First Midwest Bancorp 10Q 2013 Q2 Quarterly report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ______________ FORM 10-Q (Mark One)
[X]	Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended June 30, 2013
or
[ ]	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 0-10967 _______________ FIRST MIDWEST BANCORP, INC. (Exact name of registrant as specified in its charter)
Delaware (State or other jurisdiction of incorporation or organization)		36-3161078 (IRS Employer Identification No.)
One Pierce Place, Suite 1500 Itasca, Illinois 60143-9768 (Address of principal executive offices) (zip code) ______________ Registrant’s telephone number, including area code: (630) 875-7450 ______________
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 [ ].
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 [ ].
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. (Check one):
Large accelerated filer [X] Non-accelerated filer [ ] (Do not check if a smaller reporting company)		Accelerated filer [ ] Smaller reporting company [ ]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X].
As of August 9, 2013, there were 75,062,597 shares of $.01 par value common stock outstanding.

FIRST MIDWEST BANCORP, INC.

FORM 10-Q

TABLE OF CONTENTS

		Page
Part I.	FINANCIAL INFORMATION
Item 1.	Financial Statements (Unaudited)
	Consolidated Statements of Financial Condition	3
	Condensed Consolidated Statements of Income	4
	Consolidated Statements of Comprehensive Income	5
	Consolidated Statements of Changes in Stockholders’ Equity	6
	Condensed Consolidated Statements of Cash Flows	7
	Notes to the Condensed Consolidated Financial Statements	8
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	41
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	71
Item 4.	Controls and Procedures	72
Part II.	OTHER INFORMATION
Item 1.	Legal Proceedings	72
Item 1A.	Risk Factors	73
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	73
Item 6.	Exhibits	74

PART I. FINANCIAL INFORMATION (Unaudited)

ITEM 1. FINANCIAL STATEMENTS

FIRST MIDWEST BANCORP, INC.

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

(Amounts in thousands, except per share data)

	June 30, 2013		December 31, 2012
Assets	(Unaudited)
Cash and due from banks	$	130,992	$	149,420
Interest-bearing deposits in other banks		653,113		566,846
Trading securities, at fair value		15,451		14,162
Securities available-for-sale, at fair value		1,223,486		1,082,403
Securities held-to-maturity, at amortized cost		30,373		34,295
Federal Home Loan Bank (“FHLB”) and Federal Reserve Bank stock, at cost		35,161		47,232
Loans, excluding covered loans		5,287,565		5,189,676
Covered loans		171,861		197,894
Allowance for loan and covered loan losses		(94,110)		(99,446)
Net loans		5,365,316		5,288,124
Other real estate owned (“OREO”), excluding covered OREO		39,497		39,953
Covered OREO		13,681		13,123
Federal Deposit Insurance Corporation (“FDIC”) indemnification asset		23,158		37,051
Premises, furniture, and equipment		118,285		121,596
Accrued interest receivable		27,626		27,535
Investment in bank-owned life insurance (“BOLI”)		207,081		206,405
Goodwill and other intangible assets		279,421		281,059
Other assets		180,684		190,635
Total assets	$	8,343,325	$	8,099,839
Liabilities
Noninterest-bearing deposits	$	1,855,906	$	1,762,903
Interest-bearing deposits		5,010,841		4,909,352
Total deposits		6,866,747		6,672,255
Borrowed funds		196,603		185,984
Senior and subordinated debt		214,843		214,779
Accrued interest payable and other liabilities		90,479		85,928
Total liabilities		7,368,672		7,158,946
Stockholders’ Equity
Common stock		858		858
Additional paid-in capital		411,470		418,318
Retained earnings		813,516		786,453
Accumulated other comprehensive loss, net of tax		(10,299)		(15,660)
Treasury stock, at cost		(240,892)		(249,076)
Total stockholders’ equity		974,653		940,893
Total liabilities and stockholders’ equity	$	8,343,325	$	8,099,839
Per Common Share Data
Par Value	$	0.01	$	0.01
Shares authorized		100,000		100,000
Shares issued		85,787		85,787
Shares outstanding		75,063		74,840
Treasury shares		10,724		10,947
See accompanying notes to the unaudited condensed consolidated financial statements.

FIRST MIDWEST BANCORP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Amounts in thousands, except per share data)

(Unaudited)

		Quarter Ended June 30,				Six Months Ended June 30,
		2013		2012		2013		2012
Interest Income
Loans, excluding covered loans		$	59,111	$	61,993	$	118,542	$	123,484
Covered loans			4,151		4,473		7,600		8,675
Investment securities			7,657		8,414		15,013		17,348
Other short-term investments			834		638		1,643		1,279
Total interest income			71,753		75,518		142,798		150,786
Interest Expense
Deposits			3,003		4,678		6,323		10,191
Borrowed funds			385		490		827		1,005
Senior and subordinated debt			3,435		3,646		6,870		7,704
Total interest expense			6,823		8,814		14,020		18,900
Net interest income			64,930		66,704		128,778		131,886
Provision for loan and covered loan losses			5,813		22,458		11,487		40,668
Net interest income after provision for loan and covered loan losses			59,117		44,246		117,291		91,218
Noninterest Income
Service charges on deposit accounts			9,118		8,848		17,795		17,508
Card-based fees			5,547		5,312		10,623		10,332
Wealth management fees			6,126		5,394		11,965		10,786
Mortgage banking income			1,040		-		3,006		-
Merchant servicing fees			2,899		2,908		5,453		5,230
Other service charges, commissions, and fees			1,278		1,189		2,924		2,387
Other income			1,217		235		3,034		3,275
Net securities gains (losses)			216		151		216		(792)
Total noninterest income			27,441		24,037		55,016		48,726
Noninterest Expense
Salaries and wages			26,820		23,852		55,783		51,109
Retirement and other employee benefits			6,101		5,714		13,707		12,507
Net occupancy and equipment expense			7,793		7,513		15,940		15,844
Technology and related costs			2,884		2,851		5,367		5,709
Professional services			5,595		6,905		10,813		12,534
Net OREO expense			1,084		4,124		2,883		5,988
FDIC premiums			1,704		1,659		3,446		3,378
Other expenses			10,446		8,539		19,302		16,701
Total noninterest expense			62,427		61,157		127,241		123,770
Income before income tax expense	��		24,131		7,126		45,066		16,174
Income tax expense			7,955		761		14,248		1,917
Net income			16,176		6,365		30,818		14,257
Net income applicable to non-vested restricted shares			(219)		(76)		(431)		(215)
Net income applicable to common shares		$	15,957	$	6,289	$	30,387	$	14,042
Per Common Share Data
Basic earnings per common share		$	0.22	$	0.09	$	0.41	$	0.19
Diluted earnings per common share		$	0.22	$	0.09	$	0.41	$	0.19
Dividends declared per common share		$	0.04	$	.01	$	0.05	$	.02
Weighted-average common shares outstanding			74,017		73,659		73,942		73,582
Weighted-average diluted common shares outstanding			74,024		73,659		73,950		73,582
See accompanying notes to the unaudited condensed consolidated financial statements.

FIRST MIDWEST BANCORP, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Amounts in thousands)

(Unaudited)

	Quarters Ended June 30,				Six Months Ended June 30,
	2013		2012		2013		2012
Net income	$	16,176	$	6,365	$	30,818	$	14,257
Available-for-sale securities
Unrealized holding gains (losses):
Before tax		1,164		(1,409)		(852)		1,490
Tax effect		(945)		550		(158)		(549)
Net of tax		219		(859)		(1,010)		941
Reclassification of net gains (losses) included in net income:
Before tax		216		151		216		(792)
Tax effect		(88)		(62)		(88)		324
Net of tax		128		89		128		(468)
Net unrealized holding gains (losses)		91		(948)		(1,138)		1,409
Unrecognized net pension costs
Unrealized holding gains:
Before tax		10,997		-		10,997		-
Tax effect		(4,498)		-		(4,498)		-
Net of tax		6,499		-		6,499		-
Total other comprehensive income (loss)		6,590		(948)		5,361		1,409
Total comprehensive income	$	22,766	$	5,417	$	36,179	$	15,666

	Accumulated Unrealized (Loss) Gain on Securities Available- for-Sale		Unrecognized Net Pension Costs		Total Accumulated Other Comprehensive (Loss) Income
Balance at January 1, 2012	$	(354)	$	(12,922)	$	(13,276)
Other comprehensive income		1,409		-		1,409
Balance at June 30, 2012	$	1,055	$	(12,922)	$	(11,867)
Balance at January 1, 2013	$	1,115	$	(16,775)	$	(15,660)
Other comprehensive income		(1,138)		6,499		5,361
Balance at June 30, 2013	$	(23)	$	(10,276)	$	(10,299)

See accompanying notes to the unaudited condensed consolidated financial statements.

FIRST MIDWEST BANCORP, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

(Amounts in thousands, except per share data)

(Unaudited)

	Common Shares Outstanding	Common Stock		Additional Paid-in Capital		Retained Earnings		Accumulated Other Comprehensive (Loss) Income		Treasury Stock		Total
Balance at January 1, 2012	74,435	$	858	$	428,001	$	810,487	$	(13,276)	$	(263,483)	$	962,587
Comprehensive income	-		-		-		14,257		1,409		-		15,666
Common dividends declared ($0.02 per common share)	-		-		-		(1,494)		-		-		(1,494)
Share-based compensation expense	-		-		3,139		-		-		-		3,139
Restricted stock activity	429		-		(16,424)		-		-		15,049		(1,375)
Treasury stock (purchased for) issued to benefit plans	(2)		-		(51)		-		-		80		29
Balance at June 30, 2012	74,862	$	858	$	414,665	$	823,250	$	(11,867)	$	(248,354)	$	978,552
Balance at January 1, 2013	74,840	$	858	$	418,318	$	786,453	$	(15,660)	$	(249,076)	$	940,893
Comprehensive income	-		-		-		30,818		5,361		-		36,179
Common dividends declared ($0.05 per common share)	-		-		-		(3,755)		-		-		(3,755)
Share-based compensation expense	-		-		2,854		-		-		-		2,854
Restricted stock activity	224		-		(9,648)		-		-		8,126		(1,522)
Treasury stock (purchased for) issued to benefit plans	(1)		-		(54)		-		-		58		4
Balance at June 30, 2013	75,063	$	858	$	411,470	$	813,516	$	(10,299)	$	(240,892)	$	974,653

See accompanying notes to the unaudited condensed consolidated financial statements.

