MB Financial, Inc. Reports Third Quarter Results; Successfully Completes Taylor Capital Merger

MB Financial, Inc. (NASDAQ: MBFI), the holding company for MB Financial Bank, N.A., today announced 2014 third quarter net income of $6.9 million compared to $23.1 million last quarter and $24.4 million in the third quarter a year ago. Net income available to common stockholders was $4.9 million for the third quarter of 2014.

Key items for the third quarter include:

Completion of Taylor Capital Group, Inc. Merger:

• We completed the Taylor Capital Group, Inc. ("Taylor Capital") merger on August 18, 2014.
• Consideration paid was $639.8 million, including $519.3 million in common stock and $120.5 million in cash.
• We issued 19.6 million shares of common stock as a result of the acquisition.
• Each share of Taylor Capital’s Perpetual Non-Cumulative Preferred Stock, Series A was converted into one share of our Perpetual Non-Cumulative Preferred Stock, Series A with substantially identical terms.
• The results of operations of Taylor Capital have been included in our results of operations for the 44 days since the date of acquisition.
• We have made significant progress toward achieving targeted cost savings.
• We successfully converted Taylor Capital's clients to MB data processing systems and products in September 2014.

Operating Earnings:

• Operating earnings, which we define as earnings excluding non-core items, were $35.7 million for the third quarter of 2014 compared to $23.5 million last quarter and $26.0 million in the third quarter a year ago. A table reconciling net income, as reported to operating earnings is set forth below and in the “Non-GAAP Financial Information” section.

In December 2012, we acquired Celtic Leasing Corp. ("Celtic"). The purchase consideration paid to Celtic's selling shareholders included the right to receive certain contingent payments based on the realization of residuals owned by Celtic on the transaction closing date. Given Celtic's stronger than expected lease residual performance subsequent to the acquisition, we have increased the fair value of the residual based contingent consideration by $10.6 million.

Net Interest Income Increased $27.5 million, or 40.5%, from the Prior Quarter and $26.7 million, or 38.8%, from the Third Quarter of 2013:

• The increase in net interest income is primarily due to the Taylor Capital merger. Net interest income in the third quarter of 2014 included interest income of $6.2 million resulting from the accretion of the purchase accounting discount recorded on the loans acquired in the Taylor Capital merger ($5.9 million for non-purchased credit-impaired loans and $282 thousand for purchase credit-impaired loans).
• Our fully tax equivalent net interest margin was 3.78% for the third quarter of 2014 compared to 3.53% for the prior quarter and 3.66% for the third quarter of 2013. Excluding the purchase accounting loan discount accretion ($6.2 million)on Taylor Capital loans, the Company's net interest margin on a fully tax equivalent basis would have been 3.54% for the third quarter of 2014.

Core Non-interest Income Increased $22.8 million, or 57.6%, from the Prior Quarter and $25.2 million, or 67.8%, from the Third Quarter of 2013:

• Leasing revenues increased 19.3% from $14.9 million in second quarter of 2014 and 25.9% from $14.1 million in the third quarter of 2013 to $17.7 million in the third quarter of 2014 primarily due to higher fees and promotional revenue from the sale of third-party equipment maintenance contracts.
• Mortgage banking revenue increased by $16.6 million due to the Taylor Capital merger.
• Commercial deposit and treasury management fees increased 31.5% from $7.1 million in the second quarter of 2014 and 47.7% from $6.3 million in the third quarter of 2013 to $9.3 million in the third quarter of 2014 as a result of the Taylor Capital merger in addition to robust new customer activity prior to the merger.
• Core non-interest income was 38.23% of revenues in the third quarter of 2014 compared to 35.22% in the prior quarter.

Core Non-interest Expense Increased $27.4 million, or 35.6%, from the Prior Quarter and $30.4 million, or 41.1%, from the Third Quarter of 2013:

• The increase in the Company’s core non-interest expense from the prior quarter and third quarter of 2013 was primarily driven by the Taylor Capital merger.
• The efficiency ratio for the third quarter of 2014 decreased to 63.46% from 67.68% in the prior quarter and 65.81% in the third quarter of 2013.
• Net non-interest expense to average assets decreased to 1.35% in the third quarter of 2014 from 1.55% and 1.56% in the prior quarter and the third quarter of 2013, respectively.

