ITEM 1. BUSINESS
PrivateBancorp, Inc.
PrivateBancorp, Inc. ("PrivateBancorp," we or the "Company"), was incorporated in Delaware in 1989 and became a holding company registered under the Bank Holding Company Act of 1956, as amended. The PrivateBank and Trust Company (the "Bank" or the "PrivateBank"), the bank subsidiary of PrivateBancorp, was opened in Chicago in 1991. The Bank provides customized business and personal financial services to middle market companies and business owners, executives, entrepreneurs and families in all the markets and communities it serves.
Beginning in late 2007, we hired a team of experienced middle market bankers and, under the leadership of our current chief executive officer, initiated a strategic plan to transform the organization into a leading middle market commercial bank. Since then, we have added over 1,300 new client relationships, shifted the composition of our loan portfolio from 19% commercial and industrial and 66% commercial real estate and construction at December 31, 2007 to 67% commercial and industrial and 27% commercial real estate and construction at December 31, 2013. Over this period, total assets have grown from $5.0 billion at December 31, 2007 to $14.1 billion at December 31, 2013, with total loans up from $4.2 billion at December 31, 2007 to $10.6 billion at December 31, 2013. To support the growth and capital requirements of the organization, since December 31, 2007, we have issued $631.2 million of common stock (including the October 2012 common stock offering described below) and $143.8 million of trust preferred securities. In January 2009, the U.S. Department of the Treasury (the "U.S. Treasury") purchased $243.8 million of our preferred stock under the U.S. Treasury's Troubled Asset Relief Program ("TARP") Capital Purchase Program ("CPP"). After our return to profitability in 2011 and the continued strengthening of our balance sheet in 2012, we repurchased all of the preferred stock, and related warrants, held by the U.S. Treasury in October 2012 using net proceeds from underwritten public offerings of $75.0 million of common stock (4.8 million shares) and $125.0 million of our 7.125% subordinated debentures due 2042, together with existing cash resources.
Since we opened for business in Chicago in 1991, we have expanded into multiple geographic markets through the creation of new banks and banking offices and the acquisition of existing banks. Today, we operate through a single banking subsidiary and have 33 offices located in ten states, primarily in the Midwest, with a majority of our business conducted in the greater Chicago market. We employed 1,116 full-time equivalent employees at December 31, 2013.
Business Focus and Strategic Direction
We deliver a full spectrum of commercial and personal banking products and services to our clients through our commercial banking, community banking and private wealth businesses. Under the leadership of our current management team, our business model focuses on (1) building middle market commercial client relationships and selectively targeting clients, including clients outside our current market areas in specialized business niches, (2) commercial lending activities with diversification across industries, (3) a broad suite of fee generating products and services, including treasury management, capital markets, mortgage banking and syndications, (4) private banking and wealth management services and products, (5) a strong risk management infrastructure and (6) enhancing our community banking platform.
We leverage our model by introducing clients to a full range of lending, treasury management, and investment and capital markets products to meet their commercial needs, and private banking, trust and investment services and residential mortgage banking to meet their personal needs. Our goal is to be a trusted advisor to our clients so that we become one of their primary banks by building meaningful long-term relationships and delivering services across our entire product spectrum. Our growth strategy is primarily focused on organic growth across our lines of business. We have focused on developing new areas of specialization as part of our growth plans. We may also consider selective acquisitions from time to time to gain market share, augment our product offerings and expand our retail deposit gathering capabilities.
Commercial Banking
Our commercial banking group focuses on the specific needs of middle market companies both in the Midwest, and, to a lesser extent, nationally. Our commercial loan portfolio includes lines of credit to businesses for working capital needs, term loans, and letters of credit. Certain non-residential owner-occupied commercial real estate loans are included in our commercial loan portfolio where the cash flows from the owners' businesses serve as the primary source of loan repayment. With a focus on cross-selling our other products and services, our commercial bankers may refer commercial banking clients to our treasury management and
capital markets groups and refer the executives and owners of such clients to our private wealth group. These groups are discussed in detail below.
In the normal course of our business, we participate in loan transactions that involve a number of banks, primarily to maintain and build client relationships with a view to cross-selling products and originating loans for the borrowers in the future. Although we may strive to lead or co-lead the arrangement, we will also participate with other banks when we have a relationship with the borrower. Participations and syndications assist us with decreasing credit exposure linked to individual client relationships or loan concentrations by industry, type or size. Of our $10.6 billion in total loans at December 31, 2013, we were party to $2.0 billion in shared national credits ("SNCs") which transactions are typically led by larger institutions. At December 31, 2013, total syndications and participations outstanding were $3.4 billion, including SNCs, and of this total, we were the lead or co-lead on transactions with $1.4 billion outstanding at year end.
Illinois, Specialty and National Commercial Banking. The Illinois commercial banking group targets primarily Illinois-based middle market clients with $10 million to $2 billion in revenue, though the majority of our clients have $20 to $500 million in revenue. Closely related to this group are select specialty banking groups focused on healthcare, architecture, engineering and construction, asset-based lending, and security alarm finance. The healthcare industry is one of the largest segments within our commercial lending business and we have a specialized niche in the assisted living, skilled nursing, and residential care segment of this industry. Loan relationships to these providers tend to be larger extensions of credit and are primarily to for-profit businesses. The architecture and engineering and construction specialties focus on companies that manage large projects. These companies are a source of funding and liquidity support through escrow accounts but tend to be minimal borrowers. We provide working capital to security alarm companies, as this business requires sizeable capital outlays. We believe it is appropriate to provide more individualized assistance to these niche clients due to their specific needs, which may differ from the needs of more general commercial clients. The specialty groups employ bankers with many years of experience in these industries and market primarily to Illinois-based businesses, many of which have a national scope. The national commercial banking group manages middle market commercial banking teams in the markets outside of Illinois in which we have branch banking operations - Atlanta, Detroit, Kansas City, Milwaukee and St. Louis. In these areas, we serve clients with $10 million to $2 billion in revenue. In our business development markets - Cleveland, Denver, Des Moines, Stamford, Grand Rapids and Minneapolis - we focus on companies with $50 million to $2 billion in revenue. During 2013, commercial and industrial loans increased $635.1 million, of which approximately $320 million was originated within the Illinois commercial banking group.
Commercial Real Estate. Our commercial real estate business focuses on the needs of commercial real estate professionals including professional commercial and residential real estate developers and investors. The majority of our clients are based within our geographic footprint, though properties financed may be located in other regions. We provide funding for construction, acquisition, redevelopment, working capital, and refinancing of retail, industrial, office and multifamily properties and student housing. Our commercial real estate specialists are located in the Chicago, Denver, Detroit, Milwaukee, Minneapolis and St. Louis markets. Given the challenges in the commercial real estate industry during the past few years, we have reduced the size of our commercial real estate portfolio largely through selective exits and workouts/sales of commercial real estate credits in order to increase our commercial and industrial focus and to a lesser extent due to loan payoffs and credits moving to permanent financing. However, we recognize the long term value in serving commercial real estate clients and will continue to provide products and services to these clients, taking appropriate risk management into account. As of December 31, 2013, commercial real estate loans as a percentage of total loans were 24%, a decrease from 26% at December 31, 2012 and 30% at December 31, 2011.
Treasury Management. We provide comprehensive services for commercial clients to manage their cash and liquidity, including receivables and payables services, reporting, reconciliation and data integration solutions and demand deposit account and/or investment options for optimizing balances. During 2013, we earned treasury management fees of $24.7 million, representing an increase of 15% over the prior year. Our clients receive a credit against treasury management fees based on an earned credit rate we apply to their non-interest bearing deposit balances. We may change that rate from time to time and this, as well as interest rate changes, could impact the balances our clients maintain in non-interest bearing accounts as well as the size of the credit they may receive. Either of these factors could cause the amount of treasury management fees to vary.
Capital Markets. We assist clients with their unique financial markets and risk management objectives by providing interest rate and foreign exchange services. With respect to interest rate hedging, we offer clients interest rate swaps, rate caps, floors and collars, rate swaptions and cancellable interest rate swaps. To assist clients with their currency management, we help clients establish foreign exchange policy, budgeting, contract negotiation, risk management and research advisory services; foreign currency wire transfers, drafts, cash letter deposits and collections; and forwards, window forwards, swaps and options. Prior to the implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act"), these products were traded over-the-counter in a largely unregulated derivatives market. The Dodd-Frank Act significantly reformed the regulatory structure of this market and much of our capitals market business is now subject to regulatory requirements relating to mandatory clearing, trade execution, disclosure, client eligibility and reporting. See "Supervision and Regulation" for more information about
Dodd-Frank Act changes. The full impact of these regulatory changes on our capital markets activity is not yet certain, and it is possible that prospects for our capital markets business, and the potential demand for and pricing spreads on certain products we offer, may be diminished. During 2013, we earned capital market fees (including credit valuation adjustments) of $20.7 million, representing a decrease of 15% over the prior year. With clients demand for interest rate management products primarily driven by concern over interest rate changes, our capital markets transaction volume was impacted in 2013 by a stable interest rate environment.
Syndications. Our syndications team helps us to both generate fee revenue and strategically manage our loan portfolio. In larger transactions, we may underwrite loans on a best efforts basis (in which we commit to extend only a portion of the total loan commitment, pro-rata with other banks, and the borrower obtains the full credit request only if the syndications team arranges sufficient commitments from other banks) or we may fully underwrite loans (in which we lend the full amount to the client but then syndicate portions of that loan to other banks). As a result, syndications may assist us with decreasing credit exposure linked to individual client relationships and/or decreasing loan concentrations by industry, type or size. Whether syndicated on a fully underwritten or a best efforts basis, we receive an administrative agent and arranger's fee plus interest on the portion of the loan we retain.
Total syndication fee revenue was $13.4 million in 2013. While from time to time we may syndicate larger loans already on our balance sheet, syndication fees are primarily tied to loan origination activity and can therefore fluctuate from quarter to quarter. During 2013, we participated in 57 syndicated loan transactions, 51 of which we led or co-led, representing $2.5 billion in total commitments ($1.0 billion of which we retained). During 2013, our syndication fee revenue came primarily from loans originated in our Illinois Commercial Banking group (46%) and our National Commercial Banking group (29%).
Community Banking
Retail Banking. Through a network of 18 branch locations in and around Chicago, community banking provides personal and business banking and investment products and services including checking, savings, money market, certificates of deposit ("CDs"), home equity loans and lines of credit, business-specific banking and other tailored solutions. We also provide internet -based deposit services. Community banking typically targets individual clients with up to $250,000 in investable assets and lending needs of up to $3.5 million. Community banking relationship managers offer mortgage services to clients through the residential mortgage banking team. As of December 31, 2013, deposits from community banking clients comprised 14% of our total deposits compared to 12% as of December 31, 2012.
We plan to further develop our community banking platform as part of our strategy to attract core deposits, our primary funding source to support our commercial lending activities. In recent quarters, with significant liquidity in the banking system, our deposit mix has been comprised primarily of corporate accounts which tend to be considerably larger and where account balances may fluctuate significantly depending on client cash flows and investment opportunities. Our goal is to diversify our overall funding base over time in order to increase the granularity and stability of our core deposits. We may seek attractive opportunities to expand our branch network in an effort to increase retail deposits in selected markets in the greater Chicago area. Depending on market factors, we may also consider potential strategic acquisitions of bank branches or other financial institutions if we are able to negotiate transactions on financial terms acceptable to us. We also completed internet, mobile banking and website initiatives during 2013 to bolster our retail banking platform.
Residential Mortgage Banking. We offer a full range of residential mortgage loans for purchasing or refinancing 1-4 family residential properties. We generally use a correspondent model in which we originate loans, and sell the majority of these loans in the secondary market, based on the underwriting standards of investors who then service them. We make certain representations and warranties to the purchasers of the loans upon sale, many centering on the quality of our review of borrower information and underwriting processes. If we are found to have breached these representations (for example, if we did not correctly adhere to compliance requirements or the purchaser's underwriting standards), we could be required to repurchase the outstanding amount of the applicable loan. To mitigate this risk, we focus significant attention on the thoroughness of the origination processes. The losses arising from these limited recourse obligations in 2013, 2012 and 2011 were not material. We originate and retain some mortgages in our portfolio, primarily jumbo or nonconforming loans or a small number of loans which our investors ultimately decide not to purchase. We do not service loans for other entities at this time. At December 31, 2013, we employ 29 mortgage originators and we originated approximately $561.5 million of first mortgage loans during 2013. In addition, we employ nine mortgage originators who specialize in reverse mortgages and we broker reverse mortgages for sale to third parties.
The Consumer Financial Protection Bureau (the "CFPB"), which was created under Dodd-Frank Act and has broad rule-making authority for a wide range of consumer protection laws, promulgated certain rules imposing new requirements on mortgage origination, mortgage servicing, mortgage originator compensation, appraisals and disclosures which went into effect in January 2014. These new rules have significantly impacted the mortgage industry, have increased the cost of doing business, and have
limited the types of mortgage products we offer. We currently expect the majority of mortgages the Bank originates and sells will qualify for the regulatory safe harbor under the new ability to repay rules, although we do plan to offer mortgages under certain underwriting criteria to borrowers who the Bank has determined have the ability to repay those loans, but whose loans do not satisfy the safe harbor requirements. See "Supervision and Regulation" for additional information about the implications of Dodd-Frank Act changes.
Small-Business Banking. Small-business banking responds to the personal and corporate banking needs of small businesses, as well as their owners and executives, while targeting commercial clients with business revenue up to $10 million. This group offers commercial lending and treasury management services and products similar to those of our commercial banking group, but on a smaller scale, this group operates primarily through a Chicago-based team. We may consider further expansion in other regions. Our strategy for small-business banking includes using our branch networks and our team of business bankers to attract new small-business clients in order to diversify our loan portfolio and funding base. This client acquisition strategy includes targeted sales programs, marketing campaigns, community involvement and client referrals. To the extent such individuals have significant personal assets, we refer such clients to our private wealth group and its dedicated team of private bankers. Since 2010, we hired an experienced leader and increased the number of business bankers dedicated to small-business banking. As of December 31, 2013, small-business banking's loan portfolio was approximately $213 million (representing 2% of our total loan portfolio at that time), including approximately $43 million in covered loans, which continue to run off. During 2013, small-business banking added 130 new client relationships, effectively offsetting the run off in the covered loan portfolio.
Private Wealth
Our private wealth business offers high net-worth clients (those with more than $1 million in investable assets) private banking, investment management, trust, custody and escrow services. Most clients in this business are individuals, but we assist some corporate clients with liquidity management. We offer our private wealth services mostly in the Chicago market, and from our banking offices in St. Louis, Milwaukee and Michigan. As part of the Company's focus on cross selling, we focus on cross-selling private wealth services across our lines of business to executives and business owners who have a commercial banking relationship with us.
Private Banking. Our private banking services include residential secured loans and as well as lines of credit used for liquidity purposes that are primarily secured by marketable securities. Our private bankers work closely with our investment advisers and often introduce our investment advisory services to our private banking clients. The private banking portion of our private wealth group also had a significant deposit base of $947.0 million as of December 31, 2013.
Trust and Investments. With respect to our trust and investment services, we act as fiduciary and investment manager for individual and corporate clients which includes creating asset allocation strategies tailored to each client's unique situation while using third-party investment managers to execute these strategies. For managed assets, we offer financial advice and act either in a trustee or agency capacity. Custody and escrow services are considered non-managed in which we administer and safeguard assets but do not provide financial advice. During 2012, regulatory changes required that certain companies utilize a "qualified custodian," such as the Bank, for the administration and custody of their clients' assets. However, fees earned on "qualified custodian" and escrow assets are typically a flat fee structure and are significantly lower than fees recognized on standard custody and managed assets, which are generally based on the market value of the assets on the last day of the prior quarter or month and are therefore subject to volatility. Total assets under management and administration ("AUMA") increased from $5.2 billion at December 31, 2012 to $5.7 billion at the end of 2013. Approximately 91% of our 2013 Trust and Investment fee revenue related to managed assets.
We also earn certain non-recurring fees such as tax preparation fees, estate settlement and court-appointed guardian fees.
On December 31, 2013, we sold Lodestar Investment Counsel, LLC ("Lodestar"), an investment management firm and previously a wholly-owned subsidiary of the Bank. At the time of the sale, Lodestar had assets of $290,000 and $316.3 million in AUMA, net of custodial assets we continue to service, which are not included in the Trust and Investment segment at December 31, 2013. The sale of Lodestar is not expected to have a material impact on future period's financial results.
Lending Activities
We provide a range of commercial, real estate and personal lending products and services to our clients. While the majority of our client relationships today are Chicago-based, many of our clients do business around the country.
We have adopted comprehensive loan policies that include disciplined credit underwriting standards. The goal of our lending program is to meet the credit needs of our diverse client base while using sound credit principles to protect our asset quality. We
strive to provide a reliable source of credit, a variety of lending alternatives, and sound financial advice to our clients. When extending credit, our decisions are based upon our client's ability to repay the loan, as well as the value of any collateral securing the loan. Our assessment of the quality and integrity of the borrower are also key considerations in the loan approval process. Our bankers monitor loan performance and maintain regular contact with our clients. Our credit risk management team actively manages and monitors the loan portfolio, including performing, nonperforming, and stressed credits, and provides workout and nonperforming asset disposition-related activities.
In conjunction with our middle market strategy, our lending activities may involve larger credit relationships. The Bank's legal lending limit at December 31, 2013 was approximately $247 million for any one borrowing relationship. However, the Bank has established in-house lending limits that are below the legal lending limit. At December 31, 2013 and 2012, we had 104 and 97 unique obligors, respectively, with credit commitments of $25 million or more totaling $3.3 billion and $3.1 billion, respectively. Of this total commitment at December 31, 2013 and December 31, 2012, we had $1.8 billion and $1.7 billion in loans outstanding, respectively, or 17% of our loan portfolio at both December 31, 2013 and 2012, to 90 unique obligors in amounts in excess of $25 million, compared to 81 at December 31, 2012. Some of these obligors may be related to other obligors as guarantors or share related ownership structures with other obligors. Approximately 85% of these large obligors are commercial and industrial businesses compared to 80% at December 31, 2012; the remaining exposure relates primarily to commercial real estate loans. Of our largest commitments, five unique obligors with commitments of $50 million or more represented $302.8 million in total commitments at December 31, 2013, compared to the same number of unique obligors at December 31, 2012 with $332.5 million in total commitments. As of December 31, 2013, $15.9 million of these largest commitments was outstanding, compared to $50.5 million at December 31, 2012. These credits are subject to increased scrutiny in our credit approval process. Depending on collateral values, success of a workout strategy or the ability of a borrower to return to performing status, the unexpected occurrence of an event or development adversely impacting one or more of our large clients could materially affect our results of operation and financial condition.
Commercial
At December 31, 2013, commercial loans, excluding commercial real estate loans discussed below, comprised 67% of our loan portfolio, and include lines of credit, term loans, and letters of credit, which may have multi-year commitments. Average loan balances were $1.8 million for the years ended December 31, 2013 and 2012. Our commercial lines of credit typically are limited to a percentage of the value of the assets securing the line, and are typically priced by a floating-rate formula. In general, lines of credit are reviewed annually and are supported by accounts receivable, inventory and/or equipment. Depending on the risk profile of the borrower, we may require periodic aging of receivables, and inventory and equipment listings to verify the quality of the borrowing base prior to advancing funds. Our term loans are typically secured by the assets of our clients' businesses and have maturities between one to five years, with either floating or fixed-rates of interest. In certain circumstances, there may be an interest rate floor. We issue standby or performance letters of credit, and are able to service the international needs of our clients through correspondent banks. We use the same underwriting standards for letters of credit and other unfunded commitments that we would use for funded loans.
Commercial loans contain risks unique to the business and market of each borrower. In order to mitigate these risks, we seek to gain an understanding of the business and industry of each borrower; require appropriate reporting, financial, and/or operating covenants; and regularly evaluate our collateral position. Our commercial lending underwriting process includes an evaluation of the borrower's financial statements and projections with an emphasis on operating results, cash flow, liquidity and underwriting ratios, as well as the collateral value, to determine the level of creditworthiness of the borrower. These loans may be secured by a first priority security interest in the assets of the borrower and may require the support of a personal guarantee of one or more of the principals of the borrower. From a risk management standpoint, whether the commercial loans are originated within commercial banking or small-business banking, substantially the same credit policies are used.
Commercial Real Estate
At December 31, 2013, commercial real estate loans comprised 24% of our loan portfolio. Average loan balances were $2.6 million and $2.1 million for the years ended December 31, 2013 and 2012, respectively. Our commercial real estate portfolio is comprised of loans secured by various types of collateral including 1-4 family non-owner occupied housing units located primarily in our target market areas, multi-family real estate, office buildings, warehouses, retail space, mixed use buildings, and vacant land, the bulk of which is held for long-term investment or development. Commercial real estate loans are typically floating-rate, with a term of one to five years, and are usually refinanced with outside permanent financing. Commercial real estate loan concentrations by collateral type are monitored as part of our credit risk management process.
Risks inherent in real estate lending are related to the market value of the property taken as collateral, the underlying cash flows and documentation and the general economic condition of the market in which the collateral is located. To mitigate these risks,
we obtain and review appraisals of the property and we assess (a) the ability of the cash flow generated from the collateral property to service debt, (b) the significance of any outside income of the borrower or income from other properties owned by the borrowers, and (c) the strength of guarantors, as applicable.
Our commercial real estate loan portfolio includes loans with large principal amounts and the repayment of these loans is generally dependent on the successful leasing or sale of the property, the successful operation of the business occupying the property, and the availability of permanent financing. The repayment of these loans is particularly influenced by general conditions in the real estate markets or in the local economy where the property is located. Many commercial real estate loans do not fully amortize the balance over the loan period, but have balloon payments due at maturity. The borrower's ability to make a balloon payment may depend on their ability to either refinance the loan or complete a timely sale of the underlying property. On a non-owner occupied commercial property, if the cash flow from a borrower's project is reduced due to leases not being obtained or renewed, that borrower's ability to repay the loan may be impaired.
Construction
At December 31, 2013, construction loans comprised 3% of our loan portfolio. Average loan balances were $1.6 million and $1.5 million for the years ended December 31, 2013 and 2012, respectively. Our construction loan portfolio consists of single-family residential properties, multi-family properties, and commercial projects, and includes both investment properties and properties that will be owner-occupied. As with commercial real estate loans, we monitor our construction loan concentrations as part of our risk management program.
As a product segment, we believe construction loans have the highest inherent risk. We closely monitor the status of each construction loan throughout its term to mitigate these risks. We also seek to manage these risks by, among other things, ensuring that the collateral value of the property throughout the construction process does not fall below acceptable levels, ensuring that funds disbursed are within parameters set by the original construction budget, and properly documenting each construction draw. Typically, we require full investment of the borrower's equity in construction projects prior to injecting our funds. Generally, we do not allow borrowers to recoup their equity from the sale proceeds of a finished product, if applicable, until we have recovered our funds on the overall project.
Residential, Home Equity, and Personal
At December 31, 2013, residential, home equity, and personal loans comprised 6% of our loan portfolio. Average loan balances were $691,000 and $728,000 for the years ended December 31, 2013 and 2012, respectively.
Residential Mortgage. We have purchase and refinancing mortgage sales teams in each of the Chicago, St. Louis, Milwaukee and Detroit markets. These residential mortgage loans are secured by 1-4 family residential properties generally located in the same markets as our mortgage sales centers; however, lending outside these areas can occur. We sell the majority of the residential mortgage loans we originate into the secondary market.
Other Consumer Loans. The majority of our other consumer loan portfolio is comprised of home equity loans and lines of credit, and, to a lesser extent, car loans (mostly for used cars) and secured and unsecured consumer loans, often used to fund educational costs or to consolidate debt. Home equity loans and lines of credit are generally secured by second mortgages on 1-4 family residential properties. Since we sell the majority of the residential mortgages we originate, we are often second lien holders on these properties. We do not sell the home equity loans or lines of credit to investors. Other consumer loans include secured and unsecured consumer loans, the majority of which are term loans. Consumer loans generally have shorter terms and lower balances with higher yields as compared to residential real estate loans. Our personal loan portfolio consists largely of loans for investment asset acquisition (which may be secured by marketable or nonmarketable investment securities) and for general liquidity purposes, including lines of credit which may be unsecured. Due to our client relationship focus, which includes lending to entrepreneurs, some of these loans can be sizeable. As of December 31, 2013, the aggregate amount of such personal loans was approximately 2% of total loans.
For more information regarding the composition of our loan portfolio, see "Loan Portfolio and Credit Quality" of "Management’s Discussion and Analysis of Financial Condition and Results of Operations" in Item 7 and Note 4 of "Notes to Consolidated Financial Statements" in Item 8 of this Form 10-K. For information regarding our unfunded commitments, see Note 19 of "Notes to Consolidated Financial Statements" in Item 8 of this Form 10-K.
Deposits
We rely on a relationship-driven approach to generate client deposits and we regard client deposits as our primary source of funding. During 2013, our total deposits remained relatively flat with $12.2 billion at December 31, 2012 and $12.0 billion at year-end 2013. Client deposits represented 97% of total deposits at December 31, 2013 and December 31, 2012. Given the commercial focus of our core business strategy, a majority of our deposit base is comprised of corporate accounts which are typically larger than retail accounts. We have built a suite of deposit and cash management products and services that support our efforts to attract and retain corporate client accounts. At December 31, 2013, we had 16 client relationships in which each had more than $75 million in deposits, totaling $2.6 billion, or 22% of total deposits. In comparison, at December 31, 2012, we had 18 client relationships in which each had more than $75 million in deposits, totaling $3.1 billion, or 26% of total deposits. At both periods, over half of the deposits greater than $75 million were from financial services-related businesses, including omnibus accounts from broker-dealer and mortgage companies representing underlying accounts of their customers that may be eligible for pass-through deposit insurance limits. We had 27 client relationships at December 31, 2013 and December 31, 2012 in which each had more than $50 million in total deposits. These deposits totaled $3.3 billion, or 27% of total deposits and $3.6 billion, or 30% of total deposits at December 31, 2013 and 2012, respectively. Our ten largest depositor accounts totaled $2.1 billion, or 17% of total deposits, at December 31, 2013. Commercial deposits are held in various deposit products we offer, including interest-bearing and non-interest bearing demand deposits, CDARS®, time deposits, savings and money market accounts. The CDARS® deposit program allows clients to obtain greater FDIC deposit insurance for time deposits in excess of the FDIC insurance limits. In addition to corporate deposits, through our community banking and private wealth groups, we offer a variety of personal banking products, including checking, savings and money market accounts and CDs, which serve as an additional source of client deposits.
We also maintain access to a number of wholesale funding sources including brokered time deposits, which we utilize to supplement our client deposits as needed to fund asset growth and manage liquidity. Brokered time deposits, excluding client-related CDARS®, were 3% of total deposits at both December 31, 2013 and 2012, respectively.
For information regarding our deposits, see "Funding and Liquidity Management" of "Management’s Discussion and Analysis of Financial Condition and Results of Operations" in Item 7 and Note 9 of "Notes to Consolidated Financial Statements" in Item 8 of this Form 10-K.
Investment and Hedging Activities
We maintain a managed investment portfolio intended to provide liquidity, maximize risk-adjusted total return, and provide a means to modify our asset/liability position as deemed appropriate. We invest primarily in residential mortgage-backed securities and collateralized mortgage obligations backed by U.S. Government-owned agencies or issued by U.S. Government-sponsored enterprises and bank-qualified tax-exempt obligations of state and local political subdivisions. Under our investment policy, we also may invest in U.S. Treasury, U.S. Agency or other securities. The investment portfolio is one of the tools used to manage our net asset/liability position by countering the interest rate risk characteristics of the loan portfolio. For information regarding our investment portfolio, see "Investment Portfolio Management" of "Management’s Discussion and Analysis of Financial Condition and Results of Operations" in Item 7 and Note 3 of "Notes to Consolidated Financial Statements" in Item 8 of this Form 10-K.
We also use interest rate derivatives as part of our asset liability management strategy to hedge interest rate risk in our primarily floating-rate loan portfolio to convert certain floating-rate commercial loans to fixed-rate to reduce the variability in forecasted interest cash flows due to market interest rate changes. Depending on market conditions, we may expand or reduce this program and enter into additional interest rate swaps. For more information regarding our use of these cash flow hedges, and their potential impact on interest income and other non-interest income on our Consolidated Statements of Income, see Note 18 of "Notes to Consolidated Financial Statements" in Item 8 of this Form 10-K.
Competition
We do business in the highly competitive financial services industry. In each of our geographic markets, we compete for loans, deposits, wealth management and other financial services and products with regional, national, and international commercial banks, thrifts, credit unions, investment banks, brokerage firms, money managers, and other providers of financial products and services. The greater Chicago market is particularly competitive as a number of financial services companies are attempting to capitalize on opportunities in the commercial middle market space that have arisen as a result the fragmented nature of the Chicago market and the dislocation of customers in the market as area banks have consolidated. Given current industry trends of flat loan demand, we face pressure on pricing and loan terms for favorable lending relationships including commercial relationships.
Many of the products within the financial services industry have become commoditized over the past few years and therefore competition is very strong. Given the changing nature of the banking industry, we could experience new deposit competition from
a variety of sources including investment banks and finance companies. For private wealth services, we compete with local, regional and national brokerage firms, wealth consulting firms and investment managers, any of which may be either standalone entities or part of larger financial services institutions. Also, because our private wealth division does not create or offer its own propriety investment products, we are not incentivized to encourage clients to purchase our products, thereby enhancing the independent nature of our advice. In mortgage banking, we compete not only with commercial banks, both large and small, that have operations in our locations, but also with mortgage brokers of various sizes. In all areas, we work to distinguish ourselves through consistent delivery of superior levels of personal service, customized solutions and responsiveness expected by our clients.
