PrivateBancorp 10-Q 2009
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the quarterly period ended September 30, 2009
For the transition period from to .
Commission File Number 001-34066
(Exact name of Registrant as specified in its charter)
Registrants telephone number, including area code
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 þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer, and smaller reporting company in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
As of November 5, 2009, there were 71,401,787 shares of the issuers common stock, without par value, outstanding.
TABLE OF CONTENTS
PART 1. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Amounts in thousands, except per share data)
See accompanying notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF INCOME
(Amounts in thousands, except per share data)
See accompanying notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY
(Amounts in thousands, except per share data)
See accompanying notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
See accompanying notes to consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The accompanying unaudited consolidated interim financial statements of PrivateBancorp, Inc. (PrivateBancorp or the Company), a Delaware corporation, have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission for quarterly reports on Form 10-Q and do not include certain information and footnote disclosures required by U.S. generally accepted accounting principles (U.S. GAAP) for complete annual financial statements. Accordingly, these financial statements should be read in conjunction with the Companys 2008 Annual Report on Form 10-K.
On June 29, 2009, the Financial Accounting Standards Board (FASB) issued an accounting pronouncement establishing the FASB Accounting Standards CodificationTM (FASB ASC) as the single source of authoritative U.S. GAAP to be applied by nongovernmental entities. The FASB ASC became effective for financial statements that cover interim and annual periods ending after September 15, 2009. Other than resolving certain minor inconsistencies in current U.S. GAAP, the FASB ASC is not intended to change U.S. GAAP, but rather to make it easier to review and research U.S. GAAP applicable to a particular transaction or specific accounting issue.
The accompanying unaudited consolidated interim financial statements have been prepared in accordance with U.S. GAAP and reflect all adjustments that are, in the opinion of management, necessary for the fair presentation of the financial position and results of operations for the periods presented. All such adjustments are of a normal recurring nature. The results of operations for the quarter and the nine months ended September 30, 2009 are not necessarily indicative of the results that may be expected for the year ending December 31, 2009.
The consolidated financial statements include the accounts and results of operations of the Company and its subsidiaries after elimination of all significant intercompany accounts and transactions. Certain reclassifications have been made to prior periods to conform to the current period presentation. U.S. GAAP requires management to make certain estimates and assumptions. Although these and other estimates and assumptions are based on the best available information, actual results could be materially different from these estimates.
In preparing the consolidated financial statements, we have evaluated subsequent events for disclosure in the quarterly report on Form 10-Q through November 9, 2009, the date on which the consolidated financial statements were issued. Refer to Note 19, Subsequent Events for the required disclosures.
2. NEW ACCOUNTING STANDARDS
Recently Adopted Accounting Pronouncements
Derivative Disclosures Effective December 31, 2008, we adopted new guidance issued by the FASB which requires an entity to provide greater transparency about how its derivative, credit derivatives, certain guarantees and hedging activities affect its financial statements. The new guidance requires enhanced disclosures about: (a) how and why an entity uses derivative instruments; (b) how derivative instruments and related hedged items are accounted for; and (c) how derivative instruments and related hedged and certain guarantee items affect an entitys financial position, results of operations, and cash flows. Since this guidance affects only disclosures, its adoption did not impact our financial position or results of operations.
Variable Interest Entities Effective December 31, 2008, we adopted new guidance issued by the FASB which requires public entities to provide additional disclosures about transfers of financial assets. It also requires public enterprises, including sponsors that have a variable interest in a variable interest entity, to provide additional disclosures about their involvement with variable interest entities. Additionally, this guidance requires certain disclosures to be provided by a public enterprise that is (a) a sponsor of a qualifying special-purpose entity (SPE) that holds a variable interest in the qualifying SPE but was not the transferor (nontransferor) of financial assets to the qualifying SPE and (b) a servicer of a qualifying SPE that holds a significant variable interest in the qualifying SPE but was not the transferor (nontransferor) of financial assets to the qualifying SPE. The disclosures required are intended to provide greater transparency to financial statement users about a transferors continuing involvement with transferred financial assets and an enterprises involvement with variable interest entities and qualifying SPEs. The adoption of this guidance on December 31, 2008 did not have a material impact on our consolidated statements of financial condition, results of operations and liquidity.
Noncontrolling Interests Effective January 1, 2009 we adopted new guidance issued by the FASB which changes the accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a noncontrolling interest should be reported as a component of equity in the consolidated financial statements.
This also required expanded disclosures that identify and distinguish between the interests of the parents owners and the interests of the noncontrolling owners of an entity. The Companys sole noncontrolling interest relates to its 75.35% interest in Lodestar Investment Counsel, LLC (Lodestar). The retrospective adoption of this guidance on January 1, 2009 did not have a material impact on our consolidated statements of financial condition, results of operations and liquidity.
Business Combinations Effective January 1, 2009, we adopted new guidance the FASB issued which establishes principles and requirements for the acquirer in a business combination, including: (a) the acquisition date will be the date the acquirer obtains control; (b) all (and only) identifiable assets acquired, liabilities assumed, and noncontrolling interests in the acquiree will be stated at fair value on the acquisition date; (c) assets or liabilities arising from noncontractual contingencies will be measured at their acquisition date fair value only if it is more likely than not that they meet the definition of an asset or liability on the acquisition date; (d) adjustments subsequently made to the provisional amounts recorded on the acquisition date will be made retroactively during a measurement period not to exceed one year; (e) acquisition-related restructuring costs will be expensed rather than included in the cost of the acquisition; (f) transaction costs will be expensed as incurred, except for debt or equity issuance costs which will be accounted for in accordance with other generally accepted accounting principles; (g) reversals of deferred income tax valuation allowances and income tax contingencies will be recognized in earnings subsequent to the measurement period; and (h) the allowance for loan losses of an acquiree will not be permitted to be recognized by the acquirer, rather, credit-related factors are now incorporated directly into the fair value of loans. In addition, this guidance requires new and modified disclosures surrounding subsequent changes to acquisition-related contingencies, contingent consideration, noncontrolling interests, acquisition-related transaction costs, fair values and cash flows not expected to be collected for acquired loans, and an enhanced goodwill roll-forward.
We will prospectively apply this guidance to all business combinations completed on or after January 1, 2009. The effect of these new requirements on our financial position and results of operations will depend on the volume and terms of acquisitions in 2009 and beyond, if any, and will likely increase the amount and change the timing of recognizing expenses related to acquisition activities. The adoption of this guidance on January 1, 2009 did not have a material impact on our consolidated statements of financial condition, results of operations and liquidity.
Convertible Debt Instruments Effective January 1, 2009, we adopted new guidance issued by the FASB which clarifies that certain convertible debt instruments should be separately accounted for as liability and equity components. The guidance requires the issuer of certain convertible securities that may be settled partially in cash on conversion to separately account for the liability and equity components in a manner that will reflect the entitys nonconvertible debt borrowing rate when interest cost is recognized in subsequent periods. This guidance applies to our contingent convertible senior notes (which were redeemed during the first and second quarters of 2009) discussed in Note 8, Short-Term Debt to the Consolidated Financial Statements and required retroactive application for our 2007 and 2008 financial statements. The adoption of this guidance on January 1, 2009 did not have a material impact on our financial position, results of operations and liquidity.
Participating Securities Effective January 1, 2009, we adopted new guidance issued by the FASB which clarifies that unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of earnings per share pursuant to the two-class method. We grant restricted stock and RSUs under our stock-based compensation programs, which entitle the recipients to receive nonforfeitable dividends during the vesting period on a basis equivalent to the dividends paid to holders of common stock. These unvested awards meet the definition of participating securities. The two-class method excludes from earnings per common share calculations any dividends paid or owed to participating securities and any undistributed earnings considered to be attributable to participating securities. All previously reported earnings per share data has been retrospectively adjusted to conform with the provisions of this guidance. Our adoption of this guidance did not have a material effect on either our financial position, results of operations and liquidity.
The following table presents the impact of accounting standards adopted during the first quarter 2009.
Impact of Retrospective Application of New Accounting Guidance Impacting
Convertible Debt, Noncontrolling Interests, and Participating Securities
(Amounts in thousands, except per share data)
Fair Value Measurements In April 2009, the FASB issued new guidance which provides additional guidance for estimating fair value when the volume and level of activity for the asset or liability have significantly decreased. This guidance identifies several factors that a reporting entity should evaluate to determine whether there has been a significant decrease in the volume and level of activity for an asset or liability. If the reporting entity concludes there has been a significant decrease in the volume and level of activity for the asset or liability in relation to normal market activity, transactions or quoted prices may not be determinative of fair value (for example, there may be increased instances of transactions that are not orderly), further analysis of the transactions or quoted prices is needed, and a significant adjustment to the transactions or quoted prices may be necessary to estimate fair value. This also provides guidance on identifying circumstances that indicate a transaction is not orderly. The adoption of this guidance on April 1, 2009 did not have a material impact on our consolidated financial position, consolidated results of operations or liquidity position as of September 30, 2009.
Other-Than-Temporary Impairment (OTTI) In April 2009, the FASB issued new guidance which modified existing OTTI guidance for debt securities, modified the intent and ability indicator for recognizing OTTI, and changed the trigger used to assess the collectability of cash flows from probable that the investor will be unable to collect all amounts due to the entity does not expect to recover the entire amortized cost basis of the security. This guidance changed the total amount recognized in earnings when there are credit losses associated with an impaired debt security and management asserts that it does not have the intent to sell the security and it is more likely than not that it will not have to sell the security before recovery of its cost basis. In those situations, impairment shall be separated into (a) the amount representing a credit loss and (b) the amount related to non-credit factors. The amount of impairment related to credit losses shall be recognized in earnings. The credit loss component of an OTTI, representing an increase in credit risk, shall be determined by the reporting entity using its best estimate of the present value of cash flows expected to be collected from the debt security. The amount of impairment related to non-credit factors shall be recognized in other comprehensive income. The previous cost basis less impairment recognized in earnings becomes the new cost basis of the security and shall not be adjusted for subsequent recoveries in fair value. However, the cost basis shall be adjusted for accretion of the difference between the new cost basis and the present value of cash flows expected to be collected (portion of impairment in other comprehensive income). The total OTTI is presented in the consolidated statements of income with a reduction for the amount of the OTTI that is recognized in other comprehensive income, if any.