Credit Quality Metrics:

• We recorded a provision for credit losses of $3.1 million in the third quarter compared to a negative provision for credit losses of $2.0 million in the prior quarter and a negative provision for credit losses of $3.3 million in the third quarter of 2013.
• The third quarter 2014 provision for credit losses included a negative provision for credit losses of $1.6 million for the legacy MB Financial portfolio and a positive provision of $4.7 million related to the acquired Taylor Capital portfolio for loan renewals subsequent to the acquisition date and the establishment of a corresponding general reserve for Taylor Capital loans in excess of the loan discount. We anticipate recording a provision related to the acquired portfolio in future quarters related to renewing Taylor loans which will largely offset the accretion from non-purchase credit impaired loans.
• Non-performing loans decreased by $10.5 million from June 30, 2014, and potential problem loans decreased by $11.8 million from June 30, 2014.

RESULTS OF OPERATIONS

Third Quarter Results

Net Interest Income

Net interest income and net interest margin on a fully tax equivalent basis for the three and nine months ended September 30, 2014 were impacted by the Taylor Capital merger. Net interest income on a fully tax equivalent basis increased $28.0 million from the second quarter of 2014 to $101.7 million in the third quarter of 2014. The Company's net interest margin on a fully tax equivalent basis for the third quarter of 2014 increased 25 basis points to 3.78% compared to the second quarter of 2014.

Net interest income on a fully tax equivalent basis increased $26.9 million from the third quarter of 2013. Our net interest margin on a fully tax equivalent basis for the third quarter of 2014 increased 12 basis points compared to the third quarter of 2013.

Net interest income on a fully tax equivalent basis for the nine months ended September 30, 2014 increased $27.2 million from the nine months ended September 30, 2013. Our net interest margin on a fully tax equivalent basis for the nine months ended September 30, 2014 increased four basis points to 3.66% compared to the nine months ended September 30, 2013.

As noted earlier, on August 18, 2014, we completed the Taylor Capital merger. The acquired assets and assumed liabilities were recorded at fair value as required under the acquisition method of accounting. Fair value adjustments are amortized or accreted into net interest income over the remaining terms of the interest earning assets and interest bearing liabilities. The fair value adjustment on acquired loans had the most significant impact on net interest margin. Excluding the purchase accounting loan discount accretion on Taylor Capital loans, our net interest margin on a fully tax equivalent basis would have been 3.54% and 3.57% for the three and nine months ended September 30, 2014, respectively, compared to 3.66% and 3.62% for the three and nine months ended September 30, 2013.

In September 2014, we repositioned our balance sheet and shortened the duration of our investment securities portfolio to pre-merger levels by selling $468.7 million in investment securities and utilizing the proceeds from the sales to reduce short term FHLB advances. A $3.2 million loss was recognized on investment securities in the third quarter of 2014 as a result of this balance sheet repositioning.

In September 2014, we also redeemed all of the outstanding 9.75% junior subordinated notes relating to the trust preferred securities of TAYC Capital Trust I. These notes were originally issued by Taylor Capital and were assumed by us in connection with the merger. The TAYC Capital Trust I trust preferred securities, which had an aggregate outstanding liquidation amount of $45.4 million, were automatically redeemed as a result of our redemption of the junior subordinated notes. A $1.9 million gain on the early extinguishment of the trust preferred securities was recorded in other operating income in the third quarter of 2014, which represented the difference between the fair market value of these securities on August 18, 2014 and their aggregate liquidation amount at redemption.

Non-interest Income and Expense

We acquired Taylor Capital's mortgage operations through the merger. As there can be fluctuations in the mortgage operations from quarter to quarter based on the overall level of interest rates, we are presenting non-interest income and expense both including and excluding mortgage banking.

Non-interest Income (in thousands):

Core non-interest income for the third quarter of 2014 increased 57.6% to $62.5 million from the second quarter of 2014. Excluding mortgage banking, core non-interest income increased by 15.2%.

• Leasing revenues increased due to higher fees and promotional revenue from the sale of third-party equipment maintenance contracts. The Company acquired another leasing subsidiary, Cole Taylor Equipment Finance, through the Taylor Capital merger. Cole Taylor Equipment Finance contributed approximately $404 thousand to leasing revenues in the third quarter of 2014 since the date of acquisition.
• Commercial deposit and treasury management fees increased due to the increased customer base as a result of the Taylor Capital merger and new customer activity prior to the merger.
• Card fees increased due to the full quarter impact of a new payroll prepaid card program that started in the second quarter of 2014.
• Trust and asset management fees increased due to the addition of new customers and the impact of higher equity values.

Core non-interest income for the nine months ended September 30, 2014 increased 20.9% to $138.3 million from the nine months ended September 30, 2013. Excluding mortgage banking, core non-interest income increased by 6.0%.

• Commercial deposit and treasury management fees increased due to robust new customer activity as well as the increased customer base as a result of the Taylor Capital merger.
• Trust and asset management fees increased due to the addition of new customers and the impact of higher equity values.
• Card fees increased due to a new payroll prepaid card program as well as higher credit card fees.
• Capital markets and international banking services fees increased due to higher M&A advisory and syndication fees.
• Loan service fees decreased due to lower late, prepayment and miscellaneous loan fees collected.
• Consumer and other deposit service fees decreased due to lower demand deposit service and NSF and overdraft charges.