Some of our competitors are not subject to the same degree of regulation as that imposed on bank holding companies, federally insured state chartered banks, national banks and federal savings banks, and may be able to price loans, deposits and other products and services more aggressively. In addition, other competitors, because of their size or retail branch networks, may have greater access to lower cost capital and/or deposits and therefore may be able to compete more effectively on loan pricing or terms.
We face competition in attracting and retaining qualified employees. Our ability to continue to compete effectively will depend upon the ability to attract new employees and retain and motivate existing employees.
For more information on competition-related and other risks facing the Company, see "Risk Factors" in Item 1A
ITEM 1A. RISK FACTORS
Our business, financial condition and results of operations are subject to various risks, including those discussed below, which may affect the value of our securities. The risks discussed below are those that we believe are the most significant risks affecting us and our business, although additional risks not presently known to us or that we currently deem less significant may also adversely affect our business, financial condition and results of operations, perhaps materially. Before making a decision to invest in our securities, you should carefully consider the risks and uncertainties described below and elsewhere in this report.
A significant portion of our loan portfolio is comprised of commercial and industrial loans, many of which include larger credit relationships. The repayment of commercial loans is largely dependent upon the financial success and viability of the borrower and the state of the economy.
Our commercial and industrial loan portfolio, which includes owner-occupied commercial real estate, totaled $7.1 billion, or 67% of our total loan portfolio, at December 31, 2013, compared to $6.5 billion, or 64% of our total loan portfolio, at December 31, 2012. The repayment of the loans in our commercial and industrial portfolio is largely dependent upon the financial success and viability of the borrower.
Many of our commercial and industrial loans are secured by different types of collateral related to the underlying business, such as accounts receivable, inventory and equipment, which fluctuate in value. If we foreclose on underlying collateral in the event of default of any such loan, we may not be able to recover the full principal amount of the loan as the unique nature of certain collateral may make it difficult and costly to liquidate.
Many of our commercial and industrial loans involve larger relationships. At December 31, 2013, we had 104 unique obligors with credit commitments of $25 million or more totaling $3.3 billion. Of this total commitment at December 31, 2013, we had $1.8 billion in loans outstanding, or 17% of our loan portfolio, to 90 unique obligors in amounts in excess of $25 million. Some of these obligors may be related to other obligors as guarantors or share related ownership structures with other obligors. Approximately 85% of these large obligors are commercial and industrial businesses; the remaining exposure relates primarily to commercial real estate loans. Of our largest commitments, five unique obligors with commitments of $50 million or more represented $302.8 million in total commitments at December 31, 2013, compared to the same number of unique obligors at December 31, 2012 with $332.5 million in total commitments. As of December 31, 2013, $15.9 million of these largest commitments was outstanding, compared to $50.5 million at December 31, 2012. These credits, as well as larger credit relationships, are subject to increased scrutiny in our credit approval process. Depending on collateral values, success of a workout strategy or the ability of a borrower to return to performing status, the unexpected occurrence of an event or development adversely impacting one or more of our large clients could materially affect our results of operation and financial condition.
The largest industry segment concentration within our commercial lending business is the healthcare industry. At December 31, 2013, 23% of the commercial loan portfolio, or $1.7 billion, was composed of loans within the healthcare industry, primarily loans in which the facilities securing the loans are dependent, in part, on the receipt of payments and reimbursements under government contracts for services provided. We have a specialized niche in the nursing and residential care segment of the healthcare industry. Our clients and their ability to service debt may be adversely impacted by the financial health of state or federal payors and the ability of governmental entities, many of which have experienced budgetary stress in the recent economic environment, to make payments for services previously provided. As of December 31, 2013, 52% of the healthcare portfolio was secured by facilities in five states, with Illinois representing the highest percentage of facilities at 20%.
The success of our business is dependent on ongoing access to sufficient and cost-effective sources of liquidity.
We depend on access to a variety of funding sources to provide sufficient liquidity to grow our loan portfolio, meet our lending commitments and other business needs and accommodate the transaction and cash management needs of our clients, including client draws on unused lines of credit. We had a total of $5.0 billion of unfunded commitments to extend credit, including obligations to issue letters of credit, as of December 31, 2013. It is difficult to predict when clients may draw on such commitments or the impact such draws may have on our liquidity needs.
Our deposit base is relatively concentrated in large commercial client relationships. The loss of large client relationships could negatively impact our liquidity. At December 31, 2013, we had 16 client relationships with greater than $75 million in deposit balances and our ten largest depositor accounts totaled $2.1 billion, or 17% of total deposits.
Currently, our primary sources of liquidity are client deposits, large institutional deposits, and wholesale market-based borrowings, including brokered deposits. In addition to on-balance sheet liquidity and funding, we maintain access to various external sources of funding. These external sources of funding include Federal Funds counterparty lines with unaffiliated banks, repurchase agreements, the discount window at the Federal Reserve Bank, Federal Home Loan Bank ("FHLB") borrowings and the brokered deposit market. Our ability to access these external sources depends on availability in the market place and a number of factors such as counterparty relationship strength in the case of Federal Funds counterparty lines and repurchase agreements or the availability of loans eligible for pledging as collateral as required under the Federal Reserve's and the FHLB's lending arrangements (e.g., stipulations of documentation requirements, credit quality, payment status and other criteria). Since 2009, we have experienced a significant increase in client deposits. This has allowed us to reduce our reliance on wholesale funding sources. However, there can be no assurance that this level of client deposit growth will continue or remain at current levels or that we will be able to maintain lower reliance on brokered deposits. Some of our client deposits may move to other investment options (such as the fixed income or equity markets) or be reinvested in clients' businesses based on certain factors such as improvement in financial markets and general economic conditions or changes in interest rates.
If our primary sources of liquidity are insufficient and we are unable to adequately access external sources, we may be required to increase our on-balance sheet liquidity and funding by accessing the capital markets, which may not be cost effective or may have a dilutive effect on our shareholders.
Our allowance for loan losses may be insufficient to absorb losses in our loan portfolio.
Lending money is a substantial part of our business. Every loan we make carries a certain risk of non-payment. This risk is affected by, among other things:
•
the credit risks posed by the particular borrower and loan type;
•
changes in economic and industry conditions;
•
the duration of the loan;
•
in the case of a collateralized loan, the changes and uncertainties as to the future value of the collateral; and
•
the ability to identify potential repayment issues in loans at an early stage.
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 is assessed quarterly and represents an accounting estimate of probable losses in the portfolio at each balance sheet date based on a review of available and relevant information at that time. The allowance is not a prediction of our actual credit losses going forward. The allowance contains provisions for probable losses that have been identified relating to specific borrowing relationships that are considered to be impaired, as well as probable losses inherent in the loan portfolio that are not specifically identified, which is determined using a methodology that is a function of quantitative and qualitative factors applied to segments of our loan portfolio and management's judgment. The calculation of the allowance involves a great deal of judgment and uncertainty particularly given the state of the overall economy, the continuing stress in the commercial real estate market, and negative events or circumstances that might impact an individual borrower. Accordingly, there can be no assurance that we will not incur losses on loans greater than what we have provided for in the allowance.
The allowance for loan losses was $143.1 million at December 31, 2013, compared to $161.4 million at December 31, 2012. The allowance for loan losses as a percentage of total loans was 1.34% at December 31, 2013, compared to 1.59% at December 31, 2012. Our allowance as a percentage of total loans reflects a level based on management's analysis of the risk inherent in our loan portfolio. Although we believe our loan loss allowance is adequate to absorb probable and reasonably estimable losses in our loan portfolio as of the balance sheet date, the allowance may not be adequate especially if economic conditions worsen or the factors used to calculate the allowance change. Also, proposed changes in accounting principles related to the calculation/determination of the allowance could result in a required increase.
In calculating the allowance, we use historical default and loss information. A considerable portion of our commercial portfolio consists of recent-vintage loans, as there is considerable turnover in this portfolio. Because defaults typically do not emerge during the early stages of the life of a loan, it is more difficult to estimate the probable losses inherent in a newer portfolio, compared with a more seasoned portfolio.
In the event we are required to increase our allowance for loan losses, our credit losses exceed our allowance or we are required to take higher than anticipated charge-offs in future periods, our earnings and our capital will be adversely affected. We may experience variability in our quarterly loan loss provision expense and charge-offs if larger credits default, which may impact credit quality trends.
Our business could be significantly impacted if we, or our third party service providers, suffer failure or disruptions of information systems or if our employees cause an operational infrastructure breakdown or failure.
We rely heavily on communications, data processing and other information processing systems to conduct our business and support our day-to-day banking, investment, and trust activities, many of which are provided through third-parties. If our third party providers encounter difficulties or become the source of an attack on or breach of their operational systems, data or infrastructure, or if we have difficulty communicating with any such third party system, our business operations could suffer. Any failure or disruption to our systems, or those of a third party provider, could impede our transaction processing, service delivery, customer relationship management, data processing, financial reporting or risk management. Although we take ongoing protective monitoring, detection, and prevention measures and perform penetration testing and risk assessments at least annually, our computer systems, software and networks, and those of our third party providers, may be vulnerable to unauthorized access, loss or destruction of data (including confidential client information), account takeovers, unavailability of service, computer viruses, denial of service attacks, malicious social engineering or other malicious code, or cyber attacks beyond what we can reasonably anticipate and such events could result in material loss. Additionally, we could suffer disruptions to our systems or damage to our network infrastructure from events that are wholly or partially beyond our control, such as electrical or telecommunications outages, natural disasters, widespread health emergencies or pandemics, or events arising from local or larger scale political events, including terrorist acts. There can be no assurance that our policies, procedures and protective measures designed to prevent or limit the effect of a failure, interruption or security breach, or the policies, procedures and protective measures of our third party providers, will be effective. If significant failure, interruption or security breaches do occur in our processing systems or those of our third party providers, we could suffer damage to our reputation, a loss of customer business, additional regulatory scrutiny, or exposure to civil litigation, additional costs and possible financial liability. In addition, our business is highly dependent on our ability to process, record and monitor, on a continuous basis, a large number of transactions. To do so, we are dependent on our employees and therefore, the potential for operational risk exposure exists throughout our organization, including losses resulting from human error. We could be materially adversely affected if one or more of our employees causes a significant operational breakdown or failure. If we fail to maintain adequate infrastructure, systems, controls and personnel relative to our size and products and services, our ability to effectively operate our business may be impaired and our business could be adversely affected.
The loss of key managing directors may adversely affect our business.
We are a relationship-driven organization. Our growth and development during the past five years can be attributed in large part to the efforts of our managing directors who have primary contact with our clients and have responsibility for maintaining personalized relationships with our client base. These personalized relationships are a key aspect of our business strategy. The loss of one or more of these key employees could have a material adverse effect on our business if we are unable to hire suitable replacements or we are unable to successfully retain the client relationships of a departing managing director.
We have counterparty risk; the creditworthiness of other financial institutions could expose us to losses on contracts we have with these institutions and could adversely affect our ability to provide services to our clients, specifically products and services relating to foreign exchange, derivatives and letters of credit.
Our ability to provide certain products and service could be adversely affected by the actions and commercial soundness of other banks. Banks are interrelated as a result of lending, clearing, correspondent, counterparty and other relationships. As a result, defaults by, or even rumors or questions about, one or more banks, or the banking industry generally, have in the past led to market-wide liquidity problems and could lead to losses or defaults by us or by other institutions. Many of the transactions engaged in by us in the ordinary course of business, particularly in our capital markets group, expose us to credit risk in the event of default of a counterparty or customer. In such instances, the collateral we hold may be insufficient to mitigate our losses, as we may be unable to realize or liquidate at prices sufficient to recover the full amount of our exposure. Such losses could have a material and adverse effect on our financial condition and results of operations.
Our capital markets group offers a range of over-the-counter interest rate and foreign exchange derivatives products. Although we do not engage in any proprietary trading and we structure these client-generated trading activities to mitigate our exposure to market risk, we remain exposed to various risks, the most significant of which include credit risk of our counterparties, operational risk and settlement risk, which may be most significant in foreign exchange transactions where timing differences between settlement centers can result in us paying our client and/or counterparty before actually receiving the funds. In addition, for swaps we execute with counterparties to mitigate the market risk of our customer trades, we may be required to post collateral to secure our obligations related to those trades; if such a counterparty invokes the protection of insolvency laws, then the collateral posted to secure our obligations to that counterparty may be trapped with, and potentially subject to claims of creditors of, that counterparty. The risk exposure to our counterparties requires active monitoring as well as liquidity management to ensure timely and cost efficient posting of collateral. Operational risk includes errors in execution of internal bank procedures and controls, which could
expose us to financial risk and/or reputation loss. A lapse or breakdown of these procedures or controls could significantly increase our exposure to counterparty credit risk and operational risk, which could result in a material loss to us.
Potential acquisitions of other financial institutions could pose risk to our operations and could strain our personnel, systems and managerial resources.
While our business strategy is primarily focused on organic growth, we may from time to time seek to acquire other financial institutions or related businesses to expand or improve our business. Among other potential opportunities, we may pursue acquisitions to expand our retail branch platform and diversify our core deposit mix. Acquiring other banks, businesses or branches involve various risks commonly associated with acquisitions, including, among other things (i) potential exposure to unknown or contingent liabilities or asset quality issues of the target company; (ii) difficulty and expense of integrating the operations and personnel of the target company; (iii) potential disruption to our business, including diversion of our management’s time and attention; (iv) the possible loss of key employees and customers of the target company; (v) difficulty in estimating the value of the target company; and (vi) potential changes in regulatory expectations that may affect the target company or increase the compliance burden of the combined entity. In connection with future acquisitions, we may issue equity securities which could cause ownership and economic dilution to our current stockholders. Moreover, we cannot guarantee that our regulators will approve. Furthermore, there is no assurance that, following any future mergers or acquisitions, our integration efforts will be successful or that, after giving effect to the acquisition, we will achieve a level of profitability that will justify the investment that we made in any such acquisition.
A prolonged continuation of economic uncertainty or worsening of current economic conditions, in the U.S. or globally, could have a material adverse effect on our financial condition and results of operations.
In recent years, the U.S. economy has been marked by sluggish labor market improvements, limited GDP growth, low inflation, and, only recently, upward movement in housing prices, as well as uncertainty related to U.S. and European fiscal issues, political climates and global economic conditions. Continued uncertainty, sustained high unemployment, volatility or disruptions of global financial markets, or prolonged deterioration in the global, national or local business or economic conditions could result in, among other things, a deterioration of credit quality, further impairment of real estate values or a reduced demand for credit or other products and services we offer to clients. In particular, the financial condition of the State of Illinois where we do the majority of our business (higher corporate tax rates, significant budget deficits and a deteriorating credit rating) may contribute to an adverse climate for doing business in the state which could negatively impact us to the extent it leads to declines in business activity in Illinois. Although we do not hold direct obligations of the State of Illinois, such conditions can also negatively affect the market value of those municipal bonds that are obligations of municipalities domiciled in Illinois.
An increase in the number of delinquencies, bankruptcies or defaults in future periods by our borrowers due to any of the factors above, or otherwise, could result in a higher level of nonperforming assets, net charge-offs, provision for loan and covered asset losses, and valuation adjustments on any loans held for sale, which would materially adversely affect our financial condition and results of operations.
We may be adversely affected by interest rate changes or an extended period of continued low interest rates.
Our operating results are largely dependent on our net interest income, which is the difference between the interest income earned on earning assets, usually loans and investment securities, and the interest expense paid on deposits and borrowings. The spread between the yield on our interest-earning assets and our overall cost of funds has been compressed in the recent low interest rate environment, and our net interest income may be adversely impacted by an extended period of continued low rates. Interest rates are affected by factors including: monetary policy of the FRB, actual inflation or deflation or expectations regarding the same, actual or forecasted economic growth or contractions, unemployment rates, domestic and foreign events, and instability in domestic and foreign financial markets. The timing of any FRB action to curtail or eliminate various stimulus-related programs, as a result of inflation concerns or otherwise, could have an impact on interest rates in general and our net interest margin in particular. While the yield on our loan portfolio is primarily variable and based on short-term rates and would therefore adjust quickly to a rise in interest rates, the impact on our cost of funds from a rise in interest rates will depend on a number of factors, including but not limited to, the competitive environment in the banking sector for deposit pricing, opportunities for clients to invest in other markets such as fixed income and equity markets, and the propensity of customers to invest in their businesses. The effect on our net interest income from an increase in interest rates will ultimately depend on the extent to which the aggregate impact of loan re-pricings exceeds the impact of increases in our cost of funds. Moreover, depending on the level and trend of the aforementioned factors, our cost of funds could increase more rapidly than foreseen and level of change in cost of funds may even exceed the increase in yield in our loan portfolios.
Our investment portfolio also contains interest rate sensitive instruments and the market value of these instruments may be adversely affected by changes in interest rates, domestic and international economic and political conditions, issuer or insurer credit deterioration and market factors. A rise in interest rates or spread widening would reduce the net unrealized gains that we had in our investment portfolio at the end of 2013.
We are highly regulated and may be adversely affected by changes in banking laws, regulations, and regulatory practices.
We are subject to extensive supervision, regulation and examination. This regulatory structure gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies to address not only compliance with applicable laws and regulations (including laws and regulations governing consumer credit, fair lending, privacy, information security and anti-money laundering and anti-terrorism laws), but also capital adequacy, asset quality, risk management, management ability and performance, earnings, liquidity, and various other factors. Under this structure the regulatory agencies have broad discretion to impose restrictions and limitations on our operations if they determine, among other things, that our operations are unsafe or unsound, fail to comply with applicable law or regulations or are otherwise inconsistent with regulatory expectations or with the supervisory policies of these agencies. This supervisory framework could materially impact the conduct, growth and profitability of our operations. As described above in “Supervision and Regulation,” the provisions of the Dodd-Frank Act and recently adopted regulations have significantly changed the overall bank regulatory framework with increased capital requirements, heightened risk management expectations, and new consumer protection standards. Any failure on our part to comply with laws, regulations, and other regulatory requirements applicable to us or expectations of our regulators relating to compliance or safe and sound banking practices could result in regulatory sanctions, civil money penalties or adverse actions against us, which in turn could increase our compliance burden and costs of doing business, restrict our ability to expand our business or result in damage to our reputation.
Changes in laws, regulations and other regulatory requirements affecting the financial services industry, and the effects of such changes, are difficult to predict and may have unintended consequences. New regulations or changes in the regulatory environment, including the ongoing implementation of the Dodd-Frank Act, could limit the types of financial services and products we may offer and/or increase the ability of non-banks to offer competing financial services and products, among other things. We may incur increased costs related to additional staffing, professional services and information technology resources to support compliance or data collection and data analytics to satisfy evolving expectations for enhanced risk management processes and new regulatory reporting requirements.
The creation of the CFPB under the Dodd-Frank Act has generally led to heightened scrutiny by banking regulators of financial institutions’ compliance with consumer lending laws and consumer financial regulations. The CFPB has broad rule-making, supervision and enforcement authority relating to a wide range of consumer protection laws. The CFPB has imposed significant fines and penalties on certain organizations relating to "unfair, deceptive or abusive" acts and practices as well as alleged fair lending violations based on claims of disparate impact on minority groups. There remains significant uncertainty surrounding the CFPB's enforcement activities and the scope of its consumer protection agenda. A significant portion of the CFPB's focus relates to the residential mortgage market. Uncertainty exists regarding how potential CFPB regulations will impact that market, including whether it will affect the level of overall mortgage activity.
Our future success is dependent on our ability to compete effectively in the highly competitive banking industry.
We face substantial competition in all phases of our operations from a variety of different competitors. Our future success will depend on our ability to compete effectively in this environment. We compete for commercial business with many banks that are substantially larger than we are and, in some cases, we may have a competitive disadvantage due to their greater resources, broader product offerings and economies of scale. In the recent period of relatively low overall loan demand and persistently low interest rates, we have experienced significant competitive pricing pressure in certain of our loan segments. Because we generate earnings primarily from the difference between the interest earned on loans and the interest we pay to depositors, this pricing pressure has impacted our margins.
Remaining competitive will require ongoing investments in technology and infrastructure to enhance service delivery, support new products and services and continue to grow our business in the current regulatory environment. These investments are directed at adapting existing products and services to evolving technology and the demands of our clients. Falling behind our competitors, who may have more extensive resources to invest, in any of these areas, could adversely affect our business.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
ITEM 2. PROPERTIES
The executive offices of PrivateBancorp are located in downtown Chicago, Illinois at 120 South LaSalle Street. This building which houses a majority of our general corporate functions is leased from an unaffiliated third party. We conduct our business primarily through the Bank at 25 full service banking offices in the greater Atlanta, Chicago, Detroit, Kansas City, Milwaukee, and St. Louis metropolitan areas. We also have business development offices located in Colorado, Connecticut, Georgia, Iowa, Michigan, Minnesota, and Ohio. With the exception of 10 locations which are owned, all other offices are leased from unaffiliated third parties. At certain Bank locations, excess space is leased to third parties.
We also own 25 automated teller machines ("ATMs") located at our banking facilities.
We believe our facilities in the aggregate are suitable and adequate to operate our banking and related business. Additional information with respect to premises, equipment and lease arrangements is presented in Note 7 of "Notes to Consolidated Financial Statements" in Item 8 of this Form 10-K.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
In June 2013, we were served with a complaint naming the Bank as an additional defendant in a lawsuit pending in the Circuit Court of the 21st Judicial Circuit, Kankakee County, Illinois known as Maas vs. Marek et. al. The lawsuit, brought by the beneficiaries of two trusts for which the Bank is serving as the successor trustee, seeks reimbursement of approximately $2 million of penalties and interest assessed by the IRS due to the late payment of certain generation skipping taxes by the trusts, as well as certain related attorney fees and other damages. The other named defendants include legal and accounting professionals that provided services related to the matters involved. There have been no material developments since we were served in this lawsuit. Although we are not able to predict the likelihood of an adverse outcome, we currently anticipate that ultimate resolution of this matter will not have a material adverse impact on our financial condition or results of operations.
As of December 31, 2013, there were various legal proceedings pending against the Company and its subsidiaries in the ordinary course of business. Management does not believe that the outcome of these proceedings will have, individually or in the aggregate, a material adverse effect on the Company's results of operations, financial condition or cash flows.
ITEM 4.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY,
RELATED STOCKHOLDER MATTERS, AND
ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock is traded under the symbol "PVTB" on the NASDAQ Global Select market tier of The NASDAQ Stock Market. As of February 21, 2014, there were approximately 492 stockholders of record. The following table sets forth the high and low intraday sales prices and quarter-end closing price of our common stock, dividends declared per share, dividend yield and book value per share during each quarter of 2013 and 2012. As of February 21, 2014, our closing market price was $27.94 per share.
(1)
Ratios are presented on an annualized basis.
Payment of future dividends is within the discretion of the Board and will depend on the capital adequacy of the Company and the Bank. The Board does not have any current plans to increase future dividends, as our current strategy is focused on retaining capital to support growth in the balance sheet. The Board does evaluate dividends on a quarterly basis and may adjust those plans from time to time. A discussion regarding the restrictions applicable to our ability and the ability of our subsidiaries to pay dividends is included in the "Bank Regulation" section of "Supervision and Regulation" in Item 1 and Note 17 of "Notes to Consolidated Financial Statements" in Item 8 of this Form 10-K.
Stock Performance Graph
The graph below illustrates, over a five-year period, the cumulative total return (defined as stock price appreciation and dividends) to stockholders from an investment in our common stock against a broad-market total return equity index and a published industry total return equity index. The published industry total return equity index used in this comparison is the Center for Research in Security Prices index for NASDAQ Bank Stocks and the broad-market total return equity index used in this comparison is the Russell 2000 Index.
Comparison of Five-Year Cumulative Total Return Among
PrivateBancorp, Inc., the NASDAQ Bank Index, and the Russell 2000 Index (1)
(1)
Assumes $100 invested on December 31, 2008 in PrivateBancorp’s common stock, the NASDAQ Bank Index and the Russell 2000 Index with the reinvestment of all related dividends.
To the extent this Form 10-K is incorporated by reference into any other filing by us under the Securities Act of 1933 or the Securities Exchange Act of 1934, the foregoing "Stock Performance Graph" will not be deemed incorporated, unless specifically provided otherwise in such filing and shall not otherwise be deemed filed under such Acts.
Issuer Purchases of Equity Securities
The following table summarizes the Company's monthly common stock purchases during the quarter ended December 31, 2013, which are solely in connection with the administration of our employee share-based compensation plans. Under the terms of these plans, we accept shares of common stock from plan participants if they elect to surrender previously-owned shares upon exercise of options to cover the exercise price or, in the case of both restricted shares of common stock or stock options, the withholding of shares to satisfy tax withholding obligations associated with the vesting of restricted shares or exercise of stock options.
Issuer Purchases of Equity Securities
Unregistered Sale of Equity Securities
None.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
Consolidated financial information reflecting a summary of our operating results and financial condition for each of the five years in the period ended December 31, 2013 is presented in the following table. This summary should be read in conjunction with the consolidated financial statements and accompanying notes included elsewhere in this Form 10-K. A more detailed discussion and analysis of the factors affecting our financial condition and operating results is presented in Item 7, "Management’s Discussion and Analysis of Financial Condition and Results of Operations" of this Form 10-K.
(1)
Computed as total non-interest income less net securities gains (losses) and loss on early extinguishment of debt.
(2)
This is a non-U.S. GAAP financial measure. Refer to Table 33 of Item 7, "Management’s Discussion and Analysis of Financial Condition and Results of Operations" of this Form 10-K for a reconciliation from non-U.S. GAAP to U.S. GAAP.
(3)
Excludes covered assets.
(4)
Computed as total equity less preferred stock, goodwill, and other intangibles divided by outstanding shares of common stock at end of year.
(5)
Computed as non-interest expense divided by the sum of net interest income on a tax equivalent basis (assuming a federal income tax rate of 35%) and non-interest income.
(6)
For purposes of our presentation, we calculate this ratio under currently effective requirements and without giving effect to the final Basel III capital rules adopted and issued by the Federal Reserve Board in July 2013, which are effective January 1, 2014 with compliance required January 1, 2015.
(7)
Computed as tangible common equity divided by tangible assets, where tangible common equity equals total equity less preferred stock, goodwill, and other intangible assets and tangible assets equals total assets less goodwill and other intangible assets.
n/m
Not meaningful.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
INTRODUCTION
The following discussion and analysis is intended to address the significant factors affecting our Consolidated Statements of Income for the years 2011 through 2013 and Consolidated Statements of Financial Condition as of December 31, 2012 and 2013. 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 Bank," we are referring to our wholly owned banking subsidiary, The PrivateBank and Trust Company. The following discussion is designed to provide stockholders with a comprehensive review of our operating results and financial condition and should be read in conjunction with the consolidated financial statements, accompanying notes thereto, and other financial information presented in this Form 10-K.
Unless otherwise stated, all earnings per share data included in this section and through the remainder of this discussion are presented on a diluted basis.
CRITICAL ACCOUNTING POLICIES
Our consolidated financial statements are prepared in accordance with U.S. GAAP, and our accounting policies are consistent with predominant practices in the financial services industry. Critical accounting policies are those policies that require management to make the most significant 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.
Our most significant accounting policies are presented in Note 1, "Summary of Significant Accounting Policies" in the "Notes to Consolidated Financial Statements" of Item 8 of this 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, income taxes and fair value measurements 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 is assessed quarterly and represents an accounting estimate of probable losses in the portfolio at each balance sheet date based on a review of available and relevant information at that time. The allowance consists of reserves for probable losses that have been identified relating to specific borrowing relationships that are individually evaluated for impairment ("the specific component"), as well as probable losses inherent in our loan portfolio that are not specifically identified ("the general allocated component"), which is determined using a methodology that is a function of quantitative and qualitative factors applied to segments of our loan portfolio as well as management’s judgment.
The specific component relates to impaired loans. Impaired loans consist of nonaccrual loans (which include nonaccrual troubled debt restructurings ("TDRs")) and loans classified as accruing TDRs. A loan is considered impaired when, based on current information and events, management believes that either it is probable that we will be unable to collect all amounts due (both principal and interest) according to the original contractual terms of the loan agreement or it has been classified as a TDR. Once a loan is determined to be impaired, the amount of impairment is measured based on the loan’s observable fair value; fair value of the underlying collateral less estimated selling costs, if the loan is collateral-dependent; or the present value of expected future cash flows discounted at the loan’s effective interest rate.
If the measurement of the impaired loan is less than the recorded investment in the loan, impairment is recognized by creating a specific valuation reserve as a component of the allowance for loan losses. Impaired loans exceeding $500,000 are evaluated individually, while loans less than $500,000 are evaluated as pools using historical loss experience, as well as management’s loss expectations, for the respective asset class and product type. Of total impaired loans of $114.4 million at December 31, 2013, 76% had balances in excess of $500,000.
All impaired loans and their related reserves are reviewed and updated each quarter. Any impaired loan for which a determination has been made that the economic value is permanently reduced is charged-off against the allowance for loan losses to reflect its current economic value in the period in which the determination is made.
At the time a collateral-dependent loan is initially determined to be impaired, we review the existing collateral appraisal. If the most recent appraisal is greater than one year old, a new appraisal is obtained on the underlying collateral. The Company generally obtains "as is" appraisal values for use in the evaluation of collateral-dependent impaired loans. Appraisals for collateral-dependent impaired loans in excess of $500,000 are updated with new independent appraisals at least annually and are formally reviewed by our internal appraisal department. Additional diligence is also performed at the six-month interval between annual appraisals. If during the course of the six-month review process there is evidence supporting a meaningful decline in the value of collateral, the appraised value is either internally adjusted downward or a new appraisal is required to support the value of the impaired loan. With an immaterial number of exceptions, all appraisals and internal reviews are current under this methodology at December 31, 2013.