FIRST MIDWEST BANCORP, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollar amounts in thousands) (Unaudited)
	Six Months Ended June 30,
	2013		2012
Net cash provided by operating activities	$	70,414	$	86,051
Investing Activities
Proceeds from maturities, repayments, and calls of securities available-for-sale		125,533		191,624
Proceeds from sales of securities available-for-sale		19,745		12,059
Purchases of securities available-for-sale		(289,666)		(371,251)
Proceeds from maturities, repayments, and calls of securities held-to-maturity		5,803		10,470
Purchases of securities held-to-maturity		(1,881)		(10,945)
Proceeds from the redemption of FHLB stock		12,071		11,437
Net increase in loans		(85,210)		(236,927)
(Purchases) of BOLI, net of proceeds from claims		(76)		315
Proceeds from sales of OREO		10,907		37,983
Proceeds from sales of premises, furniture, and equipment		1,425		3
Purchases of premises, furniture, and equipment		(3,286)		(3,986)
Net cash used in investing activities		(204,635)		(359,218)
Financing Activities
Net increase in deposit accounts		194,492		148,568
Net increase (decrease) in borrowed funds		10,619		(15,847)
Payments for the retirement of subordinated debt		-		(20,004)
Cash dividends paid		(1,499)		(1,491)
Restricted stock activity		(1,588)		(1,392)
Excess tax benefit (expense) related to share-based compensation		36		(35)
Net cash provided by financing activities		202,060		109,799
Net increase (decrease) in cash and cash equivalents		67,839		(163,368)
Cash and cash equivalents at beginning of period		716,266		641,530
Cash and cash equivalents at end of period	$	784,105	$	478,162
Supplemental Disclosures:
Non-cash transfers of loans to OREO	$	11,502	$	20,828
Non-cash transfer of loans held-for-investment to loans held-for-sale		1,275		1,500
Non-cash transfer of loans held-for-sale to loans held-for-investment		-		1,500
Non-cash transfer of an investment from other assets to securities available-for-sale		2,787		-
Dividends declared but unpaid		3,005		749
See accompanying notes to the unaudited condensed consolidated financial statements.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation – The accompanying unaudited condensed consolidated interim financial statements of First Midwest Bancorp, Inc. (the “Company”), a Delaware corporation, were prepared in accordance with the rules and regulations of the SEC for quarterly reports on Form 10-Q and reflect all adjustments that management deems necessary for the fair presentation of the financial position and results of operations for the periods presented. The results of operations for the quarter and six-month periods ended June 30, 2013 are not necessarily indicative of the results that may be expected for the year ending December 31, 2013.

The accounting and reporting policies of the Company and its subsidiaries conform to U.S. generally accepted accounting principles (“GAAP”) and general practices within the banking industry. The accompanying quarterly statements do not include certain information and footnote disclosures required by GAAP for complete annual financial statements. Therefore, these financial statements should be read in conjunction with the Company’s 2012 Annual Report on Form 10-K (“2012 10-K”). The Company uses the accrual basis of accounting for financial reporting purposes. Certain reclassifications were made to prior year amounts to conform to the current year presentation.

Use of Estimates – The preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Although these estimates and assumptions are based on the best available information, actual results could differ from those estimates.

Principles of Consolidation – The accompanying consolidated financial statements include the financial position and results of operations of the Company and its subsidiaries after elimination of all significant intercompany accounts and transactions. Assets held in a fiduciary or agency capacity are not assets of the Company or its subsidiaries and are not included in the consolidated financial statements.

The Company owns interests in certain variable interest entities (“VIEs”) as described in Note 21, “Variable Interest Entities,” in the Company’s 2012 10-K. A VIE is a partnership, limited liability company, trust, or other legal entity that does not have sufficient equity to finance its activities without additional subordinated financial support from other parties, or whose investors lack the characteristics associated with owning a controlling financial interest. The VIEs are not consolidated in the Company’s financial statements since the Company is not the primary beneficiary of any of the VIEs.

The accounting policies related to loans, the allowance for credit losses, the FDIC indemnification asset, and derivative financial instruments are presented below. For a summary of all other significant accounting policies, please refer to Note 1, “Summary of Significant Accounting Policies,” in the Company’s 2012 10-K.

Loans – Loans held-for-investment are loans that the Company intends to hold until they are paid in full and are carried at the principal amount outstanding, including certain net deferred loan origination fees. Interest income on loans is accrued based on principal amounts outstanding. Loan origination fees, commitment fees, and certain direct loan origination costs are deferred, and the net amount is amortized as a yield adjustment over the contractual life of the related loans or commitments and included in interest income. Fees related to standby letters of credit are amortized into fee income over the contractual life of the commitment. Other credit-related fees are recognized as fee income when earned. Loans held-for-sale are carried at the lower of aggregate cost or fair value and included in other assets in the Consolidated Statements of Financial Condition.

Purchased Impaired Loans – Purchased impaired loans are recorded at fair value on the acquisition date and are accounted for prospectively based on estimates of expected cash flows. No allowance for credit losses is recorded on these loans at the acquisition date. To estimate the fair value, the Company generally aggregates purchased consumer loans and certain smaller balance commercial loans into pools of loans with common risk characteristics, such as delinquency status, credit score, and internal risk rating. Larger balance commercial loans are estimated on an individual basis. Expected future cash flows in excess of the fair value of loans at the purchase date (“accretable yield”) are recorded as interest income over the life of the loans if the timing and amount of the future cash flows can be reasonably estimated. The non-accretable yield represents the difference between contractually required payments and the cash flows expected to be collected at acquisition.

Subsequent increases in cash flows are recognized as interest income prospectively. The present value of any decreases in expected cash flows is recognized by recording a charge-off through the allowance for loan and covered loan losses or establishing an allowance for loan and covered loan losses.

Non-accrual Loans – Generally, corporate loans are placed on non-accrual status (i) when either principal or interest payments become 90 days or more past due based on contractual terms unless the loan is sufficiently collateralized such that full repayment of both principal and interest is expected and is in the process of collection within a reasonable period or (ii) when an individual analysis of a borrower’s creditworthiness indicates a credit should be placed on non-accrual status whether or not the loan is 90 days or more past due. When a loan is placed on non-accrual status, unpaid interest credited to income in the current year is reversed, and unpaid interest accrued in prior years is charged against the allowance for loan losses. After the loan is placed on non-accrual, all debt service payments are applied to the principal on the loan. Future interest income may only be recorded on a cash basis after recovery of principal is reasonably assured. Non-accrual loans are returned to accrual status when the financial position of the borrower and other relevant factors indicate that the Company will collect all principal and interest.

Commercial loans and loans secured by real estate are charged-off when deemed uncollectible. A loss is recorded if the net realizable value of the underlying collateral is less than the outstanding principal and interest. Consumer loans that are not secured by real estate are subject to mandatory charge-off at a specified delinquency date and are usually not classified as non-accrual prior to being charged-off. Closed-end consumer loans, which include installment, automobile, and single payment loans, are usually charged-off no later than the end of the month in which the loan becomes 120 days past due.

Purchased impaired loans are generally considered accruing loans unless reasonable estimates of the timing and amount of future cash flows cannot be determined. Loans without reasonable cash flow estimates are classified as non-accrual loans, and interest income is not recognized on those loans until the timing and amount of the future cash flows can be reasonably determined.

Troubled Debt Restructurings (“TDRs”) – A restructuring is considered a TDR when (i) the borrower is experiencing financial difficulties and (ii) the creditor grants a concession, such as forgiveness of principal, reduction of the interest rate, changes in payments, or extension of the maturity date. Loans are not classified as TDRs when the modification is short-term or results in an insignificant delay in payments. The Company’s TDRs are determined on a case-by-case basis.

The Company does not accrue interest on a TDR unless it believes collection of all principal and interest under the modified terms is reasonably assured. For a TDR to begin accruing interest, the borrower must demonstrate both some level of past performance and the capacity to perform under the modified terms. Generally, six months of consecutive payment performance under the restructured terms is required before a TDR is returned to accrual status. However, the period could vary depending on the individual facts and circumstances of the loan. An evaluation of the borrower’s current creditworthiness is used to assess the borrower’s capacity to repay the loan under the modified terms. This evaluation includes an estimate of expected cash flows, evidence of strong financial position, and estimates of the value of collateral, if applicable. However, in accordance with industry regulation, these TDRs continue to be separately reported as restructured until after the calendar year in which the restructuring occurred. If the loan was restructured at below market rates and terms, it continues to be separately reported as restructured until it is paid in full or charged-off.

Impaired Loans – Impaired loans consist of corporate non-accrual loans and TDRs.