This guidance requires that the cumulative effect of initial adoption be recorded as an adjustment to the opening balance of retained earnings with a corresponding adjustment to accumulated other comprehensive income. The amortized cost basis of a security for which an OTTI was previously recognized shall be adjusted by the amount of the cumulative effect adjustment before taxes. The difference between the new amortized cost basis and the cash flows expected to be collected shall be accreted as interest income.
This guidance expands the disclosure requirements for interim and annual periods to provide more detail on the types of available-for-sale and held-to-maturity debt securities held by major security type, including information about investment in unrealized loss position for which OTTI has or has not been recognized. In addition, disclosure is required for the reasons why an OTTI was recognized in earnings and the method and inputs used to calculate the portion of the impairment (or credit loss) recognized in earnings. The new guidance also expands disclosures by requiring entities to disclose its inputs and valuation assumptions for both interim and annual periods. In addition, disclosures are to be presented by major security type (such as commercial mortgage-backed securities or collateralized debt obligations), rather than disclosure by major category (such as trading securities and available-for-sale securities). The adoption of this guidance on April 1, 2009 did not have a material impact on our consolidated financial position, consolidated results of operations or liquidity position as of September 30, 2009.
Fair Value Disclosures Effective April 1, 2009, we adopted new guidance the FASB issued which enhances consistency in financial reporting about fair value of financial instruments by increasing the frequency of such disclosures for interim reporting periods of publicly traded companies as well as in annual financial statements. The adoption of this guidance on April 1, 2009 did not have a material impact on our consolidated financial position, consolidated results of operations or liquidity position as of September 30, 2009.
Subsequent Events Effective April 1, 2009, we adopted new guidance the FASB issued which establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. In particular, this guidance sets forth the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements. This guidance also sets forth the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements and the disclosures that an entity should make about events or transactions that occurred after the balance sheet date. The adoption of this guidance on April 1, 2009 did not have a material impact on our financial position, results of operations and liquidity.
Accounting Pronouncements Pending Adoption
Accounting for Transfers of Financial Assets In June 2009, the FASB issued accounting guidance related to the transfer of financial assets. This guidance removes the exception for qualifying special-purpose entities from consolidation guidance and the exception that permitted sale accounting for certain guaranteed mortgage securitizations when a transferor had not surrendered control over the transferred financial assets. The new guidance also establishes conditions for accounting and reporting of a transfer of a portion of a financial asset, modifies the asset sale/derecognition criteria, and changes how retained interests are initially measured. The new guidance is expected to provide greater transparency about transfers of financial assets and a transferors continuing involvement, if any, with the transferred assets. This guidance will be effective for the Company beginning January 1, 2010. We are in the process of analyzing the potential impact the new guidance will have on our consolidated financial position, results of operations and liquidity but the effect will generally be limited to future transactions.
Variable Interest Entities In June 2009, the FASB issued accounting guidance related to variable interest entities. This guidance replaces a quantitative-based risks and rewards calculation for determining which entity, if any, has a controlling financial interest in a variable interest entity with an approach focused on identifying which entity has the power to direct the activities of a variable interest entity that most significantly impact its economic performance and the obligation to absorb its losses or the right to receive its benefits. This guidance requires reconsideration of whether an entity is a variable interest entity when any changes in facts or circumstances occur such that the holders of the equity investment at risk, as a group, lose the power to direct the activities of the entity that most significantly impact the entitys economic performance. It also requires ongoing assessments of whether a variable interest holder is the primary beneficiary of a variable interest entity. This guidance will be effective for the Company beginning January 1, 2010. We are currently evaluating the effect this guidance will have on our consolidated financial position, results of operations and liquidity.
3. FDIC-ASSISTED ACQUISITION
On July 2, 2009, our primary banking subsidiary, The PrivateBank and Trust Company (The PrivateBank Chicago), acquired certain assets and assumed substantially all of the deposits of the former Founders Bank (Founders) from the Federal Deposit Insurance Corporation (FDIC). The transaction consisted of approximately $843 million in assets, including $181 million in investments, and $592 million in loans. The PrivateBank Chicago assumed $791 million in liabilities including $767 million in non-brokered deposits, and $24 million in Federal Home Loan Bank (FHLB) advances. Assets totaling approximately $843 million were purchased at a discount of $54 million. The PrivateBank Chicago and the FDIC entered into a loss sharing agreement regarding future losses incurred on loans and foreclosed loan collateral existing at July 2, 2009. Under the terms of the loss-sharing agreements, the FDIC generally will assume 80% of the first $173 million of credit losses and 95% of the credit losses in excess of $173 million.
As a result of the loss sharing agreement discussed above, the acquired loans and foreclosed loan collateral (including the fair value of expected reimbursements from the FDIC) is presented in our Consolidated Statement of Condition as covered assets. In accordance with business combination accounting rules, these loans were recorded at fair value without a corresponding allowance for loan losses.
Purchased loans acquired in a business combination, including loans purchased in the Founders transaction, are accounted for under specialized accounting rules when the loans have evidence of credit deterioration since origination and for which it is probable that not all contractual payments will be collected (purchased impaired loans). Evidence of credit quality deterioration as of the purchase date may include statistics such as past due and non-accrual status, declines in current borrower FICO scores, geographic concentration and declines in current loan-to-value ratios. U.S. GAAP requires these loans to be recorded at fair value at acquisition date and prohibits the carrying over or the creation of valuation allowances in the initial accounting for loans acquired in a transfer such as those loans we acquired in the Founders transaction.
The following table presents the carrying amount of the covered assets at September 30, 2009 and consists of loans subject to the specialized accounting rules related to purchased impaired loans, loans not subject to those rules and other assets.
(Amounts in thousands)
As of the date of acquisition, the preliminary estimate of the contractually required payments receivable for all purchased impaired loans acquired in the Founders transaction were $236.2 million, the cash flows expected to be collected were $133.9 million including interest, and the estimated fair value of the loans were $102.2 million. The fair values for loans within the scope of the specialized accounting rules are determined by discounting both principal and interest cash flows expected to be collected using an observable discount rate for similar instruments with adjustments that management believes a market participant would consider in determining fair value. We estimate the cash flows expected to be collected at acquisition using internal and third party models that incorporate managements best estimate of current key assumptions, such as default rates, loss severity and payment speeds. Assets acquired and liabilities assumed are recorded at their preliminary estimated fair values. Because of the estimation process required, certain refinements may be made to finalize these carrying values upon completion of the analysis of the fair values of assets and liabilities.
Under the specialized accounting rules, 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 using the constant effective yield method when there is a reasonable expectation about amount and timing of such cash flows. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is referred to as the non-accretable difference. Subsequent decreases to the expected cash flows will generally result in a provision for loan losses. Subsequent increases in cash flows result in a reversal of the provision for loan losses to the extent of prior charges, or a reclassification of the difference from nonaccretable to accretable with a positive impact on interest income. At September 30, 2009, there was no allowance for loan losses related to the purchased impaired loans.
For purchased loans not subject to the specialized accounting rules, differences between the purchase price and the unpaid principal balance at the date of acquisition are recorded in interest income over the life of the loan using a constant effective yield method. Decreases in expected cash flows after the purchase date are recognized by recording an additional allowance for loan losses.
Changes in the carrying amount and accretable yield for loans that evidenced deterioration at the acquisition date were as follows for the three months ended September 30, 2009.
Change in Purchased Impaired Loans Accretable Yield and Carrying Amount
(Amounts in thousands)
(Amounts in thousands)
At September 30, 2009, gross unrealized gains in the securities available-for-sale portfolio totaled $61.6 million, and gross unrealized losses totaled $125,000, resulting in a net unrealized appreciation of $61.5 million.
The carrying value of securities available-for-sale, which were pledged to secure public deposits, trust deposits and for other purposes as permitted or required by law, totaled $755.6 million at September 30, 2009 and $778.3 million at December 31, 2008.
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, 2009 and December 31, 2008. The securities presented are grouped according to the time periods during which the securities have been in a continuous unrealized loss position.
Securities In Unrealized Loss Position
(Amounts in thousands)
The unrealized loss on securities in an unrealized loss position for greater than 12 months totaled $13,000. The unrealized losses reported for residential mortgage-backed securities were caused by increases in interest rates and the contractual cash flows of those investments are primarily guaranteed by either U.S. Government agencies or by U.S. Government-sponsored enterprises. Accordingly, we believe the credit risk embedded in these securities to be inherently low. The unrealized losses in our investments in state and municipal securities are due to increases in interest rates and the Company expects to recover the entire amortized cost basis of the securities.
Since the declines in fair value on our securities are attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, we do not consider these investments to be other-than-temporarily impaired at September 30, 2009.
Remaining Contractual Maturity of Securities
(Amounts in thousands)
Securities Gains (Losses)
(Amounts in thousands)
For additional details of the securities available-for-sale portfolio and the related impact of unrealized gains (losses) thereon, see Note 11, Comprehensive Income.
Loan Portfolio (excluding covered assets) (1)
(Amounts in thousands)
Total loans reported, excluding covered assets, are net of deferred loan fees and deferred loan origination costs of $27.3 million at September 30, 2009 and $21.0 million at December 31, 2008 and include overdrawn demand deposits totaling $20.9 million at September 30, 2009 and $37.5 million at December 31, 2008.