To determine the general allocated component of the allowance for loan losses, we segregate loans by vintage ("transformational" and "legacy"), and product type (e.g., commercial, commercial real estate) because of observable similarities in the historical performance experience of loans underwritten by these business units. In general, loans originated by the business units that existed prior to the strategic changes of the Company in 2007 are considered "legacy" loans. Loans originated by a business unit that was established in connection with or following the strategic business transformation plan are considered "transformational" loans. Renewals or restructurings of legacy loans may continue to be evaluated as legacy loans depending on the structure or defining characteristics of the new transaction. The Company has implemented a line of business model that has reorganized the legacy business units so that after 2009, all new loan originations are considered transformational.
The methodology produces an estimated range of potential loss exposure for the product types within each vintage. We consider the appropriate balance of the general allocated component of the reserve in relation to a variety of internal and external quantitative and qualitative factors to reflect data or timeframes not captured by the basic allowance framework as well as market and economic data and management judgment. In certain instances, these additional factors and judgments may lead management to conclude that the appropriate level of the reserve is outside the range determined through the basic allowance framework.
Determination of the allowance is inherently subjective, as it requires significant estimates, including the amounts and timing of expected future cash flows on impaired loans; estimated losses on pools of homogeneous loans based on historical loss experience, risk ratings, product type, and vintage; and consideration of current economic trends and portfolio attributes, all of which may be susceptible to significant change. For instance, loss rates in our allowance methodology typically reflect the Company’s more recent loss experience, by product, on a trailing twelve-or eighteen-month basis. These loss rates consider both cumulative charge-offs and other OREO valuation adjustments over the period in the individual product categories that constitute our allowance. Default estimates use a multi-year originating vintage and rating approach. In addition, we compare current model-derived and historically-established reserve levels to recent and historical charge-off trends in considering the appropriate final level of the reserve at each product level.
Credit exposures deemed to be uncollectible are charged-off against the allowance, while recoveries of amounts previously charged-off are credited to the allowance. A provision for loan losses, which is a charge against earnings, is recorded to bring the allowance for loan losses to a level that, in management’s judgment, is appropriate to absorb probable losses in the loan portfolio as of the balance sheet date.
Goodwill and Intangible Assets
Goodwill represents the excess of purchase price over the fair value of net assets acquired using the acquisition 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.
Goodwill is allocated to reporting units at acquisition. The Company has two reporting units with allocated goodwill: Banking and Trust and Investments. Subsequent to initial recognition, goodwill is not amortized but, instead, is tested for impairment at the reporting unit level at least annually or more often if an event occurs or circumstances change that would indicate it is more likely than not that the fair value of a reporting unit is less than its carrying amount. In the event we conclude that all or a portion of our goodwill is impaired, a non-cash charge for the amount of such impairment would be recorded in earnings. Such a charge would have no impact on tangible or regulatory capital.
The goodwill impairment testing process is conducted by assigning net assets and goodwill to each reporting unit. In "step one," the fair value of each reporting unit is compared to the recorded book value. Our step one calculation of each reporting unit’s fair value is based upon a simple average of two metrics: (1) a primary market approach, which measures fair value based upon trading multiples of independent publicly traded financial institutions of comparable size and character to the reporting units, and (2) an income approach, which estimates fair value based upon discounted cash flows ("DCF") and terminal value (using the perpetuity growth method). If the fair value of the reporting unit exceeds its carrying value, goodwill is not considered impaired and "step two" is not considered necessary. If the carrying value of a reporting unit exceeds its fair value, the impairment test continues ("step two") by comparing the carrying value of the reporting unit’s goodwill to the implied fair value of goodwill. The implied fair value of goodwill is determined using the residual approach, where the fair value of a reporting unit is allocated to all of the assets and liabilities of that unit as if the reporting unit had been acquired in a business combination and the fair value of the reporting unit, calculated in step one, is the price paid to acquire the reporting unit. The excess of the fair value of the reporting unit over the amounts assigned to its assets and liabilities is the implied fair value of goodwill. An impairment charge is recognized to the extent the carrying value of goodwill exceeds the implied fair value of goodwill.
The Company has the option at the time of its annual impairment test to perform a qualitative assessment for each reporting unit to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value before applying the existing two-step goodwill impairment test. If the Company concludes that this is the case, the Company would proceed with the existing two-step test, as described above. Otherwise, the Company would be able to bypass the two-step test and conclude that goodwill is not impaired from a qualitative perspective.
In conjunction with our annual goodwill impairment test performed as of October 31, 2013, we did not elect to perform a qualitative assessment and chose to proceed with the quantitative two-step test. As a result of our step one analysis, the Company determined that the fair value of both the Banking and Trust and Investments (excluding Lodestar) reporting units exceeded their respective carrying amounts. As such, both of the Company's reporting units with allocated goodwill "passed" step one of the goodwill impairment test, and no further analysis was required to support the conclusion that goodwill was not impaired as of October 31, 2013. The Banking reporting unit's fair value exceeded its carrying amount by 73%, while the Trust and Investments (excluding Lodestar) reporting unit's fair value exceeded its carrying amount by approximately 161%. We are not aware of any events or circumstances subsequent to our annual goodwill impairment testing date of October 31, 2013 that would indicate impairment of goodwill allocated to the Banking and Trust and Investment (excluding Lodestar) reporting units at December 31, 2013. In connection with the sale of Lodestar on December 31, 2013, $226,000 of the goodwill assigned to Trust and Investments was allocated to Lodestar and written off, inclusive of an impairment charge of $146,000 recorded in connection with the sale.
Goodwill impairment testing is considered a "critical accounting estimate" as estimates and assumptions are made about future performance and cash flows, as well as other prevailing market factors. For our annual impairment testing, we engage an independent valuation firm to assist in the computation of the fair value estimates of each reporting unit. In connection with obtaining an independent third-party valuation, management provides certain information and assumptions that are utilized in the calculations. Assumptions critical to the process include: forecasted earnings, which are developed for each segment by considering several key business drivers such as historical performance, forward interest rates (using forward interest rate curves to forecast future expected interest rates), anticipated loan and deposit growth, and industry and economic trends; discount rates; and credit quality assessments, among other considerations. We provide the best information available at the time to be used in these estimates and calculations. Changes in these assumptions due to macroeconomic, industry-wide, or Company-specific developments subsequent to the date of our annual goodwill impairment test could affect the results of our goodwill impairment analysis.
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. During 2013, there were no events or circumstances to indicate that there may be impairment of intangible assets. In connection with the sale of Lodestar on December 31, 2013, $815,000 in net carrying value of client relationship intangibles was written off. The Company's intangible assets include core deposit premiums, client relationship, and assembled workforce intangibles. All of these intangible assets have finite lives and are amortized over varying periods not exceeding 12 years.
Income Taxes
The determination of income tax expense or benefit, and the amounts of current and deferred income tax assets and liabilities are based on complex analyses of many factors, including interpretations 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. In addition, for interim reporting purposes, management generally determines its income
tax provision, before consideration of any discrete items, based on its current best estimate of pre-tax income, permanent differences and the resulting effective tax rate expected for the full year.
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 authorities 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 December 31, 2013. However, there is no guarantee that the tax benefits associated with these deferred tax assets will be fully realized. We have concluded, as of December 31, 2013, 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 interpretations 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 tax benefits that may not be realized. The amount of any such reserves are based on the standards for determining such reserves as set forth in current accounting guidance and our 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 December 31, 2013, we had tax reserves established relating to uncertain tax positions that, if recognized, would favorably affect the Company's effective tax rate by $347,000.
For additional discussion of income taxes, see "Management's Discussion and Analysis of Financial Condition and Results of Operations - Income Taxes" and Notes 1 and 15 of "Notes to Consolidated Financial Statements" in Item 8 of this Form 10-K.
Fair Value Measurements
Certain of the Company’s assets and liabilities are measured at fair value at each reporting date, including securities available-for-sale, derivatives, and certain loans held-for-sale. Additionally, other assets are measured at fair value on a nonrecurring basis, including impaired loans and other real estate owned ("OREO"), which are subject to fair value adjustments under certain circumstances.
The Company measures fair value in accordance with U.S. GAAP, which defines fair value 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.
U.S. GAAP establishes a fair value hierarchy that categorizes fair value measurements based on the observability of the valuation inputs used in determining fair value. Level 1 valuations are based on unadjusted quoted prices for identical instruments traded in active markets. Level 2 valuations are based on quoted prices for similar instruments, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data. Level 3 valuations use at least one significant unobservable input that is supported by little or no market activity.
Judgment is required to determine whether certain assets measured at fair value are included in Level 2 or Level 3. When making this judgment, we consider the information available to us, including observable market data, indications of market liquidity and orderliness, and our understanding of the valuation techniques and significant inputs used. Classification of Level 2 or Level 3 is based upon the specific facts and circumstances of each instrument or instrument category and judgments are made regarding the significance of the Level 3 inputs to the instrument's fair value measurement in its entirety. If Level 3 inputs are considered significant, the instrument is classified as Level 3.
Judgment is also required when determining the fair value of an asset or liability when either relevant observable inputs do not exist or available observable inputs are in a market that is not active. When relevant observable inputs are not available, the
Company must use its own assumptions about future cash flows and appropriately risk-adjusted discount rates. Conversely, in some cases observable inputs may require significant adjustments. For example, in cases where the volume and level of trading activity in an asset or liability is very limited, actual transaction prices vary significantly over time or among market participants, or the prices are not current, the observable inputs may not be relevant and could require adjustment.
The Company uses a variety of methods to measure the fair value of financial instruments on a recurring basis and to validate the overall reasonableness of the fair values obtained from external sources on at least a quarterly basis, including evaluating pricing service inputs and methodologies, using exception reports based on analytical criteria, comparing prices obtained to prices received from other pricing sources, and reviewing the reasonableness of prices based on Company knowledge of market liquidity and other market-related conditions. 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 at the reporting date. The inability to precisely measure the fair value of certain assets, such as OREO, may lead to changes in the fair value of those assets over time as unobservable inputs change, which can result in volatility in the amount of income or loss recorded for a particular position from quarter to quarter.
Additional information regarding fair value measurements is included in Note 20 of "Notes to the Consolidated Financial Statements" in Item 8 of this Form 10-K.
OVERVIEW
We reported net income available to common stockholders of $122.9 million for 2013, an increase of 91% from the $64.5 million reported for 2012. Diluted earnings per share was $1.57 for 2013, increasing 78% compared to $0.88 per share for 2012. Our return on average assets grew to 0.90%, return on average common equity grew to 9.8% and the efficiency ratio improved to 56.4% for 2013; all significant improvements compared to 2012 when these performance measures were 0.60%, 5.8% and 61.3%, respectively. The improvement in 2013 earnings was primarily driven by meaningfully lower credit costs (provision for loan losses and net foreclosed property expenses), lower share-based compensation costs and deposit insurance assessments and the full year net benefit on earnings for the 2012 repayment of TARP (which led to replacing $13.4 million of preferred stock dividend with $8.9 million, pretax interest expense on subordinated debt).
Net revenue increased by $4.5 million to $538.3 million for 2013, compared to $533.8 million for 2012, with higher levels of net interest income and non-interest income contributing to the current year improvement. Non-interest income increased by $2.9 million in 2013 compared to 2012, with higher revenues from trust and investments, treasury management and syndications contributing to the year-over-year growth.
Net interest income increased by $1.1 million, in 2013 compared to 2012 benefiting from higher average interest earning assets as average loan balances increased $771.8 million combined with lower deposit costs mostly due to downward pricing on interest-bearing deposits. Net interest income grew despite the added $7.2 million in interest expense for the subordinated debt issuance in October 2012. Net interest margin was 3.23% for 2013 compared to 3.42% for the prior year reflecting competitive pricing pressure on loan yields, declining investment yields, and the subordinated debt issuance in October 2012, which were partially offset by a reduction in cost of funds as a result of lower interest rates paid on deposits.
During 2013, total loans grew $504.0 million, or 5%, from year end 2012, with most of the growth in the commercial and industrial portfolio, which represented 67% of total loans at year end 2013 compared to 64% at year end 2012.
Our asset quality position continued to improve during 2013 and is approaching more normalized levels in the post credit-crisis environment. This is reflected in the meaningful decrease in nonperforming assets, nonperforming loans, charge-offs, and potential problem and special mention loans. Total nonperforming assets and loans declined 44% and 32%, respectively, from December 31, 2012 levels with nonperforming assets to total assets representing 0.9% at year end 2013 compared to 1.6% at December 31, 2012. Dispositions of early-stage problem loans and nonperforming assets totaled $99.1 million. During 2013, the level of inflows into nonperforming loans has declined by nearly 50% as fewer early-stage problem loans developed. With credit quality improving, the provision for loans losses, excluding covered assets, declined $39.7 million from 2012 levels and we reduced our allowance for loan losses by $18.3 million from the prior year end. As the number of OREO properties declined during 2013 from $81.9 million to $28.5, we benefited from a 47% decline in net foreclosed property costs.
Please refer to the remaining sections of "Management’s Discussion and Analysis of Financial Condition and Results of Operations" for greater discussion of the various components of our 2013 performance, statement of financial condition and liquidity.
RESULTS OF OPERATIONS
The profitability of our operations depends on our net interest income, provision for loan and covered loan losses, non-interest income, and non-interest expense. Net interest income is dependent on the amount of and yields earned on interest-earning assets as compared to the amount of and rates paid on interest-bearing liabilities. Net interest income is sensitive to changes in market rates of interest as well as to the execution of our asset/liability management strategy. The provision for loan and covered loan losses is primarily affected by changes in the loan portfolio’s composition and performance, the identification of nonperforming loans and management’s assessment of the collectability of the loan portfolio, based on loss experience as well as economic and market factors. Non-interest income consists primarily of fee revenue from Trust and Investments, mortgage banking, capital markets products, treasury management, loan and credit-related fees, and other services charges and fees. Net securities gains/losses, if any, are also included in non-interest income.
Net Interest Income
Net interest income is the primary source of the Company's revenue. Net interest income is the difference between interest income and fees earned on interest-earning assets, such as loans and investments, and interest expense incurred on interest-bearing liabilities, such as deposits and borrowings, which are used to fund those assets. Net interest income is affected by the volume, pricing, mix and maturity of earning assets and interest-bearing liabilities; the volume and value of noninterest-bearing sources of funds, such as noninterest-bearing deposits and equity; the use of derivative instruments to manage interest rate risk; the sensitivity of the balance sheet to fluctuations in interest rates, including characteristics such as fixed or variable nature of the financial instruments, contractual maturities, repricing frequencies, and loan repayment behavior; and asset quality.
Interest rate spread and net interest margin are utilized to measure and explain changes in net interest income. Interest rate spread is the difference between the yield on interest-earning assets and the rate paid for interest-bearing liabilities that fund those assets. Net interest margin is expressed as the percentage of net interest income to average interest-earning assets. The net interest margin exceeds the interest rate spread because noninterest-bearing sources of funds, principally noninterest-bearing demand deposits and equity, also support interest-earning assets.
The accounting policies underlying the recognition of interest income on loans, securities, and other interest-earning assets are included in Note 1 of "Notes to Consolidated Financial Statements" in Item 8 of this Form 10-K.
For purposes of this discussion, net interest income and any ratios or metrics that include net interest income as a component, such as net interest margin, have been adjusted to a fully tax-equivalent basis to more appropriately reflect the impact of returns on certain tax-exempt securities, assuming a federal income tax rate of 35%. The effect of the tax-equivalent adjustment is presented at the bottom of the following table.
Table 1 summarizes 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 three years ended December 31, 2013. The table also presents the trend in net interest margin on a quarterly basis for 2013 and 2012, including the tax-equivalent yields on interest-earning assets and rates paid on interest-bearing liabilities. In addition, Table 2 details variances in income and expense for each of the major categories of interest-earning assets and interest-bearing liabilities and indicates the extent to which such variances are attributable to volume and rate changes.
Table 1
Net Interest Income and Margin Analysis
(Dollars in thousands)
(footnotes on following page)
Quarterly Net Interest Margin Trend
(1)
Interest income included $24.4 million, $26.3 million, and $24.4 million in loan fees for the years ended December 31, 2013, 2012, and 2011, respectively.
(2)
Interest income and yields are presented on a tax-equivalent basis, assuming a federal income tax rate of 35%. This is a non-U.S. GAAP measure.
(3)
Average loans on a nonaccrual basis for the recognition of interest income totaled $122.6 million for 2013, $212.2 million for 2012, and $340.7 million for 2011 and are included in loans for purposes of this analysis. Interest foregone on impaired loans was estimated to be approximately $4.8 million for the year ended December 31, 2013, $8.9 million for 2012 and $14.4 million for 2011, and was based on the average loan portfolio yield for the respective period.
(4)
Covered interest-earning assets consist of loans acquired through a Federal Deposit Insurance Corporation ("FDIC") assisted transaction that are subject to a loss share agreement and the related indemnification asset. Refer to the section entitled "Covered Assets" for a detailed discussion.
Table 2
Changes in Net Interest Income Applicable to Volumes and Interest Rates (1)
(Amounts in thousands)
(1)
For purposes of this table, changes which are not due solely to volume changes or rate changes are allocated to such categories in proportion to the absolute amounts of the change in each.
(2)
Interest income is presented on a tax-equivalent basis, assuming a federal income tax rate of 35%.
(3)
Covered interest-earning assets consist of loans acquired through an FDIC-assisted transaction that are subject to a loss share agreement and the related indemnification asset. Refer to the section entitled "Covered Assets" for a detail discussion.
2013 compared to 2012
Net interest income on a tax-equivalent basis increased $1.5 million, or 0.4%, to $424.3 million for the year ended December 31, 2013, compared to $422.8 million for the prior year. Interest income for the year increased $5.6 million compared to 2012 primarily due to $14.2 million in higher interest income on loans generated from $771.8 million in higher average loan balances. This was partially offset by $8.0 million in lower interest income due to declining yields on securities and reduced loan balances on the covered assets portfolio. The increase in interest income was offset by $4.1 million increase in interest expense resulting from an increase of $6.2 million in interest expense on short- and long-term debt largely due to the $125 million of subordinated debt issued in October 2012 in connection with out repayment of TARP as well as $2.1 million decrease in interest-bearing deposits costs.
Average interest-earning assets grew $759.5 million primarily driven by a $913.8 million increase in average commercial loan balances from 2012. Our loan portfolio mix continues to shift toward commercial loans, which generally provide higher yields than our current commercial real estate loans. Average commercial real estate loans declined by $145.8 million from the prior year. Average interest-bearing deposits grew $905.3 million from 2012, reflecting an increase in interest-bearing demand deposits and money market accounts. Average short term debt declined $43.9 million as average FHLB advances were higher in 2012, and average long-term debt increased $75.0 million due to the subordinated debt issuance mentioned above.
Net interest margin was 3.23% for 2013, a decline of 19 basis points from 3.42% for 2012. The year-over-year decline in net interest income was primarily due to lower loan yields, driven by competitive pricing pressures and the low interest rate environment, decline in securities yields, and the cost of the TARP restructure. Our cost of interest-bearing funds declined $2.1 million, or 8 basis points. While lower interest rates were paid on interest-bearing deposits, interest rates on long-term debt increased 28 basis points as 2013 included $7.1 million of additional expense associated with the issuance of subordinated debt. Average noninterest-bearing deposits and average equity, our principal sources of noninterest-bearing funds, declined in total by $261.0 from 2012. As shown in the table above, the effect of noninterest-bearing funds on net interest margin was four basis points lower than a year ago.
Yield trends in both our loan and investment portfolios are likely to continue to pressure net interest margin given the current operating environment and the prospects for a continuation of low short-term interest rates. Despite the highly competitive environment, we continue to take a disciplined approach to structure, pricing and overall returns as we selectively add and develop new client relationships. Loan pricing, especially renewals, remain very competitive. With respect to interest-bearing liabilities, we do not anticipate any significant benefit to net interest margin in 2014 from downward repricing of deposits.
2012 compared to 2011
For 2012, net interest margin was 3.42%, a decline of 7 basis points from 3.49% for 2011. Downward pressure on primarily short-term interest rates negatively impacted yields on loans and securities, which was partially offset by a decline in deposit costs of 9 basis points, due to a shifting in the mix of deposits towards non-interest bearing deposits and downward pricing from 2011. A decline in short-term borrowings interest expense of $1.6 million year-over-year was more than offset by interest expense on the subordinated debt issued in October 2012, which negatively impacts net interest income.
Provision for loan losses
The provision for loan losses, excluding the provision for covered loans, totaled $31.2 million in 2013, down from $70.9 million in 2012 and $130.6 million in 2011. The provision for loan losses is a function of our allowance for loan loss methodology used to determine the allowance deemed adequate to cover inherent loan losses after net charge-offs have been deducted. The current year provision benefited from continuing portfolio improvement in overall credit metrics and the reduced requirement for specific reserves on a smaller population of impaired loans. Impaired loans were $114.4 million at December 31, 2013, down from $199.8 million at December 31, 2012. In addition, the current period provision benefited from lower charge-offs. Net charge-offs were $49.5 million in 2013, compared to $101.1 million in 2012 and $161.8 million in 2011. For further analysis and information on how we determine the appropriate level for the allowance for loan losses and analysis of credit quality, see "Critical Accounting Policies" and "Credit Quality Management and Allowance for Loan Losses."
Provision for covered loan losses
For 2013, the provision for covered loan losses related to the loans purchased under the FDIC-assisted transaction loss share agreement totaled $632,000, compared to $549,000 in 2012 and $2.3 million in 2011. The provision for covered loan losses represents the 20% portion of expected losses on covered loans not reimbursed by the FDIC. For further information regarding the FDIC-assisted transaction, see "Covered Assets."
Non-interest Income
Non-interest income is derived from a number of sources related to our banking activities, including fees from our Trust and Investments business, mortgage banking income, the sale of derivative products to clients through our capital markets group, treasury management fees, loan and credit-related fees and syndication fees. The following table presents a break-out of these multiple sources of revenue for the years ended December 31, 2013, 2012 and 2011.
Table 3
Non-interest Income Analysis
(Dollars in thousands)
2013 compared to 2012
Non-interest income for 2013 totaled $114.0 million, increasing $2.9 million, or 3% compared to the prior year reflecting growth in trust and investments, treasury management, syndication fees, deposit service charges and fees and other income and net securities gains during the current year. These increases were partially offset by lower mortgage banking, capital markets products, and loan, letter of credit and commitment fees. Excluding net securities gains/losses, non-interest income increased by $1.6 million, or 1%, to $112.8 million for 2013, compared to $111.2 million for 2012.
Trust and investments fee revenue increased by $1.4 million, or 8.0%, from 2012 and is largely attributed to fees associated with strong client growth, market recovery, and the on-boarding of a new strategic partnership in the latter part of the year. These increases were partially offset by a reduction of $413,000 in fees from our former wholly-owned investment management subsidiary due the departure of two relationship managers in the prior year. The pricing on trust and investment accounts varies depending on the type of services provided. Assets under management and administration ("AUMA") grew to $5.7 billion at December 31, 2013 from $5.2 billion at December 31, 2012 primarily due to new custodial assets added in 2013, net client growth and improved market values all of which more than offset the reduction in AUMA related to the sale of Lodestar on December 31, 2013. Fees earned on "qualified custodian" and escrow assets are typically a flat fee structure and are significantly lower than fees recognized on standard custody and managed assets, which are generally based on the market value of the assets on the last day of the prior quarter or month and are therefore subject to volatility. Custody assets as a percentage of total AUMA were 44% and 45% at December 31, 2013 and 2012, respectively.
Revenue from our mortgage banking business, which includes gains on loans sold and certain mortgage related loan fees, declined $1.3 million from $13.5 million in 2012 to $12.2 million in 2013. The current year decline is primarily due to tighter spreads on a lower volume of loan sales in 2013 compared to 2012 coupled with lower application volumes which was partially offset by an expanded product offering. We sold $514.7 million of mortgage loans in the secondary market, generating gains of $9.1 million, in 2013 compared to $561.5 million of mortgages loans sold, generating gains of $10.1 million, in the prior year. During the latter half of 2013, we saw a shift in product mix with purchase activity increasing while refinancing demand declined. The rise in longer-term interest rates will continue to negatively impact refinancing activity and application volumes.
Capital markets products income declined $5.2 million from 2012 and included a $2.2 million positive credit valuation adjustment ("CVA") compared to a positive CVA of $48,000 for 2012. The CVA represents the credit component of fair value with regard to both client-based derivatives and the related matched derivatives with interbank dealer counterparties. Exclusive of CVA, capital markets products income declined $7.4 million, or 29%, compared to 2012. The current period decline was attributable to lower level of loan origination-related swap activity and a shift in product mix by clients into transactions with lower margins. Our capital markets business opportunities are sensitive to the level of loan originations and our clients' outlook on short-term interest rates.
Treasury management income increased $3.2 million, or 15%, from 2012. Revenue growth for these services is closely correlated with loan originations, the acquisition of new middle market lending clients and influenced by the nature of the client's business, though often subject to a three-to-six month lag of implementation. The current year increase reflects the ongoing success in cross-selling treasury management services to new commercial clients as we continue to build client relationships and, to a lesser extent, a decrease in our earnings credit rate (the rate applied to balances maintained in the client’s deposit account to offset activity charges) in the latter part of 2012 and 2013. Similar to loan originations, we have experienced increased pricing competition with treasury management services.
Loan, letter of credit and commitment fees declined $1.0 million, or 5%, from 2012, principally due to $555,000, or 7% decline in unused commitment fees and a $339,000, or 4% decline in standby letter of credit fees. The majority of our unused commitment fees related to revolving facilities, which at December 31, 2013 totaled $7.6 billion and, of which $4.0 billion were unused. In comparison, at December 31, 2012, commitments related to revolving facilities totaled $7.0 billion, of which $3.9 billion were unused.
Syndication fees increased $4.3 million from 2012 to $13.4 million in 2013. The increase is attributable to a higher volume of transactions, an increased demand from an expanded investor base, new product offerings, and improving pricing from both planned and opportunistic transactions recognized on origination in the fourth quarter of 2012 and throughout 2013. Syndication fees tend to fluctuate period to period depending on market conditions, loan origination trends, and portfolio management decisions.
2012 compared to 2011
Non-interest income for 2012 was $111.0 million, an increase of $12.8 million, or 13%, compared to the prior year, with all major categories, excluding trust and investments, deposit service charged and fees and other income, and net securities losses contributing to the improvement. Excluding net securities gains/losses, non-interest income grew by $18.8 million, or 20%, to $111.2 million for 2012, compared to $92.5 million for 2011.
Trust and investments fee revenue declined by $809,000, or 5% from 2011, largely due to the loss of fees within the Bank's investment management subsidiary following the departure of two relationship managers during 2012, the absence of larger estate fees recognized in the prior year, and to a lesser extent, the discontinuation of land trust fees due to the sale of the land trust business in 2011. The loss in fees was partially offset by organic growth and continued client acquisition. AUMA grew to $5.2 billion at December 31, 2012 from $4.3 billion at December 31, 2011 primarily due to new custodial assets added in first quarter 2012, net client growth, and to a lesser extent, improved market values. Custody assets as a percentage of total AUMA were 45% and 37% at December 31, 2012 and 2011, respectively.
Revenue from our mortgage banking business increased by $6.8 million, or 101%, from the prior year, as the combination of a favorably low interest rate environment throughout 2012 and the expansion of our mortgage banking staff resulted in a higher volume of transactions closed and sold into the secondary market. Further, origination fees increased $1.1 million from 2011 as the low interest rates drove strong application volumes.
Capital markets products income increased $6.6 million from 2011 and included a $48,000 positive CVA compared to a negative CVA of $719,000 for 2011. Exclusive of CVA, capital markets income increased to $25.9 million in 2012 from $20.1 million in 2011, and was favorably impacted by an increase in loan origination-related swap activity that was generally characterized by longer durations and larger deal sizes, resulting in higher revenue compared to 2011. Capital markets business opportunities are sensitive to loan originations and our clients' interest rate expectations.
Treasury management income increased $3.3 million, or 18%, from 2011. The 2012 increase reflects ongoing success in cross-selling treasury management services to new and existing commercial clients as we continue to build client relationships and, to a lesser extent, a decrease in our earnings credit rate in the latter part of 2012.
Loan and credit-related fees increased $1.5 million, or 9%, from 2011 and was largely due to greater unused commitment fees. The majority of our unused commitment fees related to revolving facilities, which at December 31, 2012 totaled $7.0 billion, of which $3.9 million were unused. In comparison, at December 31, 2011, commitments related to revolving facilities totaled $6.6 billion, of which $3.7 billion were unused.
Syndication fees increased $3.6 million from 2011 to $9.1 million in 2012 due to a higher volume of transactions and agency lead deals.
Deposit service charges and fees and other income decreased $2.2 million, or 27%, from 2011primarily due to a decline in Small Business Administration servicing and related fees, which fluctuate with loan demand, and a $646,000 reduction in card-based
interchange fees, which was attributable to new fee limits provided for under the Dodd-Frank Act. Also contributing to the year-over-year variance was $714,000 in higher gains on sale of various assets recognized in 2011.
Non-interest Expense
Table 4
Non-interest Expense Analysis
(Dollars in thousands)
(1)
Computed as non-interest expense, less non-interest income, divided by average total assets.
(2)
Computed as non-interest expense divided by the sum of net interest income on a tax equivalent basis and non-interest income. The efficiency ratio is presented on a tax-equivalent basis, assuming a federal income tax rate of 35%. See Table 33, "Non-U.S. GAAP Financial Measures," for a reconciliation of the effect of the tax-equivalent adjustment.
