First Midwest Bancorp, Inc.
 
 
                         /s/ PAUL F. CLEMENS
                               Paul F. Clemens
    Executive Vice President, Chief Financial Officer,
                 and Principal Accounting Officer*

Date:  November 8, 2013

* Duly authorized to sign on behalf of the registrant.

76