Quarterly Report (10-q)

Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

x            QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2014

or

 

o               TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from              to             

 

Commission file number: 001-36308

 

TALMER BANCORP, INC.

(Exact name of registrant as specified in its charter)

 

Michigan		61-1511150
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
2301 West Big Beaver Rd, Suite 525 Troy, Michigan		48084
(Address of principal executive offices)		(Zip Code)

 

(248) 498-2802

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x    No  o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x    No  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer  o		Accelerated filer  o
Non-accelerated filer  x  (Do not check if a smaller reporting company)		Smaller reporting company  o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o    No  x

 

The number of shares outstanding of the issuer’s Class A common stock, as of August 13, 2014 was 70,451,057.

 

 

Table of Contents

 

TABLE OF CONTENTS

 

		Page
Cautionary Note Regarding Forward-Looking Statements		1
PART I — FINANCIAL INFORMATION		2
ITEM 1.	Financial Statements	2
	Consolidated Balance Sheets as of June 30, 2014 and December 31, 2013	2
	Consolidated Statements of Income for the three and six months ended June 30, 2014 and 2013	3
	Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2014 and 2013	4
	Consolidated Statements of Changes in Shareholders’ Equity for the six months ended June 30, 2014 and 2013	5
	Consolidated Statements of Cash Flows for the six months ended June 30, 2014 and 2013	6
	Notes to Consolidated Statements	7
ITEM 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	71
ITEM 3.	Quantitative and Qualitative Disclosures About Market Risk	113
ITEM 4.	Controls and Procedures	116
PART II — OTHER INFORMATION		117
ITEM 1.	Legal Proceedings	117
ITEM 1A.	Risk Factors	117
ITEM 2.	Unregistered Sales of Equity Securities and Use of Proceeds	117
ITEM 3.	Defaults Upon Senior Securities	117
ITEM 4.	Mine Safety Disclosures	117
ITEM 5.	Other Information	117
ITEM 6.	Exhibits	117

 

Table of Contents

 

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

Statements included in this report that are not historical in nature are intended to be, and are hereby identified as, forward-looking statements for purposes of the safe harbor provided by Section 21E of the Securities Exchange Act of 1934, as amended.  The words “may,” “will,” “anticipate,” “should,” “would,” “believe,” “contemplate,” “expect,” “estimate,” “continue,” “may” and “intend,” as well as other similar words and expressions of the future, are intended to identify forward-looking statements.  These forward-looking statements include statements related to our projected growth, proposed branch sales, branch consolidations, including the anticipated costs associated with such consolidations, anticipated future financial performance, and management’s long-term performance goals, as well as statements relating to the anticipated effects on results of operations and financial condition from expected developments or events, or business and growth strategies, including anticipated internal growth and plans to establish or acquire banks (including the pending acquisition of First of Huron Corporation) or the assets of failed banks.

 

These forward-looking statements involve significant risks and uncertainties that could cause our actual results to differ materially from those anticipated in such statements.  Potential risks and uncertainties include the following:

 

·                   the reaction to the anticipated acquisition of the banks’ customers, employees and counterparties or difficulties related to the transition of services;

·                   the inability to obtain the requisite regulatory approvals for our anticipated acquisition and meet other closing terms and conditions;

·                   general economic conditions (both generally and in our markets) may be less favorable than expected, which could result in, among other things, a continued deterioration in credit quality, a further reduction in demand for credit and a further decline in real estate values;

·                   the general decline in the real estate and lending markets, particularly in our market areas, may continue to negatively affect our financial results;

·                   our ability to raise additional capital may be impaired if current levels of market disruption and volatility continue or worsen;

·                   we may be unable to collect reimbursements on losses that we incur on our assets covered under loss share agreements with the FDIC as we anticipate;

·                   costs or difficulties related to the integration of the banks we acquired or may acquire, including Talmer West Bank, may be greater than expected;

·                   restrictions or conditions imposed by our regulators on our operations or the operations of banks we acquire, including the terms of the Talmer West Bank Consent Order with the FDIC and the Michigan Department of Insurance and Financial Services, may make it more difficult for us to achieve our goals;

·                   legislative or regulatory changes, including changes in accounting standards and compliance requirements, may adversely affect us;

·                   competitive pressures among depository and other financial institutions may increase significantly;

·                   changes in the interest rate environment may reduce margins or the volumes or values of the loans we make or have acquired;

·                   other financial institutions have greater financial resources and may be able to develop or acquire products that enable them to compete more successfully than we can;

·                   our ability to attract and retain key personnel can be affected by the increased competition for experienced employees in the banking industry;

·                   adverse changes may occur in the bond and equity markets;

·                   war or terrorist activities may cause further deterioration in the economy or cause instability in credit markets; and

·                   economic, governmental or other factors may prevent the projected population, residential and commercial growth in the markets in which we operate.