We primarily lend to businesses and consumers in the market areas in which we operate. Within these areas, we diversify our loan portfolio by loan type, industry, and borrower.
It is our policy to review each prospective credit in order to determine the appropriateness and, when required, the adequacy of security or collateral to obtain prior to making a loan. In the event of borrower default, we seek recovery in compliance with state lending laws and our lending standards and credit monitoring procedures.
Book Value of Loans Pledged
(Amounts in thousands)
6. ALLOWANCE FOR LOAN LOSSES, RESERVE FOR UNFUNDED COMMITMENTS AND IMPAIRED LOANS
Allowance for Loan Losses (excluding covered assets) (1)
(Amounts in thousands)
A portion of our allowance for loan losses is allocated to loans deemed impaired. All impaired loans are included in nonperforming assets.
The reserve for unfunded commitments totaled $1.3 million at September 30, 2009.
Impaired, Nonaccrual, and Past Due Loans (excluding covered assets) (1)
(Amounts in thousands)
The average recorded investment in impaired loans was $197.9 million and $58.5 million for the nine months ended September 30, 2009 and 2008, respectively.
7. GOODWILL AND OTHER INTANGIBLE ASSETS
Carrying Amount of Goodwill by Operating Segment
(Amounts in thousands)
Goodwill decreased by $362,000 during the third quarter 2009 due to an adjustment for tax benefits associated with the goodwill attributable to Lodestar, a subsidiary of the Company. Goodwill is not amortized but is subject to impairment tests at least annually or more often if events or circumstances indicate that there may be impairment. Our annual goodwill impairment test will be completed during the fourth quarter 2009.
We have other intangible assets capitalized on the Consolidated Statements of Financial Condition in the form of core deposit premiums, client relationships and assembled workforce. These intangible assets are being amortized over their estimated useful lives, which range from 3 years to 15 years. We review intangible assets for possible impairment whenever events or changes in circumstances indicate that carrying amounts may not be recoverable.
Other Intangible Assets
(Amounts in thousands)
During the third quarter 2009, we recognized $12.4 million and $1.3 million in core deposit and client relationship intangibles, respectively, in connection with the Founders transaction. Amortization expense totaled $547,000 for the quarter ended September 30, 2009 and $241,000 for the quarter ended September 30, 2008. Amortization expense totaled $1.2 million for the nine months ended September 30, 2009 and $897,000 for the nine months ended September 30, 2008
Remaining Amortization Period of Other Intangible Assets
Scheduled Amortization of Other Intangible Assets
(Amounts in thousands)
8. SHORT-TERM BORROWINGS
Summary of Short-term Borrowings
(Amounts in thousands)
Securities sold under agreements to repurchase and federal funds purchased generally mature within 1 to 90 days from the transaction date. Securities sold under agreements to repurchase are treated as financings, and the obligations to repurchase securities sold are reflected as a liability in the Consolidated Statements of Financial Condition. Repurchase agreements are secured by U.S. Treasury, mortgage-backed securities or collateralized mortgage obligations and, if required, are held in third party pledge accounts. During the second quarter 2009, we redeemed a $97.0 million repurchase agreement in connection with the sale of the related collateral, incurring a $1.0 million early extinguishment of debt charge. The securities underlying the agreements remain in the respective asset accounts. As of September 30, 2009, we did not have amounts at risk under repurchase agreements with any individual counterparty or group of counterparties that exceeded 10% of stockholders equity.
Our subsidiary banks had unused overnight fed funds borrowings available for use of $230.0 million at September 30, 2009 and $171.0 million at December 31, 2008. Our total availability of overnight fed fund borrowings is not a committed line of credit and is dependent upon lender availability. At September 30, 2009, we also had $2.2 billion in borrowing capacity with $500.0 million outstanding through the Federal Reserve Bank discount windows primary credit program, which includes federal term auction facilities. Our borrowing capacity changes each quarter subject to available collateral and FRB discount factors.
Incident to the merger of our bank subsidiaries other than The PrivateBank, N.A. into The PrivateBank-Chicago, and because The PrivateBank-Chicago is not a FHLB member, our access to FHLB borrowings has been reduced to that available through our remaining FHLB member bank, The PrivateBank, N.A. Advances outstanding prior to the bank mergers remain outstanding to the extent not matured and are secured by qualifying residential and multi-family mortgages and state and municipal and mortgage-related securities. FHLB advances reported as short-term borrowings represent advances with a remaining maturity of one year or less. Our short-term FHLB advances have a weighted average interest rate of 2.75% at September 30, 2009 and 2.50% at December 31, 2008, payable monthly. At September 30, 2009, the weighted average remaining maturities of FHLB short-term advances were 6 months.
During the first and second quarter 2009, we redeemed all of the $115.0 million in outstanding principal amount of our contingent convertible senior notes at a redemption price in cash equal to 100% of the principal amount, plus accrued and unpaid interest. The senior convertible notes were issued in March 2007 and paid interest semi-annually at a fixed rate of 3.63% per annum. The notes were convertible under certain circumstances into cash and, if applicable, shares of the Companys common stock at an initial conversion price of $45.05 per share and were scheduled to mature on March 15, 2027.
During the first quarter 2009, we repaid in full $20.0 million under the credit facility. The credit facility matured in the third quarter 2009 and was not renewed by us.
9. LONG-TERM DEBT
(Amounts in thousands)
The amounts above are reported net of any unamortized discount and fair value adjustments recognized in connection with debt acquired through acquisitions.
We have $244.8 million in junior subordinated debentures issued to four separate wholly-owned trusts for the purpose of issuing Company-obligated mandatorily redeemable preferred securities. Refer to Note 10, Junior Subordinated Debentures, for further information on the nature and terms of these and previously issued debentures.
Long-term advances from the FHLB had weighted-average interest rates of 3.08% at September 30, 2009 and 3.33% at December 31, 2008. These advances, which had a combination of fixed and floating interest rates, were secured by qualifying residential and multi-family mortgages and state and municipal and mortgage-related securities. At September 30, 2009, the weighted average remaining maturities of FHLB long-term advances were 24 months.
The PrivateBank Chicago has $120.0 million outstanding under a 7-year subordinated debt facility. The debt facility has a variable rate of interest based on LIBOR plus 3.50%, per annum, payable quarterly and re-prices quarterly. The debt may be prepaid at any time prior to maturity without penalty and is subordinate to our senior indebtedness.
We reclassify long-term debt to short-term borrowings when the remaining maturity becomes less than one year.
Scheduled Maturities of Long-Term Debt
(Amounts in thousands)
10. JUNIOR SUBORDINATED DEFERRABLE INTEREST DEBENTURES HELD BY TRUSTS THAT ISSUED GUARANTEED CAPITAL DEBT SECURITIES
As of September 30, 2009, we sponsored and wholly owned 100% of the common equity of four trusts that were formed for the purpose of issuing Company-obligated mandatorily redeemable preferred securities (Trust Preferred Securities) to third-party investors and investing the proceeds from the sale of the Trust Preferred Securities solely in junior subordinated debt securities of the Company (the Debentures). The Debentures held by the trusts, which totaled $244.8 million, are the sole assets of each trust. Our obligations under the Debentures and related documents, taken together, constitute a full and unconditional guarantee by the Company of the obligations of the trusts. The guarantee covers the distributions and payments on liquidation or redemption of the Trust Preferred Securities, but only to the extent of funds held by the trusts. We have the right to redeem the Debentures in whole or in part, on or after specific dates, at a redemption price specified in the indentures plus any accrued but unpaid interest to the redemption date. We used the proceeds from the sales of the Debentures for general corporate purposes.
Under current accounting rules, the trusts qualify as variable interest entities for which we are not the primary beneficiary and therefore ineligible for consolidation. Accordingly, the trusts are not consolidated in our financial statements. The subordinated debentures issued by us to the trust are included in our Consolidated Statements of Financial Condition as long-term debt with the corresponding interest distributions recorded as interest expense. The common shares issued by the trust are included in other assets in our Consolidated Statements of Financial Condition.
Common Shares, Preferred Securities, and Related Debentures
(Amounts and number of shares in thousands)
11. COMPREHENSIVE INCOME
Comprehensive income includes net income as well as certain items that are reported directly within a separate component of stockholders equity that are not considered part of net income. Currently, our accumulated other comprehensive income consists of the unrealized gains (losses) on securities available-for-sale.
Components of Other Comprehensive Income
(Amounts in thousands)
Change in Accumulated Other Comprehensive Income
(Amounts in thousands)
12. EARNINGS PER COMMON SHARE
Basic and Diluted Earnings per Share
(Amounts in thousands, except per share data)
Basic earnings per share is calculated using the two-class method to determine income applicable to common stockholders. The two-class method requires undistributed earnings for the period, which represents net income less common and participating security dividends (if applicable) declared or paid, to be allocated between the common and participating security stockholders based upon their respective rights to receive dividends. Participating securities include unvested restricted shares/units that contain nonforfeitable rights to dividends. Income applicable to common stockholders is then divided by the weighted-average common shares outstanding for the period.
Diluted earnings per common share takes into consideration common stock equivalents issuable pursuant to convertible preferred stock, convertible debentures, warrants, unexercised stock options and unvested shares/units. Diluted earnings per common share is calculated under the more dilutive of either the treasury method or the two-class method.
13. INCOME TAXES
Income Tax Provision Analysis
(Dollars in thousands)
Net deferred tax assets totaled $83.0 million at September 30, 2009 and $44.4 million at December 31, 2008. Net deferred tax assets are included in other assets in the accompanying Consolidated Statements of Financial Condition and no valuation allowance is recorded. In assessing whether a deferred tax asset valuation allowance is needed, we considered the negative evidence associated with a cumulative pre-tax loss for financial statement purposes for the three-year period ended September 30, 2009. We also considered the positive evidence associated with taxable income being generated in 2009, reversing taxable temporary differences in future periods, including income associated with the unrealized gains in our investment securities portfolio, and our ability to generate future taxable income over a relatively short time period.