Non-core non-interest income for the quarter and nine months ended September 30, 2014 was impacted by the net loss on investment securities and the gain on extinguishment of debt as a result of the balance sheet repositioning that occurred in September 2014.

Non-interest Expense (in thousands):

Core non-interest expense increased by $27.4 million, or 35.6%, from the second quarter of 2014 to $104.5 million for the third quarter of 2014. Excluding mortgage banking, core non-interest expense increased by $13.1 million, or 17.0%.

• Salaries and employee benefits increased primarily due to increased staff from the Taylor Capital merger.
• Occupancy and equipment expense increased due to the additional offices acquired in the Taylor Capital merger.
• Computer services and telecommunication expenses increased primarily due to an increase in spending on IT security, data warehouse and investments in our key fee initiatives, as well as due to the Taylor Capital merger.

Core non-interest expense increased by $39.5 million, or 18.3%, from the nine months ended September 30, 2013 to $254.7 million for the nine months ended September 30, 2014. Excluding mortgage banking, core non-interest expense increased by $25.2 million, or 11.7%.

• Salaries and employee benefits increased due to annual salary increases, long-term incentive expense, health insurance and temporary staffing needs, and the increased staff from the Taylor Capital merger.
• Other operating expense increased primarily as a result of an increase in filing and other loan expense, higher FDIC assessments due to our larger balance sheet and higher currency delivery expenses related to new treasury management accounts.
• Computer services and telecommunication expenses increased due primarily to an increase in spending on IT security, data warehouse, investments in our key fee initiatives, as well as higher transaction volumes in the leasing, treasury management and card areas. The increase was also due to increased telecommunication expense related to transitioning to a new provider.

Non-core non-interest expense was primarily impacted by the merger related expenses for the Taylor Capital merger and the contingent consideration expense related to our acquisition of Celtic Leasing Corp.

The following table presents the detail of the merger related expenses (dollars in thousands):

We expect to incur additional merger related expenses in the next few quarters primarily in the area of occupancy and equipment expense.

Income Tax Expense

Income tax expense was $4.5 million for the third quarter of 2014, compared to $8.8 million for the second quarter of 2014, a decrease of 49.1%. The reduction in income tax expense is primarily due to the 64.3% decrease in income before taxes from $31.9 million in the second quarter of 2014 to $11.4 million in the third quarter of 2014, partially offset by certain costs incurred in the third quarter of 2014 that were not currently deductible for tax purposes. These include the contingent consideration expense related to the Celtic acquisition and certain legal and professional fees associated with the Taylor Capital merger.

Operating Segments

The Company's operations consist of three reportable operating segments: banking, leasing and mortgage banking. The banking segment generates its revenues primarily from its lending and deposit gathering activities. The leasing segment generates its revenues through lease originations and related services offered through the Company's leasing subsidiaries: LaSalle Systems Leasing, Inc., Celtic Leasing Corp. and Cole Taylor Equipment Finance. The mortgage banking segment originates residential mortgage loans for sale to investors through its retail and third party channels. The mortgage banking segment also services residential mortgage loans owned by investors and the Company. The segment information incorporates the result of Taylor Capital for 44 days subsequent to the merger date.

The following table presents summary financial information, adjusted for funds transfer pricing and internal allocations of certain expenses, for the reportable segments (in thousands):

The following table presents additional information regarding the mortgage banking segment (dollars in thousands) for the 44 days subsequent to the Taylor Capital Merger:

LOAN PORTFOLIO

The following table sets forth the composition of the loan portfolio (excluding loans held for sale) based on period end balances as of the dates indicated (dollars in thousands):

Legacy gross loans excluding covered loans increased $25.3 million from $5.4 billion at June 30, 2014. This increase was primarily due to growth in the commercial loans category.

ASSET QUALITY

The following table presents a summary of criticized assets (excluding loans held for sale, purchased credit-impaired loans and other real estate owned acquired as part of our FDIC-assisted transactions) as of the dates indicated (dollars in thousands):

The following table presents data related to non-performing loans by category (excluding loans held for sale and credit-impaired loans that were acquired as part of our FDIC-assisted transactions and Taylor Capital merger) as of the dates indicated (in thousands):

The increase in consumer non-performing loans relates to a group of restructured loans that are less than 90 days past due that are now reported as non-performing.

