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| TAYC > SEC Filings for TAYC > Form 10-Q on 12-Nov-2009 | All Recent SEC Filings |
12-Nov-2009
Quarterly Report
Introduction
We are a bank holding company headquartered in Rosemont, Illinois, a suburb of Chicago. We derive substantially all of our revenue from our wholly-owned subsidiary, Cole Taylor Bank. We provide a range of banking services to our customers, with a primary focus on serving closely-held businesses in the Chicago metropolitan area and the people who own and manage them.
The following discussion and analysis presents our consolidated financial condition and results of operations as of and for the dates and periods indicated. This discussion should be read in conjunction with our consolidated financial statements and the notes thereto appearing elsewhere in this document. In addition to the historical information provided below, we have made certain estimates and forward-looking statements that involve risks and uncertainties. Our actual results could differ significantly from those anticipated in these estimates and forward-looking statements as a result of certain factors, including those discussed in the section captioned "Risk Factors" in our 2008 Annual Report on Form 10-K filed with the SEC on March 11, 2009.
Application of Critical Accounting Policies
Our accounting and reporting policies conform to accounting principles generally accepted in the United States of America and general reporting practices within the financial services industry. Our accounting policies are described in the section captioned "Notes to Consolidated Financial Statements-Summary of Significant Accounting and Reporting Policies" in our 2008 Annual Report on Form 10-K.
The preparation of financial statements in conformity with these accounting principles requires management to make estimates, assumptions and judgments that affect the amounts reported in the consolidated financial statements and accompanying notes. These estimates, assumptions and judgments are based on information available to us as of the date of the consolidated financial statements and, accordingly, as this information changes, actual results could differ from the estimates, assumptions and judgments reflected in the financial statements. The estimates, assumptions and judgments made by us are based upon historical experience or other factors that we believe to be reasonable under the circumstances. Certain accounting policies inherently have greater reliance on the use of estimates, assumptions and judgments and as such, have a greater possibility of producing results that could be materially different than originally reported. We consider our policies for the allowance for loan losses, the valuation of deferred tax assets and establishment of tax liabilities and the valuation of financial instruments such as investment securities and derivatives to be critical accounting policies.
The following accounting policies materially affect our reported earnings and financial condition and require significant estimates, assumptions and judgments.
Allowance for Loan Losses
We have established an allowance for loan losses to provide for loans in our portfolio that may not be repaid in their entirety. The allowance is based on our regular, quarterly assessments of the probable estimated losses inherent in our loan portfolio. Our methodology for measuring the appropriate level of the allowance relies on several key elements, which include a general allowance computed by applying loss factors to categories of loans outstanding in the portfolio, specific allowances for identified problem loans and portfolio segments, and an unallocated allowance. We maintain our allowance for loan losses at a level considered adequate to absorb probable losses inherent in our portfolio as of the balance sheet date. In evaluating the adequacy of our allowance for loan losses, we consider numerous quantitative factors, including historical charge-off experience, growth of our loan portfolio, changes in the composition of our loan portfolio and the volume of delinquent and criticized loans. In addition, we use information about specific borrower situations, including their financial position, work-out plans and estimated collateral values under various liquidation scenarios to estimate the risk and amount of loss on loans to those borrowers. Finally, we also consider many qualitative factors, including general and economic business conditions, duration of the current business cycle, the impact of competition on our underwriting terms, current general market collateral valuations, trends apparent in any of the factors we take into account and other matters, which are by nature more subjective and fluid. Our estimates of risk of loss and amount of loss on any loan are complicated by the uncertainties surrounding not only our borrowers' probability of default, but also the fair value of the underlying collateral. The current illiquidity in the real estate market has increased the uncertainty with respect to real estate values. Because of the degree of uncertainty and the sensitivity of valuations to the underlying assumptions regarding holding period until sale and the collateral liquidation method, our actual losses may materially vary from our current estimates.