 

You should not place undue reliance on the forward-looking statements, which speak only as of the date of this report.  All subsequent written and oral forward-looking statements attributable to us or any person acting on our behalf are expressly qualified in their entirety by the cautionary statements contained or referred to in this section.  We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.  See Item 1A, Risk Factors, in our Annual Report on Form 10-K for the year ended December 31, 2013, for a description of some of the important factors that may affect actual outcomes.

 

1

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PART I

 

Item 1.  Financial Statements.

 

Talmer Bancorp, Inc.

Consolidated Balance Sheets

(Unaudited)

 

		June 30,			December 31,
(Dollars in thousands, except per share data)		2014			2013
Assets
Cash and due from banks		$	107,292		$	97,167
Interest-bearing deposits with other banks		218,309			206,160
Federal funds sold and other short-term investments		77,000			72,029
Total cash and cash equivalents		402,601			375,356
Securities available-for-sale		731,700			620,083
Federal Home Loan Bank stock		16,541			16,303
Loans held for sale, (includes $113.8 million and $85.3 million respectively, measured at fair value)		136,089			85,252
Loans:
Residential real estate (includes $18.5 million and $16.3 million respectively, measured at fair value) (1)		1,362,869			1,085,453
Commercial real estate		1,131,348			755,839
Commercial and industrial		647,090			446,644
Real estate construction (includes $1.4 million measured at fair value at December 31, 2013) (1)		112,866			176,226
Consumer		42,034			9,754
Total loans, excluding covered loans		3,296,207			2,473,916
Less: Allowance for loan losses - uncovered		(24,360		)	(17,746		)
Net loans - excluding covered loans		3,271,847			2,456,170
Covered loans		459,280			530,068
Less: Allowance for loan losses - covered		(32,743		)	(40,381		)
Net loans - covered		426,537			489,687
Net total loans		3,698,384			2,945,857
Premises and equipment		56,642			51,001
FDIC indemnification asset		102,694			131,861
Other real estate owned		52,273			29,955
Loan servicing rights		74,104			78,603
Core deposit intangible		15,378			13,205
FDIC receivable		7,198			7,783
Company-owned life insurance		95,580			39,500
Income tax benefit		187,847			126,200
Other assets		30,642			26,402
Total assets		$	5,607,673		$	4,547,361
Liabilities
Deposits:
Noninterest-bearing demand deposits		$	958,278		$	779,379
Interest-bearing demand deposits		697,031			598,281
Money market and savings deposits		1,330,036			1,215,864
Time deposits		1,187,661			927,313
Other brokered funds		123,528			80,000
Total deposits		4,296,534			3,600,837
FDIC clawback liability		26,309			24,887
FDIC warrants payable		4,493			4,118
Short-term borrowings		238,826			71,876
Long-term debt		266,407			199,037
Other liabilities		48,979			29,591
Total liabilities		4,881,548			3,930,346
Shareholders’ equity
Preferred stock - $1.00 par value
Authorized - 20,000,000 shares at 6/30/2014 and 12/31/2013
Issued and outstanding - 0 shares at 6/30/2014 and 12/31/2013		—			—
Common stock:
Class A Voting Common Stock - $1.00 par value
Authorized - 198,000,000 shares at 6/30/2014 and 12/31/2013
Issued and outstanding - 70,451,057 shares at 6/30/2014 and 66,234,397 shares at 12/31/2013		70,451			66,234
Class B Non-Voting Common Stock - $1.00 par value
Authorized - 2,000,000 shares at 6/30/2014 and 12/31/2013
Issued and outstanding - 0 shares at 6/30/2014 and 12/31/2013		—			—
Additional paid-in-capital		404,079			366,428
Retained earnings		249,362			192,349
Accumulated other comprehensive income (loss), net of tax		2,233			(7,996		)
Total shareholders’ equity		726,125			617,015
Total liabilities and shareholders’ equity		$	5,607,673		$	4,547,361

 

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(1)  Amounts represent loans for which the Company has elected the fair value option.  See Note 3.

 

See notes to Consolidated Financial Statements.

 

2

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Table of Contents

 

Talmer Bancorp, Inc.