With the exception of accruing TDRs, a loan is considered impaired when it is probable that the Company will not collect all contractual principal and interest based on current information and events. Impaired loans are classified as non-accrual and are exclusive of smaller homogeneous loans, such as home equity, 1-4 family mortgages, and installment loans. After a loan is designated as impaired, all debt service payments are applied to the principal on the loan. Future interest income may only be recorded on a cash basis after recovery of principal is reasonably assured.

Certain impaired loans with balances under a specified threshold are not individually evaluated for impairment. For all other impaired loans, impairment is measured by comparing the estimated value of the loan to the recorded book value. The value of collateral-dependent loans is based on the fair value of the underlying collateral, less costs to sell. The value of other loans is measured using the present value of expected future cash flows discounted at the loan’s initial effective interest rate. All impaired loans are included in non-performing assets. Purchased impaired loans are not reported as impaired loans provided that estimates of the timing and amount of future cash flows can be reasonably determined.

90-Days Past Due Loans –The Company’s accrual of interest on loans is discontinued at the time the loan is 90 days past due unless the credit is sufficiently collateralized and in the process of renewal or collection.

Allowance for Credit Losses – The allowance for credit losses is comprised of the allowance for loan losses, the allowance for covered loan losses, and the reserve for unfunded commitments and is maintained by management at a level believed adequate to absorb estimated losses inherent in the existing loan portfolio. Determination of the allowance for credit losses is subjective since it requires significant estimates and management judgment, including the amounts and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans, consideration of current economic trends, and other factors.

Loans deemed to be uncollectible are charged-off against the allowance for loan and covered loan losses, while recoveries of amounts previously charged-off are credited to the allowance for loan and covered loan losses. Additions to the allowance for loan and covered loan losses are charged to expense through the provision for loan and covered loan losses. The amount of provision depends on a number of factors, including net charge-off levels, loan growth, changes in the composition of the loan portfolio, and the Company’s assessment of the allowance for loan and covered loan losses based on the methodology discussed below.

Allowance for Loan Losses – The allowance for loan losses consists of (i) specific reserves established for probable losses on individual loans where the recorded investment exceeds the value, (ii) an allowance based on a loss migration analysis that uses historical credit loss experience for each loan category, and (iii) the impact of other internal and external qualitative factors.

The specific reserves component of the allowance for loan losses is based on a periodic analysis of impaired loans exceeding a fixed dollar amount. If the value of an impaired loan is less than the recorded book value, the Company either establishes a valuation allowance (i.e., a specific reserve) equal to the excess of the book value over the value of the loan as a component of the allowance for loan losses or charges off the amount if it is a confirmed loss.

The general reserve component is based on a loss migration analysis, which examines actual loss experience for a rolling 8-quarter period by loan category and the related internal risk rating for corporate loans. The loss migration analysis is updated quarterly using actual loss experience. This component is then adjusted based on management’s consideration of many internal and external qualitative factors, including:

·	Changes in the composition of the loan portfolio, trends in the volume of loans, and trends in delinquent and non-accrual loans that could indicate that historical trends do not reflect current conditions.

·	Changes in credit policies and procedures, such as underwriting standards and collection, charge-off, and recovery practices.

·	Changes in the experience, ability, and depth of credit management and other relevant staff.

·	Changes in the quality of the Company’s loan review system and Board of Directors oversight.

·	The effect of any concentration of credit and changes in the level of concentrations, such as loan type or risk rating.

·	Changes in the value of the underlying collateral for collateral-dependent loans.

·	Changes in the national and local economy that affect the collectability of various segments of the portfolio.

·	The effect of other external factors, such as competition and legal and regulatory requirements, on the Company’s loan portfolio.

Allowance for Covered Loan Losses – The Company’s allowance for covered loan losses reflects the difference between the carrying value and the discounted present value of the estimated cash flows of the covered purchased impaired loans. On a periodic basis, the adequacy of this allowance is determined through a re-estimation of cash flows on all of the outstanding covered purchased impaired loans using either a probability of default/loss given default (“PD/LGD”) methodology or a specific review methodology. The PD/LGD model is an expected loss model that estimates future cash flows using a probability of default curve and loss given default estimates.

Reserve for Unfunded Commitments – The Company also maintains a reserve for unfunded commitments, including letters of credit, for the risk of loss inherent in these arrangements. The reserve for unfunded commitments is estimated using the loss migration analysis from the allowance for loan losses, adjusted for probabilities of future funding requirements. The reserve for unfunded commitments is included in other liabilities in the Consolidated Statements of Financial Condition.

The establishment of the allowance for credit losses involves a high degree of judgment given the difficulty of assessing the factors impacting loan repayment and estimating the timing and amount of losses. While management utilizes its best

judgment and information available, the adequacy of the allowance for credit losses depends on a variety of factors beyond the Company’s control, including the performance of its loan portfolio, the economy, changes in interest rates and property values, and the interpretation of loan risk classifications by regulatory authorities.

FDIC Indemnification Asset – The majority of loans and OREO acquired through FDIC-assisted transactions are covered by loss share agreements with the FDIC (the “FDIC Agreements”), under which the FDIC reimburses the Company for the majority of the losses and eligible expenses related to these assets. The FDIC indemnification asset represents the present value of future expected reimbursements from the FDIC. Since the indemnified items are covered loans and covered OREO, which are initially measured at fair value, the FDIC indemnification asset is also initially measured at fair value by discounting the cash flows expected to be received from the FDIC. These cash flows are estimated by multiplying estimated losses on purchased impaired loans and OREO by the reimbursement rates in the FDIC Agreements.

The balance of the FDIC indemnification asset is adjusted periodically to reflect changes in estimated cash flows. Decreases in expected cash flows on the indemnification asset are recorded prospectively through amortization and increases in estimated reimbursements from the FDIC are recognized by an increase in the carrying value of the indemnification asset. Payments from the FDIC for reimbursement of losses result in a reduction of the FDIC indemnification asset.

Derivative Financial Instruments – In the ordinary course of business, the Company enters into derivative transactions as part of its overall interest rate risk management strategy to minimize significant unplanned fluctuations in earnings and cash flows caused by interest rate volatility. All derivative instruments are recorded at fair value as either other assets or other liabilities in the Consolidated Statements of Financial Condition. Subsequent changes in a derivative’s fair value are recognized in earnings unless specific hedge accounting criteria are met.

On the date the Company enters into a derivative contract, the derivative is designated as a fair value hedge, a cash flow hedge, or a non-hedge derivative instrument. Fair value hedges are designed to mitigate exposure to changes in the fair value of an asset or liability attributable to a particular risk, such as interest rate risk. Cash flow hedges are designed to mitigate exposure to variability in expected future cash flows to be received or paid related to an asset, liability, or other type of forecasted transaction. The Company formally documents all relationships between hedging instruments and hedged items, including its risk management objective and strategy for undertaking each hedge transaction.

At the hedge’s inception and quarterly thereafter, a formal assessment is performed to determine the effectiveness of the derivative in offsetting changes in the fair values or cash flows of the hedged items in the current period and prospectively. 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 into earnings. For fair value hedges, the gain or loss is amortized over the remaining life of the hedged asset or liability. For cash flow hedges, the gain or loss is amortized over the same period that the forecasted hedged transactions impact earnings. If the hedged item is disposed of, any fair value adjustments are included in the gain or loss from the disposition of the hedged item. If the forecasted transaction is no longer probable, the gain or loss is included in earnings immediately.

For effective fair value hedges, changes in the fair value of the derivative instruments, as well as changes in the fair value of the hedged item, are recognized in earnings. For cash flow hedges, the effective portion of the change in fair value of the derivative instrument is reported as a component of accumulated other comprehensive loss. The unrealized gain or loss is reclassified into earnings in the same period the hedged transaction affects earnings.

Ineffectiveness is calculated based on the change in fair value of the hedged item compared with the change in fair value of the hedging instrument. For all types of hedges, any ineffectiveness in the hedging relationship is recognized in earnings during the period the ineffectiveness occurs.

2. RECENT ACCOUNTING PRONOUNCEMENTS

Balance Sheet – Disclosures about Offsetting Assets and Liabilities: In December of 2011, the FASB issued guidance on the presentation of offsetting assets and liabilities on the balance sheet, which was further clarified in January 2013. This guidance requires an entity to disclose both the gross information and net information regarding instruments and transactions eligible for offset, such as derivatives, sale and repurchase agreements, and securities borrowing and lending arrangements. The statement is effective for annual and interim periods beginning on or after January 1, 2013. The Company’s derivative assets and liabilities are presented gross, rather than net, in the Consolidated Statements of Financial Condition. The adoption of this guidance on January 1, 2013 did not impact the Company’s financial condition, results of operations, or liquidity.

Technical Corrections and Improvements: In October of 2012, the FASB issued guidance to update the Accounting Standards Codification (the “Codification”) on a variety of topics, which include source literature amendments, guidance clarification and reference corrections, and relocated guidance. In addition, the standard includes amendments to conform terminology and clarifies certain fair value guidance in the Codification. Although the updates do not introduce any new fair value measurement requirements, they could result in changes to existing practices. Amendments that do not have transition guidance are effective immediately, and amendments subject to transition guidance was effective for fiscal periods beginning after December 15, 2012. The adoption of this guidance on January 1, 2013 did not materially impact the Company’s financial condition, results of operations, or liquidity.

Reporting Amounts Reclassified Out of Accumulated Other Comprehensive Income: In February of 2013, the FASB issued guidance to improve the reporting of reclassifications out of accumulated other comprehensive income. The amendments require an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component on either the face of the income statement or as a separate disclosure in the notes to the financial statements. This guidance was effective for fiscal periods beginning after December 15, 2012. The Company provides disclosures related to amounts reclassified out of accumulated other comprehensive income in Note 3, “Securities.” Since this guidance only impacted the placement of certain disclosures in the financial statements, the adoption of this guidance on January 1, 2013 did not impact the Company’s financial condition, results of operations, or liquidity.