*
Less than 1%
2013 compared to 2012
Non-interest expense declined by $23.8 million, or 7%, as compared to the prior year. The decline reflects lower credit related costs (i.e. net foreclosed property expense and loan and collection expense) attributable to lower level of nonperforming assets, reduced compensation expense, insurance expense combined with disciplined expense management. The current year improvement was partially offset by higher other expense which included a number of non-recurring charges.
Compensation expense declined overall by $8.0 million, or 5%, from 2012, principally benefiting from lower share-based costs. Share-based costs declined $8.0 million, or 39%, due to final expense recognition in 2012 for certain share-based compensation awards made in 2007 and 2008 which was partially offset by $3.9 million in additional expense recognition relating to the Company's February 2013 annual equity grants as part of its annual incentive and long-term incentive programs. Salary and wages were down $586,000, or 1%, primarily due to an increase in the cost-deferrals associated with loan origination salary expense, partially offset by a higher FTEs base, as well as annual compensation adjustments. Incentive compensation, retirement costs and other employee benefits were up by $546,000, or 1%, compared to 2012, largely due to the inclusion of certain executives in the 2013 incentive program which were restricted in the prior year due to TARP incentive limitations.
Marketing expenses increased $2.3 million, or 22%, compared to 2012 as a result of our new advertising and re-branding campaign in 2013.
Net foreclosed property expense, which includes write-downs on foreclosed properties, gains and losses on sales of foreclosed properties, taxes, and other expenses associated with the maintenance of OREO declined $18.1 million, or 47%, from 2012. The decline is primarily due to $5.8 million in lower OREO valuation write-downs compared to the prior year, as well as recognition of net gains on sales of OREO in 2013 of $1.7 million compared to net losses on sales of $6.0 million in 2012. In 2013 we sold OREO with a net book value of $51.2 million, compared to $48.2 million of OREO sales in 2012. In addition, property ownership costs, such as property management and real estate taxes, were down $3.5 million from the prior year as the population of OREO declined from $81.9 million at December 31, 2012 to $28.5 million at December 31, 2013. Refer to the "Foreclosed Real Estate" discussion in the "Loan Portfolio and Credit Quality" section below for more information regarding our OREO portfolio and valuation process.
Insurance expense declined $4.3 million, or 28%, from 2012, primarily due to lower FDIC deposit insurance premiums reflecting improved credit quality, liquidity, and improvement in our deposit and funding mix compared to levels in 2012 which resulted in lower current year assessments. Also included in insurance costs for 2013 were $960,000 in refunds on previously paid deposit insurance assessments due to clarification of deposit rules under the assessment model.
Loan and collection expense, which consists of certain non-reimbursable costs associated with loan origination and servicing activities and loan remediation costs for problem and nonperforming loans, declined $2.9 million, or 25%, from 2012. At December 31, 2013, workout related costs declined $2.0 million as the level of problem loans declined 22% from 2012. Performing loan expenses decreased $830,000 from reduced volumes of mortgage activity coupled with heightened expense management of credit-related costs on new and renewed loans.
Other operating expenses increased $7.7 million, or 56%, compared to the prior year period and was largely due to certain non-recurring charges that were incurred in 2013, including $2.7 million in restructuring costs associated with the vacating of excess space in the Detroit area and the restructuring of our Atlanta operation and a $1.2 million charge on repurchased loans. Other expenses for 2013 included $861,000 in losses related to our CRA investments, $600,000 in greater losses on asset sales and operating losses and an increase in our provision for unfunded commitments of $1.8 million from 2012.
Our efficiency ratio was 56.35% for 2013, improving from 61.28% for 2012.
2012 compared to 2011
Non-interest expense totaled $327.1 million for 2012, increasing by $24.9 million, or 8%, from $302.3 million in 2011. The increase was primarily due to higher compensation expense and net foreclosed property expense, which was partially offset by lower insurance expense.
Compensation expense increased overall by $18.2 million, or 12%, from 2011. Salary and wages expenses were up $3.8 million, or 4%, primarily due to an increase in FTEs since December 31, 2011, as well as annual compensation adjustments.
Share-based costs increased by $4.9 million, or 31%, from 2011. 2012 included a full year of expense related to the 2011 equity awards as well as ten months of expense recognition related to annual stock-based awards issued in February 2012. Also, at year-
end 2012, the final tranche of equity awards originally issued in 2007 and 2008 under our transformational strategic growth plan vested resulting in an increase in expense from a truing up of estimated forfeitures. Finally, 2011 share-based costs had benefited from a higher level of forfeitures on departed plan participants.
Incentive compensation, retirement costs and other employee benefits were up by $9.5 million, or 19%, compared to 2011, principally due to higher incentive compensation related to the Company's performance against stated goals in addition to performance-based pay linked to mortgage banking and capital markets fee revenues, which had higher revenues in 2012 compared to 2011.
Technology and related costs increased $1.9 million, or 16%, from 2011 and was primarily due to investments in data networking to provide greater bandwidth and improve overall service levels, as well as higher volumes in transaction-based data processing fees for client-based loan, deposit and wire services.
Marketing expense increased $1.4 million, or 16% compared to the prior year. This increase is primarily due to a new advertising program to raise our corporate profile in 2012.
Professional services expense, decreased $853,000, or 9%, from 2011, with reduced consultancy services and lower corporate legal fees driving the decline.
Net foreclosed property expense increased $10.5 million, or 38%, from 2011. The increase was primarily due to higher valuation write-downs, which totaled $25.2 million for 2012 as compared to $15.4 million for 2011. Also, a higher amount of property ownership costs, such as property management and real estate taxes, were incurred in 2012 as compared to the prior year. Offsetting the impact of the higher valuation write-downs and property ownership costs was a decrease in the net loss on sales of OREO. Net losses on sale were $6.0 million on $48.2 million of OREO in 2012, as compared to net losses of $9.1 million on $79.0 million of OREO in 2011.
Insurance expense decreased $6.1 million, or 29%, from 2011, primarily due to lower deposit insurance assessments as a result of the change in FDIC insurance assessment methodology. In 2011, the FDIC adopted final rules amending the deposit insurance assessment regulations, modifying, among other provisions, the assessment base from one based on domestic deposits to one based on total assets less average tangible equity. These rules took effect April 1, 2011, impacting assessments beginning in the second quarter 2011.
Loan and collection expense decreased $1.9 million, or 14%, from 2011 primarily due to a $4.8 million reduction in remediation costs attributable to an overall reduction in problem loans and was partially offset by higher non-reimbursable mortgage originations costs in connection with greater re-financing volumes.
Other operating expenses increased $2.0 million, or 17%, from the prior year. The increase was primarily due to $1.3 million in higher amortization on our core deposit intangible assets compared to the prior year. In addition, we recorded a $66,000 provision for unfunded commitments in 2012 as compared to an $842,000 reduction of the reserve for unfunded commitments in 2011.
Income Taxes
Our provision for income taxes includes both federal and state income tax expense. An analysis of the provision for income taxes and the effective income tax rates for the periods 2011 through 2013 are presented in the following table.
Table 5
Income Tax Provision Analysis
(Dollars in thousands)
Generally, our effective income tax rate varies from the statutory federal income tax rate of 35% principally due to state income taxes, the effects of tax-exempt earnings from municipal securities and bank-owned life insurance, non-deductible compensation and business expenses and tax credits.
For the year ended December 31, 2013 we recorded an income tax provision of $77.0 million on pre-tax income of $199.9 million (equal to a 38.5% effective tax rate) compared to an income tax provision of $54.5 million on pre-tax income of $132.4 million for the year ended December 31, 2012 (equal to a 41.2% effective tax rate).
The decrease in our effective tax rate in 2013 compared to 2012 was primarily due to the restoration of tax benefits for executive compensation subsequent to the repayment of TARP and the substantially greater amount of charges in the 2012 period associated with share-based compensation. The lower effective tax rate in 2011 was primarily due to tax benefits attributable to the repricing of our deferred tax asset that resulted from the 2011 Illinois corporate tax rate change.
Realization of Deferred Tax Assets
Net deferred tax assets are included in other assets in the accompanying Consolidated Statements of Financial Condition and totaled $98.6 million at December 31, 2013, consisting of gross deferred tax assets of $119.8 million offset by gross deferred tax liabilities of $21.2 million.
We have concluded that it is more likely than not that the deferred tax assets will be realized and no valuation allowance was recorded. This conclusion was based in part on the fact that the Company was not in a cumulative book loss position for financial statement purposes at December 31, 2013, measured on a trailing three-year basis. In addition, we considered our recent earnings history, on both a book and tax basis, and our outlook for earnings and taxable income in future periods.
Taxable income in prior years and reversing deferred taxable temporary differences provide sources from which deferred tax assets may be absorbed. Most significantly, however, we have relied on our expectation of generating pre-tax earnings in future periods, which should give rise to taxable income levels, exclusive of reversing temporary differences, that more likely than not will be sufficient to absorb the deferred tax assets.
Operating Segments Results
We have three primary business segments: Banking, Trust and Investments, and Holding Company Activities.
Banking
Our Banking segment is the Company's most significant segment, representing nearly 90% of consolidated total assets and generates nearly all of the Company's net income. The profitability of our Banking segment is dependent on net interest income, provision for loan and covered loan losses, non-interest income, and non-interest expense. The net income for the Banking segment for the year ended December 31, 2013 was $146.8 million, a $38.7 million increase from net income of $108.1 million for the year ended December 31, 2012. The increase in net income for the Banking segment was primarily due to a $39.6 million decline in the provision for loan and covered loan losses from the prior year, largely driven by decreases in special mention loans, nonperforming loans and charge-offs. Also contributing to the increase in net income was the decline in non-operating expense, including an $8 million decline in share-based costs and an $18 million decline in net foreclosed property expense primarily due to lower OREO balances in 2013. Net income for the Banking segment increased $36.2 million from the year ended December 31, 2011 to the year ended December 31, 2012, which was primarily due to a $61.5 million in lower provision for loan and covered loan losses which were partially offset by $26.7 million in higher non-interest expense compared to 2011.
Total loans for the Banking segment increased to $10.6 billion at December 31, 2013, compared to $10.1 billion at December 31, 2012. Total deposits were relatively flat from December 31, 2012 levels of $12.3 billion to $12.1 billion at December 31, 2013.
Trust and Investments
The Trust and Investments segment includes investment management, personal trust and estate administration, custodial and escrow, retirement account administration, and brokerage services. Until December 31, 2013 Lodestar Investment Counsel, LLC ("Lodestar"), an investment management firm, was a wholly-owned subsidiary of the Bank. On December 31, 2013, Lodestar was sold and the assets and liabilities were removed from the Trust and investments segment. The sale of Lodestar is not expected to have a material impact on future period's financial results.
Net income attributable to controlling interests from Trust and Investments increased to $2.3 million for the year ended December 31, 2013, from $1.6 million for the year ended December 31, 2012, and increased from $668,000 for the year ended December
31, 2011. The increase in net income from 2012 to 2013 is primarily attributable to an increase in non-interest income largely due to continued client acquisition and growth in AUMA. Overall stock market improvements also contributed to asset growth leading to increased asset-based fees. AUMA grew to $5.7 billion at December 31, 2013, from $5.2 billion at December 31, 2012, with the growth primarily due to new client relationships and improved market performance during 2013.
Holding Company Activities
The Holding Company Activities segment consists of parent company-only activity and intersegment eliminations. The Holding Company’s most significant asset is its investment in its bank subsidiary. Undistributed earnings relating to this investment is not included in the Holding Company financial results. Holding Company financial results are represented primarily by interest expense on borrowings and operating expenses. Recurring operating expenses consist primarily of compensation expense allocated to the Holding Company and professional fees. The Holding Company Activities segment reported a net loss of $26.2 million for the year ended December 31, 2013, compared to a net loss of $31.8 million for the same period in 2012 and a net loss of $28.2 million for 2011. The lower net loss for the year as compared to the prior period was the result of a decline in share-based costs, partially offset by an increase in interest expense due to subordinated debt issued in October 2012. The Holding Company had $55.9 million in cash at December 31, 2013 compared to $78.0 million at December 31, 2012.
Additional information about our operating segments are also discussed in Note 21 of "Notes to Consolidated Financial Statements" in Item 8 of this Form 10-K.
FINANCIAL CONDITION
Investment Portfolio Management
We manage our investment portfolio to maximize the return on invested funds within acceptable risk guidelines, to meet pledging and liquidity requirements, and to adjust balance sheet interest rate sensitivity to attempt to serve as some protection of net interest income levels against the impact of changes in interest rates.
We may adjust the size and composition of our securities portfolio according to a number of factors, including expected liquidity needs, the current and forecasted interest rate environment, our actual and anticipated balance sheet growth rate, the relative value of various segments of the securities markets, and the broader economic and regulatory environment.
Investments are comprised of debt securities. Our debt securities portfolio is primarily comprised of residential mortgage-backed pools, collateralized mortgage obligations, and state and municipal bonds.
Debt securities that are classified as available-for-sale are carried at fair value and may be sold as part of our asset/liability management strategy in response to changes in interest rates, liquidity needs or significant prepayment risk. Unrealized gains and losses on available-for-sale securities represent the difference between the aggregated cost and fair value of the portfolio and are reported, on an after-tax basis, as a separate component of equity in accumulated other comprehensive income ("AOCI"). This balance sheet component will fluctuate as current market interest rates and conditions change, with such changes affecting the aggregate fair value of the portfolio. In periods of significant market volatility we may experience significant changes in AOCI.
Debt securities that are classified as held-to-maturity are securities that we have the ability and intent to hold until maturity and are accounted for using historical cost, adjusted for amortization of premiums and accretion of discounts.
Table 6
Investment Securities Portfolio Valuation Summary
(Dollars in thousands)
* Less than 1%
As of December 31, 2013, our securities portfolio totaled $2.5 billion, an increase of $161.5 million, or 7%, compared to December 31, 2012. During 2013, purchases of securities totaled $827.6 million, with $641.0 million in the available-for-sale portfolio and $186.6 million in the held-to-maturity portfolio. The current year purchases in the investment portfolio primarily represented the reinvestment of proceeds from sales, maturities and paydowns in largely similar agency guaranteed residential mortgage-backed securities, as well as purchases of commercial agency guaranteed mortgage-backed securities and U.S. Treasury securities.
In conjunction with ongoing portfolio management and rebalancing activities, during 2013, we sold $108.7 million of U.S. Treasury securities and $6.1 million of state and municipal securities, resulting in a net securities gain of $1.2 million.
Investments in collateralized mortgage obligations and residential and commercial mortgage-backed securities comprise 81% of the total portfolio at December 31, 2013. All of the mortgage securities are backed by U.S. Government agencies or issued by U.S. Government-sponsored enterprises. All residential mortgage securities are composed of fixed-rate, fully-amortizing collateral with final maturities of 30 years or less.
Investments in debt instruments of state and local municipalities comprised 11% of the total portfolio at December 31, 2013. This type of security has historically experienced very low default rates and provided a predictable cash flow since it generally is not subject to significant prepayment. Insurance companies regularly provide credit enhancement to improve the credit rating and liquidity of a municipal bond issuance. Management considers the credit enhancement and underlying municipality credit strength when evaluating a purchase or sale decision.
At December 31, 2013, our reported equity reflected unrealized net securities gains on available-for-sale securities, net of tax, of $13.0 million, a decrease of $29.3 million from December 31, 2012. We continue to add, as needed, to the held-to-maturity portfolio to mitigate the potential future AOCI volatility of adding bonds to the available-for-sale portfolio in a low interest rate environment.
The following table summarizes activity in the Company's investment securities portfolio during 2013. There were no transfers of securities between investment categories during the year.
Table 7
Investment Portfolio Activity
(Dollars in thousands)
(1)
The held-to-maturity portfolio is recorded at cost, with no adjustment for the $47.6 million decrease in market value.
The following table presents the maturities of the different types of investments that we owned at December 31, 2013 and the corresponding interest rates.
Table 8
Maturity Distribution and Portfolio Yields
(Dollars in thousands)
(1)
The repricing distributions and yields to maturity of collateralized mortgage obligations and mortgage-backed securities are based on average life of expected cash flows. Actual repricings and yields of the securities may differ from those reflected in the table depending upon actual interest rates and prepayment speeds.
(2)
The maturity date of state and municipal bonds is based on contractual maturity, unless the bond, based on current market prices, is deemed to have a high probability that a call right will be exercised, in which case the call date is used as the maturity date.
LOAN PORTFOLIO AND CREDIT QUALITY (excluding covered assets)
Our principal source of revenue arises from our lending activities, primarily composed of interest income and, to a lesser extent, loan origination and commitment fees, net of related costs. The accounting policies underlying the recording of loans in the Consolidated Statements of Financial Condition and the recognition and/or deferral of interest income and fees, net of costs, arising from lending activities are included in Note 1 of "Notes to Consolidated Financial Statements" in Item 8 of this Form 10-K.
The following discussion of our loan portfolio and credit quality excludes covered assets. Covered assets represent assets acquired through an FDIC-assisted transaction that are subject to a loss share agreement and are presented separately on the Consolidated Statements of Financial Condition. For additional discussion of covered assets, refer to "Covered Assets" further in "Management's Discussion and Analysis" and Note 6 of "Notes to Consolidated Financial Statements" in Item 8 of this Form 10-K.
Portfolio Composition
Total loans increased $504.0 million to $10.6 billion as of December 31, 2013 from $10.1 billion at December 31, 2012, driven by net loan growth in the commercial and industrial loan portfolio, which increased $635.1 million from year end 2012. New client activity and increased borrowings from existing clients contributed to loan growth during the year. Construction loans, as well, increased $102.9 million from prior year end despite continued payoffs of loans, many of which were replaced with permanent financing. Revolving line usage was up modestly to 47% from 45% at December 31, 2012.
Our loan growth was strong for the year despite the level of competition in our markets from both bank and finance companies amid continuing low loan demand. Overall loan growth continues to be impacted by the heightened competition which is affecting both pricing and structure. Our strategy is to maintain a disciplined approach to pricing and structuring new credit opportunities and continue to develop comprehensive client relationships. Given the competitive environment, we may experience uneven loan growth from quarter-to-quarter.
As a result of the current year loan growth, commercial loans (including commercial owner-occupied CRE loans) increased as a proportion of total loans to 67% at December 31, 2013, compared to 64% at December 31, 2012. The mix of loans has continued to shift towards commercial loans, which generally provide us higher yields than other segments of our total loan portfolio and greater potential for cross-selling of other products and services. Additionally, construction loans increased 54% from prior year end, to 3% of the total loans at December 31, 2013, driven by continued improvement in the construction environment and acquisition activity. As we continue to grow the loan portfolio, we are targeting to keep a similar proportional mix of loans in the portfolio but will remain opportunistic.
In the normal course of our business, we participate in loan transactions that involve a number of banks, primarily to maintain and build client relationships with a view to cross-selling products and originating loans for the borrowers in the future. Although we may strive to lead or co-lead the arrangement, we will also participate with other banks when we have a relationship with the borrower. Participations and syndications assist us with decreasing credit exposure linked to individual client relationships or loan concentrations by industry, type or size. Of our $10.6 billion in total loans at December 31, 2013, we were party to $2.0 billion in shared national credits ("SNCs") which transactions are typically led by larger institutions. At December 31, 2013, total syndications and participations outstanding were $3.4 billion, including SNCs, and of this total, we were the lead or co-lead on transactions with $1.4 billion outstanding at quarter end.
The following table presents the composition of our loan portfolio at the dates shown.
Table 9
Loan Portfolio
(Dollars in thousands)
The following table summarizes the composition of our commercial loan portfolio at December 31, 2013 and 2012. Our commercial loan portfolio is categorized based on our most significant industry segments, as classified pursuant to the North American Industrial Classification System standard industry description. These categories are based on the nature of the client’s ongoing business activity as opposed to the collateral underlying an individual loan. To the extent that a client’s underlying business activity changes, classification differences between periods will arise.
Table 10
Commercial Loan Portfolio Composition by Industry Segment
(Dollars in thousands)
(1)
Calculated as nonperforming loans in the respective industry segment divided by total loans of the corresponding industry segment presented above.
(2)
All other consists of numerous smaller balances across a variety of industries with no category greater than 3%.
(3)
Includes owner-occupied commercial real estate of $1.7 billion and $1.6 billion at December 31, 2013 and 2012, respectively.
*
Less than 1%
One of the largest segments within our commercial lending business is the healthcare industry. We have a specialized niche in the assisted living, skilled nursing, and residential care segment of the healthcare industry. Loan relationships to these providers tend to be larger extensions of credit and are primarily to for-profit businesses. At December 31, 2013, 23% of the commercial loan portfolio and 16% of the total loan portfolio was composed of loans extended primarily to operators in this segment to finance the working capital needs and cost of facilities providing such services. The facilities securing the loans are dependent, in part, on the receipt of payments and reimbursements under government contracts for services provided. Our clients and their ability to service debt may be adversely impacted by the financial health of state or federal payors. In recent years, there have been reductions in the reimbursement rates in certain states and certain government entities are taking longer to reimburse for services previously provided, particularly in states experiencing some budgetary stress in the current economic environment. At December 31, 2013, approximately $326 million of our $1.7 billion healthcare portfolio related to facilities doing business in Illinois and $156 million to facilities doing business in California, two states which have experienced budgetary stress. To date, despite some impact on client cash flows, the healthcare loan portfolio segment has experienced minimal defaults and losses.
Our manufacturing portfolio, representing 22% of our commercial and industrial lending business at December 31, 2013, is well diversified among industry and product types with particular focus in serving clients in our primary market segments. The manufacturing industry segment is a key component of our core business strategy. As the general market environment for manufacturing has improved over the past several years, the manufacturing segment of the portfolio has been accretive to the relatively stable credit performance in the commercial portfolio.
At December 31, 2013, we characterized approximately 11%, or $788.1 million of our commercial loan portfolio as cash flow loans. Cash flow loans are primarily underwritten on the recurring earnings and cash flow of the borrower with less reliance on collateral coverage; as such, in the event of default, the loss potential may be greater. Our definition of cash flow loans may differ
from that of other financial institutions, and not all of our cash flow loans meet the regulatory definition of higher-risk commercial and industrial loans. Cash flow loans are spread across multiple industries.
The following table summarizes our commercial real estate and construction loan portfolios by collateral type at December 31, 2013 and 2012.
Table 11
Commercial Real Estate and Construction Loan Portfolios by Collateral Type
(Dollars in thousands)
(1)
Calculated as nonperforming loans in the respective collateral type divided by total loans of the corresponding collateral type presented above.
*
Less than 1%
Of the combined commercial real estate and construction portfolios, the three largest categories at December 31, 2013 were retail, multi-family and office real estate, which represent 21%, 20% and 18%, respectively of the combined portfolios. Our commercial real estate and construction portfolio strategy is focused on achieving market share in core real estate classes in geographically diverse but key market segments. From an overall portfolio performance perspective, the business execution plans for these assets continue to perform at a satisfactory level.
Within the commercial real estate portfolio, our exposure to land loans totaled $216.2 million at December 31, 2013 declining $24.3 million, or 10%, from $240.5 million at December 31, 2012. Land remains an illiquid asset class as buyers and sellers may hold divergent future development outlooks for the land, therefore affecting saleability and market prices. As a percentage of the commercial real estate portfolio, land loans were 9% at both December 31, 2013 and 2012.
The construction portfolio totaled $293.4 million at December 31, 2013, an increase of $102.9 million, compared to $190.5 million at December 31, 2012 with most significant increases in retail, healthcare and office categories. The current year increase was driven by continued improvement in the construction environment and acquisition activity.
Maturity and Interest Rate Sensitivity of Loan Portfolio
The following table summarizes the maturity distribution of our loan portfolio as of December 31, 2013, by category, as well as the interest rate sensitivity of loans in these categories that have maturities in excess of one year.
Table 12
Maturities and Sensitivities of Loans to Changes in Interest Rates (1)
(Amounts in thousands)
(1)
Maturities are based on contractual maturity date. Actual timing of repayment may differ from those reflected in the table as clients may choose to pre-pay their outstanding balance prior to the contractual maturity date.
Of the $7.2 billion in loans maturing after one year with a floating interest rate, $1.5 billion are subject to interest rate floors, of which $1.4 billion have such floors in effect at December 31, 2013. For further analysis and information related to interest sensitivity, see Item 7A
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As a continuing part of our asset/liability management, we attempt to manage the impact of fluctuations in market interest rates on our net interest income. This effort entails providing a reasonable balance between interest rate risk, credit risk, liquidity risk and maintenance of yield. We may manage interest rate risk by structuring the asset and liability characteristics of our balance sheet and/or by executing derivatives designated as cash flow hedges. We initiated the use of interest rate derivatives as part of our asset liability management strategy in July 2011 to hedge interest rate risk in our primarily floating-rate loan portfolio and, depending on market conditions, we may expand this program and enter into additional interest rate swaps.
Interest rate changes do not affect all categories of assets and liabilities equally or simultaneously. There are other factors that are difficult to measure and predict that would influence the effect of interest rate fluctuations on our Consolidated Statements of Income.
The majority of our interest-earning assets are floating-rate instruments. At December 31, 2013, approximately 77% of the total loan portfolio is indexed to LIBOR, 17% of the total loan portfolio is indexed to the prime rate, and another 2% of the total loan portfolio otherwise adjusts with other reference interest rates. Of the $7.2 billion in loans maturing after one year with a floating interest rate, 20% or $1.5 billion are subject to interest rate floors, of which 93% are in effect at December 31, 2013 and are reflected in the interest sensitivity analysis below. To manage the interest rate risk of our balance sheet, we have the ability to use a combination of financial instruments, including medium-term and short-term financings, variable-rate debt instruments, fixed-rate loans and securities and interest rate swaps.
We use a simulation model to estimate the potential impact of various interest rate changes on our income statement and our interest-earning asset and interest-bearing liability portfolios. The starting point of the analysis is the current size and nature of these portfolios at the beginning of the measurement period as well as the then-current applicable pricing structures. During the twelve-month measurement period, the model will re-price assets and liabilities based on the contractual terms and market rates in effect at the beginning of the measurement period and assuming instantaneous parallel shifts in the applicable yield curves and instruments remain at that new interest rate through the end of the twelve-month measurement period. The model only analyzes changes in the portfolios based on assets and liabilities at the beginning of the measurement period and does not assume any changes from growth or business plans over the following twelve months.
The sensitivity analysis is based on numerous assumptions including: the nature and timing of interest rate levels including the shape of the yield curve, prepayments on loans and securities, pricing decisions on loans and deposits, reinvestment/replacement of asset and liability cash flows and others. While our assumptions are developed based upon current economic and local market conditions, we cannot make any assurances as to the predictive nature of these assumptions including how client preferences or competitor influences might change. In addition, the simulation model assumes certain one-time instantaneous interest rate shifts that are consistent across all yield curves and do not continue to increase over the measurement period. As such, these assumptions and modeling reflect an estimation of the sensitivity to interest rates or market risk and do not predict the timing and direction of interest rates or the shape and steepness of the yield curves. Therefore, the actual results may differ materially from these simulated results due to timing, magnitude, and frequency of interest rate changes as well as changes in market conditions and management strategies.
Modeling the sensitivity of net interest income to changes in market interest rates is highly dependent on numerous assumptions incorporated into the modeling process. These assumptions are periodically reviewed and updated in the context of various internal and external factors including balance sheet changes, product offerings, product mix, external micro- and macro-economic factors, anticipated client behavior and anticipated Company and market pricing behavior. During 2012 and 2013, we conducted historical deposit re-pricing and deposit lifespan/retention analyses and adjusted our forward-looking assumptions related to client and market behavior. Based on our analyses and judgments, we modified the core deposit product repricing characteristics and retention periods, as well as average life estimates, used in our interest rate risk modeling which reflects higher interest rate sensitivity of our deposits.
The following table shows the estimated impact of an immediate change in interest rates as of December 31, 2013 based on our current simulation modeling assumptions and as of December 31, 2012, as previously reported in our Annual Report on Form 10-K for the year ended December 31, 2012.
Analysis of Net Interest Income Sensitivity
(Dollars in thousands)
The table above illustrates the estimated impact to our net interest income over a one year period is reflected in dollar terms and percentage change. As an example, if there had been an instantaneous parallel shift in the yield curve of +100 basis points on December 31, 2013, net interest income would increase by $27.6 million, or 6.9%, over a twelve-month period, as compared to a net interest income increase of $40.4 million, or 10.6%, if there had been an instantaneous parallel shift of +100 basis points at December 31, 2012. The decrease in the overall interest rate asset sensitivity at December 31, 2013 compared to December 31, 2012, is primarily due to a balance sheet migration into rate sensitive liabilities since December 31, 2012, as a result of a decrease in non-interest bearing demand deposits and an increase in interest-bearing demand deposits. Additionally, assumptions modified in 2013 had the impact of reducing overall asset sensitivity as we identified certain liabilities that demonstrated increased rate sensitivity. During 2013, assets migrated from short-term investments into loans and investment securities, however the rate sensitivity of assets was generally constant. Taken together, rate sensitive stability in assets was coupled with a migration into more rate responsive liabilities, producing a decrease in overall interest rate asset sensitivity. This effect was furthered by the continued expansion of the hedging program. Based on the modeling, the Company remains in an asset sensitive position and would benefit from a rise in interest rates. We will continue to periodically review and refine, as appropriate, the assumptions used in our interest rate risk modeling.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders of PrivateBancorp, Inc.:
We have audited the accompanying consolidated statements of financial condition of PrivateBancorp, Inc. (the "Company") as of December 31, 2013 and 2012, and the related consolidated statements of income, comprehensive income, changes in equity and cash flows for each of the three years in the period ended December 31, 2013. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company at December 31, 2013 and 2012, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2013, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company's internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (1992 Framework) and our report dated February 25, 2014 expressed an unqualified opinion thereon.