Consolidated Statements of Income

(Unaudited)

 

		Three months ended June 30,						Six months ended June 30,
(Dollars in thousands, except per share data)		2014			2013			2014			2013
Interest income
Interest and fees on loans		$	56,925		$	51,290		$	110,338		$	100,028
Interest on investments
Taxable		2,198			1,102			4,076			2,466
Tax-exempt		1,139			1,006			3,091			2,000
Total interest on securities		3,337			2,108			7,167			4,466
Interest on interest earning cash balances		172			201			388			491
Interest on federal funds and other short term investments		278			247			455			447
Dividends on FHLB stock		160			138			345			545
FDIC indemnification asset		(5,506		)	(6,908		)	(12,224		)	(15,056		)
Total interest income		55,366			47,076			106,469			90,921
Interest Expense
Interest-bearing demand deposits		216			159			440			326
Money market and savings deposits		492			494			986			1,012
Time deposits		1,432			1,545			2,923			3,206
Other brokered funds		35			48			64			72
Interest on short-term borrowings		33			33			208			55
Interest on long-term debt		627			742			1,201			1,538
Total interest expense		2,835			3,021			5,822			6,209
Net interest income		52,531			44,055			100,647			84,712
Provision for loan losses - uncovered		3,219			4,923			9,643			6,099
Benefit for loan losses - covered		(7,321		)	(7,460		)	(9,819		)	(6,376		)
Net interest income after provision for loan losses		56,633			46,592			100,823			84,989
Noninterest income
Deposit fee income		3,163			4,648			6,437			9,160
Mortgage banking and other loan fees		(1,025		)	10,770			239			15,955
Net gain on sales of loans		5,681			16,139			8,713			32,954
Bargain purchase gain		—			—			40,157			71,702
FDIC loss sharing income		(3,434		)	(2,343		)	(3,547		)	(2,213		)
Accelerated discount on acquired loans		4,326			3,920			10,792			6,213
Net gain (loss) on sales of securities		—			69			(2,310		)	100
Other income		5,185			2,858			9,590			5,790
Total noninterest income		13,896			36,061			70,071			139,661
Noninterest expenses
Salary and employee benefits		30,391			34,110			66,120			87,005
Occupancy and equipment expense		7,937			6,824			17,085			13,827
Data processing fees		2,260			1,913			4,000			3,560
Professional service fees		2,814			4,425			7,104			8,312
FDIC loss sharing expense		983			722			1,507			1,418
Bank acquisition and due diligence fees		268			474			1,979			7,703
Marketing expense		1,607			654			2,698			2,191
Other employee expense		804			958			1,500			1,705
Insurance expense		803			3,280			2,652			6,212
Other expense		6,302			6,544			15,138			12,563
Total noninterest expenses		54,169			59,904			119,783			144,496
Income before income taxes		16,360			22,749			51,111			80,154
Income tax provision (benefit)		(4,246		)	7,743			(5,902		)	4,693
Net income		$	20,606		$	15,006		$	57,013		$	75,461
Earnings per common share:
Basic		$	0.29		$	0.23		$	0.82		$	1.14
Diluted		$	0.27		$	0.21		$	0.76		$	1.08
Average common shares outstanding - basic		70,021			66,229			69,071			66,229
Average common shares outstanding - diluted		75,659			69,852			74,531			69,764

 

See notes to Consolidated Financial Statements.

 

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Talmer Bancorp, Inc.

Consolidated Statements of Comprehensive Income

(Unaudited)

 

		Three months ended June 30,						Six months ended June 30,
(Dollars in thousands)		2014			2013			2014			2013
Net income		$	20,606		$	15,006		$	57,013		$	75,461
Other comprehensive income (loss):
Unrealized holding gains (losses) on securities available-for-sale arising during the period		7,151			(13,719		)	13,427			(14,478		)
Reclassification adjustment for (gains) losses on realized income (1)		—			(69		)	2,310			(100		)
Net unrealized gains (losses) on securities available-for-sale		7,151			(13,788		)	15,737			(14,578		)
Tax effect		(2,503		)	4,818			(5,508		)	5,102
Other comprehensive income (loss), net of tax		4,648			(8,970		)	10,229			(9,476		)
Total comprehensive income, net of tax		$	25,254		$	6,036		$	67,242		$	65,985

 

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(1) Amounts are included in “Net gain (loss) on on sales of securities” in the Consolidated Statements of Income within total noninterest income. For the three months ended June 30, 2014, there was no income tax expense (benefit) associated with the reclassification adjustments.  Income tax expense (benefit) associated with the reclassification adjustments for the three months ended June 30, 2013 was $24 thousand, and for the six months ended June 30, 2014 and 2013 was ($809) thousand and $35 thousand, respectively, and are included in “Income tax provision (benefit)” in the Consolidated Statements of Income.