3. SECURITIES

Securities are generally classified as held-to-maturity, trading, or available-for-sale at the time of purchase. Securities classified as held-to-maturity are securities for which management has the positive intent and ability to hold to maturity and are stated at cost.

The Company’s trading securities consist of diversified investment securities reported at fair value that are held in a grantor trust under deferred compensation arrangements that allow plan participants to direct amounts into a variety of securities, including Company stock. Net trading gains represent changes in the fair value of the trading securities portfolio and are included in other noninterest income in the Condensed Consolidated Statements of Income.

All other securities are classified as available-for-sale and are carried at fair value with unrealized gains and losses, net of related deferred income taxes, recorded in stockholders’ equity as a separate component of accumulated other comprehensive loss.

Securities Portfolio

(Dollar amounts in thousands)

		June 30, 2013							December 31, 2012
		Amortized	Gross Unrealized				Fair		Amortized		Gross Unrealized				Fair
		Cost	Gains		Losses		Value		Cost		Gains		Losses		Value
Securities Available-for-Sale
U.S. agency securities	$	503	$	-	$	-	$	503	$	508	$	-	$	-	$	508
Collateralized mortgage obligations (“CMOs”)		543,194		1,691		(8,462)		536,423		397,146		3,752		(515)		400,383
Other mortgage-backed securities (“MBSs”)		124,773		3,540		(1,541)		126,772		117,785		5,183		(68)		122,900
Municipal securities		482,090		13,669		(5,000)		490,759		495,906		24,623		(486)		520,043
Trust-preferred collateralized debt obligations (“CDOs”)		46,532		-		(31,615)		14,917		46,533		-		(34,404)		12,129
Corporate debt securities		13,002		2,105		-		15,107		13,006		2,333		-		15,339
Equity securities:
Hedge fund investment		1,208		1,533		-		2,741		1,231		385		-		1,616
Other equity securities		11,423		24,890		(49)		36,264		8,459		1,026		-		9,485
Total equity securities		12,631		26,423		(49)		39,005		9,690		1,411		-		11,101
Total available-for- sale securities	$	1,222,725	$	47,428	$	(46,667)	$	1,223,486	$	1,080,574	$	37,302	$	(35,473)	$	1,082,403
Securities Held-to-Maturity
Municipal securities	$	30,373	$	1,698	$	-	$	32,071	$	34,295	$	1,728	$	-	$	36,023
Trading Securities							$	15,451							$	14,162

Remaining Contractual Maturity of Securities

(Dollar amounts in thousands)

	June 30, 2013
	Available-for-Sale				Held-to-Maturity
	Amortized Cost		Fair Value		Amortized Cost		Fair Value
One year or less	$	10,974	$	10,552	$	3,817	$	4,030
After one year to five years		312,235		300,232		9,548		10,082
After five years to ten years		113,812		109,437		6,999		7,390
After ten years		105,106		101,065		10,009		10,569
Securities that do not have a single contractual maturity		680,598		702,200		-		-
Total	$	1,222,725	$	1,223,486	$	30,373	$	32,071

The carrying value of securities available-for-sale that were pledged to secure deposits and for other purposes as permitted or required by law totaled $917.5 million at June 30, 2013 and $675.3 million at December 31, 2012. No securities held-to-maturity were pledged as of June 30, 2013 or December 31, 2012.

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 Condensed Consolidated Statements of Income. The cost of securities sold is based on the specific identification method.

Securities Gains (Losses)

(Dollar amounts in thousands)

	Quarters Ended June 30,				Six Months Ended June 30,
	2013		2012		2013		2012
Proceeds from sales	$	19,745	$	9,397	$	19,745	$	12,059
Gains (losses) on sales of securities:
Gross realized gains		216		1,556		216		1,603
Gross realized losses		-		-		-		(253)
Net realized gains on securities sales		216		1,556		216		1,350
Non-cash impairment charges:
Other-than-temporary securities impairment (“OTTI”)		-		(1,591)		-		(2,328)
Portion of OTTI recognized in other comprehensive loss		-		186		-		186
Net non-cash impairment charges		-		(1,405)		-		(2,142)
Net realized gains (losses)		216		151		216		(792)
Income tax (expense) benefit on net realized gains (losses)		(88)		(62)		(88)		324
Net amount reclassified from accumulated other comprehensive loss	$	128	$	89	$	128	$	(468)
Net trading gains (losses)(1)	$	214	$	(575)	$	1,250	$	826

(1)	All net trading gains relate to trading securities still held as of June 30, 2013 and June 30, 2012.

The non-cash impairment charges in the table above primarily relate to OTTI charges on CDOs. Accounting guidance requires that the credit portion of an OTTI charge be recognized through income. If a decline in fair value below carrying value is not attributable to credit deterioration and the Company does not intend to sell the security or believe it would not be more likely than not required to sell the security prior to recovery, the Company records the non-credit related portion of the decline in fair value in other comprehensive income. In deriving the credit component of the impairment on the CDOs, projected cash flows were discounted at the contractual rate and compared to the fair values computed by discounting future projected cash flows at the London Interbank Offered Rate (“LIBOR”) plus an adjustment to reflect the higher risk inherent in these securities given their complex structures and the impact of market factors.

Credit-Related CDO Impairment Losses

(Dollar amounts in thousands)

	Quarters Ended June 30,				Six Months Ended June 30,
CDO Number	2013		2012		2013		2012		Life-to-Date
1	$	-	$	-	$	-	$	-	$	10,360
2		-		893		-		1,535		9,402
3		-		512		-		591		2,262
4		-		-		-		-		1,078
5		-		-		-		-		8,570
6		-		-		-		-		243
	$	-	$	1,405	$	-	$	2,126	$	31,915

The following table presents a rollforward of life-to-date credit losses recognized in earnings attributable to available-for-sale debt securities held by the Company for the quarters and six months ended June 30, 2013 and 2012.

Changes in Credit Losses Recognized in Earnings

(Dollar amounts in thousands)

	Quarters Ended June 30,				Six Months Ended June 30,
	2013		2012		2013		2012
Cumulative amount recognized at the beginning of the period	$	38,803	$	37,262	$	38,803	$	36,525
Credit losses included in earnings (1):
Losses recognized on securities that previously had credit losses		-		1,405		-		2,142
Losses recognized on securities that did not previously have credit losses		-		-		-		-
Reduction for a security sale (2)		(6,750)		-		(6,750)		-
Cumulative amount recognized at the end of the period	$	32,053	$	38,667	$	32,053	$	38,667

(1)	Included in net securities losses in the Condensed Consolidated Statements of Income.
(2)	During the second quarter of 2013, one CDO with a carrying value of zero was sold, resulting in a gain of $101,000. This CDO had OTTI of $6.8 million that were previously recognized in earnings.

The following table presents the aggregate amount of unrealized losses and the aggregate related fair values of securities with unrealized losses as of June 30, 2013 and December 31, 2012.

Securities in an Unrealized Loss Position

(Dollar amounts in thousands)

		Less Than 12 Months				12 Months or Longer				Total
	Number of Securities	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
As of June 30, 2013
CMOs	60	$	343,795	$	7,979	$	42,355	$	483	$	386,150	$	8,462
Other MBSs	17		52,776		1,514		5,296		27		58,072		1,541
Municipal securities	143		64,014		4,142		21,884		858		85,898		5,000
CDOs	6		-		-		14,917		31,615		14,917		31,615
Equity securities	1		2,183		49		-		-		2,183		49
Total	227	$	462,768	$	13,684	$	84,452	$	32,983	$	547,220	$	46,667
As of December 31, 2012
CMOs	19	$	102,939	$	421	$	12,796	$	94	$	115,735	$	515
Other MBSs	6		7,210		55		176		13		7,386		68
Municipal securities	49		28,903		459		1,238		27		30,141		486
CDOs	6		-		-		12,129		34,404		12,129		34,404
Total	80	$	139,052	$	935	$	26,339	$	34,538	$	165,391	$	35,473

Substantially all of the Company’s CMOs and other MBSs are either backed by U.S. government-owned agencies or issued by U.S. government-sponsored enterprises. Municipal securities are issued by municipal authorities, and the majority are supported by third-party insurance or some other form of credit enhancement. Management does not believe any remaining individual unrealized loss as of June 30, 2013 represents an OTTI attributable to credit quality. In addition, the Company does not intend to sell the securities with unrealized losses, and it is not more likely than not that the Company will be required to sell them before recovery of their amortized cost basis, which may be at maturity.

The unrealized losses on CDOs as of June 30, 2013 reflect the illiquidity of these structured investment vehicles. Management does not believe any remaining unrealized losses on the CDOs represent OTTI related to credit deterioration. In addition, the Company does not intend to sell the CDOs with unrealized losses, and the Company does not believe it is more likely than not that it will be required to sell them before recovery of their amortized cost basis, which may be at maturity. As of June 30, 2013, the portion of unrealized losses not related to credit deterioration totaled $31.6 million.

Significant judgment is required to calculate the fair value of the CDOs, all of which are pooled. The Company estimates the fair value of these securities using discounted cash flow analyses with the assistance of a structured credit valuation firm. For additional discussion of the CDO valuation methodology, refer to Note 12, “Fair Value.”

4. LOANS

Loans Held-for-Investment

Loans that the Company intends to hold until they are paid in full or mature are classified as loans held-for-investment. The following table presents the Company’s loans held-for-investment by class.