As a business bank, our loan portfolio is comprised primarily of commercial loans to businesses. These loans are inherently larger in amount than loans to individual consumers and, therefore, have higher potential losses on an individual loan basis. The individually larger commercial loans can cause greater volatility in our reported credit quality performance measures, such as total impaired or nonperforming loans. Our current credit risk rating and loss estimate with respect to a single sizable loan can have a material impact on our reported impaired loans and related loss estimates. Because our loan portfolio contains a significant number of commercial loans with relatively large balances, the deterioration of any one or a few of these loans can cause a significant increase in uncollectible loans and, therefore, our allowance for loan losses. We review our estimates on a quarterly basis and, as we identify changes in estimates, our allowance for loan losses is adjusted through the recording of a provision for loan losses.
Income Taxes
We have maintained significant net deferred tax assets for deductible temporary differences, the largest of which relates to the allowance for loan losses. For income tax return purposes, only net charge-offs are deductible, not the provision for loan losses. Under generally accepted accounting principles, a valuation allowance is required to be recognized if it is "more
likely than not" that the deferred tax asset will not be realized. The determination of the realizability of the deferred tax assets is highly subjective and dependent upon judgment concerning management's evaluation of both positive and negative evidence, the forecasts of future income, applicable tax planning strategies, and assessments of the current and future economic and business conditions. We consider both positive and negative evidence regarding the ultimate realizability of our deferred tax assets. Positive evidence includes the existence of taxes paid in available carry-back years as well as the probability that taxable income will be generated in future periods, while negative evidence includes a cumulative loss in the current year and prior two years and general business and economic trends. We currently maintain a valuation allowance against significantly all of our deferred tax asset because it is more likely than not that all of this deferred tax asset will not be realized. This determination was based, largely, on the negative evidence of a cumulative loss in the most recent three year period caused primarily by the significant loan loss provisions made during recent periods. In addition, general uncertainty surrounding future economic and business conditions have increased the likelihood of volatility in our future earnings.
At times, we apply different tax treatment for selected transactions for tax return purposes than for income tax financial reporting purposes. The different positions result from the varying application of statutes, rules, regulations, and interpretations, and our accruals for income taxes include reserves for these differences in position. Our estimate of the value of these reserves contains assumptions based upon our past experience and judgments about potential actions by taxing authorities, and we believe that the level of these reserves is reasonable. We initially recognize the financial statement effects of a tax position when it is more likely than not, based on the technical merits, that the position will be sustained upon examinations. Subsequently, the reserves are then utilized or reversed when we determine the more likely than not threshold is no longer met, once the statute of limitations has expired, or the tax matter is effectively settled. However, because reserve balances are estimates that are subject to uncertainties, the ultimate resolution of these matters may be greater or less than the amounts we have accrued.
Derivative Financial Instruments
We use derivative financial instruments (derivatives), including interest rate exchange, floor and collar agreements, and forward loan sale commitments to either accommodate individual customer needs or to assist in our interest rate risk management. All derivatives are measured and reported at fair value on our consolidated balance sheet as either an asset or a liability. For derivatives that are designated and qualify as a fair value hedge, the gain or loss on the derivative, as well as the offsetting loss or gain on the hedged item attributable to the effective portion of the hedged risk, are recognized in current earnings during the period of the change in the fair values. For derivatives that are designated and qualify as a cash flow hedge, the effective portion of the gain or loss on the derivative is reported as a component of other comprehensive income and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. For all hedging relationships, derivative gains and losses that are not effective in hedging the changes in fair value or expected cash flows of the hedged item are recognized immediately in current earnings during the period of the change in fair value. Similarly, the changes in the fair value of derivatives that do not qualify for hedge accounting or are not designated as an accounting hedge are also reported currently in earnings.