The following table represents a summary of other real estate owned (excluding other real estate owned related to assets acquired in FDIC-assisted transactions) as of the dates indicated (in thousands):

Below is a reconciliation of the activity in our allowance for credit and loan losses for the periods indicated (dollars in thousands):

The following table presents the three elements of the Company's allowance for loan losses (in thousands):

Specific reserves decreased during the quarter due to an improvement in credit quality on impaired loans.

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

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

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

For pass rated loans (non-purchased credit impaired loans), the difference between the estimated fair value of the loans and the principal outstanding is accreted over the remaining life of the loans. We anticipate recording a provision for the acquired portfolio in future quarters related to renewing Taylor loans which will largely offset the accretion from the pass rated loans.

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

Changes in the purchase accounting discount for loans acquired in the Taylor Capital merger were as follows for the three months ended September 30, 2014 (in thousands):

INVESTMENT SECURITIES

The following table sets forth, by type, the fair value and amortized cost of our investment securities, excluding FHLB and FRB stock, as well as the unrealized gain of our investment securities available for sale (in thousands):

During the third quarter of 2014, the Company repositioned its balance sheet subsequent to the Taylor Capital merger and sold certain longer-term and lower-coupon investment securities with an approximate carrying amount of $468.7 million. These investment security sales shortened the overall duration of the investment securities portfolio to pre-merger levels. Also as a part of the balance sheet repositioning, securities of states and political subdivisions with an approximate fair value of $291.2 million were transferred from held to maturity to available for sale during the third quarter of 2014. As a result of the repositioning, we recognized a net loss of $3.2 million.

DEPOSIT MIX

The following table shows the composition of deposits based on period end balances as of the dates indicated (dollars in thousands):

Total legacy deposits decreased $25.1 million from $7.8 billion at June 30, 2014 primarily due to the decrease in certificates of deposit. Legacy low cost deposits increased by $24.8 million from June 30, 2014. Shortly after the acquisition the rates paid on the Taylor Capital deposit products, primarily affecting money markets and certificates of deposit, were reduced to align with the Company’s current rate offerings. We expect to see a decline in balances from rate sensitive customers over the next few quarters.

CAPITAL

Tangible book value per common share decreased to $15.36 at September 30, 2014 compared to $15.83 a year ago and $16.81 last quarter.

Our regulatory capital ratios remain strong. MB Financial Bank, N.A. was categorized as “well capitalized” at September 30, 2014 under the Prompt Corrective Action (“PCA”) provisions.

FORWARD-LOOKING STATEMENTS

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

Important factors that could cause actual results to differ materially from the results anticipated or projected include, but are not limited to, the following: (1) expected revenues, cost savings, synergies and other benefits from the recently completed MB Financial-Taylor Capital merger and our other merger and acquisition activities might not be realized within the anticipated time frames or at all, and costs or difficulties relating to integration matters, including but not limited to customer and employee retention, might be greater than expected; (2) the possibility that the expected benefits of the other acquisition transactions we previously completed will not be realized; (3) the credit risks of lending activities, including changes in the level and direction of loan delinquencies and write-offs and changes in estimates of the adequacy of the allowance for loan losses, which could necessitate additional provisions for loan losses, resulting both from loans we originate and loans we acquire from other financial institutions; (4) results of examinations by the Office of Comptroller of Currency, the Federal Reserve Board, the Consumer Financial Protection Bureau and other regulatory authorities, including the possibility that any such regulatory authority may, among other things, require us to increase our allowance for loan losses or write-down assets; (5) competitive pressures among depository institutions; (6) interest rate movements and their impact on customer behavior and net interest margin; (7) the possibility that our mortgage banking business may increase volatility in our revenues and earnings and the possibility that the profitability of our mortgage banking business could be significantly reduced if we are unable to originate and sell mortgage loans at profitable margins; (8) the impact of repricing and competitors’ pricing initiatives on loan and deposit products; (9) fluctuations in real estate values; (10) the ability to adapt successfully to technological changes to meet customers’ needs and developments in the market-place; (11) our ability to realize the residual values of our direct finance, leveraged, and operating leases; (12) our ability to access cost-effective funding; (13) changes in financial markets; (14) changes in economic conditions in general and in the Chicago metropolitan area in particular; (15) the costs, effects and outcomes of litigation; (16) new legislation or regulatory changes, including but not limited to the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”) and regulations adopted thereunder, changes in capital requirements pursuant to the Dodd-Frank Act and the implementation of the Basel III capital standards, other governmental initiatives affecting the financial services industry and changes in federal and/or state tax laws or interpretations thereof by taxing authorities; (17) changes in accounting principles, policies or guidelines; (18) our future acquisitions of other depository institutions or lines of business; and (19) future goodwill impairment due to changes in our business, changes in market conditions, or other factors.

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

TABLES TO FOLLOW