Loan Portfolio

(Dollar amounts in thousands)

	June 30, 2013		December 31, 2012
Commercial and industrial	$	1,743,139	$	1,631,474
Agricultural		288,632		268,618
Commercial real estate:
Office, retail, and industrial		1,319,849		1,333,191
Multi-family		306,182		285,481
Residential construction		50,384		61,462
Commercial construction		117,116		124,954
Other commercial real estate		759,367		773,121
Total commercial real estate		2,552,898		2,578,209
Total corporate loans		4,584,669		4,478,301
Home equity		374,406		390,033
1-4 family mortgages		291,770		282,948
Installment		36,720		38,394
Total consumer loans		702,896		711,375
Total loans, excluding covered loans		5,287,565		5,189,676
Covered loans (1)		171,861		197,894
Total loans	$	5,459,426	$	5,387,570
Deferred loan fees included in total loans	$	5,180	$	5,941
Overdrawn demand deposits included in total loans	$	3,001	$	4,451

(1)	For information on covered loans, refer to Note 5, “Acquired Loans.”

The Company primarily lends to small and mid-sized businesses, commercial real estate customers, and consumers in the Company’s markets. Within these areas, the Company diversifies its loan portfolio by loan type, industry, and borrower.

It is the Company’s policy to review each prospective credit to determine the appropriateness and the adequacy of security or collateral prior to making a loan. In the event of borrower default, the Company seeks recovery in compliance with state lending laws, the Company’s lending standards, and credit monitoring and remediation procedures. A discussion of risk characteristics relevant to each portfolio segment is presented in Note 4, “Loans,” in the Company’s 2012 10-K.

Mortgage Loan Sales

During the quarter ended June 30, 2013, the Company sold $28.0 million of mortgage loans at a gain of $1.0 million, which is included in mortgage banking income in the Consolidated Statements of Income. For the six months ended June 30, 2013, a gain of $3.0 million was recognized on $82.0 million of mortgage loans sold. The Company retained servicing responsibilities for the sold mortgages and collects servicing fees equal to a percentage of the outstanding principal balance.

The Company also retained limited recourse for credit losses on the sold loans. A description of the recourse obligation is presented in Note 11, “Commitments, Guarantees, and Contingent Liabilities.”

5. ACQUIRED LOANS

Since 2009, the Company acquired the majority of the assets and assumed the deposits of four financial institutions in FDIC-assisted transactions. In three of those transactions, most loans and OREO acquired are covered by the FDIC Agreements. The significant accounting policies related to purchased impaired loans and the related FDIC indemnification asset are presented in Note 1, “Summary of Significant Accounting Policies.”

Acquired Loans

(Dollar amounts in thousands)

	June 30, 2013							December 31, 2012
	Covered			Non-Covered		Total		Covered			Non-Covered		Total
Purchased impaired loans	$	133,675	(1)	$	16,312	$	149,987	$	154,762	(1)	$	18,198	$	172,960
Other loans (2)		38,186			20,441		58,627		43,132			22,480		65,612
Total acquired loans	$	171,861		$	36,753	$	208,614	$	197,894		$	40,678	$	238,572

(1)	At acquisition, the Company made an election to account for certain covered loans as purchased impaired loans. These loans totaled $26.3 million at June 30, 2013 and $28.1 million at December 31, 2012.
(2)	These loans did not meet the requirements to be accounted for as purchased impaired loans at acquisition.

Except for leases and revolving loans, management determined that a significant portion of the acquired loans had evidence of credit deterioration since origination (“purchased impaired loans”), and it was probable at the date of acquisition that the Company would not collect all contractually required principal and interest payments. Evidence of credit quality deterioration was evaluated using indicators, such as past due and non-accrual status. Other key considerations and indicators included the past performance of the troubled institutions’ credit underwriting standards, completeness and accuracy of credit files, maintenance of risk ratings, and age of appraisals.

In connection with the FDIC Agreements, the Company recorded an indemnification asset. To maintain eligibility for the loss share reimbursement, the Company is required to follow certain servicing procedures as specified in the FDIC Agreements. The Company is in compliance with those requirements as of June 30, 2013 and December 31, 2012.

Changes in the FDIC Indemnification Asset

(Dollar amounts in thousands)

	Quarters Ended June 30,				Six Months Ended June 30,
	2013		2012		2013		2012
Beginning balance	$	28,958	$	58,488	$	37,051	$	65,609
Amortization		(908)		(2,517)		(2,232)		(4,496)
Expected reimbursements from the FDIC for changes in expected credit losses		(1,512)		7,738		(2,454)		9,772
Payments received from the FDIC		(3,380)		(5,407)		(9,207)		(12,583)
Ending balance	$	23,158	$	58,302	$	23,158	$	58,302

Changes in the accretable yield for purchased impaired loans were as follows.

Changes in Accretable Yield

(Dollar amounts in thousands)

	Quarters Ended June 30,				Six Months Ended June 30,
	2013		2012		2013		2012
Beginning balance	$	45,532	$	41,045	$	51,498	$	52,147
Accretion		(4,456)		(5,794)		(8,342)		(11,181)
Other		6,028		13,729		3,948		8,014
Ending balance	$	47,104	$	48,980	$	47,104	$	48,980

6. PAST DUE LOANS, ALLOWANCE FOR CREDIT LOSSES, AND IMPAIRED LOANS

Past Due and Non-accrual Loans

The following table presents an aging analysis of the Company’s past due loans as of June 30, 2013 and December 31, 2012. The aging is determined without regard to accrual status. The table also presents non-performing loans, consisting of non-accrual loans (the majority of which are past due) and loans 90 days or more past due and still accruing interest, as of each balance sheet date.

Aging Analysis of Past Due Loans and Non-Performing Loans by Class

(Dollar amounts in thousands)

	Aging Analysis (Accruing and Non-accrual)										Non-performing Loans
	Current		30-89 Days Past Due		90 Days or More Past Due		Total Past Due		Total Loans		Non- accrual Loans		90 Days Past Due Loans, Still Accruing Interest
June 30, 2013
Commercial and industrial	$	1,720,522	$	10,911	$	11,706	$	22,617	$	1,743,139	$	28,157	$	425
Agricultural		287,789		167		676		843		288,632		786		-
Commercial real estate:
Office, retail, and industrial		1,297,720		1,477		20,652		22,129		1,319,849		24,428		160
Multi-family		304,304		570		1,308		1,878		306,182		2,068		131
Residential construction		47,259		-		3,125		3,125		50,384		3,331		-
Commercial construction		112,218		2,965		1,933		4,898		117,116		3,878		-
Other commercial real estate		746,039		3,000		10,328		13,328		759,367		13,022		99
Total commercial real estate		2,507,540		8,012		37,346		45,358		2,552,898		46,727		390
Total corporate loans		4,515,851		19,090		49,728		68,818		4,584,669		75,670		815
Home equity		362,492		4,574		7,340		11,914		374,406		6,377		2,222
1-4 family mortgages		284,672		1,841		5,257		7,098		291,770		5,064		767
Installment		34,289		348		2,083		2,431		36,720		2,082		28
Total consumer loans		681,453		6,763		14,680		21,443		702,896		13,523		3,017
Total loans, excluding covered loans		5,197,304		25,853		64,408		90,261		5,287,565		89,193		3,832
Covered loans		122,129		6,573		43,159		49,732		171,861		28,468		27,700
Total loans	$	5,319,433	$	32,426	$	107,567	$	139,993	$	5,459,426	$	117,661	$	31,532
December 31, 2012
Commercial and industrial	$	1,614,167	$	4,883	$	12,424	$	17,307	$	1,631,474	$	25,941	$	2,138
Agricultural		267,077		79		1,462		1,541		268,618		1,173		375
Commercial real estate:
Office, retail, and industrial		1,306,526		4,130		22,535		26,665		1,333,191		23,224		823
Multi-family		283,634		761		1,086		1,847		285,481		1,434		153
Residential construction		57,009		-		4,453		4,453		61,462		4,612		-
Commercial construction		124,081		-		873		873		124,954		873		-
Other commercial real estate		755,103		1,053		16,965		18,018		773,121		16,214		1,534
Total commercial real estate		2,526,353		5,944		45,912		51,856		2,578,209		46,357		2,510
Total corporate loans		4,407,597		10,906		59,798		70,704		4,478,301		73,471		5,023
Home equity		376,801		6,482		6,750		13,232		390,033		6,189		1,651
1-4 family mortgages		272,270		4,472		6,206		10,678		282,948		4,874		1,947
Installment		35,936		2,390		68		2,458		38,394		-		68
Total consumer loans		685,007		13,344		13,024		26,368		711,375		11,063		3,666
Total loans, excluding covered loans		5,092,604		24,250		72,822		97,072		5,189,676		84,534		8,689
Covered loans		147,462		6,517		43,915		50,432		197,894		14,182		31,447
Total loans	$	5,240,066	$	30,767	$	116,737	$	147,504	$	5,387,570	$	98,716	$	40,136

Allowance for Credit Losses

The Company maintains an allowance for credit losses at a level deemed adequate by management to absorb probable losses inherent in the loan portfolio. Refer to Note 1, “Summary of Significant Accounting Policies,” for the accounting policy for the allowance for credit losses.