We have concluded that based on the weight given to this positive evidence, it is more likely than not that the deferred tax asset will be realized.
As of September 30, 2009, there were $667,000 of unrecognized tax benefits relating to uncertain tax positions that were included in the Consolidated Statements of Financial Condition.
14. MATERIAL TRANSACTIONS AFFECTING STOCKHOLDERS EQUITY
Conversion of Preferred Stock to Common Stock
In June 2009, we amended our amended and restated certificate of incorporation to (1) create a new class of non-voting common stock (the Non-voting Common Stock), and (2) amend and restate the Certificate of Designations of the Companys Series A Junior Nonvoting Preferred Stock (the Series A Preferred Stock) to provide, among other things, that the shares of Series A Preferred Stock are convertible only into shares of Non-voting Common Stock. Under the amended terms of the Series A Preferred Stock, each share of Series A Preferred Stock is convertible into one share of Non-voting Common Stock. We issued 1,951,037 shares of Non-voting Common Stock to Golder Rauner II, LLC (collectively, GTCR) upon notice of conversion by GTCR of all of its 1,951.037 shares of Series A Preferred Stock. The shares of Series A Preferred Stock held and converted by GTCR represented all of the issued and outstanding shares of Series A Preferred Stock on such date. We also entered into an amendment to our existing Preemptive and Registration Rights Agreement with GTCR pursuant to which we agreed, among other things, to register the shares of common stock issuable upon conversion of the newly issued shares of Non-voting Common Stock for resale under the Securities Act of 1933.
Issuance of Common Stock
In May 2009, we completed an underwritten public offering of 11.6 million shares of newly issued common stock at a public offering price of $19.25 per share. The underwriters of the offering partially exercised their over-allotment option and purchased an additional 266,673 shares of newly issued common stock. We had granted the underwriters an over-allotment option to purchase an additional 1.74 million shares. The net proceeds from the offering, including the partial exercise of the over-allotment option, were approximately $217 million after deducting underwriting commissions but before offering expenses. The net proceeds from the offering qualify as tangible common equity and Tier 1 capital and are being used for working capital and general corporate purposes.
TARP Capital Purchase Program
In January 2009, we issued 243,815 shares of fixed rate cumulative perpetual preferred stock, Series B (Series B Preferred Stock) to the United States Treasury (U.S. Treasury) under the TARP Capital Purchase Program (CPP) of the Emergency Economic Stabilization Act of 2008 for proceeds of $243.8 million. Cumulative dividends on the Series B Preferred Stock are payable at 5% per annum for the first five years and at a rate of 9% per annum thereafter on the liquidation preference of $1,000 per share. We are prohibited from paying any dividend with respect to shares of our common stock unless all accrued and unpaid dividends are paid in full on the Series B Preferred Stock for all past dividend periods. The Series B Preferred Stock is non-voting, other than class voting rights on matters that could adversely affect the Series B Preferred Stock. The Series B Preferred Stock is callable at par after three years. Prior to the end of three years, the Series B Preferred Stock may be redeemed with the proceeds from one or more qualified equity offerings of any Tier 1 perpetual preferred or common stock of at least $61.0 million (each a Qualified Equity Offering). The redemption price is equal to the sum of the liquidation amount per share and any accrued and unpaid dividends on the Series B preferred Stock. The U.S. Treasury may also transfer the Series B Preferred Stock to a third party at any time. Notwithstanding the foregoing limitations, the American Recovery and Reinvestment Act of 2009 (ARRA) requires the U.S. Treasury, subject to consultation with appropriate banking regulators, to permit participants in the CPP to redeem preferred stock issued under the CPP without regard to whether the recipient has completed a Qualified Equity Offering or replaced such funds from any other source, or to any waiting period.
In conjunction with the purchase of the Companys Series B Preferred Stock, the U.S. Treasury received a ten year warrant to purchase up to 1,290,026 shares of the Companys common stock with an aggregate market price equal to $36.6 million or 15% of the Series B Preferred Stock. The warrants exercise price of $28.35 per share was calculated based on the average closing price of the Companys common stock on the 20 trading days ending on the last trading day prior to the date of the U.S. Treasurys approval of our application under the CPP. The U.S. Treasury may not exercise or transfer the warrants with respect to more than half of the initial shares of common stock underlying the warrants prior to the earlier of (a) the date on which we receive aggregate gross proceeds of not less than $243.8 million from one or more Qualified Equity Offerings and (b) December 31, 2009. The number of shares of common stock to be delivered upon settlement of the warrants will be reduced by 50% if we receive aggregate gross proceeds of at least $243.8 million from one or more Qualified Equity Offerings prior to December 31, 2009. The ARRA requires the U.S. Treasury to liquidate these warrants if we fully redeem the Series B Preferred Stock either as a result of redemption by us at a market price determined under the warrants or sale by the U.S. Treasury to third party.
The Series B Preferred Stock and the warrants issued under the CPP are accounted for as permanent equity on the Consolidated Statements of Financial Condition. The proceeds received were allocated between the Series B Preferred Stock and the warrants based upon their relative fair values as of January 30, 2009, the date of issuance, which resulted in the recording of a discount on the Series B Preferred Stock upon issuance that reflects the value allocated to the warrants. The discount is accreted by a charge to retained earnings using a level-yield method over five years and reported as a reduction of income applicable to common equity over that period. The allocated carrying value of the Series B Preferred Stock and warrants on the date of issuance (based on their relative fair values) were $236.3 million and $7.6 million, respectively. The Series B Preferred Stock and warrants qualify as Tier 1 regulatory capital.
Under the terms of our agreements with the U.S. Treasury in connection with our participation in the CPP, we may increase quarterly common stock dividends at any time, but are precluded from raising the quarterly dividend above $0.075 per share prior to January 30, 2012, the date that is three years following the sale of the Series B Preferred Stock to the U. S. Treasury. Furthermore, as a bank holding company, our ability to pay dividends is subject to the guidelines of the Federal Reserve regarding capital adequacy and dividends and we are required to consult with the Federal Reserve before declaring or paying any dividends. Dividends also may be limited as a result of safety and soundness considerations. Refer to the section entitled Supervision and Regulation in our 2008 Annual Report on Form 10-K, as amended, for a discussion of regulatory and other restrictions on dividend declarations. Our quarterly common stock dividend for the third quarter was $0.01 per share, consistent with the first and second quarter 2009 dividend payments.
15. DERIVATIVE INSTRUMENTS
We are an end-user of certain derivative financial instruments which we use to manage our exposure to interest rate and foreign exchange risk. We also use these instruments for client accommodation as we make a market in derivatives for our clients.
None of the end-user and client related derivatives have been designated as hedging instruments. Both end-user and client related derivatives are recorded at fair value in the Consolidated Statements of Financial Condition as either derivative assets or derivative liabilities, with changes in their fair value recorded in current earnings. Refer to Table A for the fair values of our derivative instruments on a gross basis as of September 30, 2009, and where they are recorded in the Consolidated Statements of Financial Condition and Table B for the related net gains/(losses) recognized during the three-month period ended September 30, 2009, and where they are recorded in the Consolidated Statements of Income.
Derivative assets and liabilities are recorded at fair value in the Consolidated Statements of Financial Condition, after taking into account the effects of master netting agreements as allowed under authoritative accounting guidance.
Derivatives expose us to credit risk measured as replacement cost (current positive mark to market value plus potential future exposure from positive movements in mark to market). Credit risk is managed through the banks standard underwriting process. Actual exposures are monitored against various types of credit limits established to contain risk within parameters. Additionally, credit risk is managed through the use collateral and netting agreements.
End-User Derivatives We enter into derivatives that include commitments to fund certain mortgage loans to be sold into the secondary market and forward commitments for the future delivery of residential mortgage loans. It is our practice to enter into forward commitments for the future delivery of fixed rate residential mortgage loans when interest rate lock commitments are entered into in order to economically hedge the effect of changes in interest rates on our commitments to fund the loans as well as on our portfolio of mortgage loans held-for-sale. At September 30, 2009, we had approximately $32.7 million of interest rate lock commitments and $51.7 million of forward commitments for the future delivery of residential mortgage loans with rate locks.
We are also exposed at times to foreign exchange risk as a result of issuing loans in which the principal and interest are settled in a currency other than US dollars. Currently our exposure is to the British pound and we manage this risk by using currency forward derivatives.
Client Related Derivatives We offer, through our Capital Markets group, an extensive range of over-the-counter interest rate and foreign exchange derivatives to our clients including but not limited to interest rate swaps, options on interest rate swaps, interest rate options (also referred to as Caps, Floors, Collars, etc.), foreign exchange forwards and options as well as cash products such as foreign exchange spot transactions. These client generated activities are structured to mitigate our exposure to market risk through the execution of off-setting positions with inter-bank dealer counterparties. This permits the Capital Markets group to offer customized risk management solutions to our clients while maintaining high capital velocity. Although transactions originated by Capital Markets do not expose us to overnight market risk, they do expose us to other risks including counterparty credit, settlement, and operational risk.
To accommodate our loan clients, we occasionally enter into risk participation agreements (RPAs) with counterparty banks to either accept or transfer a portion of the credit risk related to their interest rate derivatives. This allows clients to execute an interest rate derivative with one bank while allowing for distribution of the credit risk between participating members. We have entered into written RPAs for terms ranging from two-to-five years in which the bank accepts a portion of the credit risk associated with a loan clients interest rate derivative in exchange for a fee. The bank manages this credit risk through its loan underwriting process and when appropriate the RPA is backed by collateral provided by our clients under their loan agreement.