At the inception of a hedge and quarterly thereafter, a formal assessment is performed to determine whether changes in the fair values or cash flows of the derivatives have been highly effective in offsetting the changes in the fair values or cash flows of the hedged item and whether they are expected to be highly effective in the future. If it is determined that derivatives are not highly effective as a hedge, hedge accounting is discontinued for the period. Once hedge accounting is terminated, all changes in fair value of the derivatives flow through the consolidated statements of operations in other noninterest income, which results in greater volatility in our earnings.
The estimates of fair values of our interest rate swap, floors, and collar derivatives are calculated using independent valuation models to estimate market-based valuations. The valuations are determined using widely accepted valuation techniques, including discounted cash flow analysis of the expected cash flow of each derivative. This analysis reflects the contractual terms of the derivative and uses observable market-based inputs, including interest rate curves and implied volatilities. In addition, the fair value estimate also incorporates a credit valuation adjustment to reflect the risk of nonperformance by both us and our counterparties in the fair value measurement. The resulting fair values produced by these proprietary valuation models are in part theoretical and, therefore, can vary between derivative dealers and are not necessarily reflective of the actual price at which the derivative contract could be traded. Small changes in assumptions can result in significant changes in valuation. The risks inherent in the determination of the fair value of a derivative may result in volatility in our statement of operations.
Valuation of Investment Securities
The fair value of our investment portfolio is determined in accordance with generally accepted accounting principals, which requires that we classify financial assets and liabilities measured at fair value into a three-level fair value hierarchy. The determination of fair value is highly subjective and requires management to rely on estimates, assumptions, and judgments that can affect amounts reported in our financial statements. We obtain the fair value of investment securities from an independent pricing service. We review the pricing methodology for each significant class of assets used by this third party pricing service to assess the compliance with accounting standards for fair value measurement and classification in the fair value measurement hierarchy. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information, including credit spreads and current rating from credit rating agencies, and the bond's terms and conditions, among other things. We have determined that these valuations are classified in Level 2 of the fair value hierarchy.
While we use an independent pricing service to obtain the fair values of our investment portfolio, we do employ certain control procedures to determine the reasonableness of the valuations. We validate the overall reasonableness of the fair values by comparing information obtained from our independent pricing service to other third party valuation sources for selected assets and review the valuations and any differences in valuations with members of management who have the relevant technical expertise to assess the results. We do not alter the fair values provided by our independent pricing service.
Our investment portfolio includes $1.08 billion of mortgage related investment securities which consisted of mortgage-backed securities and collateralized mortgage obligations. We do not have subprime loans in this portfolio. Of the total mortgage related investment securities, $1.05 billion, or 97.5%, were issued by government sponsored enterprises, such as Ginnie Mae, Fannie Mae, and Freddie Mac. The mortgage related portfolio included $27.5 million of private-label mortgage related securities that has received heightened monitoring because the Company believe the fair values of these securities have been impacted by illiquidity in the market place because of a lack of active trading in these securities. While none of these securities contain subprime mortgage loans, the portfolio does include Alt-A loans, adjustable rate mortgages with initial interest only periods, and loans that are secured by collateral in geographic areas adversely impacted by the housing downturn. While the fair value of these securities has been impacted by market illiquidity, the Company does not modify the fair value determined by the independent pricing but takes additional steps to review for other-than-temporary impairment.