Allowance for Credit Losses by Portfolio Segment

(Dollar amounts in thousands)

	Commercial, Industrial, and Agricultural			Office, Retail, and Industrial		Multi- Family		Residential Construction		Other Commercial Real Estate		Consumer		Covered Loans		Reserve for Unfunded Commitments		Total Allowance
Quarter ended June 30, 2013
Beginning balance	$	36,544		$	10,695	$	3,704	$	4,667	$	17,757	$	11,997	$	12,227	$	2,866	$	100,457
Charge-offs		(3,116)			(1,453)		(213)		(850)		(547)		(2,523)		(1,980)		-		(10,682)
Recoveries		573			35		30		5		329		413		3		-		1,388
Net charge-offs		(2,543)			(1,418)		(183)		(845)		(218)		(2,110)		(1,977)		-		(9,294)
Provision for loan and covered loan losses and other		(2,259)			2,580		(97)		348		(1,370)		2,480		4,131		-		5,813
Ending balance	$	31,742		$	11,857	$	3,424	$	4,170	$	16,169	$	12,367	$	14,381	$	2,866	$	96,976
Quarter ended June 30, 2012
Beginning balance	$		44,715	$	17,556	$	5,082	$	14,095	$	20,848	$	12,975	$	993	$	2,500	$	118,764
Charge-offs			(6,423)		(2,570)		(344)		(3,598)		(5,568)		(2,744)		(2,434)		-		(23,681)
Recoveries			535		307		31		-		18		250		-		-		1,141
Net charge-offs			(5,888)		(2,263)		(313)		(3,598)		(5,550)		(2,494)		(2,434)		-		(22,540)
Provision for loan and covered loan losses and other			4,583		3,060		20		2,235		7,935		2,202		2,423		-		22,458
Ending balance	$		43,410	$	18,353	$	4,789	$	12,732	$	23,233	$	12,683	$	982	$	2,500	$	118,682
Six months ended June 30, 2013
Beginning balance	$		36,761	$	11,432	$	3,575	$	5,242	$	17,512	$	12,862	$	12,062	$	3,366	$	102,812
Charge-offs			(6,291)		(2,715)		(378)		(1,415)		(3,082)		(4,887)		(2,686)		-		(21,454)
Recoveries			2,662		37		35		5		1,361		520		11		-		4,631
Net charge-offs			(3,629)		(2,678)		(343)		(1,410)		(1,721)		(4,367)		(2,675)		-		(16,823)
Provision for loan and covered loan losses and other			(1,390)		3,103		192		338		378		3,872		4,994		(500)		10,987
Ending balance	$		31,742	$	11,857	$	3,424	$	4,170	$	16,169	$	12,367	$	14,381	$	2,866	$	96,976
Six months ended June 30, 2012
Beginning balance	$		46,017	$	16,012	$	5,067	$	14,423	$	22,823	$	14,131		989	$	2,500	$	121,962
Charge-offs			(14,613)		(5,237)		(484)		(4,281)		(13,922)		(5,122)		(2,708)		-		(46,367)
Recoveries			1,251		309		162		220		25		452		-		-		2,419
Net charge-offs			(13,362)		(4,928)		(322)		(4,061)		(13,897)		(4,670)		(2,708)		-		(43,948)
Provision for loan and covered loan losses and other			10,755		7,269		44		2,370		14,307		3,222		2,701		-		40,668
Ending balance	$		43,410	$	18,353	$	4,789	$	12,732	$	23,233	$	12,683		982	$	2,500	$	118,682

The table below provides a breakdown of loans and the related allowance for credit losses by portfolio segment.

Loans and Related Allowance for Credit Losses by Portfolio Segment

(Dollar amounts in thousands)

	Loans								Allowance for Credit Losses
	Individually Evaluated for Impairment		Collectively Evaluated for Impairment		Acquired with Deteriorated Credit Quality		Total		Individually Evaluated for Impairment		Collectively Evaluated for Impairment		Acquired with Deteriorated Credit Quality		Total
June 30, 2013
Commercial, industrial, and agricultural	$	25,127	$	2,004,771	$	1,873	$	2,031,771	$	3,687	$	28,055	$	-	$	31,742
Commercial real estate:
Office, retail, and industrial		22,895		1,296,954		-		1,319,849		1,081		10,776		-		11,857
Multi-family		1,047		305,007		128		306,182		157		3,267		-		3,424
Residential construction		2,902		47,482		-		50,384		59		4,111		-		4,170
Other commercial real estate		15,303		857,164		4,016		876,483		636		15,533		-		16,169
Total commercial real estate		42,147		2,506,607		4,144		2,552,898		1,933		33,687		-		35,620
Total corporate loans		67,274		4,511,378		6,017		4,584,669		5,620		61,742		-		67,362
Consumer		-		692,601		10,295		702,896		-		12,367		-		12,367
Total loans, excluding covered loans		67,274		5,203,979		16,312		5,287,565		5,620		74,109		-		79,729
Covered loans:
Purchased impaired loans		-		-		133,675		133,675		-		-		13,545		13,545
Other loans		-		38,186		-		38,186		-		836		-		836
Total covered loans		-		38,186		133,675		171,861		-		836		13,545		14,381
Reserve for unfunded commitments		-		-		-		-		-		2,866		-		2,866
Total loans	$	67,274	$	5,242,165	$	149,987	$	5,459,426	$	5,620	$	77,811	$	13,545	$	96,976
December 31, 2012
Commercial, industrial, and agricultural	$	23,731	$	1,874,464	$	1,897	$	1,900,092	$	9,404	$	27,357	$	-	$	36,761
Commercial real estate:
Office, retail, and industrial		21,736		1,311,455		-		1,333,191		971		10,461		-		11,432
Multi-family		642		284,718		121		285,481		-		3,575		-		3,575
Residential construction		4,040		57,422		-		61,462		-		5,242		-		5,242
Other commercial real estate		16,160		877,749		4,166		898,075		1,247		16,265		-		17,512
Total commercial real estate		42,578		2,531,344		4,287		2,578,209		2,218		35,543		-		37,761
Total corporate loans		66,309		4,405,808		6,184		4,478,301		11,622		62,900		-		74,522
Consumer		-		699,361		12,014		711,375		-		12,862		-		12,862
Total loans, excluding covered loans		66,309		5,105,169		18,198		5,189,676		11,622		75,762		-		87,384
Covered loans:
Purchased impaired loans		-		-		154,762		154,762		-		-		11,134		11,134
Other loans		-		43,132		-		43,132		-		928		-		928
Total covered loans		-		43,132		154,762		197,894		-		928		11,134		12,062
Reserve for unfunded commitments		-		-		-		-		-		3,366		-		3,366
Total loans	$	66,309	$	5,148,301	$	172,960	$	5,387,570	$	11,622	$	80,056	$	11,134	$	102,812

Loans Individually Evaluated for Impairment

Corporate non-accrual loans exceeding a fixed dollar amount are individually evaluated for impairment when the internal risk rating is at or below a certain level. The following table presents loans individually evaluated for impairment by class of loan as of June 30, 2013 and December 31, 2012. Loans acquired with deteriorated credit quality are excluded from this disclosure.

Impaired Loans Individually Evaluated by Class

(Dollar amounts in thousands)

	June 30, 2013								December 31, 2012
	Recorded Investment In								Recorded Investment In
	Loans with No Specific Reserve		Loans with a Specific Reserve		Unpaid Principal Balance		Specific Reserve		Loans with No Specific Reserve		Loans with a Specific Reserve		Unpaid Principal Balance		Specific Reserve
Commercial and industrial	$	20,635	$	4,492	$	40,989	$	3,687	$	5,636	$	18,095	$	39,834	$	9,404
Agricultural		-		-		-		-		-		-		-		-
Commercial real estate:
Office, retail, and industrial		19,133		3,762		31,736		1,081		14,504		7,232		29,631		971
Multi-family		902		145		3,045		157		642		-		2,406		-
Residential construction		2,032		870		7,200		59		4,040		-		10,741		-
Commercial construction		3,881		-		4,247		-		-		876		1,242		90
Other commercial real estate		8,588		2,834		15,479		636		5,218		10,066		23,907		1,157
Total commercial real estate		34,536		7,611		61,707		1,933		24,404		18,174		67,927		2,218
Total impaired loans individually evaluated for impairment	$	55,171	$	12,103	$	102,696	$	5,620	$	30,040	$	36,269	$	107,761	$	11,622

Average Recorded Investment and Interest Income Recognized on Impaired Loans by Class

(Dollar amounts in thousands)

	Quarters Ended June 30,
	2013				2012
	Average Recorded Balance		Interest Income Recognized (1)		Average Recorded Balance		Interest Income Recognized (1)
Commercial and industrial	$	25,757	$	1	$	55,623	$	-
Agricultural		-		-		932		-
Commercial real estate:
Office, retail, and industrial		23,662		6		35,348		-
Multi-family		1,009		-		9,424		-
Residential construction		4,018		-		19,912		-
Commercial construction		2,379		-		20,353		-
Other commercial real estate		13,762		5		40,127		6
Total commercial real estate		44,830		11		125,164		6
Total impaired loans	$	70,587	$	12	$	181,719	$	6

	Six Months Ended June 30,
	2013				2012
	Average Recorded Balance		Interest Income Recognized (1)		Average Recorded Balance		Interest Income Recognized (1)
Commercial and industrial	$	24,429	$	3	$	50,626	$	9
Agricultural		-		-		927		-
Commercial real estate:
Office, retail, and industrial		22,316		10		32,015		-
Multi-family		845		-		7,976		-
Residential construction		3,471		-		18,493		-
Commercial construction		2,379		-		21,554		-
Other commercial real estate		13,353		8		45,985		6
Total commercial real estate		42,364		18		126,023		6
Total impaired loans	$	66,793	$	21	$	177,576	$	15

(1)	Recorded using the cash basis of accounting.

TDRs

TDRs are generally performed at the request of the individual borrower and may include forgiveness of principal, reduction in interest rates, changes in payments, and maturity date extensions. A discussion of our accounting policies for TDRs can be found in Note 1, “Summary of Significant Accounting Policies.”