/S/ ERNST & YOUNG LLP
Chicago, Illinois
February 25, 2014
PRIVATEBANCORP, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Amounts in thousands)
(1)
Amounts represent items for which the Bank has elected fair value option.
See accompanying notes to consolidated financial statements.
PRIVATEBANCORP, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION - (Continued)
(Amounts in thousands, except per share data)
See accompanying notes to consolidated financial statements.
PRIVATEBANCORP, INC.
CONSOLIDATED STATEMENTS OF INCOME
(Amounts in thousands, except per share data)
See accompanying notes to consolidated financial statements.
PRIVATEBANCORP, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Amounts in thousands)
See accompanying notes to consolidated financial statements.
PRIVATEBANCORP, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
(Amounts in thousands, except per share data)
(1)
Net of taxes and reclassification adjustments.
See accompanying notes to consolidated financial statements.
PRIVATEBANCORP, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY - (Continued)
(Amounts in thousands, except per share data)
(1)
Net of taxes and reclassification adjustments.
See accompanying notes to consolidated financial statements.
PRIVATEBANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
See accompanying notes to consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations - PrivateBancorp, Inc. ("PrivateBancorp" or the "Company") was incorporated in Delaware in 1989 and became a holding company registered under the Bank Holding Company Act of 1956, as amended. The PrivateBank and Trust Company (the "Bank" or the "PrivateBank"), the sole banking subsidiary of PrivateBancorp, was opened in Chicago in 1991. The Company completed its initial public offering in June 1999. The Bank provides customized business and personal financial services to middle market companies and business owners, executives, entrepreneurs and families in all of the markets and communities it serves. The majority of the Bank’s business is conducted in the greater Chicago market.
Principles of Consolidation and Basis of Presentation - The accompanying 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. In general, investments in unconsolidated entities where the Company has the ability to exercise significant influence over the entities' operating and financing decisions are accounted for using the equity method of accounting. Investments that do not meet the criteria for equity method accounting are accounted for using the cost method of accounting. Assets held in a fiduciary or agency capacity are not assets of the Company or its subsidiaries, and accordingly, are not included in the consolidated financial statements.
The accounting and reporting policies of the Company and its subsidiaries conform to U.S. generally accepted accounting principles ("U.S. GAAP") and general practice within the banking industry. We use the accrual basis of accounting for financial reporting purposes.
Certain reclassifications have been made to prior year amounts to conform to the current year presentation.
In preparing the consolidated financial statements, we have considered the impact of events occurring subsequent to December 31, 2013 for potential recognition or disclosure in this annual report on Form 10-K. The following is a summary of the significant accounting policies adhered to in the preparation of the consolidated financial statements.
Business Combinations - Business combinations are accounted for under the acquisition method of accounting. Under the acquisition method, assets and liabilities of the business acquired are recorded at their estimated fair value as of the date of acquisition, with any excess of the cost of the acquisition over the fair value of the net tangible and identifiable intangible assets acquired recorded as goodwill. Results of operations of the acquired business are included in the Consolidated Statements of Income from the effective date of acquisition.
Use of Estimates - The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make certain estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from these estimates.
Cash and Cash Equivalents - For purposes of the Consolidated Statements of Cash Flows, management has defined cash and cash equivalents to include cash and due from banks, federal funds sold, and other interest-bearing deposits in banks. Generally, federal funds are sold for one-day periods, but not longer than 30 days. Short-term investments generally mature in less than 30 days. All cash and cash equivalents have maturities of three months or less.
Debt Securities - At the time of purchase, debt securities are classified as held-to-maturity or available-for-sale. Debt securities are classified as held-to-maturity when the Company has the positive intent and ability to hold the securities to maturity. Held-to-maturity securities are carried at amortized cost. Debt securities are classified as available-for-sale when management has the intent and ability to hold such securities for an indefinite period of time, but not necessarily to maturity. Any decision to sell available-for-sale securities would be based on various factors, including, but not limited to asset/liability management strategies, changes in interest rates or prepayment risks, liquidity needs, or regulatory capital considerations. Available-for-sale securities are carried at fair value with unrealized gains and losses, net of related deferred income taxes, recorded as a separate component of other comprehensive income ("OCI").
The historical cost of debt securities is adjusted for amortization of premiums and accretion of discounts over the life of the security, using the level-yield method. Amortization of premium and accretion of discount are included in interest income.
Purchases and sales of securities are recognized on a trade date basis. Realized securities gains or losses are reported in net securities gains (losses) in the Consolidated Statements of Income. The cost of securities sold is based on the specific identification method. On a quarterly basis, we assess whether there have been any events or circumstances to indicate that a security for which there is
an unrealized loss is impaired on an other-than-temporary ("OTTI") basis. This determination requires significant judgment. OTTI is considered to have occurred (1) if management intends to sell the security; (2) if it is more likely than not we will be required to sell the security before recovery of its amortized cost basis; or (3) if the present value of the expected cash flows is not sufficient to recover the entire amortized cost basis. For debt securities that we do not expect to sell or for which it is not more likely than not that the Company will be required to sell prior to recovery, the OTTI is separated into credit and noncredit components. The credit-related OTTI, represented by the expected loss in principal, is recognized in non-interest income, while noncredit-related OTTI is recognized in OCI. Noncredit-related OTTI results from other factors, including increased liquidity spreads and changes in risk-free interest rates. All of the OTTI is recognized in earnings for securities we expect to sell. Presentation of OTTI is made in the income statement on a gross basis with a reduction for the amount of OTTI recognized in OCI. Once OTTI is recorded, future significant increases in expected cash flows are treated as prospective yield adjustments.
Federal Home Loan Bank ("FHLB") Stock - Investments in FHLB stock are restricted as to redemption and are carried at cost.
Loans Held for Sale - Loans held for sale ("LHFS") represent mortgage loan originations intended to be sold in the secondary market and other loans that management has an active plan to sell. LHFS are carried at the lower of cost or fair value as determined on an individual asset basis or carried at fair value where the Company has elected fair value accounting. The Company has elected to measure residential mortgage loans originated as held for sale under the fair value option. Increases or decreases in the fair value of these LHFS are recognized in mortgage banking income in the Consolidated Statements of Income. Mortgage loan origination costs related to LHFS that the Company accounts for under the fair value option are recognized in noninterest expense as incurred. Held for investment loans that have been transferred to LHFS are carried at the lower of cost or fair value. For these LHFS, any decreases in value below cost are recognized in other income in the Consolidated Statements of Income and increases in fair value above cost are not recognized until the loans are sold. The credit component of any write down upon transfer to LHFS is reflected in charge-offs to the allowance for loan losses. Loan origination costs for LHFS carried at the lower of cost or fair value are capitalized as part of the carrying amount of the loans.
Gains and losses on the disposition of loans held for sale are determined on the specific identification method. Residential mortgage loans sold in the secondary market are sold without retaining servicing rights.
Originated Loans Held for Investment - Originated loans held for investment are carried at the principal amount outstanding, net of unearned income, deferred loan fees and costs, and any direct principal charge-offs. Interest income on loans is accrued based on principal amounts outstanding. Loan origination fees, fees for commitments that are expected to be exercised and certain direct loan origination costs are deferred and the net amount is amortized over the life of the related loan or commitment period as a yield adjustment. Other fees, not associated with originating a loan are recognized as fee income when earned.
Delinquent and Nonaccrual Loans - Loans are reported as past due if contractual principal or interest payments are due and unpaid for 30 days or more. All loans that are over 90 days past due in principal or interest are considered "impaired" and placed on nonaccrual status. Management may also place some loans on nonaccrual status before they are 90 days past due if they meet the below definition of "impaired." When a loan is placed on nonaccrual status, accrued and unpaid interest credited to income is reversed and accretion of net deferred loan fees ceases. Subsequent receipts on nonaccrual loans are recorded as a reduction of principal, and interest income may only be recorded on a cash basis if the remaining book balance is deemed fully collectible. Nonaccrual loans are returned to accrual status when all delinquent principal and interest payments become current in accordance with the terms of the loan agreement and when the financial position of the borrower and other relevant factors indicate there is no longer doubt as to such collectibility.
Impaired Loans - Impaired loans consist of nonaccrual loans (which include nonaccrual troubled debt restructurings ("TDRs")) and loans classified as accruing TDRs. A loan is considered impaired when, based on current information and events, management believes that either it is probable that we will be unable to collect all amounts due (both principal and interest) according to the original contractual terms of the loan agreement or it has been classified as a TDR. Once a loan is determined to be impaired, the amount of impairment is measured based on the loan’s observable fair value; the fair value of the underlying collateral less selling costs if the loan is collateral-dependent; or the present value of expected future cash flows discounted at the loan’s effective interest rate.
If the measurement of the impaired loan is less than the recorded investment in the loan (including accrued interest, net of deferred loan fees and costs and unamortized premium or discount), impairment is recognized by creating a specific valuation reserve as a component of the allowance for loan losses. Impaired loans exceeding $500,000 are evaluated individually, while loans less than $500,000 are evaluated as pools using historical loss experience, as well as management’s loss expectations, for the respective asset class and product type.
All impaired loans and their related reserves are reviewed and updated each quarter. Any impaired loan for which a determination
has been made that the economic value is permanently reduced is charged-off against the allowance for loan losses to reflect its current economic value in the period in which the determination has been made.
At the time a collateral-dependent loan is initially determined to be impaired, we review the existing collateral appraisal. If the most recent appraisal is greater than one year old, a new appraisal is obtained on the underlying collateral. The Company generally obtains "as is" appraisal values for use in the evaluation of collateral-dependent impaired loans. Appraisals for collateral-dependent loans in excess of $500,000 are updated with new independent appraisals at least annually and are formally reviewed by our internal appraisal department. Additional diligence is also performed at the six-month interval between the independent appraisals. All impaired loans and their related reserves are reviewed and updated each quarter. If during the course of the six-month review process there is evidence supporting a meaningful decline in the value of the collateral, the appraised value is either internally adjusted downward or a new appraisal is required to support the value of the impaired loan. With an immaterial number of exceptions, all appraisals and internal reviews are current under this methodology at December 31, 2013.
Restructured Loans - Loans may be modified in the normal course of business for competitive reasons or to strengthen the Company’s position. Loan modifications and restructurings may also occur when the borrower experiences financial difficulty and needs temporary or permanent relief from the original contractual terms of the loan. These modifications are structured on a loan-by-loan basis, and depending on the circumstances, may include extensions of maturity dates, rate reductions, forgiveness of principal, or other concessions. The Company may also utilize a multiple note structure as a workout alternative for certain loans. The multiple note structure typically bifurcates a troubled loan into two separate notes, where the first note is reasonably assured of repayment and performance according to the modified terms, and the portion of the troubled loan that is not reasonably assured of repayment is charged-off. Loans that have been modified to accommodate a borrower who is experiencing financial difficulties, and for which the Company has granted a concession that it would not otherwise consider, are considered TDRs.
We consider many factors in determining whether to agree to a loan modification involving concessions, and seek a solution that will both minimize potential loss to the Company and attempt to help the borrower. We evaluate our borrowers’ current and forecasted future cash flows, their ability and willingness to make current contractual or proposed modified payments, the value of the underlying collateral (if applicable), the possibility of obtaining additional security or guarantees, and the potential costs related to a repossession or foreclosure and the subsequent sale of the collateral.
Restructured loans can involve loans remaining on nonaccrual, moving to nonaccrual, or continuing on accrual status, depending on the individual facts and circumstances of the borrower. Generally, a nonaccrual loan that is restructured remains on nonaccrual for a period of at least six months to ensure that the borrower performs in accordance with the restructured terms including consistent and timely loan payments. However, the borrower’s performance prior to the restructuring or other significant events at the time of the restructuring may be considered in assessing whether the borrower can meet the new terms and may result in the loan being returned to accrual status after a shorter performance period or concurrent with the restructuring. In such situations, the loan will be reported as a "restructured loan accruing interest." If the borrower’s performance under the new terms is not reasonably assured, the loan remains classified as a nonaccrual loan.
The allowance for loan losses on restructured loans is determined by discounting the restructured cash flows by the original effective interest rate, or if collateral-dependent, by obtaining an appraisal.
Allowance for Loan Losses (the "Allowance") - 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 is assessed quarterly and represents an accounting estimate of probable losses in the portfolio at each balance sheet date based on a review of available and relevant information at that time. The allowance consists of reserves for probable losses that have been identified relating to specific borrowing relationships that are individually evaluated for impairment ("the specific component"), as well as probable losses inherent in our loan portfolio that are not specifically identified ("the general allocated component"), which is determined using a methodology that is a function of quantitative and qualitative factors applied to segments of our loan portfolio as well as management’s judgment.
The specific component relates to impaired loans. Impaired loans consist of nonaccrual loans (which include nonaccrual TDRs) and loans classified as accruing TDRs. See "Impaired Loans" section of this Note 1 for a detailed discussion of the specific component of the allowance for loan losses.
To determine the general allocated component of the allowance for loan losses, we segregate loans by vintage ("transformational" and "legacy") and product type (e.g., commercial, commercial real estate) because of observable similarities in the historical performance experience of loans underwritten by these business units. In general, loans originated by the business units that existed prior to the strategic changes of the Company in 2007 are considered "legacy" loans. Loans originated by a business unit that was established in connection with or following the strategic business transformation plan are considered "transformational" loans.
Renewals or restructurings of legacy loans may continue to be evaluated as legacy loans depending on the structure or defining characteristics of the new transaction. The Company has implemented a line of business model that has reorganized the legacy business units so that after 2009, all new loan originations are considered transformational. At the time an accruing loan becomes modified and meets the definition of a TDR, it is considered impaired and is no longer included as part of the general allocated component. However, our general reserve methodology considers the amount and product type of the TDRs removed as one of many credit or portfolio considerations in establishing final reserve requirements.
The methodology produces an estimated range of potential loss exposure for the product types within each vintage. We consider the appropriate balance of the general allocated component of the reserve in relation to a variety of internal and external quantitative and qualitative factors to reflect data or timeframes not captured by the basic allowance framework as well as market and economic data and management judgment. In certain instances, these additional factors and judgments may lead management to conclude that the appropriate level of the reserve is outside the range determined through the basic allowance framework.
The product segments we evaluate in the general reserve methodology are commercial loans, commercial real estate loans, construction loans and consumer loans (which include personal loans, residential mortgage loans and home equity lines of credit). Our commercial loan portfolio includes lines of credit to businesses and term loans. Certain non-residential owner-occupied commercial real estate loans are also included in our commercial loan portfolio if the cash flows from the owner’s business serve as the primary source of loan repayment. Commercial loans contain risks unique to the business and market of each borrower and the repayment is dependent upon the financial success and viability of the borrower.
Commercial real estate loans comprise loans secured by various types of collateral including 1-4 family non-owner occupied housing units located primarily in our target market areas, multi-family real estate, office buildings, warehouses, retail space, mixed use buildings, and vacant land, the bulk of which is held for long-term investment or development. Risks inherent in real estate lending are related to the market value of the property taken as collateral, the underlying cash flows and the general economic condition of the market in which the collateral is located. Repayment is generally dependent on the ability of the borrower to attract tenants at rental rates that provide for debt service. Repayment of commercial real estate loans is also somewhat dependent on long term financing options available to the borrower.
Our construction loan portfolio consists of single-family residential properties, multi-family properties, and commercial projects, and includes both investment properties and properties that will be owner-occupied. Risks inherent in construction lending are similar to those in commercial real estate lending. Additional risks include unexpected cost increases or delays in constructing or improving a property, the borrower’s inability to use funds generated by a project to service a loan until a project is completed, the more pronounced risk to interest rate movements and the real estate market that these borrowers face while a project is being completed or seeking a buyer, and the lack of availability of permanent financing. Construction loans, as a product segment, have the highest inherent risk in our portfolio.
Consumer loans are a smaller portion of our overall portfolio and consist of residential home mortgages, home equity lines of credit and personal loans. The risk issues associated with these products are closely correlated to the U.S. housing market and the local markets in which the collateral resides and include home price declines and resulting increases in loan to value ratios, low sales volume, high unemployment rates, increases in foreclosure rates, and high delinquency rates. Some personal loans may be unsecured.
Determination of the allowance is inherently subjective, as it requires significant estimates, including the amounts and timing of expected future cash flows and collateral appraisal values on impaired loans; estimated losses on pools of homogeneous loans based on historical loss experience, risk ratings, product type, and vintage; and consideration of current economic trends and portfolio attributes, all of which may be susceptible to significant change. For instance, loss rates in our allowance methodology typically reflect the Company's more recent loss experience, by product, on a trailing twelve or eighteen month basis. These loss rates consider both cumulative charge-offs and other real estate owned ("OREO") valuation adjustments over the period in the individual product categories that constitute our allowance. Default estimates use a multi-year originating vintage and rating approach. In addition, we compare current model-derived and historically-established reserve levels to recent charge-off trends and history in considering the appropriate final level of reserve at each product level.
Credit exposures deemed to be uncollectible are charged-off against the allowance, while recoveries of amounts previously charged-off are credited to the allowance. A provision for loan losses, which is a charge against earnings, is recorded to bring the allowance for loan losses to a level that, in management’s judgment, is appropriate to absorb probable losses in the loan portfolio as of the balance sheet date.
Reserve for Unfunded Commitments - We maintain a reserve for unfunded commitments at a level we believe to be sufficient to absorb estimated probable losses related to unfunded credit facilities. The reserve is included in other liabilities on the
Consolidated Statements of Financial Condition. The reserve is computed using a methodology similar to that used to determine the general allocated component of the allowance for loan losses and is based on a model that uses recent commitment utilization patterns at the product level as a method of predicting future usage across the portfolio. Net adjustments to the reserve for unfunded commitments are included in other non-interest expense in the Consolidated Statements of Income.
Purchased Loans - Purchased loans acquired through portfolio purchases or in a business combination are accounted for under specialized accounting guidance when the loans have evidence of credit deterioration at the time of acquisition and 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 nonaccrual status, declines in borrower FICO scores, geographic concentration and declines in loan-to-value ratios. U.S. GAAP requires these loans to be recorded at fair value at the acquisition date and prohibits the "carrying over" or creation of valuation allowances in the initial accounting for loans acquired in a transfer.
The fair values for purchased impaired loans are determined by discounting cash flows expected to be collected using an observable discount rate for similar instruments with adjustments to the discount rate that management believes a market participant would consider in determining fair value. We estimate the timing and amount of cash flows expected to be collected at acquisition using internal models that incorporate management’s best estimate of current key assumptions, such as default rates, loss severity and payment speeds.
Under the applicable accounting guidance for purchased impaired loans, 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 the 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. Decreases in expected cash flows subsequent to acquisition generally result in an allowance for loan losses. Subsequent increases in cash flows result in a reversal of the allowance for losses to the extent previously established or a prospective adjustment to the accretable yield. Purchased impaired loans with common risk characteristics are accounted for on a pool basis as a single asset with a single composite interest rate and an aggregate expectation of cash flows. Because we are recognizing interest income on each pool of loans, they are all considered to be performing.
U.S. GAAP requires purchased loans not subject to the specialized accounting guidance ("purchased non-impaired loans") to be recorded at fair value at the acquisition date and prohibits the "carrying over" or creation of valuation allowances in the initial accounting for loans acquired in a transfer. 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. Decreases in expected cash flows after the purchase date are recognized by recording an allowance for loan losses.
Covered Assets - Purchased loans and foreclosed loan collateral covered under loss sharing or similar credit protection agreements with the Federal Deposit Insurance Corporation ("FDIC") are reported separately on the face of the Consolidated Statements of Financial Condition inclusive of the fair value of reimbursement cash flows the Company expects to receive from the FDIC under the agreement. The allowance for covered loan losses is determined without regard to the expected reimbursement from the FDIC with any provision for covered loan loss charges recorded in the Consolidated Statements of Income reflected net of such FDIC reimbursement.
Other Real Estate Owned ("OREO") - OREO is comprised of property acquired through foreclosure proceedings or acceptance of a deed-in-lieu of foreclosure in partial or total satisfaction of certain loans. Properties are initially recorded at fair value less estimated selling costs. Any write-downs in the carrying value of a property at the time of acquisition are charged against the allowance for loan losses. Subsequent to initial recognition, OREO is recorded at the lower of the initial cost basis or current fair value. Any subsequent write-downs to reflect current fair value, as well as gains or losses on disposition and revenues or expenses incurred in maintaining such properties are treated as period costs and reported in non-interest expense in the Consolidated Statements of Income.
Depreciable Assets - Premises, leasehold improvements, furniture and equipment, and software are stated at cost less accumulated depreciation. Depreciation expense is determined by the straight-line method over the estimated useful lives of the assets. Leasehold improvements are amortized on a straight-line basis over the shorter of the life of the asset or the lease term. Rates of depreciation are generally based on the following useful lives: buildings, 30-40 years; leasehold improvements, typically 1-16 years; furniture and equipment, 3-7 years; and software, 3-5 years. Gains on dispositions are included in other income, and losses on dispositions are included in other expense in the Consolidated Statements of Income. Maintenance and repairs are charged to operating expenses as incurred, while improvements that extend the useful life of assets are capitalized and depreciated over the estimated remaining life.
Long-lived depreciable assets are evaluated periodically for impairment when events or changes in circumstances indicate the carrying amount may not be recoverable. Impairment exists when the expected undiscounted future cash flows of a long-lived asset are less than its carrying value. In that event, the Company recognizes a loss equal to the difference between the carrying amount and the estimated fair value of the asset based on a quoted market price, if applicable, or a discounted cash flow analysis. Impairment losses are recorded in other non-interest expense in the Consolidated Statements of Income.
Bank Owned Life Insurance ("BOLI") - BOLI represents life insurance policies on the lives of certain Company officers or former officers for which the Company is the beneficiary. These policies are recorded as an asset on the Consolidated Statements of Financial Condition at their cash surrender value, or the amount that could be realized currently. The change in cash surrender value and insurance proceeds received are recorded as BOLI income in non-interest income in the Consolidated Statements of Income.
Goodwill and Other Intangible Assets - Goodwill represents the excess of purchase price over the fair value of net assets acquired (including identifiable intangible assets) using the acquisition method of accounting. Other intangible assets represent purchased assets that 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.
Goodwill is allocated to reporting units at acquisition. We have determined that our operating segments qualify as reporting units under U.S. GAAP, and goodwill is allocated to the Banking and Trust and Investments reporting units. Subsequent to initial recognition, goodwill is not amortized but, instead, is tested for impairment at the reporting unit level at least annually or more often if an event occurs or circumstances change that would indicate it is more likely than not that the fair value of a reporting unit is less than its carrying amount. We perform our annual goodwill impairment assessment as of October 31 each year. In the event we conclude that all or a portion of our goodwill is impaired, a non-cash charge for the amount of such impairment would be recorded in earnings. Such a charge would have no impact on tangible or regulatory capital.
The goodwill impairment testing process is conducted by assigning net assets and goodwill to each reporting unit. In "step one," the fair value of each reporting unit is compared to the recorded book value. Our step one calculation of each reporting unit’s fair value is based upon a simple average of two metrics: (1) a primary market approach, which measures fair value based upon trading multiples of independent publicly traded financial institutions of comparable size and character to the reporting units, and (2) an income approach, which estimates fair value based upon discounted cash flows and terminal value (using the perpetuity growth method). If the fair value of the reporting unit exceeds its carrying value, goodwill is not considered impaired and "step two" is not considered necessary. If the carrying value of a reporting unit exceeds its fair value, the impairment test continues ("step two") by comparing the carrying value of the reporting unit’s goodwill to the implied fair value of goodwill. The implied fair value of goodwill is determined using the residual approach, where the fair value of a reporting unit is allocated to all of the assets and liabilities of that unit as if the reporting unit had been acquired in a business combination and the fair value of the reporting unit, calculated in step one, is the price paid to acquire the reporting unit. The excess of the fair value of the reporting unit over the amounts assigned to its assets and liabilities is the implied fair value of goodwill. An impairment charge is recognized to the extent the carrying value of goodwill exceeds the implied fair value of goodwill.
The Company has the option at the time of its annual impairment test to perform a qualitative assessment for each reporting unit to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value before applying the existing two-step goodwill impairment test. If the Company concludes it is more likely than not, the Company would proceed with the existing two-step test, as described above. Otherwise, the Company would be able to bypass the two-step test and conclude that goodwill is not impaired from a qualitative perspective.
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 Company’s other intangible assets have finite lives and are amortized over their estimated useful lives with varying periods not exceeding 12 years.
Fiduciary Assets and Assets Under Management - Assets held in a fiduciary capacity for clients are not included in the consolidated financial statements as they are not assets of the Company or its subsidiaries. Fiduciary and asset management fees are generally determined based upon market values of assets under management as of a specified date during the period and are included as a component of non-interest income in the Consolidated Statements of Income.
Advertising Costs - All advertising costs are expensed in the period they are incurred.
Loss Contingencies - Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated.
Derivative Instruments - We utilize an overall risk management strategy that incorporates the use of derivative instruments to reduce interest rate risk, as it relates to mortgage loan commitments and planned sales of loans, and foreign currency volatility. We also use these instruments to accommodate our clients as we provide them with risk management solutions, including interest rate and foreign currency contracts. None of the aforementioned end-user and client-related derivatives were designated as hedging instruments at December 31, 2013 and 2012.
We also use interest rate derivatives to hedge variability in forecasted interest cash flows in our loan portfolio which is comprised primarily of floating-rate loans. These derivatives are designated as cash flow hedges.
All derivative instruments are recorded at fair value on the Consolidated Statements of Financial Condition, after considering the effects of master netting agreements as allowed under authoritative accounting guidance.
On the date we enter into a derivative contract, we designate the derivative instrument as a fair value hedge, cash flow hedge, or as a freestanding derivative instrument. Derivative instruments designated in a hedge relationship to mitigate exposure to changes in the fair value of an asset or liability attributable to a particular risk, such as interest rate risk, are considered to be fair value hedges. Derivative instruments designated in a hedge relationship to mitigate exposure to variability in the cash flows of a recognized asset or liability of a forecasted transaction are considered to be cash flow hedges. We formally document all relationships between hedging instruments and hedged items, as well as our risk management objective and strategy for undertaking each hedge transaction.
For derivative instruments that are designated and qualify as a fair value hedge and are effective, the gain or loss on the derivative instrument, as well as the offsetting loss or gain on the hedged item attributable to the hedged risk, are recognized in current earnings during the period of the change in fair values. For derivative instruments that are designated and qualify as a cash flow hedge, the effective portion of the gain or loss on the derivative instrument is reported as a component of OCI. The unrealized gain or loss is reclassified into earnings in the same period or periods during which the hedged item affects earnings. For all hedge relationships, derivative gains and losses not effective in hedging the change in fair value or expected cash flows of the hedged item are recognized immediately in current earnings during the period of change. For derivatives not designated in a hedge relationship, changes in fair value are reported in current earnings during the period of change.
At the hedge’s inception and at least quarterly thereafter, a formal assessment is performed to determine whether changes in the fair values or cash flows of the derivative instruments have been highly effective in offsetting changes in the fair values or cash flows of the hedged item and whether they are expected to be highly effective in the future. If a derivative instrument designated as a hedge is terminated or ceases to be highly effective, hedge accounting is discontinued prospectively and the gain or loss is amortized to earnings over the remaining life of the hedged asset or liability (fair value hedge) or over the same period(s) that the forecasted hedged transactions impact earnings (cash flow hedge). However, if the forecasted transaction is probable of not occurring, the gain or loss is included in earnings immediately.
The Company classifies cash flows from derivative instruments designated in a hedge relationship in the same category as the cash flows from the items being hedged as long as the derivatives do not include an other-than-insignificant financing element.
Income Taxes - The Company and its subsidiaries file a consolidated Federal income tax return. The provision for income taxes is based on income reported in the Consolidated Statements of Income, rather than amounts reported on our income tax return.
We recognize a deferred tax asset or liability for the estimated future tax effects attributable to "temporary differences." Temporary differences include differences between financial statement income and tax return income that are expected to reverse in future periods, as well as differences between the financial reporting and tax bases of assets and liabilities that are also expected to be settled in future periods. Deferred tax assets and liabilities are measured using the enacted tax rates that we expect will apply when the differences are reversed or settled. Changes in corporate income tax rates, if any, would impact the pricing of our deferred tax assets and liabilities in the period of enactment, with any changes in the valuation of deferred tax assets and liabilities reflected as an adjustment to income tax expense. A valuation allowance is recorded to reduce deferred tax assets to the amount management concludes is more likely than not to be realized.
We periodically review and evaluate the status of uncertain tax positions and may establish tax reserves for tax benefits that may not be realized. Any income tax-related interest and penalties are included in income tax expense.
Net Earnings Per Common Share - Basic income per common share is calculated using the two-class method. The two-class method is an earnings allocation formula that determines earnings per share for each share of common stock and participating securities according to dividends declared (distributed earnings) and participation rights in undistributed earnings. Distributed and
undistributed earnings are allocated between common and participating security stockholders based on their respective rights to receive dividends. Unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents are considered participating securities (i.e., the Company’s deferred stock units and nonvested restricted stock awards and restricted stock units). Undistributed net losses are not allocated to holders of participating securities, as they do not have a contractual obligation to fund the losses incurred by the Company. Net income attributable to common shares is then divided by the weighted-average number of common shares outstanding during the period, net of participating securities.