Each quarter we review our investment securities portfolio to determine whether unrealized losses are temporary or other than temporary, based on an evaluation of the creditworthiness of the issuers/guarantors, as well as the underlying collateral, if applicable. Our analysis includes an evaluation of the type of security, the length of time and extent to which the fair value has been less than the security's carrying value, the characteristics of the underlying collateral, the degree of credit support provided by subordinate tranches within the total issuance, independent credit ratings, changes in credit ratings and a cash flow analysis, considering default rates, loss severities based upon the location of the collateral, and estimated prepayments. Those securities with unrealized losses for more than 12 months and for more than 10% of their carrying value are subjected to further analysis to determine if we expect to receive all the contractual cash flows. We utilize other independent pricing sources to obtain fair values and perform discounted cash flow analysis for selected securities. When the discounted cash flow analysis we obtain from those independent pricing sources indicates that we expect all future principal and interest payments would be received in accordance with their original contractual terms, we do not intend to sell the security, and we more-likely-than-not will not be required to sell the security before recovery, the unrealized loss is deemed temporary. If such analysis shows that we expect not to be able to recover our entire investment, then an other-than-temporary impairment charge would be recorded in current earnings for the amount of the credit loss. The amount of impairment that related to factors other than the credit loss is recognized in other comprehensive income. Our assessments of creditworthiness and the resultant expected cash flows are complicated by the significant uncertainties surrounding not only the specific security and its underlying collateral but also the severity of the current overall economic downturn. Our cash flow estimates for mortgage related securities are based on estimates of mortgage default rates, severity of loss, and prepayments, which are difficult to predict. Changes in assumptions can result in material changes in expected cash flows. Therefore, unrealized losses that we have determined to be temporary may at a later date be determined to be other-than-temporary and have a material impact on our statement of operations.
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
Some of the statements under "Management Discussion and Analysis of Financial Condition and Results of Operations" and elsewhere in this Quarterly Report on Form 10-Q constitute forward-looking statements. We have tried to identify these forward-looking statements by using words including "may," "might," "expect," "plan," "predict," "potential," "should," "will," "expect," "anticipate," "believe," "intend," "could" and "estimate" and similar expressions. These forward-looking statements are based on information currently available to us and are subject to a number of risks, uncertainties and other factors that could cause our actual results, performance, prospects or opportunities in 2009 and beyond to differ materially from those expressed in, or implied by, these forward-looking statements. These risks, uncertainties and other factors include, without limitation:
• the risk that our allowance for loan losses may prove insufficient to absorb probable losses in our loan portfolio;
• possible volatility in loan charge-offs and recoveries between periods;
• negative developments and disruptions in the credit and lending markets, including the impact of the ongoing credit crisis on our business and on the businesses of our customers as well as other banks and lending institutions with which we have commercial relationships;
• the decline in residential real estate sales volume and the likely potential for continuing illiquidity in the real estate market, including within the Chicago metropolitan area;
• the risks associated with the high concentration of commercial real estate loans in our portfolio;
• costs, risks and effects of deficiencies in or impairments of mortgage loans acquired from other financial institutions;
• uncertainty in estimating the fair value of residential mortgage loans held for sale by us based upon quoted market prices;
• the possibility that we will not be able to securitize the residential mortgages held for sale by us on terms acceptable to us;
• the uncertainties in estimating the fair value of developed real estate and undeveloped land in light of declining demand for such assets and continuing illiquidity in the real estate market;
• the risks associated with implementing our business strategy and managing our growth effectively, including our ability to preserve and access sufficient capital to execute on our strategy;
• the risks associated with management changes, employee turnover and our commercial banking growth initiative, including our expansion of our asset-based lending operations and our entry into new geographical markets;
• the effect on our profitability if interest rates fluctuate as well as the effect of our customers' changing use of our deposit products;
• the possibility that our wholesale funding sources may prove insufficient to replace deposits at maturity and support our growth;
• a continuation of the unprecedented volatility in the capital markets;
• the effectiveness of our hedging transactions and their impact on our future results of operations;
• changes in legislation or regulatory and accounting principles, policies or guidelines affecting our business; and
• other economic, competitive, governmental, regulatory and technological factors impacting our operations.
For further information about these and other risks, uncertainties and factors, please review the disclosure included in the section captioned "Risk Factors" in our December 31, 2008 Annual Report on Form 10-K filed with the SEC on March 11, 2009. You should not place undue reliance on any forward-looking statements. We undertake no obligation to publicly update or revise any forward-looking statements or risk factors, whether as a result of new information, future events, changed circumstances or any other reason after the date of this press release.