TDRs by Class

(Dollar amounts in thousands)

	As of June 30, 2013						As of December 31, 2012
	Accruing		Non-accrual (1)		Total		Accruing		Non-accrual (1)		Total
Commercial and industrial	$	695	$	15,699	$	16,394	$	519	$	2,545	$	3,064
Agricultural		-		-		-		-		-		-
Commercial real estate:
Office, retail, and industrial		628		365		993		-		2,407		2,407
Multi-family		1,053		264		1,317		-		150		150
Residential construction		500		-		500		-		-		-
Commercial construction		-		-		-		-		-		-
Other commercial real estate		4,300		1,003		5,303		5,206		4,649		9,855
Total commercial real estate		6,481		1,632		8,113		5,206		7,206		12,412
Total corporate loans		7,176		17,331		24,507		5,725		9,751		15,476
Home equity		160		220		380		40		234		274
1-4 family mortgages		951		899		1,850		1,102		939		2,041
Installment		-		-		-		-		-		-
Total consumer loans		1,111		1,119		2,230		1,142		1,173		2,315
Total loans	$	8,287	$	18,450	$	26,737	$	6,867	$	10,924	$	17,791

(1)	These loans are included in non-accrual loans in the preceding tables.

TDRs are included in the calculation of the allowance for credit losses in the same manner as impaired loans. TDRs had related specific reserves totaling $2.2 million as of June 30, 2013 and $2.8 million as of December 31, 2012.

The following table presents a summary of loans that were restructured during the quarters and six months ended June 30, 2013 and 2012.

TDRs Restructured During the Period

(Dollar amounts in thousands)

	Number of Loans	Pre- Modification Recorded Investment		Funds Disbursed		Interest and Escrow Capitalized		Charge-offs		Post- Modification Recorded Investment
Quarter ended June 30, 2013
Commercial and industrial	2	$	13,354	$	-	$	-	$	-	$	13,354
Office, retail, and industrial	3		386		-		-		-		386
Multi-family	5		1,275		-		57		-		1,332
Residential construction	-		-		-		-		-		-
Other commercial real estate	5		564		-		-		-		564
Home equity	1		125		-		-		-		125
1-4 family mortgages	-		-		-		-		-		-
Total TDRs restructured during the period	16	$	15,704	$	-	$	57	$	-	$	15,761
Quarter ended June 30, 2012
Commercial and industrial	1	$	252	$	-	$	-	$	170	$	82
Office, retail, and industrial	1		625		-		-		-		625
Other commercial real estate	7		11,906		-		-		652		11,254
1-4 family mortgages	1		133		-		-		-		133
Total TDRs restructured during the period	10	$	12,916	$	-	$	-	$	822	$	12,094
Six months ended June 30, 2013
Commercial and industrial	4	$	14,070	$	-	$	2	$	-	$	14,072
Office, retail, and industrial	4		601		30		-		-		631
Multi-family	5		1,275		-		57		-		1,332
Residential construction	2		508		-		-		-		508
Other commercial real estate	5		564		-		-		-		564
Home equity	1		125		-		-		-		125
1-4 family mortgages	1		132		-		4		-		136
Total TDRs restructured during the period	22	$	17,275	$	30	$	63	$	-	$	17,368
Six months ended June 30, 2012
Commercial and industrial	1	$	252	$	-	$	-	$	170	$	82
Office, retail, and industrial	1		625		-		-		-		625
Other commercial real estate	7		11,906		-		-		652		11,254
1-4 family mortgages	4		563		-		4		-		567
Total TDRs restructured during the period	13	$	13,346	$	-	$	4	$	822	$	12,528

Accruing TDRs that have payment defaults and do not perform in accordance with their modified terms are transferred to non-accrual. The following table presents TDRs that had payment defaults during the six months ended June 30, 2013 and 2012 where the default occurred within twelve months of the restructure date.

TDRs That Defaulted Within Twelve Months of the Restructure Date

(Dollar amounts in thousands)

	Quarters Ended						Six Months Ended
	June 30, 2013			June 30, 2012			June 30, 2013			June 30, 2012
	Number of Loans	Recorded Investment		Number of Loans	Recorded Investment		Number of Loans	Recorded Investment		Number of Loans	Recorded Investment
Commercial and industrial	-	$	-	-	$	-	1	$	350	-	$	-
Office, retail, and industrial	-		-	1		220	-		-	1		220
Other commercial real estate	1		198	-		-	3		354	-		-
1-4 family mortgages	-		-	-		-	-		-	1		62
Total	1	$	198	1	$	220	4	$	704	2	$	282

For TDRs to be removed from TDR status, the loans must (i) have an interest rate and terms that reflect market conditions at the time of restructuring and (ii) be in compliance with the modified loan terms. TDRs that were returned to performing status totaled $5.0 million and $16.6 million for the six months ended June 30, 2013 and 2012, respectively. For the quarter ended June 30, 2013, no TDRs were returned to performing status compared to $576,000 for the quarter ended June 30, 2012.

There were no commitments to lend additional funds to borrowers with TDRs as of June 30, 2013 or December 31, 2012.

Credit Quality Indicators

Corporate loans and commitments are assessed for credit risk and assigned ratings based on various characteristics, such as the borrower’s cash flow, leverage, and collateral. Ratings for commercial credits are reviewed periodically. On a quarterly basis, consumer loans are assessed for credit quality based on the accrual status of the loan.

Corporate Credit Quality Indicators by Class, Excluding Covered Loans

(Dollar amounts in thousands)

	Pass		Special Mention (1)		Substandard (2)		Non-accrual (3)		Total
June 30, 2013
Commercial and industrial	$	1,674,784	$	31,029	$	9,169	$	28,157	$	1,743,139
Agricultural		287,846		-		-		786		288,632
Commercial real estate:
Office, retail, and industrial		1,219,337		53,574		22,510		24,428		1,319,849
Multi-family		301,406		1,921		787		2,068		306,182
Residential construction		29,104		10,029		7,920		3,331		50,384
Commercial construction		85,638		8,747		18,853		3,878		117,116
Other commercial real estate		717,192		9,875		19,278		13,022		759,367
Total commercial real estate		2,352,677		84,146		69,348		46,727		2,552,898
Total corporate loans	$	4,315,307	$	115,175	$	78,517	$	75,670	$	4,584,669
December 31, 2012
Commercial and industrial	$	1,558,932	$	37,833	$	8,768	$	25,941	$	1,631,474
Agricultural		267,114		331		-		1,173		268,618
Commercial real estate:
Office, retail, and industrial		1,235,950		57,271		16,746		23,224		1,333,191
Multi-family		282,126		1,921		-		1,434		285,481
Residential construction		33,392		11,870		11,588		4,612		61,462
Commercial construction		95,567		14,340		14,174		873		124,954
Other commercial real estate		712,702		14,056		30,149		16,214		773,121
Total commercial real estate		2,359,737		99,458		72,657		46,357		2,578,209
Total corporate loans	$	4,185,783	$	137,622	$	81,425	$	73,471	$	4,478,301

(1)	Loans categorized as special mention exhibit potential weaknesses that require the close attention of management since these potential weaknesses may result in the deterioration of repayment prospects at some future date.
(2)	Loans categorized as substandard exhibit a well-defined weakness or weaknesses that may jeopardize the liquidation of the debt. These loans continue to accrue interest because they are well secured and collection of principal and interest is expected within a reasonable time.
(3)	Loans categorized as non-accrual exhibit a well-defined weakness or weaknesses that may jeopardize the liquidation of the debt and are characterized by the distinct possibility that the Company could sustain some loss if the deficiencies are not corrected.

Consumer Credit Quality Indicators by Class, Excluding Covered Loans

(Dollar amounts in thousands)

	Performing		Non-accrual		Total
June 30, 2013
Home equity	$	368,029	$	6,377	$	374,406
1-4 family mortgages		286,706		5,064		291,770
Installment		34,638		2,082		36,720
Total consumer loans	$	689,373	$	13,523	$	702,896
December 31, 2012
Home equity	$	383,844	$	6,189	$	390,033
1-4 family mortgages		278,074		4,874		282,948
Installment		38,394		-		38,394
Total consumer loans	$	700,312	$	11,063	$	711,375

7. EARNINGS PER COMMON SHARE

Basic and Diluted Earnings per Common Share

(Amounts in thousands, except per share data)

	Quarters Ended June 30,				Six Months Ended June 30,
	2013		2012		2013		2012
Net income	$	16,176	$	6,365	$	30,818	$	14,257
Net income applicable to non-vested restricted shares		(219)		(76)		(431)		(215)
Net income applicable to common shares	$	15,957	$	6,289	$	30,387	$	14,042
Weighted-average common shares outstanding:
Weighted-average common shares outstanding (basic)		74,017		73,659		73,942		73,582
Dilutive effect of common stock equivalents		7		-		8		-
Weighted-average diluted common shares outstanding		74,024		73,659		73,950		73,582
Basic earnings per common share	$	0.22	$	0.09	$	0.41	$	0.19
Diluted earnings per common share	$	0.22	$	0.09	$	0.41	$	0.19
Anti-dilutive shares not included in the computation of diluted earnings per common share (1)		1,447		1,756		1,520		1,809

(1)	This amount represents outstanding stock options for which the exercise price is greater than the average market price of the Company’s common stock.