Diluted income per common share considers common stock issuable under the assumed release of nonvested restricted stock awards and units and the assumed exercise of stock options granted under the Company’s stock plans ("potentially dilutive common stock equivalents"). The dilutive effect of these share-based payment awards that are not deemed to be participating securities is calculated using the treasury stock method, which assumes that the proceeds from exercise are used to purchase common stock at the average market price for the period. The dilutive effect of participating securities is calculated using the more dilutive of the treasury stock method (which assumes that the participating securities are exercised/released) or the two-class method (which assumes that the participating securities are not exercised/released and earnings are reallocated between common and participating security stockholders). Potentially dilutive common stock equivalents are excluded from the computation of diluted earnings per common share in periods in which the effect would be antidilutive.
Treasury Stock - Treasury stock acquired is recorded at cost and is carried as a reduction of equity on the Consolidated Statements of Financial Condition.
Share-Based Compensation - Share-based compensation cost is recognized as expense for stock options, restricted stock awards, and restricted stock units issued to employees and non-employee directors based on the fair value of these awards at the date of grant. A binomial option-pricing model is utilized to estimate the fair value of stock options, while the closing market price of the Company’s common stock at the date of grant is used for restricted stock awards, restricted stock units and performance share units ("full value awards"). To the extent full value awards are subject to post-vesting transferability restrictions, a discount for lack of marketability may be applied to the grant date fair value. The costs are recognized ratably on a straight-line basis over the requisite service period, generally defined as the vesting period for the awards. For performance share units, an estimate is made as to the number of shares expected to vest as a result of actual performance against the performance criteria to determine the amount of compensation expense to be recognized. The estimate is re-evaluated quarterly and total compensation expense is adjusted for any change in the current period. When an award is granted to an employee who is retirement eligible or who will become retirement eligible prior to the end of the service period and will continue to vest after retirement, the compensation cost of these awards is recognized over the period up to the date an employee first becomes eligible to retire. The amortization of share-based compensation generally reflects estimated forfeitures adjusted for actual forfeiture experience. As compensation expense is recognized, a deferred tax asset is recorded that represents an estimate of the future tax deduction from exercise or release of restrictions. At the time share-based awards expire, are exercised or canceled, or as restrictions are released, we may be required to recognize an adjustment to stockholders’ equity or income tax expense, depending on the market price of the Company’s stock at that time and the amount of the deferred tax asset relating to such awards. Share-based compensation expense is included in "salaries and wages" in the Consolidated Statements of Income.
Comprehensive Income - Comprehensive income consists of two components, reported net income and OCI. OCI refers to revenue, expenses, gains, and losses that are recorded as an element of equity but are excluded from reported net income. OCI consists of unrealized gains (losses) on securities available-for-sale and changes in the fair value of derivative instruments designated as cash flow hedges, net of tax.
Segment Disclosures - An operating segment is a component of a business that (i) engages in business activities from which it may earn revenues and incur expenses; (ii) has operating results that are reviewed regularly by the entity’s chief operating decision maker to make decisions about resources to be allocated to the segment and assess its performance; and (iii) has discrete financial information available. Our chief operating decision maker evaluates the operations of the Company under three operating segments: Banking, Trust and Investments, and Holding Company. Refer to Note 21 for additional disclosure regarding the performance of our operating segments.
Variable Interest Entities - A variable interest entity ("VIE") is a partnership, limited liability company, trust, or other legal entity that does not have sufficient equity to permit it to finance its activities without additional subordinated financial support from other parties, or whose investors lack one of three characteristics associated with owning a controlling financial interest. Those characteristics are: (i) the power, through voting rights or similar rights, to direct the activities of an entity that most significantly impact the entity’s economic performance, (ii) the obligation to absorb the expected losses of an entity; and (iii) the right to receive the expected residual returns of the entity.
U.S. GAAP requires VIEs to be consolidated by the party that has a controlling financial interest in the VIE (i.e., the primary beneficiary). The Company is deemed to have a controlling financial interest and is the primary beneficiary of a VIE if it has both the power to direct the activities of the VIE that most significantly impact the VIE’s economic performance and an obligation to absorb losses or the right to receive benefits that could potentially be significant to the VIE.
2. RECENT ACCOUNTING PRONOUNCEMENTS
Recently Adopted Accounting Pronouncements
Disclosures about Offsetting Assets and Liabilities - On January 1, 2013, we adopted new accounting guidance issued by the Financial Accounting Standards Board ("FASB") relating to disclosure requirements on offsetting financial assets and liabilities. The new disclosure requirements are limited to recognized derivatives, repurchase agreements and reverse repurchase agreements, and securities borrowing and lending transactions that are either offset on the statement of financial position or subject to enforceable master netting arrangements or similar agreements. At a minimum, we are required to disclose the following information separately for financial assets and liabilities: (a) the gross amounts of recognized financial assets and liabilities, (b) the amounts offset under current U.S. GAAP, (c) the net amounts presented in the balance sheet, (d) the amounts subject to an enforceable master netting arrangement or similar agreement that were not included in (b), and (e) the difference between (c) and (d). This guidance affected our disclosures, however adoption of the guidance did not impact our financial position or consolidated results of operations. Refer to Note 18 for the required disclosures.
Subsequent Accounting for Indemnification Assets Recognized in a Government-Assisted Acquisition - On January 1, 2013, we adopted new accounting guidance issued by the FASB to clarify the subsequent accounting for an indemnification asset recognized as a result of a government-assisted acquisition of a financial institution that included a loss sharing agreement. The guidance clarifies that subsequent changes in expected cash flows related to an indemnification asset should be amortized over the shorter of the life of the indemnification agreement or the life of the underlying covered assets. This guidance is applicable for new indemnification assets as well as existing indemnification assets, such as our indemnification receivable recorded in conjunction with the acquired loans and foreclosed loan collateral covered under our loss sharing agreement with the FDIC. As we previously accounted for our indemnification asset in accordance with this guidance, the adoption of this guidance did not impact our financial position or consolidated results of operations.
Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income - On January 1, 2013, we adopted new accounting guidance issued by the FASB that requires disclosure of the effect of reclassifications from accumulated other comprehensive income into net income for each affected net income line item. We have two items that are reclassified out of accumulated other comprehensive income and into net income to which this guidance is applicable, namely (1) net gains (losses) on available-for-sale securities, and (2) net gains (losses) on cash flow hedges. The guidance did not change existing requirements for reporting net income or other comprehensive income in the financial statements. This guidance affected our disclosures, however the adoption of the guidance did not impact our financial position or consolidated results of operations. Refer to Note 13 for the required disclosures.
3. SECURITIES
Securities Portfolio
(Amounts in thousands)
The carrying value of securities pledged to secure public deposits, FHLB advances, trust deposits, Federal Reserve Bank ("FRB") discount window borrowing availability, derivative transactions, standby letters of credit with counterparty banks and for other purposes as permitted or required by law, totaled $401.4 million and $455.6 million at December 31, 2013 and 2012, respectively. Of total pledged securities, securities pledged to creditors under agreements pursuant to which the collateral may be sold or re-pledged by the secured parties totaled $108.1 million and $144.2 million at December 31, 2013 and 2012, respectively.
Excluding securities issued or backed by the U.S. Government and its agencies and U.S. Government-sponsored enterprises, there were no investments in securities from one issuer that exceeded 10% of consolidated equity at December 31, 2013 or 2012.
The following table presents the fair values of securities with unrealized losses as of December 31, 2013 and 2012. 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)
There were $38.9 million of securities with $2.6 million in an unrealized loss position for greater than 12 months at December 31, 2013. At December 31, 2012, there were $3.3 million of securities with $27,000 in an unrealized loss position greater than 12 months. The Company does not consider these unrealized losses to be credit-related. These unrealized losses primarily relate to changes in interest rates and market spreads. We do not intend to sell the securities and it is not more likely than not that we will be required to sell the investments before recovery of their amortized cost bases, which may be at maturity. Accordingly, no other-than-temporary impairments have been recorded on these securities during 2013 or 2012.
The following table presents the remaining contractual maturity of securities as of December 31, 2013 by amortized cost and fair value.
Remaining Contractual Maturity of Securities
(Amounts in thousands)
The following table presents gains (losses) on securities for the three years ended 2013, 2012, and 2011.
Securities Gains (Losses)
(Amounts in thousands)
(1)
Includes net losses of $520,000, and $41,000 in 2012 and 2011, respectively, associated with certain investment funds that make qualifying investments for purposes of supporting our community reinvestment initiatives in accordance with the Community Reinvestment Act ("CRA" investments). These investments are classified in other assets in the Consolidated Statements of Financial Condition. Effective in fourth quarter 2012, net losses from these investments are recorded in other non-interest expense in the Consolidated Statements of Income.
Refer to Note 13 for additional details of the securities available-for-sale portfolio and the related impact of unrealized gains (losses) on other comprehensive income.
4. LOANS
The following loan portfolio and credit quality disclosures exclude covered loans. Covered loans represent loans acquired through an FDIC-assisted transaction that are subject to a loss share agreement and are presented separately in the Consolidated Statements of Financial Condition. Refer to Note 6 for a detailed discussion regarding covered loans.
Loan Portfolio
(Amounts in thousands)
We primarily lend to businesses and consumers in the market areas in which we have physical locations. We seek to diversify our loan portfolio by loan type, industry, and borrower.
Carrying Value of Loans Pledged
(Amounts in thousands)
(1)
No borrowings were outstanding at December 31, 2013 or 2012.
Related Party Loans
Some of our executive officers and directors are clients of our Bank, and some of our executive officers and directors are direct or indirect owners of 10% or more of the stock of corporations which are, or have been in the past, clients of the Bank. As clients, they have had transactions with the Bank, in the ordinary course of business of the Bank, including borrowings, that are or were on substantially the same terms (including interest rates and collateral on loans) as those prevailing at the time for comparable transactions with non-affiliated persons. These loans totaled $14.2 million and $15.5 million at December 31, 2013 and 2012, respectively. In the opinion of management, none of the transactions involved more than the normal risk of collectability or presented any other unfavorable features.
Loan Portfolio Aging
Loan Portfolio Aging
(Amounts in thousands)
Impaired Loans
Impaired loans consist of nonaccrual loans (which include nonaccrual TDRs) and loans classified as accruing TDRs. A loan is considered impaired when, based on current information and events, management believes that either it is probable that we will be unable to collect all amounts due (both principal and interest) according to the original contractual terms of the loan agreement or it has been classified as a TDR. The following two tables present our recorded investment on impaired loans outstanding by product segment, including our recorded investment in impaired loans, which represents the principal amount outstanding, net of unearned income, deferred loan fees and costs, and any direct principal charge-offs.
Impaired Loans
(Amounts in thousands)
Average Recorded Investment and Interest Income Recognized on Impaired Loans (1)
(Amounts in thousands)
(1)
Represents amounts while classified as impaired for the periods presented.
Credit Quality Indicators
We have adopted an internal risk rating policy in which each loan is rated for credit quality with a numerical rating of 1 through 8. Loans rated 5 and better (1-5 ratings, inclusive) are credits that exhibit acceptable financial performance, cash flow, and leverage. We attempt to mitigate risk by loan structure, collateral, monitoring, and other credit risk management controls. Credits rated 6 are performing in accordance with contractual terms but are considered "special mention" as these credits demonstrate potential weakness that if left unresolved, may result in deterioration in the Company’s credit position and/or the repayment prospects for the credit. Borrowers rated special mention may exhibit adverse operating trends, high leverage, tight liquidity or other credit concerns. Loans rated 7 may be classified as either accruing ("potential problem") or nonaccrual ("nonperforming"). Potential problem loans, like special mention, are loans that are performing in accordance with contractual terms, but for which management has some level of concern (greater than that of special mention loans) about the ability of the borrowers to meet existing repayment terms in future periods. These loans continue to accrue interest but the ultimate collection of these loans in full is questionable due to the same conditions that characterize a 6-rated credit. These credits may also have somewhat increased risk profiles as a result of the current net worth and/or paying capacity of the obligor or guarantors or the value of the collateral pledged. These loans generally have a well-defined weakness that may jeopardize collection of the debt and are characterized by the distinct possibility that the Company may sustain some loss if the deficiencies are not resolved. Although these loans are generally identified as potential problem loans and require additional attention by management, they may never become nonperforming. Nonperforming loans include nonaccrual loans risk rated 7 or 8 and have all the weaknesses inherent in a 7-rated potential problem loan with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently-existing facts, conditions and values, highly questionable and improbable. Special mention, potential problem and nonperforming loans are reviewed at a minimum on a quarterly basis, while all other rated credits over a certain dollar threshold, depending on loan type, are reviewed annually or more frequently as the situation warrants.
Credit Quality Indicators
(Dollars in thousands)
*
Less than 0.1%
Troubled Debt Restructured Loans
Troubled Debt Restructured Loans Outstanding
(Amounts in thousands)
At December 31, 2013 and 2012, credit commitments to lend additional funds to debtors whose loan terms have been modified in a TDR (both accruing and nonaccruing) totaled $5.5 million and $16.3 million, respectively.
Additions to Accruing Troubled Debt Restructurings During the Year
(Dollars in thousands)
(1)
Represents amounts outstanding as of the date immediately prior to and immediately after the modification is effective.
(2)
Extension of maturity date also includes loans renewed at existing rate of interest which is considered a below market rate for that particular loan’s risk profile.
(3)
Other concessions primarily include interest rate reductions, loan increases, or deferrals of principal.
(4)
The multiple note structure typically bifurcates a troubled loan into two separate notes, where the first note is reasonably assured of repayment and performance according to the modified terms, and the portion of the troubled loan that is not reasonably assured of repayment is charged-off.
Additions to Nonaccrual Troubled Debt Restructurings During the Period
(Dollars in thousands)
(1)
Represents amounts outstanding as of the date immediately prior to and immediately after the modification is effective.
(2)
Extension of maturity date also includes loans renewed at existing rate of interest which is considered a below market rate for that particular loan’s risk profile.
(3)
Other concessions primarily include interest rate reductions, loan increases, or deferrals of principal.
At the time an accruing loan becomes modified and meets the definition of a TDR, it is considered impaired and no longer included as part of the general loan loss reserve calculation. However, our general reserve methodology considers the amount and product type of the TDRs removed as a proxy for potentially heightened risk in the portfolio when establishing final reserve requirements.
As impaired loans, TDRs (both accruing and nonaccruing) are evaluated for impairment at the end of each quarter with a specific valuation reserve created, or adjusted (either individually or as part of a pool), if necessary, as a component of the allowance for loan losses. Refer to the "Impaired Loan" and "Allowance for Loan Loss" sections of Note 1 regarding our policy for assessing potential impairment on such loans. Our allowance for loan losses included $8.6 million and $23.3 million in specific reserves for nonaccrual TDRs at December 31, 2013 and 2012, respectively. For accruing TDRs there were specific reserves of $37,000 and $40,000 at December 31, 2013 and 2012, respectively, with the specific reserve representing the difference between the present value of cash flows for the restructured loan as compared to the original loan.
The following table presents the recorded investment and number of loans modified as an accruing TDR during the previous 12 months which subsequently became nonperforming during the years ended December 31, 2013 and 2012. A loan becomes nonperforming and placed on nonaccrual status typically when the principal or interest payments are 90 days past due based on contractual terms or when an individual analysis of a borrower’s creditworthiness indicates a loan should be placed on nonaccrual status earlier than when the loan becomes 90 days past due.
Accruing Troubled Debt Restructurings
Reclassified as Nonperforming Within 12 Months of Restructuring
(Dollars in thousands)
(1)
Represents amounts as of the balance sheet date from the quarter the default was first reported.
5. ALLOWANCE FOR LOAN LOSSES AND RESERVE FOR UNFUNDED COMMITMENTS
The following allowance and credit quality disclosures exclude covered loans. Refer to Note 6 for a detailed discussion regarding covered loans.
Allowance for Loan Losses and Recorded Investment in Loans
(Amounts in thousands)
(1)
Refer to Notes 1 and 4 for additional information regarding impaired loans.
(1)
Refer to Notes 1 and 4 for additional information regarding impaired loans.
(1)
Refer to Notes 1 and 4 for additional information regarding impaired loans.
Reserve for Unfunded Commitments (1)
(Amounts in thousands)
(1)
Unfunded commitments include commitments to extend credit, standby letters of credit and commercial letters of credit. Covered assets are excluded as they are covered under a loss sharing agreement with the FDIC.
Refer to Note 19 for additional details of commitments to extend credit, standby letters of credit and commercial letters of credit.
6. COVERED ASSETS
Covered assets represent acquired loans and foreclosed loan collateral covered under a loss sharing agreement with the FDIC and include an indemnification receivable representing the present value of the expected reimbursement from the FDIC related to expected losses on the acquired loans and foreclosed real estate under such agreement. The carrying amount of covered assets is presented in the following table.
Covered Assets
(Amounts in thousands)
(1)
Excludes purchased impaired loans which are accounted for on a pool basis based on common risk characteristics as a single asset with a single composite interest rate and an aggregate expectation of cash flows. Because we are recognizing interest income on each pool of loans, all purchased impaired loans are considered to be performing.
At the date of purchase, all purchased loans and the related indemnification asset were recorded at fair value. On an ongoing basis, the accounting for purchased loans and the related indemnification asset follows applicable authoritative accounting guidance for purchased nonimpaired loans and purchased impaired loans. The amounts we ultimately realize on these loans and the related indemnification asset could differ materially from the carrying value reflected in these financial statements, based upon the timing and amount of collections on the acquired loans in future periods compared to what is assumed in our current estimate of cash flows. Our losses on loans and foreclosed real estate may be mitigated to the extent covered under the specific terms and provisions of our loss share agreement with the FDIC. The loss share agreement expires on September 30, 2014 for non-single family homes and September 30, 2019 for single family homes.
The allowance for covered loan losses is determined in a manner consistent with our policy for the originated loan portfolio.
The following table presents changes in the allowance for covered loan losses for the periods presented.
Allowance for Covered Loan Losses
(Amounts in thousands)
(1)
Includes a provision for credit losses of $632,000, $549,000, and $2.3 million recorded in the Consolidated Statements of Income for the years ended December 31, 2013, 2012, and 2011, respectively, representing our 20% non-reimbursable portion of losses under the loss share agreement.
Changes in the carrying amount and accretable yield for purchased impaired loans are set forth in the following table.
Change in Purchased Impaired Loans Accretable Yield and Carrying Amount
(Amounts in thousands)
(1)
Includes transfers to covered foreclosed real estate.
7. PREMISES, FURNITURE, AND EQUIPMENT
Premises, Furniture, and Equipment
(Amounts in thousands)
Depreciation expense on premises, furniture, and equipment totaled $8.5 million in 2013, $9.3 million in 2012, and $8.8 million in 2011.
At December 31, 2013, we were obligated under certain non-cancellable operating leases for premises and equipment, which expire at various dates through the year 2023. Many of these leases contain renewal options, and certain leases provide a right of refusal to purchase the leased property during the lease term. Some leases contain escalation clauses calling for rentals to be adjusted for increased real estate taxes and other operating expenses, or proportionately adjusted for increases in the consumer or other price indices. The following summary reflects the future minimum rental payments, by year, required under operating leases that, as of December 31, 2013, have initial or remaining non-cancellable lease terms in excess of one year.
Operating Leases (1)
(Amounts in thousands)
(1)
Minimum payments have not been reduced by minimum sublease rentals of $231,000 due in the future under non-cancellable subleases.
(1)
Including amounts paid under short-term cancellable leases.
(2)
Does not include rental expense or sublease rental income for certain restructured leases.
8. GOODWILL AND OTHER INTANGIBLE ASSETS
Changes in the Carrying Amount of Goodwill by Reporting Unit
(Amounts in thousands)
In connection with the sale of Lodestar Investment Counsel, LLC ("Lodestar") on December 31, 2013, an investment management firm and previously a wholly-owned subsidiary of the Company, $226,000 of the goodwill assigned to the Trust and Investment reporting unit was allocated to Lodestar and written off. A goodwill impairment charge of $146,000 was recorded in connection with the sale. Goodwill also decreased $254,000 due to an adjustment for tax benefits associated with the goodwill attributable to Lodestar.
For our annual goodwill impairment test performed as of October 31, 2013, as permitted under current accounting guidance, we elected to not perform a qualitative assessment and instead chose to proceed with the quantitative two-step test. As a result of our step one analysis, we determined that the fair value of both the Banking and Trust and Investments (excluding Lodestar) reporting units exceeded their respective carrying amounts. As such, both of our reporting units with allocated goodwill "passed" step one of the goodwill impairment test, and no further analysis was required to support the conclusion that goodwill was not impaired as of October 31, 2013. The Banking reporting unit's fair value exceeded its carrying amount by approximately 73%, while the Trust and Investments reporting unit's fair value exceeded its carrying amount by approximately 161%.
The fair value of the reporting units as determined in our annual goodwill impairment test resulted in an implied control premium in excess of our market capitalization of approximately 20%. We believe this control premium is reasonable and supports the appropriate estimation of the reporting units' fair value as compared to our market capitalization.
We are not aware of any events or circumstances subsequent to our annual goodwill impairment testing date of October 31, 2013 that would indicate impairment of goodwill allocated to the Banking and Trust and Investment (excluding Lodestar) reporting units at December 31, 2013. There were no impairment charges for goodwill recorded in 2012 or 2011.
We have other intangible assets capitalized on the Consolidated Statements of Financial Condition in the form of core deposit premiums and client relationships. These intangible assets are being amortized over their estimated useful lives, which range from 8 to 12 years.
We review intangible assets for possible impairment whenever events or changes in circumstances indicate that carrying amounts may not be recoverable. In connection with the sale of Lodestar on December 31, 2013, we reduced the client relationships intangibles net carrying amount by $815,000. During 2013, there were no events or circumstances to indicate there may be impairment of intangible assets, and no impairment charges for other intangible assets were recorded in 2013, 2012, or 2011.
Other Intangible Assets
(Amounts in thousands)
Scheduled Amortization of Other Intangible Assets
(Amounts in thousands)
9. DEPOSITS
Summary of Deposits
(Amounts in thousands)
(1)
Includes deposits which, to our knowledge, have been placed with the Bank by a person who acts as a broker in placing these deposits on behalf of others or are otherwise deemed to be "brokered" by bank regulatory rules and regulations such as deposits under the CDARS® deposit program ("brokered time deposits").
Maturities of Time Deposits of $100,000 or More (1)
(Amounts in thousands)
(1)
Includes brokered time deposits.
10. SHORT-TERM AND SECURED BORROWINGS
Summary of Short-Term Borrowings
(Dollars in thousands)
(1)
Our total availability of overnight fed fund borrowings is not a committed line of credit and is dependent upon lender availability.
(2)
Includes federal term auction facilities. Our borrowing capacity changes each quarter subject to available collateral and FRB discount factors.
As a member of the FHLB Chicago, we have access to a borrowing capacity of $645.6 million at December 31, 2013, of which $395.3 million is available subject to the availability of acceptable collateral to pledge. Qualifying residential, multi-family and commercial real estate loans, home equity lines of credit, and residential mortgage-backed securities are held as collateral towards current outstanding balances and additional borrowing availability. FHLB advances reported as short-term borrowings represent advances with a remaining maturity of one year or less at December 31, 2013.
In September 2013, the Company entered into a 364-day Revolving Line of Credit (the "Facility") with a group of commercial banks allowing borrowing of up to $60.0 million, converting to an amortizing term loan on or before the maturity date of September 27, 2015. The interest rate applied on the Facility will be at the Company's discretion either 30-day or 90-day LIBOR plus 1.95% or Prime minus 0.50% at the time the advance is made. At December 31, 2013, no amounts have been drawn on the Facility.
Also included in short-term and secured borrowings on the Consolidated Statements of Financial Condition are amounts related to certain loan participation agreements on loans we originated that were classified as secured borrowings as they did not qualify for sale accounting treatment. As of December 31, 2013, these loan participation agreements totaled $6.4 million. A corresponding amount was recorded within loans on the Consolidated Statements of Financial Condition.
11. LONG-TERM DEBT
Long-Term Debt
(Dollars in thousands)
(1)
Variable rate in effect at December 31, 2013, based on three-month LIBOR +2.65%.
(2)
Variable rate in effect at December 31, 2013, based on three-month LIBOR +1.71%.
(3)
Variable rate in effect at December 31, 2013, based on three-month LIBOR +1.50%.
(4)
Variable rate in effect at December 31, 2012, based on three-month LIBOR +3.50%.
(a)
Qualifies as Tier 1 capital for regulatory capital purposes under current guidelines. Under the final regulatory capital rules issued in July 2013, these instruments are grandfathered for inclusion as a component of Tier 1 capital, although the Tier 1 capital treatment for these instruments will be subject to phase-out if an organization exceeds $15 billion in total consolidated assets due to acquisitions.
(b)
Qualifies as Tier 2 capital for regulatory capital purposes.
(c)
For regulatory capital purposes, as of December 31, 2012, 40%, of the outstanding balance qualified as Tier 2 capital.
The $244.8 million in junior subordinated debentures reflected in the table above were issued to four separate wholly-owned trusts for the purpose of issuing Company-obligated mandatorily redeemable trust preferred securities. Refer to Note 12 for further information on the nature and terms of these and previously issued debentures.
FHLB long-term advances, which had a combination of fixed and floating interest rates, were all secured by residential mortgage-backed securities.
The subordinated debt facility of the Company’s wholly-owned bank subsidiary, the Bank, was repaid in full prior to maturity and without penalty on October 24, 2013.
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)
12. JUNIOR SUBORDINATED DEFERRABLE INTEREST DEBENTURES HELD BY TRUSTS THAT ISSUED GUARANTEED CAPITAL DEBT SECURITIES
As of December 31, 2013, 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 trust preferred securities ("Trust Preferred Securities") to third-party investors and investing the proceeds from the sale of the Trust Preferred Securities solely in a series of junior subordinated debentures of the Company ("Debentures"). The Debentures held by the trusts, which in aggregate total $244.8 million, are the sole assets of each respective trust. Our obligations under the Debentures and related documents, including the indentures, the declarations of trust and related Company guarantees, taken together, constitute a full and unconditional guarantee by the Company on a subordinated basis of distributions and redemption payments and liquidation payments on the Trust Preferred Securities. We currently have the right to redeem, in whole or in part, subject to any required regulatory approval, all or any series of the Debentures, in each case, at a redemption price of 100% of the principal amount of the Debentures being redeemed plus any accrued but unpaid interest to the redemption date. The repayment, redemption or repurchase of any of the Debentures would be subject to the terms of the applicable indenture and would result in a corresponding repayment, redemption or repurchase of an equivalent amount of the related series of Trust Preferred Securities. Any redemption of the Debentures held by the PrivateBancorp Statutory Trust IV (the "Series IV Debentures"), would be subject to the terms of the replacement capital covenant described below and any required regulatory approval.
In connection with the issuance in 2008 of the Series IV Debentures, which rank junior to the other Debentures, we entered into a replacement capital covenant that relates to redemption of the Series IV Debentures and the related Trust Preferred Securities. Under the replacement capital covenant, as amended in October 2012, we committed, for the benefit of certain debt holders, that we would not repay, redeem or repurchase the Series IV Debentures or the related Trust Preferred Securities prior to June 2048 unless we have (1) obtained any required regulatory approval, and (2) raised certain amounts of qualifying equity or equity-like replacement capital at any time after October 10, 2012. The replacement capital covenant benefits holders of our "covered debt" as specified under the terms of the replacement capital covenant. Currently, under the replacement capital covenant, the "covered debt" is the Debentures held by PrivateBancorp Statutory Trust II. In the event that the Company's 7.125% subordinated debentures due 2042 are designated as or become the covered debt under the replacement capital covenant, the terms of such debentures provide that the Company is authorized to terminate the replacement capital covenant without any further action or payment. We may amend or terminate the replacement capital covenant in certain circumstances without the consent of the holders of the covered debt.
Under current accounting rules, the trusts qualify as variable interest entities for which we are not the primary beneficiary and therefore are ineligible for consolidation in our financial statements. The Debentures issued by us to the trusts 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 trusts are included in other assets in our Consolidated Statements of Financial Condition with the related dividend distributions recorded in other non-interest income.
Common Securities, Preferred Securities, and Related Debentures
(Dollars in thousands)
(1)
The trust preferred securities accrue distributions at a rate equal to the interest rate on and have a maturity identical to that of the related Debentures. The trust preferred securities will be redeemed upon maturity or earlier redemption of the related Debentures.
(2)
Reflects the coupon rate in effect at December 31, 2013. The coupon rate for the Bloomfield Hills Statutory Trust I is a variable rate and is based on three-month LIBOR plus 2.65%. The coupon rates for the PrivateBancorp Statutory Trusts II and III are at a variable rate based on three-month LIBOR plus 1.71% for Trust II and three-month LIBOR plus 1.50% for Trust III. The coupon rate for the PrivateBancorp Statutory Trust IV is fixed. Distributions for all of the Trusts are payable quarterly. We have the right to defer payment of interest on the Debentures at any time or from time to time for a period not exceeding ten years in the case of the Debentures held by Trust IV, and five years in the case of all other Debentures, without causing an event of default under the related indenture, provided no extension period may extend beyond the stated maturity of the Debentures. During such extension period, distributions on the trust preferred securities would also be deferred, and our ability to pay dividends on our common stock would generally be prohibited. The Federal Reserve has the ability to prevent interest payments on the Debentures.
(3)
The trust preferred securities are subject to mandatory redemption, in whole or in part, upon repayment of the Debentures at maturity or upon their earlier redemption in whole or in part. The Debentures are redeemable in whole or in part prior to maturity at any time after the dates shown in the table and, only after we have obtained Federal Reserve approval, if then required under applicable guidelines or regulations.