The current payment/performance risk of written RPAs is assessed using internal risk ratings which range from 1 to 8 with the latter representing the highest credit risk. The risk rating is based on several factors including the financial condition of the RPAs underlying derivative counterparty, present economic conditions, performance trends, leverage, and liquidity. As of September 30, 2009, written RPAs were assigned a risk rating of between 3 and 6.
The maximum potential amount of future undiscounted payments that we could be required to make under our written risk participation agreements is approximately $4.7 million. This assumes that the underlying derivative counterparty defaults and that the floating interest rate index of the underlying derivative remains at zero percent. In the event that we would have to pay out any amounts under our RPAs, we will seek to recover these from assets that our clients pledged as collateral for the derivative and the related loan. We believe that proceeds from the liquidation of the collateral will cover approximately 68% of the maximum potential amount of future payments under our outstanding RPAs. At September 30, 2009, the fair value of written RPAs totaled ($111,000).
Consolidated Statement of Financial Condition Location of and Fair Value of Derivative Instruments
(Amounts in thousands)
Consolidated Statement of Income Location of and Gain (Loss) Recognized
(Amounts in thousands)
Certain of our derivative contracts contain embedded credit risk contingent features that if triggered either allow the derivative counterparty to terminate the derivative or require additional collateral. These contingent features are triggered if we do not meet specified financial performance indicators such as capital or credit ratios.
The aggregate fair value of all derivatives and RPA transactions subject to credit risk contingency features that are in a net liability position on September 30, 2009, totaled $58.3 million for which we have posted collateral of $56.7 million in the normal course of business. If the credit risk contingency features were triggered on September 30, 2009, we would be required to post an additional $1.0 million of collateral to our derivative counterparties and immediately settle outstanding derivative instruments for $39.5 million, not taking into account posted collateral.
16. COMMITMENTS, GUARANTEES, AND CONTINGENT LIABILITIES
Credit Extension Commitments and Guarantees
In the normal course of business, we enter into a variety of financial instruments with off-balance sheet risk to meet the financing needs of our customers, to reduce our exposure to fluctuations in interest rates, and to conduct lending activities. These instruments principally include commitments to extend credit, standby letters of credit, and commercial letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the Consolidated Statements of Financial Condition.
Contractual or Notional Amounts of Financial Instruments
(Amounts in thousands)
Commitments to extend credit are agreements to lend funds to a client as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and variable interest rates tied to the prime rate or LIBOR and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash-flow requirements.
Standby and commercial letters of credit are conditional commitments issued by us to guarantee the performance of a customer to a third party. Standby letters of credit generally are contingent upon the failure of the client to perform according to the terms of the underlying contract with the third party and are most often issued in favor of a municipality where construction is taking place to ensure the borrower adequately completes the construction. Commercial letters of credit are issued specifically to facilitate commerce and typically result in the commitment being drawn on when the underlying transaction is consummated between the client and the third party. This type of letter of credit is issued through a correspondent bank on behalf of a client who is involved in an international business activity such as the importing of goods.
In the event of a clients nonperformance, our credit loss exposure is equal to the contractual amount of those commitments. The credit risk is essentially the same as that involved in extending loans to clients and is subject to our normal credit policies. We use the same credit policies in making credit commitments as for on-balance sheet instruments, with such exposure to credit loss minimized due to various collateral requirements in place. In the event of nonperformance by the clients, we have rights to the underlying collateral, which could include commercial real estate, physical plant and property, inventory, receivables, cash and marketable securities.
The maximum potential future payments guaranteed by the Company under standby letters of credit arrangements are equal to the contractual amount of the commitment. The unamortized fees associated with standby letters of credit, which is included in other liabilities in the Consolidated Statements of Financial Condition, totaled $704,000 as of September 30, 2009. We amortize these amounts into income over the commitment period. As of September 30, 2009, standby letters of credit had a remaining weighted-average term of approximately 15 months, with remaining actual lives ranging from less than 1 year to 8 years.
As of September 30, 2009, there were certain legal proceedings pending against us and our subsidiaries in the ordinary course of business. We do not believe that liabilities, individually or in the aggregate, arising from these proceedings, if any, would have a material adverse effect on our consolidated financial condition or results of operations as of September 30, 2009.
17. FAIR VALUE
We measure, monitor, and disclose certain of our assets and liabilities on a fair value basis. Fair value is used on a recurring basis to account for securities available-for-sale, derivative assets, and derivative liabilities. In addition, fair value is used on a non-recurring basis to apply lower-of-cost-or-market accounting to foreclosed real estate; evaluate assets or liabilities for impairment, including collateral-dependent impaired loans and for disclosure purposes. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Depending on the nature of the asset or liability, we use various valuation techniques and input assumptions when estimating fair value.
U.S. GAAP requires us to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value and establishes a fair value hierarchy that prioritizes the inputs used to measure fair value into three broad levels based on the reliability of the input assumptions. The hierarchy gives the highest priority to level 1 measurements and the lowest priority to level 3 measurements. The three levels of the fair value hierarchy are defined as follows:
The categorization of where an asset or liability falls within the hierarchy is based on the lowest level of input that is significant to the fair value measurement.
We believe our valuation methods are appropriate and consistent with other market participants. However, the use of different methodologies, or assumptions, to determine the fair value of certain financial instruments could result in a different estimate of fair value. Additionally, the methods used may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values.
The following describes the valuation methodologies we use for assets and liabilities measured at fair value, including the general classification of the assets and liabilities pursuant to the valuation hierarchy.
Securities Available-for-Sale Securities available-for-sale includes U.S. Treasury, collateralized mortgage obligations, residential mortgage-backed securities, corporate collateralized mortgage obligations and state and municipal securities. Substantially all available-for-sale securities are fixed income instruments that are not quoted on an exchange, but may be traded in active markets. The fair value of these securities is based on quoted market prices obtained from external pricing services or dealer market participants where trading in an active market exists. In obtaining such data from external pricing services, we have evaluated the methodologies used to develop the fair values in order to determine whether such valuations are representative of an exit price in our principal markets. The principal markets for our securities portfolio are the secondary institutional markets, with an exit price that is predominantly reflective of bid level pricing in those markets. U.S. Treasury securities have been classified in level 1 of the valuation hierarchy. Virtually all other remaining securities are classified in level 2 of the valuation hierarchy.
Collateral-Dependent Impaired Loans The carrying value of impaired loans is disclosed in Note 6, Allowance for Loan Losses and Impaired Loans. We do not record loans at fair value on a recurring basis. However, from time to time, fair value adjustments are recorded on these loans to reflect (1) partial write-downs that are based on the current appraised or market-quoted value of the underlying collateral or (2) the full charge-off of the loan carrying value. In some cases, the properties for which market quotes or appraised values have been obtained are located in areas where comparable sales data is limited, outdated, or unavailable. Accordingly, fair value estimates, including those obtained from real estate brokers or other third-party consultants, for collateral-dependent impaired loans are classified in level 3 of the valuation hierarchy.
Other Real Estate Owned (OREO) OREO is valued based on third-party appraisals of each property and our judgment of other relevant market conditions and are classified in level 3 of the valuation hierarchy.
Derivative Assets and Derivative Liabilities Client related derivative instruments with positive fair values are reported as an asset and derivative instruments with negative fair value are reported as liabilities and after taking into account the effects of master netting agreements. The fair value of client related derivative assets and liabilities are determined based on the fair market value as quoted by broker-dealers using standardized industry models, third party advisors using standardized industry models, or internally generated models based primarily on observable inputs. Client related derivative assets and liabilities are generally classified in level 2 of the valuation hierarchy.
Other Assets and Other Liabilities Included in Other Assets and Other Liabilities are end-user derivative instruments that we use to manage our foreign exchange and interest rate risk. End-user derivative instruments with positive fair value are reported as an asset and end-user derivative instruments with a negative fair value are reported as liabilities and after taking into account the effects of master netting agreements. The fair value of end-user derivative assets and liabilities are determined based on the fair market value as quoted by broker-dealers using standardized industry models, third party advisors using standardized industry models, or internally generated models based primarily on observable inputs. End-user derivative assets and liabilities are classified in level 2 of the valuation hierarchy.
Assets and Liabilities Measured at Fair Value
The following table provides the hierarchy level and fair value for each major category of assets and liabilities measured at fair value at September 30, 2009 and December 31, 2008.
Fair Value Measurements
(Amounts in thousands)
At September 30, 2009, we had collateral-dependent impaired loans with a carrying value of $359.9 million, a specific reserve of $42.0 million and a fair value of $317.9 million. The specific reserve for impaired loans included a write-down of $37.3 million during the third quarter 2009.
Reconciliation of Beginning and Ending Fair Value For Those
Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
(Amounts in thousands)
U.S. GAAP requires disclosure of the estimated fair values of certain financial instruments, both assets and liabilities, on and off-balance sheet, for which it is practical to estimate the fair value. Because the estimated fair values provided herein exclude disclosure of the fair value of certain other financial instruments and all non-financial instruments, any aggregation of the estimated fair value amounts presented would not represent our underlying value. Examples of non-financial instruments having significant value include the future earnings potential of significant customer relationships and the value of The PrivateWealth Groups operations and other fee-generating businesses. In addition, other significant assets including property, plant, and equipment and goodwill are not considered financial instruments and, therefore, have not been valued.
Various methodologies and assumptions have been utilized in managements determination of the estimated fair value of our financial instruments, which are detailed below. The fair value estimates are made at a discrete point in time based on relevant market information. Because no market exists for a significant portion of these financial instruments, fair value estimates are based on judgments regarding future expected economic conditions, loss experience, and risk characteristics of the financial instruments. These estimates are subjective, involve uncertainties, and cannot be determined with precision. Changes in assumptions could significantly affect the estimates.