 

See notes to Consolidated Financial Statements.

 

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Talmer Bancorp, Inc.

Consolidated Statements of Changes in Shareholders’ Equity

(Unaudited)

 

							Additional						Accumulated Other			Total
		Common Stock					Paid in			Retained			Comprehensive			Shareholders’
(In thousands)		Shares		Amount			Capital			Earnings			Income (Loss)			Equity
Balance at December 31, 2012		66,229		$	66,229		$	356,836		$	93,760		$	3,918		$	520,743
Cumulative effect adjustment of change in accounting policy to beginning retained earnings										31						31
Net income										75,461						75,461
Other comprehensive loss													(9,476		)	(9,476		)
Stock based compensation expense							9,090									9,090
Balance at June 30, 2013		66,229		$	66,229		$	365,926		$	169,252		$	(5,558	)	$	595,849
Balance at December 31, 2013		66,234		$	66,234		$	366,428		$	192,349		$	(7,996	)	$	617,015
Net income										57,013						57,013
Other comprehensive income													10,229			10,229
Stock-based compensation expense							454									454
Issuance of common shares		3,839		3,839			37,575									41,414
Restricted stock awards		378		378			(378		)							—
Balance at June 30, 2014		70,451		$	70,451		$	404,079		$	249,362		$	2,233		$	726,125

 

See notes to Consolidated Financial Statements.

 

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Talmer Bancorp, Inc.

Consolidated Statements of Cash Flows

(Unaudited)

 

		Six Months Ended June 30,
(Dollars in thousands)		2014			2013
Cash flows from operating activities
Net income		$	57,013		$	75,461
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		3,386			4,348
Amortization of core deposit intangibles		1,460			1,356
Stock-based compensation expense		454			9,090
Benefit for loan losses		(176		)	(277		)
Originations of loans held for sale		(510,154		)	(1,575,966		)
Proceeds from sales of loans		489,389			1,479,430
Net gain from sales of loans		(8,713		)	(32,954		)
Net (gain)/loss on sales of securities		2,310			(100		)
Gain on acquisition		(40,157		)	(71,702		)
Valuation writedowns on other real estate		2,404			3,559
Valuation change in Company-owned life insurance		(1,080		)	(665		)
Valuation change in loan servicing rights		9,014			(2,480		)
Net additions to loan servicing rights		(3,748		)	(15,083		)
Net decrease in FDIC indemnification asset and receivable		29,752			54,826
Net gain on sales of other real estate owned		(4,233		)	(2,544		)
Net increase in accrued interest receivable and other assets		(21,211		)	(9,274		)
Net increase in accrued expenses and other liabilities		17,168			39,058
Net securities premium amortization		2,286			3,930
Deferred income tax expense		20,665			6,588
Change in valuation allowance of deferred income tax asset		(10,127		)	—
Other, net		183			(57		)
Net cash from (used in) operating activities		35,886			(33,456		)
Cash flows from investing activities
Net increase in uncovered loans		(288,289		)	(81,209		)
Net decrease in covered loans		68,023			107,113
Purchases of FHLB stock		(5,300		)	(490		)
Purchases of securities available-for-sale		(185,687		)	(406,000		)
Purchases of Company-owned life insurance		(55,000		)	—
Purchases of premises and equipment		(6,995		)	(2,059		)
Proceeds from:
Maturities and redemptions of securities available-for-sale		44,619			202,385
Sale of FHLB stock		10,995			—
Sale of securities available-for-sale		54,211			7,500
Sale of uncovered loans		5,526			—
Sale of other real estate owned		24,161			18,869
Sale of premises and equipment		1,621			46
Net cash provided from acquisition		209,831			394,805
Net cash from (used in) investing activities		(122,284		)	240,960
Cash flows from financing activities
Net decrease in deposits		(162,072		)	(143,151		)
Net increase in other short-term borrowings		201,932			134,817
Issuances of long-term FHLB advances		90,000			30,000
Repayments of long-term FHLB advances		(21,880		)	(112,948		)
Repayments on long-term sweep repurchase agreements		(816		)	(813		)
Repayments of senior unsecured line of credit		(35,000		)	—
Other changes in long-term debt		66			527
Proceeds from issuance of common stock		41,414			—
Net cash from (used in) financing activities		113,644			(91,568		)
Net change in cash and cash equivalents		27,245			115,936
Beginning cash and cash equivalents		375,356			362,771
Ending cash and cash equivalents		$	402,601		$	478,707
Supplemental disclosure of cash flow information:
Interest paid		$	6,125		$	5,690
Income taxes paid		4,344			15,775
Transfer from loans to other real estate owned		13,097			11,689
Net transfer of loans held for investment to loans held for sale		21,456			—
Transfer from premises and equipment to other bank owned property		675			2,324
Non-cash transactions:
Increase in assets and liabilities in acquisitions:
Securities		13,619			139,764
FHLB stock		5,933			12,993
Loans held-for-sale		—			213,946
Uncovered loans		571,666			1,530,376
Premises and equipment		4,912			22,168
Loan servicing rights		767			41,967
Company-owned life insurance		—			38,172
Other real estate owned		30,878			18,448
Core deposit intangible		3,633			9,816
Other assets		60,722			128,278
Deposits		857,769			2,121,258
Short-term borrowings		18			21,892
Long-term debt		—			312,956
Other liabilities		4,017			22,925