13. EQUITY
Conversion of Nonvoting Common Stock
During the second quarter 2013, holders of our nonvoting common stock sold 1.95 million shares of our nonvoting common stock, which were converted to shares of voting common stock on a one-for-one basis in accordance with their terms upon settlement. At December 31, 2013, 1.59 million shares of nonvoting common stock remained outstanding.
TARP Capital Purchase Program
In January 2009, as part of the Troubled Asset Relief Program ("TARP") Capital Purchase Program ("CPP"), the U.S. Treasury purchased $243.8 million, or 243,815 shares, of the Company's Series B fixed-rate cumulative perpetual preferred stock, with a liquidation preference of $1,000 per share and a related ten-year warrant. The warrant gave the U.S. Treasury the right to purchase 1,290,026 shares of the Company's common stock at $28.35 per share of which such shares were subsequently reduced by 50% to 645,013 shares in December 2009 as provided by the terms of the warrant due to the completion of two qualified equity offerings. The preferred stock provided for cumulative dividends of five percent per annum for the first five years and nine percent thereafter, unless the shares were redeemed. The shares were callable by the Company at par after three years and could be repurchased at any time under certain circumstances.
On October 24, 2012, the Company repurchased all of the preferred stock held by the U.S. Treasury using net proceeds raised from a $75.0 million underwritten public offering of its common stock (4,761,905 shares with an offering price of $15.75 per share) and net proceeds from the $125.0 million subordinated debentures offering, together with existing cash resources.
In connection with the repurchase of the preferred stock, the Company accelerated the accretion of the remaining issuance discount on the preferred stock of $2.2 million. On November 14, 2012, the Company repurchased the warrant issued to the U.S. Treasury in connection with the preferred stock investment at a mutually agreed upon price of $1.2 million, which was recorded as a reduction to additional paid-in capital in the Company's Consolidated Financial Statements. Following the settlement of the warrant, the U.S. Treasury has no remaining stake in the Company.
There were no public or private offerings of common stock during 2013 or 2011 other than common stock issued in connection with our share-based compensation plans. Refer to Note 16 for a detailed discussion of such plans.
Treasury Stock
During first quarter 2013, the Company began issuing shares from treasury upon the exercise of stock options, granting of restricted stock awards and the settlement of share unit awards pursuant to its share-based compensation plans. Treasury shares are reissued at average cost. The Company held 274,000 and 947,000 shares in treasury at December 31, 2013 and December 31, 2012, respectively. Prior to 2013, the Company issued new shares to fulfill its obligation to settle share-based awards.
Comprehensive Income
Change in Accumulated Other Comprehensive Income ("AOCI") by Component
(Amounts in thousands)
(1)
The amounts reclassified from AOCI for the available-for-sale securities are included in net securities gains on the Consolidated Statements of Income, while the amounts reclassified from AOCI for cash flow hedges are included in interest income on loans on the Consolidated Statements of Income.
(2)
The tax expense amounts reclassified from AOCI in connection with the available-for-sale securities reclassification and cash flow hedges reclassification are included in income tax provision on the Consolidated Statements of Income.
14. EARNINGS PER COMMON SHARE
Basic and Diluted Earnings per Common Share
(Amounts in thousands, except per share data)
(1)
Participating stockholders are those that hold certain share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents. Such shares or units are considered participating securities (i.e., the Company’s deferred and restricted stock units and nonvested restricted stock awards).
(2)
Earnings allocated to common stockholders for basic and diluted earnings per share may differ under the two-class method as a result of adding common stock equivalents for options to dilutive shares outstanding, which alters the ratio used to allocate earnings to common stockholders and participating securities for the purposes of calculating diluted earnings per share.
(3)
The following table presents outstanding non-participating securities that were not included in the computation of diluted earnings per common share because their inclusion would have been antidilutive for the years presented.
15. INCOME TAXES
Components of Income Taxes
(Amounts in thousands)
Tax expense of $2.6 million in 2011 is not included in the totals above and relates to a "shortfall" in tax benefits due to stock price valuation on the exercise and expiration of stock options and vesting of restricted stock. In accordance with applicable accounting guidance, such "shortfall" amounts were charged to equity because there was a sufficient level of "excess" tax benefits accumulated from prior years. Such accumulated "excess" tax benefits were reduced to zero in 2011, which resulted in additional "shortfall" amounts of $200,000, $2.5 million and $645,000 for 2013, 2012, and 2011, respectively, being charged to income tax expense and included in the totals above.
Reconciliation of Income Tax Provision to Statutory Federal Rate
(Amounts in thousands)
Differences between the amounts reported in the consolidated financial statements and the tax bases of assets and liabilities result in temporary differences for which deferred tax assets and liabilities have been recorded.
Deferred Tax Assets and Liabilities
(Amounts in thousands)
Deferred Tax Assets
At December 31, 2013, we have concluded that it is more likely than not that the deferred tax assets will be realized and no valuation allowance was recorded. This conclusion was based in part on the fact that we were not in a cumulative book loss position for financial statement purposes at December 31, 2013, measured on a trailing three-year basis. In addition, we considered our recent earnings history, on both a book and tax basis, and our outlook for earnings and taxable income in future periods.
Taxable income in prior years and reversing deferred taxable temporary differences provide sources from which deferred tax assets may be absorbed. Most significantly, however, we have relied on our expectation of generating pre-tax earnings in future periods, which should give rise to taxable income levels, exclusive of reversing temporary differences, that more likely than not will be sufficient to absorb the deferred tax assets.
Liabilities Associated with Unrecognized Tax Benefits
A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:
Roll Forward of Unrecognized Tax Benefits
(Amounts in thousands)
(1)
Not included in the unrecognized tax benefits roll forward presented above.
As of December 31, 2013 and 2012, we had unrecognized tax benefits relating to uncertain tax positions that, if recognized, would favorably impact the effective tax rate by $347,000 and $130,000, respectively. While it is expected that the amount of unrecognized tax benefits will change in the next twelve months, the Company does not anticipate this change will have a material impact on the results of operations or the financial position of the Company.
We file a U.S. federal income tax return and state income tax returns in various states. We are no longer subject to examinations by U.S. federal tax authorities for 2007 and prior years. We are also no longer subject to examinations by certain state departments of revenue for 2007 and prior years.
16. SHARE-BASED COMPENSATION AND OTHER BENEFITS
Share-Based Plans
At December 31, 2013, the Company had one active share-based compensation plan, the 2011 Incentive Compensation Plan (the "2011 Plan") which was approved by the Company's stockholders in May 2011. The 2011 Plan is designed to align the interests of management with the interests of shareholders, foster retention, create a long-term focus and provide participants a competitive long-term incentive opportunity. The 2011 Plan allows for the issuance of incentive and non-qualified stock options, stock appreciation rights, restricted stock and restricted stock units, equity-based performance stock and units, stock awards and other cash and share-based incentives to employees, including officers and non-employee directors of the Company and its subsidiaries. At December 31, 2013, 2.3 million shares are available for future grant under the 2011 Plan. The Company has three other inactive share-based compensation plans for which no shares remain available for grant, but have unvested or unexercised awards outstanding at December 31, 2013. The Company issues shares from treasury, when available, or new shares to fulfill its obligation to issue shares granted pursuant to the share-based compensation plans. To the extent new shares are issued, the Company believes as of December 31, 2013, there are adequate authorized shares to satisfy anticipated award issuances in 2014.
Financial Statement Impact
The Company recognizes share-based compensation expense based on the estimated fair value of the award at the date of grant and the expense is recorded on a straight-line basis over the vesting period of the grant. Share-based compensation costs are adjusted for the estimated potential forfeiture of awards with changes in estimated forfeitures to be recognized in the period of change. Share-based compensation costs are recorded as a component of salaries and employee benefits in the Consolidated Statements of Income.
Effect of Recognizing Share-based Compensation Expense
(Amounts in thousands)
Stock Options
Stock option awards have an exercise price equal to the closing price of the Company's common stock on the date the awards are granted. Stock options generally vest ratably over three years or at the end of three years based on continuous service and have a 10-year term. The following table summarizes stock option activity for the years ended December 31, 2013, 2012 and 2011.
Stock Option Transactions
(Amounts in thousands, except per share data)
(1)
Represents the average contractual life remaining in years.
(2)
Aggregate intrinsic value represents the total pretax intrinsic value of the "in-the-money" stock options, (i.e., the difference between our closing stock price on the last trading day of the respective year and the option exercise price, multiplied by the number of shares) that would have been received by the option holders if they had exercised their options on the last day of the respective year. This amount will fluctuate with changes in the fair value of our common stock.
(3)
As a percentage of total stock options granted, 20% in 2013, 6% in 2012 and 10% in 2011 were granted to the Company’s named executive officers ("NEOs"), as will be reported in its 2014 Proxy Statement.
Summary of Stock Options Outstanding and Exercisable
(Number of shares in thousands)
(1)
Represents the weighted average contractual life remaining in years.
Stock Option Valuation Assumptions - The fair value of stock options is estimated at the date of grant using a binomial option-pricing model that utilizes the assumptions outlined in the following table.
Stock Option Valuation Assumptions
Expected life is based on historical exercise and termination behavior. Expected stock price volatility is based on historical volatility of our common stock combined with the implied volatility on the exchange-traded stock options that are derived from the value of our common stock. The risk-free interest rate is based on the implied yield currently available on U.S. Treasury zero-coupon issues with a remaining term equal to the expected life of the option. The expected dividend yield represents the most recent annual dividend yield as of the date of grant. Management reviews and adjusts the assumptions used to calculate the fair value of an option on a periodic basis to reflect updated information.
Other Stock Option Information
(Dollars in thousands)
(1)
Amounts were more than deferred tax benefit recorded during vesting period.
Restricted Stock and Restricted Unit Awards
We also issue common stock with restrictions to certain key employees. The shares are restricted as to transfer, but are not restricted as to voting rights and generally receive similar dividend payments as stockholders. The transfer restrictions generally lapse over a three year period and are contingent upon continued employment. We also issue restricted stock units which settle in common
stock when restrictions lapse which generally coincides with the vest date for most awards, however certain awards have a delayed settlement date. Restricted stock units are issued on similar terms as restricted common stock (with the exception of non-employee directors whose restrictions lapse in equal monthly installments over a one-year period) and have no voting rights. Restricted share and unit awards are awarded at no cost to the recipient upon grant. The fair value of restricted stock and units is based on our closing stock price on the date of grant and is recognized as compensation expense over the vesting period. For certain restricted stock awards with post-vesting transferability restrictions and certain unit awards with delayed settlement, a discount for lack of marketability ("DLOM") was applied to the grant date fair value. The weighted average DLOM applied to awards granted in 2013 was 21% and 25% in 2012. The following table summarizes our restricted stock and unit activity for the years ended December 31, 2013, 2012 and 2011.
Restricted Stock and Unit Award Transactions (1)
(Number of shares/units in thousands)
(1)
2012 and 2011 include salary stock awards as further discussed below.
(2)
As a percentage of total restricted stock and unit awards granted, 16% in 2013, 20% in 2012, and 19% in 2011 were granted to the Company’s NEOs, as will be reported in its 2014 Proxy Statement. Excluding the stock awards granted as salary stock as part of certain NEOs’ fixed compensation, 15%, and 10% of the total restricted stock and unit awards were granted to the NEOs in 2012, and 2011, respectively.
(3)
Represents restricted stock units with a delayed settlement date.
In connection with compensation restrictions under the TARP CPP, in 2011 and 2012, the Company paid a portion of the base salary of certain executives in shares of the Company's common stock ("salary stock"). In October 2012, the Company redeemed all of the preferred stock held by the U.S. Treasury under the TARP CPP and as a result of the redemption; the final payment of salary stock was made on December 31, 2012. The salary stock was fully vested upon issuance, had all of the rights of a stockholder, including the right to vote and receive dividends but was restricted from sale or transfer for a period of 24 to 36 months after issuance, except in the event of death or disability. The related expense is included in compensation expense on the Consolidated Statements of Income. In 2012, 49,992 shares were granted and issued at an average price of $15.51 per share and in 2011, 53,862 shares were granted and issued at an average price of $11.26 per share.
Other Restricted Stock and Unit Award Information
(Dollars in thousands)
(1)
Amount may be more or less than deferred tax benefit recorded during vesting period.
Performance Share Units
As part of our 2013 executive incentive program, we introduced performance share units ("PSUs") which entitles recipients to the underlying shares of common stock at no cost subject to continued service and the Company's achievement of specified performance criteria over a three-year period ending December 31, 2015. PSUs are granted at a target number; based on the Company's performance, the number of units that vest can be adjusted downward to zero and upward to a maximum of 150% of target. The PSUs vest in the quarter following the end of the performance period, after review and certification of the achievement of the specified performance criteria by the Company's Compensation Committee of the Board of Directors. The PSUs will be settled and converted to shares of common stock two years after vesting, subject to recoupment under certain circumstances. Holders of PSUs are not entitled to vote or receive cash dividends until settlement, but do accrue a dividend equivalent at the same rate as dividend payments to stockholders from grant date until settlement and to be paid out at that time based on actual shares converted to common stock. The fair value of PSUs is based on our closing stock price on the date of grant, less a DLOM due to the delayed settlement provisions and is recognized as compensation expense over the vesting period. An estimate is made as to the number of shares expected to vest as a result of actual performance against the performance criteria to determine the amount of compensation expense to be recognized. The estimate is re-evaluated quarterly and total compensation expense is adjusted for any change in the current period.
In 2013, we granted 53,994 PSUs, representing target level of performance at a grant date fair value of $15.44 per unit which includes the effect of a 20% DLOM.
Liability Awards
The Company had no liability awards during 2012 and 2013. In 2011 we settled, for $3.6 million in cash, the share-based awards associated with the issuance of certain contractual "put" rights and recognized a $197,000 charge to expense for the change in fair value of the awards during 2011.
Share-Based Compensation Award Modifications
The Company had no material modifications of share-based awards during 2012 and 2013.
In December, 2011, the Compensation Committee of the Board of Directors approved changes to the vesting schedules of certain equity awards previously granted to two executives of the Company to ensure that the vesting of such awards would comply with restrictions on incentive compensation applicable to certain of the most highly compensated employees of companies that received funding under the TARP CPP.
The amended awards included 47,650 stock options at $14.99 per share and 28,506 shares of restricted stock. Both the options and restricted shares were scheduled to vest in three equal annual installments beginning on the first anniversary of their respective grant dates.
The amendments provide for (1) acceleration of the vesting dates of the options to December 29, 2011 and (2) restructuring of the restricted stock to be TARP-compliant by pushing back the first vesting tranche of the restricted shares so that they will vest two-thirds on the second anniversary of their respective 2011 grant dates and one-third on the third anniversary. As a result of the accelerated option vesting dates, the full fair value of the options, $329,000, was accelerated into 2011, but such action did not create any additional overall expense for the Company. The modification to the vesting dates for the restricted stock awards did not modify the fair value nor expense recognition of the fair value on such awards.
Savings and Retirement Plan
The Company has a defined contribution retirement plan, The PrivateBancorp, Inc. Savings, Retirement and Employee Stock Ownership Plan (the "KSOP"), which allows employees, at their option, to make contributions up to 75% of compensation on a pre-tax basis and/or after-tax basis through salary deferrals under Section 401(k) of the Internal Revenue Code. At the employees’ direction, employee contributions are invested among a variety of investment alternatives. For employees who have met a 1 year service requirement and make voluntary contributions to the KSOP, we contribute an amount equal to $0.50 for each dollar contributed up to 6% of an employee’s compensation (subject to certain maximum compensation amounts as prescribed in Internal Revenue Service guidance). The Company’s matching contribution vests in increments of 20% annually for each year in which 1,000 hours are worked. The KSOP also allows for a discretionary company contribution. Although no such contribution was made for 2013, 2012 or 2011, the discretionary component vests in increments of 20% annually over a period of 5 years based on the employee’s years of service.
KSOP Plan Information
(Amounts in thousands)
Deferred Compensation Plan
We maintain a non-qualified deferred compensation plan (the "Plan") which allows eligible participants to defer the receipt of cash compensation or non-employee director fees otherwise payable to them. The purpose of the Plan is to further our ability to attract and retain high quality executives and non-employee directors. Employees who participate in the Plan may elect to defer up to 50% of annual base salary and 100% of annual bonus amounts and directors may elect to defer up to 100% of his or her annual director’s fees. Participants elect at the time amounts are deferred whether such deferral amounts will be credited with "earnings" as if they were invested in either a fixed income account with interest credited based on our prime rate (not to exceed 120% of the applicable federal long-term rate) on the cash value of the funds deposited, or in deferred stock units ("DSUs") in Company stock with earnings credited in the form of dividends equivalent to that paid to our common stockholders. Except for an "earnings" credit on the deferred amounts, we do not provide any contributions or credits to participants under the Plan. At December 31, 2013 and 2012, there were 126,393 and 124,952 DSUs, respectively, in the Plan. At the time of distribution, amounts credited in DSUs are paid in shares of our common stock while amounts credited in the fixed income account are paid in cash. All elections and payments under the Plan are subject to compliance with requirements of Section 409A of the Internal Revenue Code which may limit elections and require delay in payment of benefits in certain circumstances.
17. REGULATORY AND CAPITAL MATTERS
The Company and the Bank are subject to various regulatory requirements that impose requirements or restrictions on cash reserves, loans or advances, and dividends. The Bank is required to maintain reserves against deposits. Reserves are held either in the form of vault cash or non-interest-bearing balances maintained with the FRB and are based on the average daily balances and statutory reserve ratios prescribed by the type of deposit account. Reserve balances required to be maintained at the FRB were $123.4 million and $92.8 million at December 31, 2013 and 2012, respectively.
Under current FRB regulations, the Bank is limited in the amount it may loan or advance to the Company. Loans or advances to a single subsidiary may not exceed 10% of the Bank's capital stock and surplus (as defined) and loans to all subsidiaries may not exceed 20%. Loans from the Bank to the Company are also required to meet certain collateral requirements.
Various state banking regulations limit the amount of dividends that may be paid to the Company by the Bank and the payment of such dividends is contingent upon a number of factors including the Bank’s ability to meet applicable regulatory capital requirements, the strength of the Bank’s balance sheet, the Bank’s profitability and earnings and the Bank's ability to satisfy its obligations and support any projected growth. No dividends were paid by the Bank to the Company during 2013 or 2012. As of December 31, 2013, the Bank had the capacity under banking regulation to pay dividends of $443.4 million, subject to the Company’s internal capital policy.
Under applicable regulatory capital adequacy guidelines, the Company and the Bank are subject to various capital requirements adopted and administered by the federal banking agencies. These guidelines specify minimum capital ratios calculated in accordance with the definitions in the guidelines, including the leverage ratio which is Tier 1 capital as a percentage of adjusted average assets, and the Tier 1 capital ratio and the total capital ratio each as a percentage of risk-weighted assets and off-balance sheet items that have been weighted according to broad risk categories. These minimum ratios are shown in the table below.
To satisfy safety and soundness standards, banking institutions are expected to maintain capital levels in excess of the regulatory minimums depending on the risk inherent in the balance sheet, regulatory expectations and the changing risk profile of business activities and plans. Under our capital management policy, we conduct periodic stress testing of our capital adequacy and target capital ratios at levels above regulatory minimums that we believe are appropriate based on various other risk considerations,
including the current operating and economic environment and outlook, internal risk guidelines, and our strategic objectives as well as regulatory expectations.
As of December 31, 2013, the Company's and the Bank's capital position was in excess of all minimum regulatory capital adequacy requirements to which they are subject. As of December 31, 2013, the most recent regulatory notification classified the Bank as "well-capitalized" under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes would change the Bank’s classification for this purpose. Failure to meet minimum capital requirements could result in certain mandatory, and possible discretionary, actions by regulators which, if undertaken, could have a material effect on our consolidated financial statements.
The following table presents information about our capital measures and the related regulatory capital guidelines.
Capital Measurements
(Amounts in thousands, except for ratios)
n/a
Not applicable.
In July 2013, the FRB and other U.S. banking regulators adopted final rules that revise and replace the agencies' current regulatory capital requirements to align with the Basel III international capital standards and to implement certain changes required by the Dodd-Frank Act. The new rules require U.S. banks to hold higher amounts of capital, especially common equity, against their risk-weighted assets. The new capital requirements are higher in both quantity and quality of capital, with compliance required beginning January 1, 2015 (subject to a phase-in period). For additional information, see the "Dodd-Frank Wall Street Reform and Consumer Protection Act" and "New Regulatory Capital Rules" in Part I, Item 1 of this Form 10-K.
18. DERIVATIVE INSTRUMENTS
We utilize an overall risk management strategy that incorporates the use of derivative instruments to reduce interest rate risk, as it relates to mortgage loan commitments and planned sales of loans, and foreign currency volatility as it relates to certain loans denominated in currencies other than the U.S dollar. We also use these instruments to accommodate our clients as we provide them with risk management solutions. None of the above-mentioned end-user and client-related derivatives were designated as hedging instruments at December 31, 2013 and 2012.
We also use interest rate derivatives to hedge variability in forecasted interest cash flows in our loan portfolio which is comprised primarily of floating-rate loans. These derivatives are designated as cash flow hedges.
Derivatives expose us to counterparty credit risk. Credit risk is managed through our 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 of collateral and netting agreements.
Composition of Derivative Instruments and Fair Value
(Amounts in thousands)
(1)
The remaining average notional amounts are shown for credit contracts.
(2)
Represents netting of derivative asset and liability balances, and related cash collateral, with the same counterparty subject to master netting agreements.
Master Netting Agreements
Certain of the Company's end-user and client-related derivative contracts are subject to enforceable master netting agreements with derivative counterparties. Authoritative accounting guidance permits the netting of derivative receivables and payables when a legally enforceable master netting agreement exists between the Company and a derivative counterparty. A master netting agreement is an agreement between two counterparties who have multiple derivative contracts with each other that provide for the net settlement of contracts through a single payment, in a single currency, in the event of default on or termination of any one
contract. For those derivative contracts subject to enforceable master netting agreements, derivative assets and liabilities, and related cash collateral, with the same counterparty are reported on a net basis within derivative assets and derivative liabilities on the Consolidated Statements of Financial Condition.
Derivative contracts may require the Company to provide or receive cash or financial instrument collateral. Collateral associated with derivative assets and liabilities subject to enforceable master netting agreements with the same counterparty is posted on a net basis. All of the Company's derivative assets and liabilities subject to collateral posting requirements are in a net liability position as of December 31, 2013 and the Company has pledged cash or financial collateral in accordance with each counterparty's collateral posting requirements. Certain collateral posting requirements are subject to posting thresholds and minimum transfer amounts, such that the Company is only required to post collateral once the posting threshold is met, and any adjustments to the amount of collateral posted must meet minimum transfer amounts.
As of December 31, 2013, $5.6 million of cash collateral pledged was netted with the related derivative liabilities and no cash collateral received was netted with the related derivative assets on the Consolidated Statements of Financial Condition. To the extent not netted against derivative fair values under a master netting agreement, the receivable for cash pledged is included in other short-term investments. There was no receivable for cash pledged at December 31, 2013. Any securities pledged to counterparties as financial instrument collateral remain on the Consolidated Statements of Financial Condition as long as the Company does not default.
The following table presents information about the Company's derivative assets and liabilities and the related collateral by derivative type (e.g., interest rate contracts). As the Company posts collateral with counterparties on the basis of its net position in all derivative contracts with a given counterparty, the information presented below aggregates end-user and client-related derivative contracts entered into with the same counterparty.
Offsetting of Derivative Assets and Liabilities
(Amounts in thousands)
(1)
All derivative contracts are over-the-counter contracts.
(2)
Represents end-user, client-related and cash flow hedging derivative contracts and related cash collateral entered into with the same counterparty and subject to a master netting agreement.
(3)
Collateralization is determined at the counterparty level. If overcollateralization exists, the amount shown is limited to the fair value of the derivative.
(4)
Financial collateral is disclosed at fair value. Financial instrument collateral is allocated pro-rata amongst the derivative liabilities to which it relates.
(1)
All derivative contracts are over-the-counter contracts.
(2)
Represents end-user, client-related and cash flow hedging derivative contracts entered into with the same counterparty and subject to a master netting agreement.
(3)
Financial collateral is disclosed at fair value. Collateralization is determined at the counterparty level. If overcollateralization exists, the amount shown is limited to the fair value of the derivative. Financial instrument collateral is allocated pro-rata amongst the derivative liabilities to which it relates.
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 minimum capital ratios under the federal banking agencies’ guidelines. All requirements were met at December 31, 2013 and December 31, 2012. Details on these derivative contracts are set forth in the following table.
Derivatives Subject to Credit Risk Contingency Features
(Amounts in thousands)
Derivatives Designated in Hedge Relationships
The objective of our hedging program is to use interest rate derivatives to manage our exposure to interest rate movements.
Cash flow hedges - Under our cash flow hedging program we enter into receive fixed/pay variable interest rate swaps to convert certain floating-rate commercial loans to fixed-rate to reduce the variability in forecasted interest cash flows due to market interest rate changes. We use regression analysis to assess the effectiveness of cash flow hedges at both the inception of the hedge relationship and on an ongoing basis. Ineffectiveness is generally measured as the amount by which the cumulative change in fair value of the hedging instrument exceeds the present value of the cumulative change in the expected cash flows of the hedged item. Measured ineffectiveness is recognized directly in other non-interest income in the Consolidated Statements of Income. During the year ended December 31, 2013, there were no gains or losses from cash flow hedge derivatives related to ineffectiveness that were reclassified to current earnings. The effective portion of the gains or losses on cash flow hedges are recorded, net of tax, in accumulated other comprehensive income ("AOCI") and are subsequently reclassified to interest income on loans in the period that the hedged interest cash flows affect earnings. As of December 31, 2013, the maximum length of time over which forecasted interest cash flows are hedged is six years. There are no components of derivative gains or losses excluded from the assessment of hedge effectiveness related to our cash flow hedge strategy.
Change in Accumulated Other Comprehensive Income
Related to Interest Rate Swaps Designated as Cash Flow Hedge
(Amounts in thousands)
As of December 31, 2013, $3.0 million in net deferred gains, net of tax, recorded in AOCI are expected to be reclassified into earnings during the next twelve months. This amount could differ from amounts actually recognized due to changes in interest rates, hedge de-designations, and the addition of other hedges subsequent to December 31, 2013. During the year ended December 31, 2013, there were no gains or losses from cash flow hedge derivatives reclassified to current earnings because it became probable that the original forecasted transaction would not occur.
Derivatives Not Designated in Hedge Relationships
Other End-User Derivatives - We enter into derivatives that include commitments to fund residential 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 residential mortgage loans when we enter into customer interest rate lock commitments. This practice allows us 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 December 31, 2013, the par value of our mortgage loans held-for-sale totaled $17.6 million, the notional value of our interest rate lock commitments totaled $20.0 million, and the notional value of our forward commitments for the future delivery of residential mortgage loans totaled $37.9 million.
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 U.S. dollars. As of December 31, 2013, our exposure was to the Euro, Canadian dollar and British pound on $12.4 million of loans. We manage this risk using forward currency derivatives.
Client-Related Derivatives - We offer, through our capital markets group, over-the-counter interest rate and foreign exchange derivatives to our clients, including but not limited to, 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. When our clients enter into an interest rate or foreign exchange derivative transaction with us, we mitigate our exposure to market risk through the execution of off-setting positions with inter-bank dealer counterparties. Although the off-setting nature of transactions originated by our capital markets group limits our market risk exposure, 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 ("RPA") with counterparty banks to either accept or transfer a portion of the credit risk related to their interest rate derivatives or transfer a portion of the credit risk related to our interest rate derivatives. This allows clients to execute an interest rate derivative with one bank while allowing for distribution of the credit risk among participating members. We have entered into written RPAs in which we accept a portion of the credit risk associated with an interest rate derivative of another bank's loan client in exchange for a fee. We manage this credit risk through our 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 RPA’s underlying derivative counterparty, present economic conditions, performance trends, leverage, and liquidity.
The maximum potential amount of future undiscounted payments that we could be required to make under our written RPAs 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 maximize the recovery of these amounts from assets that our clients pledged as collateral for the derivative and the related loan.
Risk Participation Agreements
(Dollars in thousands)
Gain (Loss) Recognized on Derivative Instruments
Not Designated in Hedging Relationship
(Amounts in thousands)
19. 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 clients 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 liquidity risk in excess of the amounts reflected in the Consolidated Statements of Financial Condition.
Contractual or Notional Amounts of Financial Instruments (1)
(Amounts in thousands)
(1)
Includes covered asset commitments of $18.7 million and $23.0 million as of December 31, 2013 and 2012, respectively.
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 loan agreement. 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 for the unused portion of the commitment or for the amounts issued but not drawn on letters of credit. All or a portion of commitments with an initial term extending beyond one year require regulatory capital support, while commitments of less than one year do not, although under newly issued regulatory capital rules, unfunded commitments of less than one year will require regulatory capital unless unconditionally cancellable. Since many of our commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements of the borrowers. As of December 31, 2013, we had a reserve for unfunded commitments of $9.2 million, which reflects our estimate of inherent losses associated with these commitment obligations. The balance of this reserve changes based on a number of factors including: the balance of outstanding commitments and our assessment of the likelihood of borrowers to utilize these commitments. The reserve is recorded in other liabilities in the Consolidated Statements of Financial Condition.
Standby and commercial letters of credit are conditional commitments issued by us to guarantee the performance of a client to a third party. Standby letters of credit include performance and financial guarantees for clients in connection with contracts between our clients and third parties. Standby letters of credit are agreements where we are obligated to make payment to a third party on behalf of a client in the event the client fails to meet their contractual obligations. 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. In most cases, the Company receives a fee for the amount of a letter of credit issued but not drawn upon.