The following methods and assumptions were used in estimating the fair value of 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, funds sold and other short-term investments, accrued interest receivable, and accrued interest payable.
Mortgages held for sale The fair value of mortgages held for sale are based on quoted market rates or, in the case where a firm commitment has been made to sell the loan, the firm committed price.
Securities Available-for-Sale The fair value of securities 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.
Non-marketable equity investments Non-marketable equity investments include FHLB stock and other various equity securities. The carrying value of FHLB stock approximates fair value as the stock is non-marketable, but redeemable at par value. The carrying value of all other equity investments approximates fair value.
Loans The fair value of performing loans is calculated by discounting scheduled cash flows through the estimated maturity using estimated market discount rates that reflect the credit and interest rate risk inherent in the loan. The estimate of maturity is based on our and the industrys historical experience with repayments for each loan classification, modified, as required, by an estimate of the effect of current economic and lending conditions. Fair value of impaired loans approximates their carrying value because such loans are recorded at estimated recoverable value of the collateral or the underlying cash flow.
Covered assets Covered assets include the acquired loans and foreclosed loan collateral (including the fair value of expected reimbursements from the FDIC). These loans were recorded at fair value without a corresponding allowance for loan losses.
Investment in Bank Owned Life Insurance The fair value of our investment in bank owned life insurance is equal to its cash surrender value.
Deposit liabilities The fair values disclosed for non-interest bearing demand deposits, savings deposits, interest-bearing deposits, and money market deposits are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). The fair value for certificate of deposits and brokered deposits were estimated using present value techniques by discounting the future cash flows. The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities.
Short-term borrowings The fair value of repurchase agreements and FHLB advances with the remaining maturities of one year or less is estimated by discounting the agreements based on maturities using the rates currently offered for repurchase agreements or borrowings of similar remaining maturities. The carrying amounts of funds purchased and other borrowed funds approximate their fair value due to their short-term nature.
Long-term debt The fair value of subordinated debt was determined using available market quotes. The fair value of FHLB advances with remaining maturities greater than one year and other long-term debt is estimated by discounting future cash flows using current interest rates for similar financial instruments.
Derivative assets and liabilities The fair value of derivative instruments are based either on cash flow projection models acquired from third parties or observable market price.
Commitments Given the limited interest rate exposure posed by the commitments outstanding at year-end due to their general variable nature, combined with the general short-term nature of the commitment periods entered into, termination clauses provided in the agreements, and the market rate of fees charged, we have estimated the fair value of commitments outstanding to be immaterial.
(Amounts in thousands)
18. OPERATING SEGMENTS
We have three primary operating segments, Banking and The PrivateWealth Group that are delineated by the products and services that each segment offers, and the Holding Company. The Banking operating segment includes both commercial and personal banking services and The PrivateBank Mortgage Company. Commercial banking services are primarily provided to corporations and other business clients and include a wide array of lending and cash management products. Personal banking services offered to individuals, professionals, and entrepreneurs include direct lending and depository services. The PrivateWealth Group segment includes investment management, investment advisory, personal trust and estate administration, custodial and escrow, retirement account administration, and brokerage services. The activities of the third operating segment, the Holding Company, include the direct and indirect ownership of our banking and nonbanking subsidiaries and the issuance of debt.
The accounting policies of the individual operating segments are the same as those of the Company as described in Note 1. Transactions between operating segments are primarily conducted at fair value, resulting in profits that are eliminated from consolidated results of operations. Financial results for each segment are presented below. For segment reporting purposes, the statement of condition of The PrivateWealth Group is included with the Banking segment.
19. SUBSEQUENT EVENTS
On November 2, 2009, we closed on an underwritten public offering of common stock, which included the full exercise of the underwriters overallotment option, and issued a total of 22.2 million shares for net proceeds of $181.2 million to the Company after deducting underwriting commissions. Of that amount, approximately $35.3 million was purchased by certain funds managed by GTCR.
In addition, GTCR purchased approximately $12.8 million of non-voting common stock of the Company, equating to 1.6 million shares, through an exercise of its existing preemptive rights (based on the aggregate public offering amount less the amount being purchased by GTCR in the public offering including the exercise by the underwriters of their option to purchase additional shares). The purchase price of the non-voting common stock, which converts into common stock on a one-for-one basis, was $8.075 per share and equals the public offering price less the underwriting discount per share.
The net proceeds from the public offering, as well as from the sale of non-voting common stock, will qualify as tangible common equity and Tier 1 capital and will be used to further capitalize our subsidiary banks in order to support continued growth and for working capital and other general corporate purposes, including possible FDIC-assisted acquisition transactions subject to satisfying eligibility requirements to participate in such transactions.
At September 30, 2009 our total risk-based capital ratio was 13.40%, Tier 1 capital ratio was 11.01% and tangible common equity ratio was 6.00%. Giving effect to the common stock offering and issuance of the non-voting common stock under the preemptive rights agreement and on a pro-forma basis, at September 30, 2009 our capital ratios would have been 15.24%, 12.84% and 7.62% for total risk-based capital, Tier 1 capital and tangible common equity, respectively.
In addition, upon completion of the offering, we are eligible to request that the U.S. Department of the Treasury reduce the number of shares of common stock issuable upon exercise of the warrant held by the U.S. Treasury by 50 percent to 645,013 shares. Refer to Note 14, material Transactions Affecting Stockholders Equity for additional information as a result of our participation in the CPP.
ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
PrivateBancorp, Inc. (PrivateBancorp or the Company) was incorporated in Delaware in 1989 for the purpose of becoming a holding company registered under the Bank Holding Company Act of 1956, as amended (the Act). PrivateBancorp, through its PrivateBank subsidiaries (the Banks), provides customized business and personal financial services to middle-market commercial and commercial real estate companies, as well as business owners, executives, entrepreneurs and families in all of the markets we serve. We seek to develop lifetime relationships with our clients. Through a team of highly-qualified managing directors, the Banks deliver a sophisticated suite of tailored credit and non-credit solutions, including lending, treasury management, investment products, capital markets products and wealth management and trust services, to meet their clients commercial and personal needs. Since our inception, we have expanded into multiple geographic markets in the Midwest and Southeastern United States through the creation of new banks and banking offices and the acquisition of existing banks. Our clients also have access to mortgage loans offered through The PrivateBank Mortgage Company, a subsidiary of PrivateBancorp.
The discussion presented below provides an analysis of our results of operations and financial condition for the quarters and nine months ended September 30, 2009 and 2008. When we use the terms PrivateBancorp, the Company, we, us, and our, we mean PrivateBancorp, Inc. and its consolidated subsidiaries. When we use the term the the Banks, we are referring to our wholly owned banking subsidiaries, known under The PrivateBank brand. Managements discussion and analysis should be read in conjunction with the unaudited interim consolidated financial statements and accompanying notes presented elsewhere in this report, as well as our audited consolidated financial statements and accompanying notes included in our 2008 Annual Report on Form 10-K. Results of operations for the quarter and nine months ended September 30, 2009 are not necessarily indicative of results to be expected for the year ending December 31, 2009. Unless otherwise stated, all earnings per share data included in this section and throughout the remainder of this discussion are presented on a fully diluted basis.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
This report contains 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 managements 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, could, would, expect, plan, anticipate, intend, believe, estimate, predict, project, potential, or continue, and the negative of these terms and other comparable terminology. These forward-looking statements include statements relating to our projected growth, anticipated future financial performance and managements long-term performance goals. Forward-looking statements also include statements that anticipate the effects on our financial condition and results of operations from expected developments or events, such as the implementation of internal and external business and growth plans and strategies.
These forward-looking statements are subject to significant risks, assumptions and uncertainties, and could be affected by many factors. Factors that could have a material adverse effect on our financial condition, results of operations and future prospects include, but are not limited to:
Because of these and other uncertainties, our actual future results, performance or achievements, or industry results, may be materially different from the results indicated by these forward-looking statements. In addition, our past results of operations do not necessarily indicate our future results.
You should not place undue reliance on any forward-looking statements, which speak only as of the dates on which they were made. We are not undertaking an obligation to update these forward-looking statements, even though our situation may change in the future, except as required under federal securities law. We qualify all of our forward-looking statements by these cautionary statements.
CRITICAL ACCOUNTING POLICIES
Our consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles (U.S. GAAP) and are consistent with predominant practices in the financial services industry. Critical accounting policies are those 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 at 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, in turn, may affect amounts reported in the consolidated financial statements.
We have numerous accounting policies, of which the most significant are presented in Note 1, Summary of Significant Accounting Policies, to the Consolidated Financial Statements of our 2008 Annual Report on Form 10-K. These policies, along with the disclosures presented in the other consolidated financial statement notes and in this discussion, provide information on how significant assets and liabilities are valued in the consolidated financial statements and how those values are determined. Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions, and estimates underlying those amounts, management has determined that our accounting policies with respect to the allowance for loan losses, goodwill and intangible assets, and income taxes are the accounting areas requiring subjective or complex judgments that are most important to our financial position and results of operations, and, as such, are considered to be critical accounting policies, as discussed below.
Allowance for Loan Losses
We maintain an allowance for loan losses at a level management believes is sufficient to absorb credit losses inherent in our loan portfolio. The allowance for loan losses represents our estimate of probable losses in the portfolio at each balance sheet date and is based on a review of available and relevant information. The allowance contains provisions for probable losses that have been identified relating to specific borrowing relationships as well as probable losses inherent in our loan portfolio and credit undertakings that are not specifically identified. Our allowance for loan losses is assessed monthly to determine the appropriate level of the allowance. The amount of the allowance for loan losses is determined based on a variety of factors, including, among other factors, assessment of the credit risk of the loans in the portfolio, delinquent loans, impaired loans, evaluation of current economic conditions in the market area, actual charge-offs and recoveries during the period, industry loss averages and historical loss experience.