 

See notes to Consolidated Financial Statements.

 

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TALMER BANCORP, INC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2014

 

1 . BASIS OF PRESENTATION AND RECENTLY ADOPTED AND ISSUED ACCOUNTING STANDARDS

 

The accompanying unaudited consolidated financial statements of Talmer Bancorp, Inc. (“the Company”), and its wholly-owned subsidiaries have been prepared in accordance with United States (U.S.) generally accepted accounting principles (“GAAP”) for interim financial information and with instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, the statements do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation of the Consolidated Financial Statements, primarily consisting of normal recurring adjustments, have been included. The results of operations for interim periods are not necessarily indicative of the results that may be expected for the full year or for any other interim period. Certain items in prior periods were reclassified to conform to the current presentation.  For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s consolidated financial statements and footnotes included in the Annual Report of Talmer Bancorp, Inc. on Form 10-K for the year ended December 31, 2013.

 

On February 11, 2014, the Securities and Exchange Commission declared effective the Company’s registration statement on Form S-1 registering the shares of the Company’s common stock as “TLMR” on the Nasdaq Capital Market.  On February 14, 2014, the Company completed the initial public offering of 15,555,555 shares of Class A common stock for $13 per share.  Of the 15,555,555 shares sold, 3,703,703 shares were sold by the Company and 11,851,852 shares were sold by certain selling shareholders.  In addition, on February 21, 2014, the selling shareholders sold an additional 2,333,333 shares of Class A common stock to cover the exercise of the underwriters’ over-allotment option.  The Company received net proceeds of approximately $42.0 million from the offering, after deducting the underwriting discounts and commissions and estimated offering expenses.  The Company did not receive any proceeds from the sale of shares by the selling shareholders.

 

Subsequent Events

 

In July 2014, Talmer West Bank sold its single branch office in Albuquerque, New Mexico along with its $34.1 million of deposits and $23.7 million of loans to Grants State Bank, a unit of First Bancorp of Durango, Inc. The net impact to pre-tax income related to this transaction recorded in the third quarter of 2014 is a $1.6 million benefit, as gains on sales of loans and deposits of $1.5 million and $400 thousand, respectively, were partially offset by the write-off of the related core deposit intangible, loss on the sale of fixed assets and other costs associated with the transaction.

 

In August 2014, the Company entered into an agreement to acquire First of Huron Corporation, the holding company for Signature Bank headquartered in Bad Axe, Michigan, for aggregate cash consideration of $13.4 million.  Signature Bank had total assets of $228.0 million as of June 30, 2014, including $172.3 million of net total loans.  The Company will acquire and simultaneously retire certain outstanding subordinated debentures of First of Huron Corporation and assume its trust preferred securities.  The closing of the transaction is pending regulatory approval and customary closing conditions, including the approval by the shareholders of First of Huron Corporation.  The transaction is expected to close in the fourth quarter of 2014 or the first quarter of 2015.

