| TAYLOR CAPITAL GROUP INC Item 1A Risk Factors You should read carefully and consider the following risks and uncertainties because they could materially and adversely affect our business, financial condition, results of operations and prospects |
| Fluctuations in interest rates could reduce our profitability |
| We are subject to interest rate risk |
| We realize income primarily from the difference between interest earned on loans and investments and the interest paid on deposits and borrowings |
| We expect that we will periodically experience imbalances in the interest rate sensitivities of our assets and liabilities and the relationships of various interest rates to each other |
| Over any defined period of time, our interest-earning assets may be more sensitive to changes in market interest rates than our interest-bearing liabilities, or vice versa |
| In addition, the individual market interest rates underlying our loan and deposit products (eg, LIBOR and prime) may not change to the same degree over a given time period |
| In any event, if market interest rates should move contrary to our position, our earnings may be negatively affected |
| In addition, loan volume and quality and deposit volume and mix can be affected by market interest rates |
| Changes in levels of market interest rates could materially adversely affect our net interest spread, asset quality, origination volume and overall profitability |
| As of December 31, 2005, our internal financial models indicated an exposure to our net interest income from both declining or flat rates |
| If market interest rates were to remain flat and we experienced no change in the volume and mix of our earning assets or funding liabilities, we expect that our earning asset yields would likely remain flat and our liability rates would likely increase, resulting in a reduced net interest spread |
| Our net interest income would also likely decline if rates were to fall |
| We estimate that, as of December 31, 2005, our net interest income at risk for year one in a falling rate scenario of 200 basis points would be approximately dlra3dtta0 million, or 2dtta75prca, lower than our net interest income in a rates unchanged scenario |
| Computation of prospective effects of hypothetical interest rate changes are based on numerous assumptions, including relative levels of market interest rates, loan and security prepayments, deposit decay and pricing and reinvestment strategies and should not be relied upon as indicative of actual results |
| We manage interest rate risk by managing our volume and mix of our earning assets and funding liabilities and using derivative financial instruments to hedge interest rate risk associated with specific hedged items |
| In a changing interest rate environment, we may not be able to manage this risk effectively |
| If we are unable to manage interest rate risk effectively, our business, financial condition and results of operations could be materially harmed |
| Our wholesale funding sources may prove insufficient to replace deposit withdrawals and support our future growth |
| We must maintain sufficient funds to respond to the needs of depositors and borrowers |
| As part of our liquidity management, we use a number of funding sources in addition to what is provided by in-market deposits and repayments and maturities of loans and investments |
| As we continue to grow, we are likely to become more dependent on these sources, which include brokered and out-of-local-market certificates of deposit, broker/dealer repurchase agreements, federal funds purchased and Federal Home Loan Bank, or FHLB, advances |
| At December 31, 2005, we had approximately dlra505dtta8 million of brokered deposits, dlra131dtta1 million of out-of-local-market certificates of deposit, dlra100dtta0 million of broker/dealer repurchase agreements, and dlra75dtta0 million of FHLB advances outstanding |
| Adverse operating results or changes in industry conditions could lead to an inability to obtain the necessary funding at maturity |
| Our financial flexibility will be severely constrained if we are unable to maintain our access to funding or if adequate financing is not available at acceptable interest rates |
| Finally, if we are required to rely more heavily on more expensive funding sources to support future growth, our revenues may not increase proportionately to cover our costs |
| In this case, our operating margins and profitability would be adversely affected |
| 9 ______________________________________________________________________ [36]Table of Contents We may be unable to respond cost effectively to deposit volatility created by significant deposit customers |
| As a part of our liquidity management, we must ensure we can respond effectively to potential volatility in our customers’ deposit balances |
| We have customers that maintain significant deposit balances, the immediate withdrawal of which would be material to our daily liquidity management |
| We could encounter difficulty meeting a significant deposit outflow which could negatively impact our profitability or reputation |
| We use primarily FHLB borrowings, broker/dealer repurchase agreements and federal funds purchased to meet immediate liquidity needs |
| In addition, the Bank is able to borrow from the Federal Reserve Bank through the Borrower-in-Custody (“BIC”) program |
| At December 31, 2005, the Bank maintained pre-approved overnight federal funds borrowing lines at various correspondent banks totaling dlra165 million, repurchase agreement availability with major brokers and banks totaling dlra750 million and collateral under the BIC program for borrowings totaling dlra308 million |
| While we believe these alternative funding sources are adequate to meet any significant unanticipated deposit withdrawal, we may not be able to manage the risk of deposit volatility effectively |
| Our allowance for loan losses may prove to be insufficient to absorb losses in our loan portfolio |
| Like all financial institutions, we maintain an allowance for loan losses to provide for loans in our portfolio that may not be repaid in their entirety |
| We believe that our allowance for loan losses is maintained at a level adequate to absorb probable losses inherent in our loan portfolio as of the corresponding balance sheet date |
| However, our allowance for loan losses may not be sufficient to cover actual loan losses, and future provisions for loan losses could materially adversely affect our operating results |