Management adjusts the allowance for loan losses by recording a provision for loan losses in an amount sufficient to maintain the allowance at the level determined appropriate. Loans are charged-off when deemed to be uncollectible by management.
Goodwill and Intangible Assets
Goodwill represents the excess of purchase price over the fair value of net assets acquired using the purchase method of accounting. Other intangible assets represent purchased assets that also lack physical substance but can be distinguished from goodwill because of contractual or other legal rights or because the asset is capable of being sold or exchanged either on its own or in combination with a related contract, asset, or liability. We test goodwill at least annually for impairment or more often if events or circumstances indicate that there may be impairment. Impairment losses on recorded goodwill, if any, will be recorded as operating expenses.
Goodwill is allocated to business segments at acquisition. Fair values of reporting units are determined using either market-based valuation multiples for comparable businesses if available, or discounted cash flow analyses based on internal financial forecasts. If the fair value of a reporting unit exceeds its net book value, goodwill is considered not to be impaired.
Identified intangible assets that have a finite useful life are amortized over that life in a manner that reflects the estimated decline in the economic value of the identified intangible asset and are subject to impairment testing whenever events or changes in circumstances indicate that the carrying value may not be recoverable. All of the other intangible assets have finite lives which are amortized over varying periods not exceeding 15 years and include core deposit premiums that use an accelerated method of amortization and client relationship intangibles and assembled workforce which are amortized on a straight line basis.
The determination of income tax expense or benefit, and the amounts of current and deferred income tax assets and liabilities are based on a complex analyses of many factors, including interpretation of federal and state income tax laws, current financial accounting standards, the difference between tax and financial reporting bases of assets and liabilities (temporary differences), assessments of the likelihood that the reversals of deferred deductible temporary differences will yield tax benefits and estimates of reserves required for tax uncertainties.
We are subject to the federal income tax laws of the United States and the tax laws of the states and other jurisdictions where we conduct business. We periodically undergo examination by various governmental taxing authorities. Such agencies may require that changes in the amount of tax expense be recognized when their interpretations of tax law differ from those of management, based on their judgments about information available to them at the time of their examinations. There can be no assurance that future events, such as court decisions, new interpretations of existing law or positions by federal or state taxing authorities, will not result in tax liability amounts that differ from our current assessment of such amounts, the impact of which could be significant to future results.
Temporary differences may give rise to deferred tax assets or liabilities, which are recorded on our Consolidated Statements of Financial Condition. We assess the likelihood that deferred tax assets will be realized in future periods based on weighing both positive and negative evidence and establish a valuation allowance for those deferred tax assets for which recovery is unlikely, based on a standard of more likely than not. In making this assessment, we must make judgments and estimates regarding the ability to realize these assets through: (a) the future reversal of existing taxable temporary differences, (b) future taxable income, (c) the possible application of future tax planning strategies, and (d) carryback to taxable income in prior years. We have not established a valuation allowance relating to our deferred tax assets at September 30, 2009. However, there is no guarantee that the tax benefits associated with these deferred tax assets will be fully realized. We have concluded, as of September 30, 2009, that it is more likely than not that such tax benefits will be realized.
In the preparation of income tax returns, tax positions are taken based on interpretation of federal and state income tax laws for which the outcome of such positions may not be certain. We periodically review and evaluate the status of uncertain tax positions and may establish tax reserves for estimates of amounts that may ultimately be due or owed (including interest). These estimates may change from time to time based on our evaluation of developments subsequent to the filing of the income tax return, such as tax authority audits, court decisions or other tax law interpretations. There can be no assurance that any tax reserves will be sufficient to cover tax liabilities that may ultimately be determined to be owed. At September 30, 2009, we had $667,000 of tax reserves established relating to uncertain tax positions that would favorably affect the Companys effective tax rate if recognized in future periods.
THIRD QUARTER PERFORMANCE OVERVIEW
The Company reported a net loss of $31.2 million, or $0.68 per diluted share, for the third quarter ended September 30, 2009, compared with a net loss of $7.8 million, or $0.25 per diluted share, for the third quarter 2008. For the nine months ended September 30, 2009, the net loss was $23.9 million, or $0.62 per diluted share, compared to a net loss of $30.7 million, or $1.07 per diluted share, for the prior year period. Earnings for the third quarter 2009 were negatively impacted by ongoing weakness in the economy and in particular its impact on our commercial real estate borrowers, which directly impacted the performance of our loan portfolio and the amount of provision we recorded to maintain our allowance for loan losses in an amount adequate for GAAP accounting purposes. Despite the earnings setback this quarter, we believe we continue to meet many of the goals of our Strategic Growth Plan (the Plan) announced in the fourth quarter 2007 and remain well-positioned to seize market opportunities that drive long-term shareholder value. We continue to be selective in the clients we choose to do business with, opting for people and businesses we know and with which we have relationships. Based on our strategy, loans and deposits, due in large part to the FDIC-assisted acquisition of Founders Bank, have continued to grow. Notable items for the third quarter 2009 include:
On November 2, 2009, we closed an underwritten public offering of common stock, which included the full exercise of the underwriters overallotment option, and issued a total of 22.2 million shares for net proceeds of $181.2 million to the Company after deducting underwriting commissions. Of that amount, approximately $35.3 million was purchased by certain funds managed by GTCR Golder Rauner II, L.L.C (collectively, GTCR).
In addition, certain funds affiliated with GTCR, purchased approximately $12.8 million of non-voting common stock of the Company, equating to 1.6 million shares through an exercise of its existing preemptive rights. The net proceeds from the public offering, as well as from the sale of non-voting common stock, will qualify as tangible common equity and Tier 1 capital and will be used to further capitalize our subsidiary banks in order to support continued growth and for working capital and other general corporate purposes, including possible FDIC-assisted acquisition transactions subject to satisfying eligibility requirements to participate in such transactions.
At September 30, 2009 our total risk-based capital ratio was 13.40%, Tier 1 capital ratio was 11.01% and tangible common equity ratio was 6.00%. Giving effect to the public offering and issuance of the non-voting common stock under the preemptive rights agreement and on a pro-forma basis, at September 30, 2009 our capital ratios would have been 15.24%, 12.84% and 7.62% for total risk-based capital, Tier 1 capital and tangible common equity, respectively.
In addition, upon completion of the offering, we are eligible to request that the U.S. Department of the Treasury reduce the number of shares of common stock issuable upon exercise of the warrant held by the U.S. Treasury by 50 percent to 645,013 shares.
Update on Founders Bank Transaction
On July 2, 2009, The PrivateBank Chicago acquired all the non-brokered deposits and certain assets of the former Founders Bank, which are reflected in our unaudited consolidated financial statements as of September 30, 2009. In conjunction with the FDIC loss sharing agreement on the Founders transaction, the acquired loans and foreclosed loan collateral, including the fair value of expected FDIC reimbursements, is presented in our consolidated statement of financial condition as covered assets. In accordance with business combination accounting rules, these loans were recorded at fair value without a related allowance for loan losses. The transaction is contributing to the overall execution of the Strategic Growth Plan according to managements expectations. The client retention has been strong since the transaction, with total deposits growing 3% to $793.9 million as of September 30, 2009, and we believe the transaction provides us with a strong platform for cross-selling, new business development and core funding opportunities.
Balance Sheet Growth
Total assets increased to $12.1 billion at September 30, 2009, from $10.0 billion at December 31, 2008. Assets attributable to Founders totaled $836.5 million at September 30, 2009. Total loans increased to $9.0 billion at September 30, 2009, from $8.0 billion at December 31, 2008. Commercial loans, including commercial and industrial and owner-occupied commercial real estate loans, increased to 51% of the Companys total loans at September 30, 2009 from 49% of total loans at December 31, 2008. Commercial real estate loans were 29% of total loans at September 30, 2009, compared to 30% of the Companys total loans at December 31, 2008.
Total deposits were $9.6 billion at September 30, 2009, compared to $8.0 billion at December 31, 2008. Deposits attributable to Founders totaled $793.9 million at September 30, 2009. Client deposits increased to $8.9 billion at September 30, 2009, from $6.0 billion at December 31, 2008. Client deposits at September 30, 2009, include $981.7 million in client CDARS® deposits. Brokered deposits (excluding client CDARS®) were 7% of total deposits at September 30, 2009, a decrease from 25% of total deposits at December 31, 2008.
Net Revenue Growth
Net revenue grew to $101.2 million in the third quarter 2009, including $11.5 million attributable to Founders, from $65.2 million in the third quarter 2008. Net interest income improved to $87.4 million in the third quarter 2009, including $9.8 million attributable to Founders, up from $52.6 million for the third quarter 2008. Net interest margin (on a tax equivalent basis) was 3.09% for the third quarter 2009, compared to 2.70% for the third quarter 2008. The improvement in net interest margin was primarily the result of our interest bearing liabilities repricing downward more quickly than our interest earning assets. An increased client deposit base and repositioning within funding types further served to reduce our cost of funds by 166 basis points. The inclusion of Founders net interest income during the third quarter 2009 also aided our net interest margin improvement by 16 basis points over the second quarter 2009.
Non-interest income was $12.9 million in the third quarter 2009, compared to $11.7 million in the third quarter 2008. Founders contributed $1.6 million to non-interest income in the third quarter 2009. Treasury management income was $3.1 million in the third quarter 2009 compared to $600,000 in the third quarter 2008. Mortgage banking income increased to $1.8 million in the third quarter 2009, compared to $776,000 for the third quarter 2008. Banking and other services income was $4.1 million in the third quarter 2009, compared to $1.7 million in the third quarter 2008. Capital markets activities resulted in a negative revenue position of $322,000, compared with income of $3.9 million in the third quarter 2008, primarily due to a trading credit valuation adjustment of $2.4 million.