 

On August 8, 2014, we sold our branch offices located in Wisconsin to Town Bank, a wholly owned bank subsidiary of Wintrust Financial Corporation.  Under the terms of the agreement we sold our 10 branch offices to Town Bank, for approximately $13.5 million more than the net book value of the assets acquired and liabilities assumed in the transaction.  Town Bank assumed all of our deposits in Wisconsin totaling $354.8 million as of August 8, 2014. Concurrent with the closing of this transaction, Town Bank will sell two of the branch locations and related deposits in Kenosha and Genoa City, Wisconsin to its affiliate, State Bank of the Lakes, a Wintrust community bank. As of June 30, 2014, $9.0 million of premises and equipment is accounted for at lower of cost or fair value and considered held for sale related to this transaction.  The

 

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net impact to pre-tax income related to this transaction recorded in the third quarter of 2014 was a $12.1 million benefit, related to gains on the sale of net assets and liabilities, offset by the write-off of the related core deposit intangible of $911 thousand and other costs associated with the transaction of approximately $1.0 million.

 

Customer Initiated Derivatives

 

In the first quarter of 2014, the Company began entering into interest rate derivatives to provide a service to certain qualifying customers to help facilitate their respective risk management strategies (“customer-initiated derivatives”).  Therefore, these derivatives are not used to manage interest rate risk in the Company’s assets or liabilities. The Company generally takes offsetting positions with dealer counterparties to mitigate the valuation risk of the customer-initiated derivatives.  Income primarily results from the spread between the customer derivatives and the offsetting dealer positions. The accounting for changes in the fair value (i.e. gains or losses) of a derivative instrument is determined by whether it has been designated and qualifies as part of a hedging relationship and, further by the type of hedging relationship.  The Company presents derivative instruments at fair value in the Consolidated Balance Sheets on a net basis when a right of offset exists, based on transactions with a single counterparty and any cash collateral paid to and/or received from that counterparty for derivative contracts that are subject to legally enforceable master netting arrangements.  The Company has no derivatives designated as qualifying accounting hedging instruments.  For derivative instruments not designated as hedging instruments, the gain or loss derived from changes in fair value are recognized in current earnings during the period of change.

 

Earnings Per Share

 

On June 10, 2014, the Company awarded restricted stock to certain employees and directors of the Company which qualify as participating securities. As such, beginning in June of 2014, the Company applies the two-class method of computing earnings per share.  Under this calculation, all outstanding unvested share-based payment awards that contain right to nonforfeitable dividends are considered participating securities and earnings per share is determined according to dividends declared, when applicable, and participating rights in undistributed earnings.

 

Basic earnings per common share is net income divided by the weighted average number of common shares outstanding during the period.  Distributed and undistributed earnings are allocated between common and participating security shareholders based on their respective rights and then are divided by the weighted-average number of common shares outstanding during the period.  Diluted earnings per common share includes the dilutive effect of additional potential common shares issuable under stock options and warrants.

 

Deferred Compensation Plan

 

As of June 26, 2014, the Company maintains a deferred compensation plan to certain key employees and members of the Board of Directors which allows participants to defer a portion of their compensation.  Participants have the ability to begin deferrals into the Deferred Compensation Plan beginning July 1, 2014.  While the Company maintains ownership of the deferred compensation asset, the participants are able to direct the investment of the assets into a pre-determined selection of investment options.  Company stock is not an investment option for the participants.  The assets are recorded at fair value in other assets on the Consolidated Balance Sheets.  A liability is established, in other liabilities on the Consolidated Balance Sheets, for the fair value of the obligation to the participants.  Any increase or decrease in the fair value of the deferred compensation plan assets is recorded in other noninterest income on the Consolidated Statements of Income.  Any increase or decrease in the fair value of the deferred compensation obligation to participants is recorded as additional compensation expense or a reduction of compensation expense on the Consoldiated Statements of Income.

 

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Recently Adopted and Issued Accounting Standards

 

In January 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-04, “ Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure ” (“ASU 2014-04”), which clarifies the time at which a creditor is considered to have physical possession of residential real estate that is collateral for a residential mortgage loan.  The creditor is considered to have physical possession when legal title to the collateral or a deed in lieu of foreclosure or similar legal agreement is completed.  Consequently it should reclassify the loan to other real estate owned at that time.  ASU 2014-04 is effective for public companies for annual periods, and interim periods within those annual periods, beginning after December 15, 2014, as such, the Company will adopt ASU 2014-04 as of January 1, 2015.  Under the provisions, the Company will have the option to adopt the amendments in the ASU using either a modified retrospective transition method or a prospective transition method.  The Company is currently evaluating the provisions of ASU 2014-04.