RESULTS OF OPERATIONS
Overview
We reported a net loss applicable to common stockholders of $5.3 million, or $0.51 per diluted common share outstanding, for the third quarter of 2009, compared to a net loss applicable to common stockholders of $97.2 million, or $9.30 per diluted common share, in the third quarter of 2008. The lower net loss applicable to common stockholders in the third quarter of 2009 was due to a $37.2 million decrease in the provision for loan losses and $25.5 million decrease in income tax expense, largely due to a $47.3 million non-cash charge recorded in the third quarter of 2008 to establish a valuation allowance against our deferred tax asset. In addition, in connection with the completion of our private placement of 8% non-cumulative convertible perpetual preferred stock, Series A, in the third quarter of 2008, we recorded a $16.7 million implied non-cash dividend to the holders of this preferred stock to reflect the beneficial conversion feature, as the market value of our common stock at the date of the stock purchase agreement exceeded the $10.00 conversion price per share. In addition, a $10.5 million increase in net interest income and a $4.8 million decrease in noninterest expense also contributed to the lower net loss applicable to common stockholders during the third quarter of 2009.
For the first nine months of 2009, we reported a net loss applicable to common stockholders of $37.1 million, or $3.54 per diluted common share, compared to a net loss applicable to common stockholders of $126.4 million, or $12.10 per diluted share, during the first nine months of 2008. The lower net loss applicable to common stockholders resulted from a $43.2 million decrease in the provision for loan losses, a $22.2 million increase in net interest income, a $9.5 million increase in noninterest income, and a decrease in noninterest expense of $4.4 million.
Throughout 2009, we have taken additional steps in an effort to improve our operating results by increasing the level of net interest income and noninterest income while holding the level of noninterest expense relatively flat with prior periods. In both the third quarter and
year-to-date period ending September 30, 2009, our net interest income increased over the comparable periods in 2008. These increases were due to both higher interest-earning asset volumes and a declining cost of funds.
We have also focused on improving our loan pricing, including the use of interest rate floors in new loan originations, and increased the size and duration of our investment portfolio to take advantage of higher yields. On the liability side, we continue to strengthen our liquidity position by obtaining more funding from core customers and reducing our reliance on more costly brokered deposits. Noninterest income also increased in both the third quarter and year-to-date period in 2009, as an increase in service charge revenue was partly offset by lower trust and investment management fees. In addition, noninterest expense has decreased in both the three month and year-to-date periods ended September 30, 2009 as compared to the same periods in 2008. Despite the significant increase in deposit insurance premiums, we have instituted a number of cost control measures to reduce our noninterest expense, such as salaries and benefit costs and certain other overhead expenses.
Net Interest Income
Net interest income is the difference between total interest income and fees earned on interest-earning assets, including investment securities and loans, and total interest expense paid on interest-bearing liabilities, including deposits and other borrowed funds. Net interest income is our principal source of earnings. The amount of net interest income is affected by changes in the volume and mix of earning assets and interest-bearing liabilities, the level of rates earned or paid on those assets and liabilities and the amount of loan fees earned.
Quarter Ended September 30, 2009 Compared to the Quarter Ended September 30, 2008
Net interest income was $32.4 million for the third quarter of 2009, an increase of $10.5 million, or 47.8%, from $21.9 million of net interest income in the third quarter of 2008. With an adjustment for tax-exempt income, our consolidated net interest income for the third quarter of 2009 was $33.1 million, compared to $22.7 million for the same quarter a year ago. This non-GAAP presentation is discussed in a following section captioned "Tax-Equivalent Adjustments to Yields and Margins". Net interest income for the third quarter of 2009 increased due to higher interest-earning asset levels and an increase in net interest margin.
Net interest margin is determined by dividing taxable equivalent net interest income by average interest-earning assets. For the third quarter of 2009, our net interest margin was 2.92%, compared to 2.35% for the same quarter a year ago, an increase of 57 basis points. As market interest rates decreased between the third quarter of 2008 and the third quarter of 2009, our net interest margin increased in the third quarter of 2009 because the decrease in our cost of funds . . .
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