The combination of the need for specific reserves, deteriorating credit quality and increased charge-offs necessitated the provisioning of $90.0 during the third quarter 2009, compared to $30.2 million in the third quarter 2008. Charge-offs were $40.1 million for the quarter ended September 30, 2009, offset by recoveries of $2.8 million, and $109.5 million for the quarter ended December 31, 2008, offset by recoveries of $658,000. The allowance for loan losses as a percentage of total loans was increased to 2.14% at September 30, 2009, compared with 1.40% at December 31, 2008.
We had $396.6 million in total non-performing assets at September 30, 2009, compared to $212.8 million at June 30, 2009 and $155.7 million at December 31, 2008, reflecting a continuing weakening credit environment. Non-performing assets to total assets were 3.28% at September 30, 2009 compared to 1.94% at June 30, 2009 and 1.55% at December 31, 2008. The elevated levels of nonperforming loans and the increase in provision expense reflect ongoing deterioration primarily in our commercial real estate portfolio but also across select industry sectors. The increased level of loan loss coverage reflects growth in non-performing assets and recognition of lower underlying collateral values. During the quarter, deterioration of the commercial real estate portfolio followed trends in the sector, including elevated commercial vacancy rates, limited sales and financing activity, sponsor bankruptcies and downward pressure on real estate values. The weak state of the economy continues to put pressure on other business sectors represented in our portfolio, but not to the degree seen in commercial real estate.
While a substantial majority of the commercial real estate loans that became non-performing during the quarter were originated prior to November 2007, we began to see several newer commercial (including Shared National Credits SNCs) and commercial real estate loans migrate to non-performing during the third quarter. SNCs are defined as loan commitments of at least $20.0 million that are shared by three or more financial institutions.
Non-interest expense was $56.8 million in the third quarter, of which $8.7 million relates to ongoing and defined transaction integration costs from Founders, compared to $47.1 million in the third quarter 2008. The increase over the third quarter 2008 reflects the ongoing investment in the Plan throughout the year, increased Federal Deposit Insurance Company (FDIC) insurance premiums due to significant growth in insured deposits over the past year, an increase in foreclosed property expense related to credit deterioration, and an increase in salaries and benefits as well as professional fees related primarily to the Founders transaction. The efficiency ratio was 56.2% in the third quarter 2009 compared to 72.2% in the third quarter 2008 primarily due to the reduction in salaries and benefits as a result of a $9.8 million reversal of incentive compensation accruals and a reduction in incentive compensation expenses during the third quarter.
Update on Strategic Growth Plan
The second phase of our Plan focuses on execution and, in particular, driving profitability with a focus on improving our operating leverage through continued organic growth and through acquisitions as strategic opportunities arise. In developing the second phase of our Plan, we believe it is prudent and desirable to assess the capabilities of the Company to support additional growth as we focus on execution. In this regard, we have developed a capital plan that sets as a goal maintaining our regulatory capital levels in excess of well capitalized standards and considers the sources and timing of future capital injections. We also continue to assess our infrastructure and risk management practices on an ongoing basis to ensure that as we continue to grow the Company in size and scope, we have the right systems, processes, people and technology to position us to seize market opportunities. The execution phase of our Plan contemplates that we continue to reassess a number of elements of the Plan in light of the dramatic change in the operating environment for financial institutions since we launched the Plan in November 2007. In this regard, we are actively assessing the emphasis we will place on organic growth versus growth through acquisition, particularly the value of pursuing additional FDIC-assisted transactions. We also continue to examine the advantages and disadvantages to the execution of our Plan in focusing on certain loan portfolios, continuing to review our growth targets, and evaluating new lines of business based on our operating environment.
Over the last 12 months we have seen the pace of our organic loan growth slow as we focus on developing selective, high-quality relationships and as a result of a decrease generally in loan demand reflective of the continuing deterioration in the economy. We will continue to look for opportunities to capitalize on the dislocation that has begun to occur, particularly in the Chicago market, as a result of a number of recent bank failures and related FDIC-assisted acquisitions, such as our acquisition of the former Founders Bank in the Southwestern suburbs of Chicago on July 2, 2009. We believe there will be similar acquisition opportunities available in the next 12-18 months, and a focus of our Plan includes pursuing these opportunities to the extent we believe they add long-term stockholder value and subject to, in the case of FDIC-assisted transactions, regulatory consent to participate in such transactions. These FDIC transactions can be particularly valuable as we continue to build out our deposit franchise.
RESULTS OF OPERATIONS
Net Interest Income
Net interest income totaled $87.4 million in the third quarter 2009, compared to $52.6 million in the third quarter 2008, an increase of 66%. For the nine months ended September 30, 2009, net interest income was $225.4 million compared to $131.2 million in the prior year period. Net interest income equals the difference between interest income plus fees earned on interest-earning assets and interest expense incurred on interest-bearing liabilities. The level of interest rates and the volume and mix of interest-earning assets and interest-bearing liabilities impact net interest income. Net interest margin represents net interest income as a percentage of total average interest-earning assets. The accounting policies underlying the recognition of interest income on loans, securities, and other interest-earning assets are included in the Notes to Consolidated Financial Statements contained in our 2008 Annual Report on Form 10-K.
Our accounting and reporting policies conform to U.S. GAAP and general practice within the financial services industry. For purposes of this discussion, net interest income and any ratios or metrics that include net interest income as a component, such as for example, net interest margin, have been adjusted to a fully tax-equivalent basis to more appropriately compare the returns on certain tax-exempt securities to those on taxable interest-earning assets. Although we believe that these non-U.S. GAAP financial measures enhance investors understanding of our business and performance, these non-U.S. GAAP financial measures should not be considered an alternative to U.S. GAAP. The reconciliation of such adjustment is presented in the following table.
Effect of Tax-Equivalent Adjustment
(Amounts in thousands)
Tables 2 and 3 below summarize the changes in our average interest-earning assets and interest-bearing liabilities as well as the average interest rates earned and paid on these assets and liabilities, respectively, for the quarters and nine months ended September 30, 2009 and 2008, respectively. The tables also detail increases and decreases in income and expense for each of the major categories of interest-earning assets and interest-bearing liabilities and analyzes the extent to which such variances are attributable to volume and rate changes. Interest income and yields are presented on a tax-equivalent basis assuming a federal income tax rate of 35%, which includes the tax-equivalent adjustment as presented in Table 1 above.
Net interest margin for the third quarter 2009 of 3.09% was up from 2.70% in the third quarter 2008. Our net interest margin increased between the periods primarily due to our Founders acquisition, our interest-bearing liabilities repricing downward more quickly than our assets, along with a shift in our funding mix to less expensive funding classes. The prime rate and LIBOR reductions throughout the second half of 2008 initially compressed net interest margin as loans repriced more quickly than deposits and short-term borrowings. However, as deposits and short-term borrowings repriced downward throughout the first nine months of 2009, our margin benefited.
The average balance of interest-earning assets grew approximately 44% from the third quarter 2008 to the third quarter 2009. Our net interest income increased significantly year-over-year as a result of the substantial increase in our interest-earning assets, primarily loans. The yield we earn on our interest-earning assets decreased by 119 basis points, due to reductions in the prime rate and LIBOR between the periods, offset by a 166 basis point reduction in our cost of funds, as pricing on, and the mix of, our interest-bearing liabilities reduced our funding costs in an amount greater than the reduction of interest income caused by earning assets re-pricing. During the third quarter 2009, we continued to reduce our reliance on high-costing brokered deposits which represented 17% of total deposits at September 30, 2009 compared to 33% of total deposits at September 30, 2008. The reduction in brokered deposits contributed $2.3 million toward a lower cost of funds during the third quarter 2009.
As shown in Table 2, third quarter 2009 tax-equivalent net interest income increased to $88.3 million compared to $53.5 million in the third quarter 2008. The increase in interest-earning assets increased interest income by $43.6 million, while a decline in the average rate earned on interest-earning assets reduced interest income by $28.8 million. Third quarter 2009 interest expense declined $20.0 million compared to third quarter 2008.
The increase in interest-bearing liabilities increased interest expense by $9.5 million, however we recorded an overall decrease in interest expense of $20.0 million resulting from an increase in client deposits in part due to the Founders transaction, a decrease in brokered deposits, a shift to less expensive wholesale borrowings, coupled with an overall decrease in the average rate paid on interest-bearing liabilities. We achieved growth in our net interest income between the periods despite the drag on our net interest margin from the significant increase in non-accrual loans. Annualized interest foregone on non-accrual loans was approximately $12.7 million for the three months ended September 30, 2009 compared to approximately $4.5 million for the prior year period.
For the nine months ended September 30, 2009, net interest margin was 2.93% compared to 2.74% for the prior year period. Tax-equivalent net interest income increased to $228.1 million for the nine months ended September 30, 2009 compared to $134.2 million in the prior year period. The increase in interest-earning assets increased interest income by $143.1 million, while a decline in the average rate earned on interest-earning assets reduced interest income by $82.3 million. Interest expense for the nine months ended September 30, 2009 declined $33.0 million compared to the prior year period. The increase in interest-bearing liabilities increased interest expense by $52.2 million, but the decrease in brokered deposits and less expensive wholesale borrowings, coupled with an overall decrease in the average rate paid on interest-bearing liabilities reduced interest expense by $85.2 million.
We continue to use multiple interest rate scenarios to assess the direction and magnitude of changes in interest rates and their impact on net interest income. A description and analysis of our market risk and interest rate sensitivity profile and management policies is included in Item 3, Quantitative and Qualitative Disclosures About Market Risk, of this Form 10-Q.
Net Interest Income and Margin Analysis
(Dollars in thousands)
Quarterly Net Interest Margin Trend
Net Interest Income and Margin Analysis
(Dollars in thousands)