 

In April 2014, the FASB issued ASU No. 2014-08 , “Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity” (“ASU 2014-08”), which raises the threshold for a disposal to qualify as a discontinued operation and requires new disclosures of both discontinued operations and certain other disposals that do not meet the definition of a discontinued operation.  The ASU is intended to reduce the frequency of disposals reported as discontinued operations by focusing on strategic shifts that have or will have a major effect on an entity’s operations and financial results and will permit companies to have continuing cash flows and significant continuing involvement with the disposed component.  ASU 2014-08 is effective for disposals (or classifications as held for sale) and acquired businesses or nonprofit activities that are classified as held for sale upon acquisition that occur within annual periods beginning on or after December 15, 2014, and interim periods within those years.  As such, the Company will evaluate the provisions of ASU 2014-08 as it relates to any potential disposals or acquisitions beginning on or after January 1, 2015.

 

In May 2014, the FASB issued ASU 2014-09, “ Revenue from Contracts with Customers ” (“ASU 2014-09”), which outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including revenue recognition guidance.  The core principle of the revenue model is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The ASU is intended to clarify and converge the revenue recognition principles under U.S. GAAP and International Financial Reporting Standards and to streamline revenue recognition requirements in addition to expanding required revenue recognition disclosures.  ASU 2014-09 is effective for public companies for annual periods, and interim periods within those annual periods, beginnining on or after December 15, 2016.  As such, the Company will adopt ASU 2014-09 as of January 1, 2017.  Under the provision, the Company will have the option to adopt the guidance using either a full retrospective method or a modified transition approach.  The Company is currently evaluating the provisions of ASU 2014-09.

 

In June 2014, the FASB issued ASU 2014-11, “ Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures ” (“ASU 2014-11”), which amends Accounting Standards Codification (“ASC”) 860 to require entities to account for repurchase-to-maturity transactions as secured borrowings, elimate accounting guidance on linked repurchase financing transactions and expand disclosure requirements related to certain transfers of financial assets that are accounted for as sales and certain transfers accounted for as secured borrowings.  The disclosure requirements related to transactions accounted for as a sale and all of the accounting guidance within ASU 2014-11are effective for public companies for interim and annual periods beginning after December 15, 2014, and require the new guidance to be applied by making a cumulative-effect adjustment to retained earnings as of the beginning of the period of adoption.  The disclosure requirements related to repurchase agreements, securities lending transactions and repurchase-to-maturity transactions accounted for as secured borrowings within ASU 2014-11 are effective for public companies for annual periods beginning after December 15, 2014 and for interim periods

 

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beginning after March 15, 2015.  As such, the Company will adopt the accounting guidance under ASU 2014-11 as of January 1, 2015.  The Company is currently evaluating the provisions of ASU 2014-11.

 

2.  BUSINESS COMBINATIONS

 

The Company has determined that the acquisitions of Talmer West Bank (formerly known as Michigan Commerce Bank) and First Place Bank constitute business combinations as defined by the FASB ASC Topic 805, “ Business Combinations. ”  Accordingly, the assets acquired and liabilities assumed were recorded at their fair values on the date of acquisition, as required. Fair values were determined based on the requirements of FASB ASC Topic 820, “ Fair Value Measurement ”. In many cases the determination of these fair values required management to make estimates about discount rates, future expected cash flows, market conditions and other future events that are highly subjective in nature and subject to change.

 

On January 1, 2014, the Company purchased 100% of the capital stock of Financial Commerce Corporation’s wholly-owned subsidiary banks, Michigan Commerce Bank, a Michigan state-chartered bank, Indiana Community Bank, an Indiana state-chartered bank, Bank of Las Vegas, a Nevada state-chartered bank and Sunrise Bank of Albuquerque, a New Mexico state-chartered bank, and certain other bank-related assets from Financial Commerce Corporation and its parent holding company, Capitol Bancorp Ltd., in a transaction facilitated under Section 363 of the U.S. Bankruptcy Code, for cash consideration of $4.0 million and a separate $2.5 million payment to fund an escrow account to pay the post-petition administrative fees and expenses of the professionals in the bankruptcy cases of Financial Commerce Corporation and Capital Bancorp, Ltd., each of which filed voluntary bankruptcy petitions under Chapter 11 of the U.S. Bankruptcy Code on August 9, 2012, with any unused escrowed funds to be refunded to the Company.