| In evaluating the adequacy of our allowance for loan losses, we consider numerous quantitative factors, including our historical charge-off experience, growth of our loan portfolio, changes in the composition of our loan portfolio and the volume of delinquent and criticized loans |
| In addition, we use information about specific borrower situations, including their financial position and estimated collateral values under various liquidation scenarios, to estimate the risk and amount of loss for those borrowers |
| Finally, we also consider many qualitative factors, including general and economic business conditions, duration of the current business cycle, the impact of competition on our underwriting terms, current general market collateral valuations, trends apparent in any of the factors we take into account and other matters, which are by nature more subjective and fluid |
| Our estimates of the risk of loss and amount of loss on any loan are complicated by the significant uncertainties surrounding our borrowers’ abilities to successfully execute their business models through changing economic environments, competitive challenges and other factors |
| Because of the degree of uncertainty and susceptibility of these factors to change, our actual losses may vary from our current estimates |
| As a business bank, our loan portfolio is comprised primarily of commercial loans to businesses |
| These loans are typically larger in amount than loans to individual consumers and generally are viewed as having more risk of default than first lien residential real estate loans |
| Larger commercial loans also can cause greater volatility in reported credit quality performance measures, such as total impaired or nonperforming loans |
| For example, our current credit risk rating and loss estimate with respect to a single sizeable loan can have a material impact on our reported impaired loans and related loss exposure estimates |
| Because our loan portfolio contains a significant number of commercial and commercial real estate loans with relatively large balances, the deterioration of any one or a few of these loans may cause a significant increase in uncollectible loans that could have an adverse impact on our results of operations and financial condition |
| In addition, federal and state regulators periodically review our allowance for loan losses and may require us to increase our allowance for loan losses by recognizing additional provisions for loan losses charged to expense, or to decrease our allowance for loan losses by recognizing loan charge-offs, net of recoveries |
| Any such additional provisions for loan losses or charge-offs, as required by these regulatory agencies, could have a material adverse effect on our financial condition and results of operations |
| Our business is subject to the conditions of the local economy in which we operate |
| Our success is dependent to a significant extent upon economic conditions in the Chicago metropolitan area, where substantially all of our loans are originated |
| For example, our small- and middle-market business and 10 ______________________________________________________________________ [37]Table of Contents commercial real estate customers in the Chicago metropolitan area could be significantly affected by a local recession or economic downturn, which may result in an increase of defaults on outstanding loans and reduced demand for future loans, both of which could adversely affect us |
| Adverse changes in the economy of the Chicago metropolitan area could also impair our ability to gather deposits and could otherwise have a negative effect on our business, including the demand for new loans, the ability of customers to repay loans and the value of the collateral securing loans |
| Furthermore, as of December 31, 2005, 71prca of our loan portfolio involves loans that are to some degree secured by real estate properties located primarily within the Chicago metropolitan area |
| In the event that real estate values in the Chicago area decline, the value of this collateral would be impaired |
| Competition from financial institutions and other financial services providers may adversely affect our growth and profitability |
| We operate in a highly competitive industry and experience intense competition from other financial institutions in our market |
| We compete with these institutions in making loans, attracting deposits and recruiting and retaining talented people |
| Many of our competitors are well-established, larger financial institutions |
| We have observed that the competition in our market for making commercial loans has resulted in more competitive pricing and credit structure as well as intense competition for skilled commercial lending officers |
| These trends could have a material adverse effect on our ability to grow and remain profitable |
| Significant discounting of interest rates offered on loans negatively impacts interest income and can therefore adversely impact net interest income |
| More liberal credit structures can expose a financial institution to higher losses from lending activities |
| An inability to recruit and retain skilled commercial loan officers poses a significant barrier to retaining and growing our customer base |
| While we believe we can and do successfully compete with other financial institutions in our market, we may face a competitive disadvantage as a result of our smaller size and lack of geographic diversification |
| Although our competitive strategy is to provide a distinctly superior customer and employee experience, we can give no assurance this strategy will be successful |
| We are dependent upon the services of our senior management team |
| Our future success and profitability is substantially dependent upon the management and banking abilities of our senior executives, including Jeffrey and Bruce Taylor, the two most senior officers of our company and Cole Taylor Bank |
| We have not entered into employment or non-competition agreements with Jeffrey or Bruce Taylor or any other officers of our company or Cole Taylor Bank, and can provide no assurance that we will be able to retain these key people or prevent them from competing with us should we lose their services |
| The unexpected loss of the services of any one of these key people could have a material adverse effect on our business, financial condition and results of operations |
| Our business strategy is dependent on our ability to attract, develop and retain highly skilled and experienced personnel in our customer relationship positions |
| Our competitive strategy is to provide each of our commercial customers with a highly skilled relationship manager that will serve as the customer’s key point of contact with us |