In the event of a client’s nonperformance, our credit loss exposure is equal to the contractual amount of those commitments. We manage this credit risk in a similar manner to evaluating credit risk in extending loans to clients under our credit policies. We use the same credit policies in making credit commitments as for on-balance sheet instruments, mitigating exposure to credit loss through various collateral requirements, if deemed necessary. 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 us 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 are included in other liabilities in the Consolidated Statements of Financial Condition, totaled $1.4 million as of December 31, 2013. We amortize these amounts into income over the commitment period. As of December 31, 2013, standby letters of credit had a remaining weighted-average term of approximately 13 months, with remaining actual lives ranging from less than 1 year to 7 years.
Other Commitments
The Company has unfunded commitments to CRA investments as well as commitments to provide contributions to other investment partnerships totaling $14.2 million at December 31, 2013. Of these commitments, $2.2 million related to legally-binding unfunded commitments for tax-credit investments and was included within other assets and other liabilities on the Consolidated Statements of Financial Condition.
Credit Card Settlement Guarantees
Our third-party corporate credit card vendor issues corporate purchase credit cards on behalf of our commercial clients. The corporate purchase credit cards are issued to employees of certain of our commercial clients at the client’s direction and used for payment of business-related expenses. In most circumstances, these cards will be underwritten by our third-party vendor. However, in certain circumstances, we may enter into a recourse agreement, which transfers the credit risk from the third-party vendor to us in the event that the client fails to meet its financial payment obligation. In these circumstances, a total maximum exposure amount is established for our corporate client. In addition to the obligations presented in the prior table, the maximum potential future payments guaranteed by us under this third-party settlement guarantee were $3.8 million at December 31, 2013.
We believe that the estimated amounts of maximum potential future payments are not representative of our actual potential loss given our insignificant historical losses from this third-party settlement guarantee program. As of December 31, 2013, we have not recorded any contingent liability in the consolidated financial statements for this settlement guarantee program, and management believes that the probability of any loss under this arrangement is remote.
Mortgage Loans Sold with Recourse
Certain mortgage loans sold have limited recourse provisions. The losses for the year ended December 31, 2013 and December 31, 2012 arising from limited recourse provisions were not material. Based on this experience, the Company has not established any liability for potential future losses relating to mortgage loans sold in prior periods.
Legal Proceedings
In June 2013, we were served with a complaint naming the Bank as an additional defendant in a lawsuit pending in the Circuit Court of the 21st Judicial Circuit, Kankakee County, Illinois known as Maas vs. Marek et. al. The lawsuit, brought by the beneficiaries of two trusts for which the Bank is serving as the successor trustee, seeks reimbursement of approximately $2 million of penalties and interest assessed by the IRS due to the late payment of certain generation skipping taxes by the trusts, as well as certain related attorney fees and other damages. The other named defendants include legal and accounting professionals that provided services related to the matters involved. There have been no material developments since we were served in this lawsuit. Although we are not able to predict the likelihood of an adverse outcome, we currently anticipate that ultimate resolution of this matter will not have a material adverse impact on our financial condition or results of operations.
As of December 31, 2013, there were various legal proceedings pending against the Company and its subsidiaries in the ordinary course of business. Management does not believe that the outcome of these proceedings will have, individually or in the aggregate, a material adverse effect on the Company's results of operations, financial condition or cash flows.
20. ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS
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, mortgage loans held for sale, derivative assets, derivative liabilities, and certain other assets and other liabilities. In addition, fair value is used on a non-recurring basis to apply lower-of-cost-or-market accounting to foreclosed real estate and certain other loans held for sale, 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:
•
Level 1 - Unadjusted quoted prices for identical assets or liabilities traded in active markets.
•
Level 2 - Observable inputs other than level 1 prices, such as quoted prices for similar instruments; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the asset or liability.
•
Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
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.
Valuation Methodology
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 include U.S. Treasury, collateralized mortgage obligations, residential mortgage-backed securities, state and municipal securities, and foreign sovereign debt. 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. 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. All other remaining securities are classified in level 2 of the valuation hierarchy. On a quarterly basis, the Company uses a variety of methods to validate the overall reasonableness of the fair values obtained from external pricing services, including evaluating pricing service inputs and methodologies, using exception reports based on analytical criteria, comparing prices obtained to prices received from other pricing sources, and reviewing the reasonableness of prices based on the Company’s knowledge of market liquidity and other market-related conditions. While we may challenge valuation inputs used in determining prices obtained from external pricing services based on our validation procedures, we have not altered the fair values ultimately provided by the external pricing services.
Mortgage Loans Held-for-Sale - Mortgage loans held-for-sale represent residential mortgage loan originations intended to be sold in the secondary market. We have elected the fair value option for residential mortgage loans originated with the intention of selling to a third party. The election of the fair value option aligns the accounting for these loans with the related mortgage banking derivatives used to economically hedge them. These mortgage loans are measured at fair value as of each reporting date, with changes in fair value recognized through mortgage banking non-interest income. The fair value of mortgage loans held-for-sale is determined based on prices obtained for loans with similar characteristics from third party sources. On a quarterly basis, the Company validates the overall reasonableness of the fair values obtained from third party sources by comparing prices obtained to prices received from various other pricing sources, and reviewing the reasonableness of prices based on Company knowledge of market liquidity and other market-related conditions. Mortgage loans held-for-sale are classified in level 2 of the valuation hierarchy.
Collateral-Dependent Impaired Loans - We do not record loans held for investment at fair value on a recurring basis. However, periodically, we record nonrecurring adjustments to reduce the carrying value of certain impaired loans based on fair value measurement. This population of impaired loans includes those for which repayment of the loan is expected to be provided solely by the underlying collateral. We measure the fair value of collateral-dependent impaired loans based on the fair value of the collateral securing these loans less estimated selling costs. A majority of collateral-dependent impaired loans are secured by real estate with the fair value generally determined based upon appraisals performed by a certified or licensed appraiser using a combination of valuation techniques such as sales comparison, income capitalization and cost approach and include inputs such as absorption rates, capitalization rates and comparables. We also consider other factors or recent developments that could result in adjustments to the collateral value estimates indicated in the appraisals. Accordingly, fair value estimates for collateral-dependent
impaired loans are classified in level 3 of the valuation hierarchy. The carrying value of all impaired loans and the related specific reserves are disclosed in Note 4.
At the time a collateral-dependent loan is initially determined to be impaired, we review the existing collateral appraisal. If the most recent appraisal is greater than one year old, a new appraisal is obtained on the underlying collateral. The Company generally obtains "as is" appraisal values for use in the evaluation of collateral-dependent impaired loans. Appraisals for loans in excess of $500,000 are updated with new independent appraisals at least annually and are formally reviewed by our internal appraisal department. Additional diligence is also performed at the six-month interval between annual appraisals. If during the course of the six-month review period there is evidence supporting a meaningful decline in the value of the collateral, the appraised value is either internally adjusted downward or a new appraisal is required to support the value of the impaired loan. As part of our internal review process, we consider other factors or recent developments that could adjust the valuations indicated in the appraisals or internal reviews. The Company’s internal appraisal review process validates the reasonableness of appraisals in conjunction with analyzing sales and market data from an array of market sources.
Covered Asset OREO and OREO - Covered asset OREO and OREO generated from our originated book of business are valued on a nonrecurring basis using third-party appraisals of each property and our judgment of other relevant market conditions and are classified in level 3 of the valuation hierarchy. As part of our internal review process, we consider other factors or recent developments that could adjust the valuations indicated in the appraisals or internal reviews. Updated appraisals on both OREO portfolios are typically obtained every twelve months and evaluated internally at least every six months. In addition, both property-specific and market-specific factors as well as collateral type factors are taken into consideration, which may result in obtaining more frequent appraisal updates or internal assessments. Appraisals are conducted by third-party independent appraisers under internal direction and engagement using a combination of valuation techniques such as sales comparison, income capitalization and cost approach and include inputs such as absorption rates, capitalization rate and comparables. Any appraisal with a value in excess of $250,000 is subject to a compliance review. Appraisals received with a value in excess of $1.0 million are subject to a technical review. Appraisals are either reviewed internally by our appraisal department or sent to an outside technical firm if appropriate. Both levels of review involve a scope appropriate for the complexity and risk associated with the OREO. To validate the reasonableness of the appraisals obtained, the Company compares the appraised value to the actual sales price of properties sold and analyzes the reasons why a property may be sold for less than its appraised value.
Derivative Assets and Derivative Liabilities - Derivative instruments with positive fair values are reported as an asset and derivative instruments with negative fair value are reported as liabilities, in both cases after taking into account the effects of master netting agreements. For derivative counterparties with which we have a master netting agreement, we elect to measure nonperformance risk on the basis of our net exposure to the counterparty. The fair value of derivative assets and liabilities is determined based on prices obtained from third party advisors using standardized industry models. Many factors affect derivative values, including the level of interest rates, the market’s perception of our nonperformance risk as reflected in our credit spread, and our assessment of counterparty nonperformance risk. The nonperformance risk assessment is based on our evaluation of credit risk, or if available, on observable external assessments of credit risk. Values of derivative assets and liabilities are primarily based on observable inputs and are classified in level 2 of the valuation hierarchy, with the exception of certain client related derivatives and risk participation agreements, as discussed below. On a quarterly basis, the Company uses a variety of methods to validate the overall reasonableness of the fair values obtained from third party advisors, including evaluating inputs and methodologies used by the third party advisors, comparing prices obtained to prices received from other pricing sources, and reviewing the reasonableness of prices based on the Company's knowledge of market liquidity and other market-related conditions. While we may challenge valuation inputs used in determining prices obtained from third party advisors based on our validation procedures, we have not altered the fair values ultimately provided by the third party advisors.
Level 3 derivatives include risk participation agreements and derivatives associated with clients whose loans are risk rated 6 or higher ("watch list derivative"). Refer to "Credit Quality Indicators" in Note 4 for further discussion on risk ratings. For these level 3 derivatives, the Company obtains prices from third party advisors, consistent with the valuation processes employed for the Company’s derivatives classified in level 2 of the fair value hierarchy, and then applies loss factors to adjust the prices obtained from third party advisors. The significant unobservable inputs that are employed in the valuation process for the risk participation agreements and watch list derivatives that cause these derivatives to be classified in level 3 of the fair value hierarchy are the historic loss factors specific to the particular industry segment and risk rating category. The loss factors are updated quarterly and are derived and aligned with the loss factors utilized in the calculation of the Company’s general reserve component of the allowance for loan losses. Changes in the fair value measurement of risk participation agreements and watch list derivatives are largely due to changes in the fair value of the derivative, risk rating adjustments and fluctuations in the pertinent historic average loss rate.
Assets and Liabilities Measured at Fair Value on a Recurring Basis
The following table presents the hierarchy level and fair value for each major category of assets and liabilities measured at fair value at December 31, 2013 and 2012 on a recurring basis.
Fair Value Measurements on a Recurring Basis
(Amounts in thousands)
If a change in valuation techniques or input assumptions for an asset or liability occurred between periods, we would consider whether this would result in a transfer between the three levels of the fair value hierarchy. There have been no transfers of assets or liabilities between level 1 and level 2 of the valuation hierarchy between December 31, 2012 and December 31, 2013.
There have been no other changes in the valuation techniques we used for assets and liabilities measured at fair value on a recurring basis from December 31, 2012 to December 31, 2013.
Reconciliation of Beginning and Ending Fair Value for Those
Fair Value Measurements Using Significant Unobservable Inputs (Level 3) (1)
(Amounts in thousands)
(1)
Fair value is presented prior to giving effect to netting adjustments.
(2)
Amounts disclosed in this line are included in the Consolidated Statements of Income as capital markets products income for derivatives.
(3)
Transfers in and transfers out are recognized at the end of each quarterly reporting period. In general, derivative assets and liabilities are transferred into Level 3 from Level 2 due to a lack of observable market data, as there was deterioration in the credit risk of the derivative counterparty. Conversely, derivative assets and liabilities are transferred out of Level 3 into Level 2 due to an improvement in the credit risk of the derivative counterparty.
Financial Instruments Recorded Using the Fair Value Option
Difference Between Aggregate Fair Value and Aggregate Remaining Principal Balance
for Mortgage Loans Held-For-Sale Elected to be Carried at Fair Value (1)
(Amounts in thousands)
(1)
The change in fair value is reflected in mortgage banking non-interest income.
As of December 31, 2013, none of the mortgage loans held-for-sale were on nonaccrual or 90 days or more past due and still accruing interest. Changes in fair value due to instrument-specific credit risk for the year ended December 31, 2013 were not material.
Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis
From time to time, we may be required to measure certain other financial assets at fair value on a nonrecurring basis. These adjustments to fair value usually result from the application of lower-of-cost-or-fair-value accounting or write-downs of individual assets when there is evidence of impairment.
The following table provides the fair value of those assets that were subject to fair value adjustments during the years ended December 31, 2013 and 2012 and still held at December 31, 2013 and 2012, respectively. All fair value measurements on a nonrecurring basis were measured using level 3 of the valuation hierarchy.
Fair Value Measurements on a Nonrecurring Basis
(Amounts in thousands)
(1)
Represents the fair value of loans adjusted to the appraised value of the collateral with a write-down in fair value or change in specific reserves during the respective period. These fair value adjustments are recognized as part of the provision for loan losses charged to earnings.
(2)
Represents the fair value of foreclosed properties that were adjusted subsequent to their initial classification as foreclosed assets. Write-downs are recognized as a component of net foreclosed real estate expense in the Consolidated Statements of Income.
(3)
The 20% portion of any covered asset OREO write-down not reimbursed by the FDIC is recorded as net foreclosed real estate expense.
There have been no changes in the valuation techniques we used for assets and liabilities measured at fair value on a nonrecurring basis from December 31, 2012 to December 31, 2013.
Additional Information Regarding Level 3 Fair Value Measurements
The following table presents information regarding the unobservable inputs developed by the Company for its level 3 fair value measurements.
Quantitative Information Regarding Level 3 Fair Value Measurements
(Dollars in thousands)
(1)
Represents fair value of underlying swap.
(2)
Weighted average is calculated based on assets with a property specific adjustment.
The significant unobservable inputs used in the fair value measurement of the risk participation agreements and watch list derivatives are the historic loss factors. A significant increase (decrease) in the pertinent loss factor would result in a significantly lower (higher) fair value measurement.
Estimated Fair Value of Certain Financial Instruments
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 disclosure of estimated fair values provided herein excludes 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 total underlying value. Examples of non-financial instruments having value not disclosed herein include the future earnings potential of significant customer relationships and the value of Trust and Investments’ 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 included in the disclosure.
Various methodologies and assumptions have been utilized in management’s 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.
In addition to the valuation methodology explained above for financial instruments recorded at fair value, the following methods and assumptions were used in estimating the fair value of financial instruments that are carried at cost in the Consolidated Statements of Financial Condition and includes the general classification of the assets and liabilities pursuant to the valuation hierarchy.
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, federal funds sold and interest-bearing deposits in banks (including the receivable for cash collateral pledged), accrued interest receivable, and accrued interest payable. Accrued interest receivable and accrued interest payable are classified consistent with the hierarchy of their corresponding assets and liabilities.
Securities held-to-maturity - Securities held-to-maturity include collateralized mortgage obligations, residential mortgage-backed securities, agency commercial mortgage-backed securities and state and municipal securities. Substantially all held-to-maturity 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. 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.
FHLB stock -The carrying value of FHLB stock approximates fair value as the stock is non-marketable, but can only be sold to the FHLB or another member institution at par.
Loans - The fair value of loans is calculated by discounting estimated cash flows through the estimated maturity using estimated market discount rates that reflect the credit and interest rate risk inherent in the loan. Cash flows are estimated by applying contractual payment terms to assumed interest rates. The estimate of maturity is based on contractual terms and includes assumptions that reflect our and the industry’s historical experience with repayments for each loan classification. The estimation is modified, as required, by the effect of current economic and lending conditions, collateral, and other factors.
Covered assets - Covered assets include acquired loans and foreclosed loan collateral covered under a loss sharing agreement with the FDIC (including the fair value of expected reimbursements from the FDIC). The fair value of covered assets is calculated by discounting contractual cash flows through the estimated maturity using estimated market discount rates that reflect the credit and interest rate risk inherent in the asset. The estimate of maturity is based on contractual terms and includes assumptions that reflect our and the industry’s historical experience with repayments for each asset classification. The estimate is modified, as required, by the effect of current economic and lending conditions, collateral, and other factors.
Investment in BOLI - The cash surrender value of our investment in bank owned life insurance approximates the fair value.
Deposit liabilities - The fair values disclosed for noninterest-bearing deposits, savings deposits, interest-bearing demand deposits, and money market deposits are approximately equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). The fair values for certificate of deposits and brokered time deposits were estimated using present value techniques by discounting the future cash flows at rates based on internal models and broker quotes.
Short-term and other borrowings - The fair value of FHLB advances with remaining maturities of one year or less is estimated by discounting the obligations using the rates currently offered for borrowings of similar remaining maturities. The fair value of
secured borrowings is equal to the value of the loans they are collateralizing. See "Loans" above for further information. The carrying amount of the obligation for cash collateral held is considered to be its fair value because of its short-term nature.
Long-term debt - The fair value of the Company's fixed-rate long-term debt was estimated using the unadjusted publicly-available market price as of period end.
The fair value of the Bank's subordinated debt facility, FHLB advances with remaining maturities greater than one year, and the Company's variable-rate junior subordinated debentures is estimated by discounting future cash flows. For the FHLB advances with remaining maturities greater than one year, the Company discounts cash flows using quoted interest rates for similar financial instruments. For the Bank's subordinated debt and the Company's variable-rate junior subordinated debentures, we interpolate a discount rate we believe is appropriate based on quoted interest rates and entity specific adjustments.
Commitments - Given the limited interest rate risk posed by the commitments outstanding at period-end due to their variable rate structure, termination clauses provided in the agreements, and the market rate of fees charged, we have deemed the fair value of commitments outstanding to be immaterial.
Financial Instruments
(Amounts in thousands)
Financial Instruments (Continued)
(Amounts in thousands)
21. OPERATING SEGMENTS
We have three primary operating segments: Banking, Trust and Investments, and the Holding Company. With respect to the Banking and Trust and Investments' segments, each is delineated by the products and services that each segment offers. The Banking operating segment is comprised of commercial and personal banking services, including mortgage originations. 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 Trust and Investments segment includes certain activities of our PrivateWealth group, including investment management, 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 subsidiary, the issuance of debt and intersegment eliminations.
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 financial condition of Trust and Investments is included with the Banking segment.
Operating Segments Performance
(Amounts in thousands)
(1)
Deposit amounts represent the elimination of Holding Company cash accounts included in total deposits of the Banking segment.
22. VARIABLE INTEREST ENTITIES
At December 31, 2013 and 2012, the Company had no variable interest entity ("VIE") consolidated in its financial statements.
Nonconsolidated VIEs
(Amounts in thousands)
(1)
Excludes personal loans and loans to non-for-profit entities.
Trust preferred capital securities issuances - As discussed in Note 12, we sponsor and wholly own 100% of the common equity of four trusts that were formed for the purpose of issuing Trust Preferred Securities to third-party investors and investing the proceeds from the sale of the Trust Preferred Securities solely in Debentures issued by the Company. The trusts’ only assets were the principal balance of the Debentures and the related interest receivable, which are included within long-term debt in our Consolidated Statements of Financial Condition. The Company is not the primary beneficiary of the trusts and accordingly, the trusts are not consolidated in our financial statements.
Community reinvestment investments - We hold certain investments in funds that make investments to further our community reinvestment initiatives. Such investments are included within other assets in our Consolidated Statements of Financial Condition. Certain of these investments meet the definition of a VIE, but the Company is not the primary beneficiary as we are a limited investor in those investment funds and do not have the power to direct their investment activities. Accordingly, we will continue to account for our interests in these investments on an unconsolidated basis. Our maximum exposure to loss is limited to the carrying amount plus additional required future capital contributions.
Troubled debt restructured loans - For certain troubled commercial loans, we restructure the terms of the borrower’s debt in an effort to increase the probability of collecting amounts contractually due. Following a TDR, the borrower entity typically meets the definition of a VIE as the initial determination of whether an entity is a VIE must be reconsidered and economic events have proven that the entity’s equity is not sufficient to permit it to finance its activities without additional subordinated financial support or a restructuring of the terms of its financing. As we do not have the power to direct the activities that most significantly impact such troubled commercial borrowers’ operations, we are not considered the primary beneficiary even in situations where, based on the size of the financing provided, we are exposed to potentially significant benefits and losses of the borrowing entity. We have no contractual requirements to provide financial support to the borrowing entities beyond certain funding commitments established upon restructuring of the terms of the debt. Our interests in the troubled commercial borrowers include outstanding loans and related derivative assets. Our maximum exposure to loss is limited to these interests plus any additional future funding commitments.
23. CONDENSED PARENT COMPANY FINANCIAL STATEMENTS
The following represents the condensed financial statements of PrivateBancorp, Inc., the parent company.
Statements of Financial Condition
(Parent Company only)
(Amounts in thousands)
Statements of Income
(Parent Company only)
(Amounts in thousands)
Statements of Cash Flows
(Parent Company only)
(Amounts in thousands)
24. QUARTERLY EARNINGS PERFORMANCE (UNAUDITED)
Quarterly Earnings Performance (1)
(Dollars in thousands, except per share data)
(1)
All ratios are presented on an annualized basis.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
As of the end of the period covered by this report (the "Evaluation Date"), the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and its Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Rule 13a-15 and 15d-15 of the Securities Exchange Act of 1934 (the "Exchange Act"). Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that as of the Evaluation Date, the Company’s disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in Securities and Exchange Commission rules and forms. There were no changes in the Company’s internal control over financial reporting during the quarter ended December 31, 2013 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
Management’s Report On Internal Control Over Financial Reporting
Management of the Company is responsible for establishing and maintaining effective internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. The Company’s internal control over financial reporting is designed to provide reasonable assurance to the Company’s management and board of directors regarding the preparation and fair presentation of published financial statements.
Management, including our Chief Executive Officer and Chief Financial Officer, assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2013. In making this assessment, management used the criteria set forth in "Internal Control - Integrated Framework" issued by the Committee of Sponsoring Organizations of the Treadway Commission (1992 framework) (the COSO criteria). Based on this assessment, management has determined that the Company’s internal control over financial reporting as of December 31, 2013 was effective based on the specified criteria.
Ernst & Young LLP, the independent registered public accounting firm that audited the Company’s consolidated financial statements included in this Annual Report on Form 10-K, has issued an attestation report on the effectiveness of the Company’s internal control over financial reporting as of December 31, 2013. That report, which expresses an unqualified opinion on the Company’s internal control over financial reporting as of December 31, 2013, is included in this Item under the heading "Attestation Report of Independent Registered Public Accounting Firm."
Attestation Report of Independent Registered Public Accounting Firm
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders of PrivateBancorp, Inc.
We have audited PrivateBancorp, Inc.’s (the "Company") internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (1992 framework) (the COSO criteria). The Company’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2013, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated statements of financial condition of the Company as of December 31, 2013 and December 31, 2012, and the related consolidated statements of income, comprehensive income, changes in equity, and cash flows for each of the three years in the period ended December 31, 2013, of the Company and our report dated February 25, 2014 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Chicago, Illinois
February 25, 2014
ITEM 9B.
ITEM 9B. OTHER INFORMATION
Paul Carey, who has served as the Company's Controller since June 2009, assumed the responsibilities of principal accounting officer effective February 21, 2014. Previously, our Chief Financial Officer, Kevin Killips, signed our quarterly reports as both principal financial officer and principal accounting officer.
Prior to joining the Company, Mr. Carey, age 48, held the position of Senior Vice President, Transition Services at Bank of America, and he previously served for more than eight years in various roles at ABN-AMRO Bank, N.A. and its U.S. subsidiary, LaSalle Bank, which was acquired by Bank of America in 2007. Mr. Carey began his career in public accounting with Ernst & Whinney, a predecessor firm to Ernst & Young LLP, and is licensed as a certified public accountant.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE
Certain information regarding our executive officers is included under "Executive Officers" in Item 1of this Form 10-K and the information included therein is incorporated herein by reference.
Information regarding our directors will be included in our Proxy Statement to be filed for our 2014 Annual Meeting of Stockholders (the "Proxy Statement") under the heading "Election of Directors" and the information to be included therein is incorporated herein by reference.
Information regarding our directors’ and executive officers’ compliance with Section 16(a) of the Exchange Act will be included in the Proxy Statement under the heading "Section 16(a) Beneficial Ownership Reporting Compliance" and the information to be included therein is incorporated herein by reference.
Information regarding the Corporate Governance Committee of our Board of Directors and the procedures by which our stockholders may recommend nominees to our Board of Directors, and information regarding the Audit Committee of our Board
of Directors and its "audit committee financial expert," will be included in the Proxy Statement under the heading "Corporate Governance" and the information to be included therein is incorporated herein by reference.
We have adopted a Code of Ethics as required by the NASDAQ listing standards and the rules of the SEC. The Code of Ethics applies to all of our directors, officers, including our Chief Executive Officer and Chief Financial Officer, and employees. The Code of Ethics is publicly available on our website at http://investor.theprivatebank.com or at www.theprivatebank.com. If we make substantive amendments to the Code of Ethics or grant any waiver, including any implicit waiver, that applies to any of our directors or executive officers, we will disclose the nature of such amendment or waiver on our website or in a report on Form 8-K in accordance with applicable NASDAQ and SEC rules.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Information regarding compensation of our executive officers and directors is included in the Proxy Statement under the headings "Compensation Discussion and Analysis," "Executive Compensation," and "Director Compensation" and the information included therein is incorporated herein by reference.
The information required by this item regarding Compensation Committee Interlocks and Insider Participation is included under the heading "Executive Compensation - Compensation Committee Interlocks and Insider Participation" in the Proxy Statement, and the Compensation Committee Report is included in the Proxy Statement under the heading "Compensation Committee Report." The information included therein is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Information regarding security ownership of certain beneficial owners and management is included in the Proxy Statement under the heading "Security Ownership of Certain Beneficial Owners, Directors and Executive Officers" and the information included therein is incorporated herein by reference.
Securities Authorized for Issuance Under Equity Compensation Plans
The following table sets forth information, as of December 31, 2013, relating to our equity compensation plans pursuant to which equity awards are authorized for issuance. Refer to Note 16 of "Notes to Consolidated Financial Statements" in Item 8 of this Form 10-K for additional information regarding our equity compensation plans.
(1)
Includes all outstanding stock options and performance share units under the 2011 Incentive Compensation Plan, all outstanding stock options under the 2007 Long-Term Incentive Compensation Plan and the Incentive Compensation Plan, and shares underlying deferred stock units credited under the Deferred Compensation Plan, payable on a one-for-one basis in shares of our common stock.
(2)
Weighted average exercise price is based solely on securities with an exercise price.
(3)
Represents all remaining outstanding stock options under the Strategic Long Term Incentive Plan ("SLTIC Plan"). At December 31, 2013, the weighted average remaining contractual term was 3.9 years. In 2007, our Board of Directors adopted the SLTIC Plan which provided for the granting of inducement equity awards to newly recruited officers and employees recruited to join the Company as part of our business plan. The SLTIC Plan was not submitted to stockholders for their approval, and since December 31, 2009, no further awards can be issued under this plan.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR
INDEPENDENCE
Information regarding certain relationships and related party transactions is included in our Proxy Statement under the heading "Transactions with Related Persons" and the information included therein is incorporated herein by reference. Information regarding our directors and their independence is included in the Proxy Statement under the heading "Corporate Governance" and the information included therein is incorporated herein by reference.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Information regarding the fees we paid our independent accountants, Ernst & Young LLP, during 2013 and 2012 and the Audit Committee's policies and procedures regarding the pre-approval of accounting services is included in the Proxy Statement under the headings "Principal Accounting Firm Fees" and "Pre-Approval Procedures" and the information included therein is incorporated herein by reference.
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
PRIVATEBANCORP, INC.
Registrant
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below hereby constitutes and appoints Larry D. Richman, Jennifer R. Evans and Kevin M. Killips, and each of them, the true and lawful attorney-in-fact and agents of the undersigned, with full power of substitution and resubstitution, for and in the name, place and stead of the undersigned, to sign any and all amendments to this Annual Report on Form 10-K, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, and hereby grants to such attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done, as fully as to all intents and purposes as each of the undersigned might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or any of them, or their or his substitutes, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on February 25, 2014.
Signatures
Title
/s/ Larry D. Richman
President, Chief Executive Officer and Director
Larry D. Richman
/s/ Kevin M. Killips
Chief Financial Officer and Principal Financial Officer
Kevin M. Killips
/s/ Paul E. Carey
Controller and Principal Accounting Officer
Paul E. Carey
/s/ James M. Guyette
Chairman and Director
James M. Guyette
/s/ Norman R. Bobins
Director
Norman R. Bobins
/s/ Robert F. Coleman
Director
Robert F. Coleman
Signatures
Title
/s/ Ralph B. Mandell
Director
Ralph B. Mandell
/s/ Cheryl Mayberry McKissack
Director
Cheryl Mayberry McKissack
/s/ James B. Nicholson
Director
James B. Nicholson
/s/ Edward W. Rabin
Director
Edward W. Rabin
/s/ Collin E. Roche
Director
Collin E. Roche
/s/ William R. Rybak
Director
William R. Rybak
Director
Alejandro Silva
EXHIBIT INDEX
(a)
Filed herewith.
(b)
This exhibit shall not be deemed "filed" for purposes of Section 18 of the Securities Exchange Act of 1934, or otherwise subject to the liability of that section, and shall not be deemed to be incorporated by reference into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934.
Exhibits 10.5 through 10.42 are management contracts or compensatory plans or arrangements.