 

Immediately prior to consummation of the acquisition, Capitol Bancorp Ltd. merged Indiana Community Bank, Bank of Las Vegas and Sunrise Bank of Albuquerque with and into Michigan Commerce Bank, with Michigan Commerce Bank as the surviving bank in the merger.  Simultaneously with the merger, Michigan Commerce Bank changed its name to Talmer West Bank.  The Company contributed $99.5 million of additional capital during the three months ended March 31, 2014 to Talmer West Bank in order to recapitalize the bank.  In order to support the acquisition and recapitalization of Talmer West Bank, the Company borrowed $35.0 million under a senior unsecured line of credit. The Company used a portion of the net proceeds from the initial public offering that closed on February 14, 2014 to repay the $ 35.0 million during the first quarter of 2014.  The Company incurred $191 thousand and $1.8  million of acquisition related expenses during the three and six months ended June 30, 2014, respectively, related to the acquisition of Talmer West Bank, included within “Bank acquisition and due diligence fees” in the Consolidated Statements of Income.  Although the acquisition included five branches in Nevada and New Mexico that are outside of the Company’s target markets, 12 of the branches acquired, or 70% of the total number of branches acquired in the acquisition, fit squarely within the Company’s target market areas.

 

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The assets and liabilities associated with the acquisition of Talmer West Bank were recorded in the consolidated balance sheets at estimated fair value as of the acquisition date.  The following allocation is based on the information that was available to make preliminary estimates of the fair value and may change as additional information becomes available and additional analyses are completed.  While the Company believes that information provided a reasonable basis for estimating the fair values, it expects that it could obtain additional information and evidence during the measurement period that may result in changes to the estimated fair value amounts. This measurement period ends on the earlier of one year after the acquisition date or the date we receive the information about the facts and circumstances that existed at acquisition date. Subsequent adjustments are, and if necessary, will be retrospectively reflected in future filings. These refinements include: (1) changes in the estimated fair value of loans acquired and changes in the determination on whether such loans are considered purchased credit impaired; (2) changes in the estimated fair value of certain premises and equipment acquired; (3) changes in deferred tax assets related to fair value estimates and a change in the expected realization of items considered to be built in losses and (4) a change in the bargain purchase gain caused by the net effect of these adjustments.

 

(Dollars in thousands)
Consideration paid:
Cash		$	6,500
Fair value of identifiable assets acquired:
Cash and cash equivalents		216,331
Investment securities		13,619
Federal Home Loan Bank stock		5,933
Loans		571,666
Premises and equipment		4,912
Loan servicing rights		767
Other real estate owned		30,878
Core deposit intangible		3,633
Other assets		60,722
Total identifiable assets acquired		908,461
Fair value of liabilities assumed:
Deposits		857,769
Other liabilities		4,035
Total liabilities assumed		861,804
Fair value of net identifiable assets acquired		46,657
Bargain purchase gain resulting from acquisition		$	40,157

 

The estimated fair values presented in the above table reflect additional information that the Company obtained following the acquisition, which resulted in changes to certain fair value estimates made as of the acquisition date within the measurement period.  Material adjustments to the acquisition date estimated fair values are recorded in the period in which the acquisition occurred and, as a result, previously recorded results have changed.  After considering this additional information, the estimated fair value of the deferred tax assets included within “other assets”  increased $4.2 million, the estimated fair value of loans decreased $507 thousand and the estimated fair value of other liabilities increased $500 thousand.  These revised fair value estimates resulted in a net increase to the bargain purchase gain resulting from acquisition of $3.2 million to $40.2 million, which is recognized in the Consolidated Statement of Income for the six months ended June 30, 2014.  The increase in the acquisition date deferred tax asset resulted from changes in the amounts of temporary differences related to nonaccrual interest and federal loss carryforwards that were deemed necessary based on information obtained subsequent to the acquisition that affected the value of deferred tax assets on January 1, 2014.  In addition to the increase in the acquisition date deferred tax asset value, the amount of the valuation allowance on the deferred tax assets was reduced to zero from $961 thousand.  The decrease in the valuation allowance at acquisition was driven by the change in federal loss carryforwards.

 

The Talmer West Bank acquisition resulted in a pre-tax bargain purchase gain of $40.2 million as the estimated fair value of assets acquired exceeded the estimated fair value of liabilities assumed and consideration paid.  The gain was included within “Bargain purchase gain” in the Consolidated Statements of Income.

 

Loans acquired in the Talmer West Bank acquisition were initially recorded at fair value with no separate allowance for loan losses.  The Company reviewed the loans at acquisition to determine which should be considered purchased credit impaired loans (i.e. loans accounted for under FASB ASC Subtopic 310-30 , “Loans and Debt

 

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