| Our business model is to provide our customers with seasoned relationship managers that can deliver greater value to our customers than our competitors |
| Achieving the status of a “trusted advisor” for our customers also requires that we minimize relationship manager turnover and provide stability to the customer relationship |
| Competition for experienced personnel is intense, and we have no existing non-competition agreements with our key personnel, including our relationship managers |
| Therefore, we cannot assure you that we will be able to successfully attract and retain such personnel or prevent them from competing with us should we lose their services |
| We may not be able to execute our growth strategy |
| Our future success depends on our achieving growth in commercial banking relationships that result in increased commercial loans outstanding at yields that are profitable to us |
| Achieving our growth targets requires 11 ______________________________________________________________________ [38]Table of Contents us to attract customers that currently bank at other financial institutions in our market, thereby increasing our share of the market |
| We cannot assure you that we will be able to expand our market presence or that any such expansion will not adversely affect our results of operations |
| Our strategy for future growth also may place a significant strain on our management, personnel, systems and resources |
| Maintaining strong credit quality while growing our loan portfolio is critical to achieving and sustaining profitable growth |
| We cannot assure you that we will manage our growth effectively |
| If we fail to do so, our business could be materially harmed |
| Our business may be adversely affected by the highly regulated environment in which we operate |
| We are subject to extensive federal and state regulation and supervision, which is primarily for the protection of depositors and customers rather than for the benefit of investors |
| As a bank holding company, we are subject to regulation and supervision primarily by the Federal Reserve |
| Cole Taylor Bank, as an Illinois-chartered member bank, is subject to regulation and supervision by the DFPR and by the Federal Reserve |
| We must undergo periodic examinations by our regulators, who have extensive discretion and power to prevent or remedy unsafe or unsound practices or violations of law by banks and bank holding companies |
| Our failure to comply with state and federal regulations can lead to, among other things, termination or suspension of our licenses, rights of rescission for borrowers, class action lawsuits and administrative enforcement actions |
| We cannot assure you that we will be able to fully comply with these regulations |
| Recently enacted, proposed and future legislation and regulations have had, and will continue to have, a significant impact on the financial services industry |
| Regulatory or legislative changes could cause us to change or limit some of our loan products or the way we operate our business and could adversely affect our profitability |
| Our business is subject to the vagaries of domestic and international economic conditions and other factors, many of which are beyond our control and could significantly harm our business |
| Our business is directly affected by domestic and international factors that are beyond our control, including economic, political and market conditions, broad trends in industry and finance, legislative and regulatory changes, competition, changes in government monetary and fiscal policies, consolidation within our customer base and within our industry and inflation |
| For example, a significant decline in general economic conditions, such as recession, increased unemployment and other factors beyond our control, would significantly impact our business |
| A deterioration in economic conditions may result in a decrease in demand for commercial credit and a decline in real estate and other asset values |
| Delinquencies, foreclosures and losses generally increase during economic slowdowns and recessions, and we therefore expect that our servicing costs and credit losses would increase during such periods |
| Alternatively, increases in the level of interest rates could negatively impact the real estate market resulting in reduced real estate development activity and reduced debt service coverage |
| We are subject to certain operational risks, including, but not limited to, data processing system failures and errors and customer or employee fraud |
| There have been a number of highly publicized cases involving fraud or other misconduct by employees of financial services firms in recent years |
| Misconduct by our employees could include hiding unauthorized activities from us, improper or unauthorized activities on behalf of our customers or improper use of confidential information |
| Employee fraud, errors and employee and customer misconduct could subject us to financial losses or regulatory sanctions and seriously harm our reputation |
| It is not always possible to prevent employee errors and misconduct, and the precautions we take to prevent and detect this activity may not be effective in all cases |
| Employee errors could also subject us to civil claims for negligence |
| We maintain a system of internal controls and procedures designed to reduce the risk of loss from employee or customer fraud or misconduct and employee errors as well as insurance coverage to mitigate against 12 ______________________________________________________________________ [39]Table of Contents operational risks, including data processing system failures and errors and customer or employee fraud |
| Should our internal controls fail to prevent or detect an occurrence, or if an occurrence is not insured or exceeds applicable insurance limits, it could have a material adverse effect on our business, financial condition or results of operations |
| We are subject to security risks relating to our internet banking activities that could damage our reputation and our business |
| Security breaches in our internet banking activities could expose us to possible liability and damage our reputation |
| Any compromise of our security also could deter customers from using our internet banking services that involve the transmission of confidential information |
| We rely on standard internet security systems to provide the security and authentication necessary to effect secure transmission of data |
| These precautions may not protect our systems from compromises or breaches of our security measures that could result in damage to our reputation and our business |