8. INCOME TAXES

Income Tax Expense

(Dollar amounts in thousands)

	Quarters Ended June 30,				Six Months Ended June 30,
	2013		2012		2013		2012
Income before income tax expense	$	24,131	$	7,126	$	45,066	$	16,174
Income tax expense:
Federal income tax expense	$	5,553	$	126	$	9,913	$	971
State income tax expense		2,402		635		4,335		946
Total income tax expense	$	7,955	$	761	$	14,248	$	1,917
Effective income tax rate		33.0%		10.7%		31.6%		11.9%

Federal income tax expense and the related effective income tax rate are influenced primarily by the amount of tax-exempt income derived from investment securities and bank-owned life insurance in relation to pre-tax income and state income taxes. State income tax expense and the related effective income tax rate are driven by the amount of state tax-exempt income in relation to pre-tax income and state tax rules related to consolidated/combined reporting and sourcing of income and expense.

Income tax expense was $8.0 million and $14.2 million for the second quarter and six months ended June 30, 2013, respectively, compared to $761,000 and $1.9 million for the same periods in 2012. The rise in income tax expense, and related increases in effective tax rates, resulted primarily from higher levels of income during 2013, which are subject to tax at statutory rates and an increase in taxable income in relation to pre-tax income. In addition, changes in Indiana tax law during the second quarter of 2013 resulted in a rise in state income tax expense.

The Company’s accounting policies underlying the recognition of income taxes in the Consolidated Statements of Financial Condition and Income are included in Note 1, “Summary of Significant Accounting Policies,” and Note 14, “Income Taxes,” in the Company’s 2012 10-K.

9. EMPLOYEE BENEFIT PLANS

The Company sponsors a defined contribution retirement savings plan (the “Profit Sharing Plan”) and a noncontributory defined benefit retirement plan (the “Pension Plan”) that covers eligible employees. Additional information regarding the Profit Sharing Plan and Pension Plan can be found in Note 15, “Employee Benefit Plans,” in the Company’s 2012 10-K.

The Pension Plan covers a majority of employees who met certain eligibility requirements and were hired before April 1, 2007, the date it was amended to eliminate enrollment of new participants. During the second quarter of 2013, the Board of Directors approved an amendment to freeze benefit accruals under the Pension Plan effective on January 1, 2014. As a result of the Pension Plan amendment, the Company recorded an immaterial curtailment loss and remeasured the Pension Plan obligations and assets as of June 30, 2013. The remeasurement decreased the projected pension obligation by $11.0 million and increased other comprehensive income by $6.5 million, after tax. Depending on various factors, these actions could reduce 2013 pension expense by approximately $1.0 million.

Components of Net Periodic Benefit Cost

(Dollar amounts in thousands)

	Quarters Ended June 30,				Six Months Ended June 30,
	2013		2012		2013		2012
Service cost	$	678	$	540	$	1,916	$	1,081
Interest cost		629		513		1,779		1,027
Expected return on plan assets		(1,120)		(841)		(3,167)		(1,684)
Recognized net actuarial loss		-		318		-		637
Amortization of prior service cost		378		1		1,070		2
Net periodic cost	$	565	$	531	$	1,598	$	1,063

The Company’s policy is to amortize the Pension Plan’s net actuarial losses into income over the average remaining life expectancy of the Pension Plan participants.

10. DERIVATIVE FINANCIAL INSTRUMENTS

The Company hedges the fair value of fixed rate commercial real estate loans using interest rate swaps through which the Company pays fixed amounts and receives variable amounts. These derivative contracts are designated as fair value hedges.

Fair Value Hedges

(Dollar amounts in thousands)

	June 30, 2013		December 31, 2012
Notional amount outstanding	$	15,300	$	15,860
Derivative liability fair value		(1,730)		(2,270)
Weighted-average interest rate received		2.11%		2.12%
Weighted-average interest rate paid		6.39%		6.39%
Weighted-average maturity (in years)		4.27		4.76
Cash pledged to collateralize net unrealized losses with counterparties (1)	$	1,863	$	2,516
Fair value of assets needed to settle derivative transactions (2)		1,759		2,301

(1)	No other collateral was required to be pledged.
(2)	This amount represents the fair value if credit risk related contingent factors were triggered.

Hedge ineffectiveness is recognized in other noninterest income in the Consolidated Statements of Income. For the quarters and six months ended June 30, 2013 and 2012, gains or losses relating to fair value hedge ineffectiveness were not material.

The Company also enters into derivative transactions with customers and simultaneously enters into an offsetting interest rate derivative transaction with a third-party. This transaction allows the Company’s customers to effectively convert a variable rate loan into a fixed rate loan. Due to the offsetting nature of these transactions, the Company does not apply hedge accounting treatment. Transaction fees of $522,000 related to customer derivative instruments were recorded in noninterest income for the six months ended June 30, 2013. There were no transaction fees recorded for the quarter ended June 30, 2013 and for the quarter and six months ended June 30, 2012.

Other Derivative Instruments

(Dollar amounts in thousands)

	June 30, 2013		December 31, 2012
Notional amount outstanding	$	23,211	$	-
Derivative asset fair value		241		-
Derivative liability fair value		(241)		-

Derivative instruments are inherently subject to credit risk, which represents the Company’s risk of loss when the counterparty to a derivative contract fails to perform according to the terms of the agreement. Credit risk is managed by limiting and collateralizing the aggregate amount of net unrealized losses by transaction, monitoring the size and the maturity structure of the derivatives, and applying uniform credit standards. Company policy establishes limits on credit exposure to any single counterparty. In addition, the Company established bilateral collateral agreements with derivative counterparties that provide for exchanges of marketable securities or cash to collateralize either party’s net losses above a stated minimum threshold. At June 30, 2013, these collateral agreements covered 100% of the fair value of the Company’s outstanding fair value hedges. Derivative assets and liabilities are presented gross, rather than net, of pledged collateral amounts.

As of June 30, 2013 and December 31, 2012, the Company’s derivative instruments generally contained provisions that require the Company’s debt to remain above a certain credit rating by each of the major credit rating agencies. If the Company’s debt were to fall below that credit rating, it would be in violation of those provisions, and the counterparties to the derivative instruments could terminate the swap transaction and demand cash settlement of the derivative instrument in an amount equal to the derivative liability fair value. As of June 30, 2013, the Company was not in violation of these provisions.

The Company’s derivative portfolio also includes other derivative instruments that do not receive hedge accounting treatment consisting of commitments to originate 1-4 family mortgage loans and foreign exchange contracts. In addition, the Company occasionally enters into risk participation agreements with counterparty banks to transfer or assume a portion of the credit risk related to customer transactions. The amounts of these instruments were not material for any period presented. The Company had no other derivative instruments as of June 30, 2013 or December 31, 2012. The Company does not enter into derivative transactions for purely speculative purposes.

11. COMMITMENTS, GUARANTEES, AND CONTINGENT LIABILITIES

Credit Commitments and Guarantees

In the normal course of business, the Company enters into a variety of financial instruments with off-balance sheet risk to meet the financing needs of its customers and to conduct lending activities, including commitments to extend credit and standby and commercial letters of credit. These instruments involve elements of credit and interest rate risk in excess of the amount recognized in the Consolidated Statements of Financial Condition.

Contractual or Notional Amounts of Financial Instruments

(Dollar amounts in thousands)

	June 30, 2013		December 31, 2012
Commitments to extend credit:
Commercial and industrial	$	790,927	$	737,973
Commercial real estate		196,987		168,105
Residential construction		14,089		18,986
Home equity lines		261,962		258,156
Credit card lines		26,804		25,459
Overdraft protection program (1)		174,681		176,328
All other commitments		103,890		105,344
Total commitments	$	1,569,340	$	1,490,351
Letters of credit:
Commercial real estate	$	43,635	$	52,145
Residential construction		5,694		5,696
All other		58,412		57,996
Total letters of credit	$	107,741	$	115,837
Unamortized fees associated with letters of credit (2)(3)	$	559	$	740
Remaining weighted-average term, in months		10.26		13.20
Remaining lives, in years		0.1 to 11.1		0.1 to 11.6
Recourse on assets sold:
Unpaid principal balance of assets sold	$	126,901	$	50,110
Carrying value of recourse obligation (2)		129		55

	Advance Dated
	May 17, 2012		October 3, 2012
Forward committed advances with FHLB:
Amount of advance	$	200,000	$	50,000
Interest rate		2.05%		1.77%
Expected settlement date	May 19, 2014		October 3, 2014
Maturity date	May 20, 2019		October 3, 2019

(1)	Federal regulations regarding electronic fund transfers require customers to affirmatively consent to the institution’s overdraft service for automated teller machine and one-time debit card transactions before overdraft fees may be assessed on the account. Customers are provided a specific line for the amount they may overdraw.
(2)	Included in other liabilities in the Consolidated Statements of Financial Condition.
(3)	The Company amortizes these amounts into income over the commitment period.

Commitments to extend credit are agreements to lend funds to a customer, subject to contractual terms and covenants. Commitments generally have fixed expiration dates or other termination clauses, variable interest rates, and fee requirements, when applicable. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash flow requirements.

In the event of a customer’s non-performance, the Company’s credit loss exposure is equal to the contractual amount of the commitments. The credit risk is essentially the same as extending loans to customers. The Company uses the same credit policies for credit commitments and its loans and minimizes exposure to credit loss through various collateral requirements.

Letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Standby letters of credit generally are contingent on the failure of the customer to perform according to the terms of the contract with the third party and are often issued in favor of a municipality where construction is taking place to ensure the borrower adequately completes the construction.

The maximum potential future payments guaranteed by the Company under standby letters of credit arrangements are equal to the contractual amount of the commitment. If a commitment is funded, the Company may seek recourse through the liquidation of the underlying collateral including real estate, production plants and property, marketable securities, or receipt of cash.

As a result of the sale of certain 1-4 family mortgage loans, the Company is contractually obligated to repurchase any non-performing loans or loans that do not meet underwriting requirements at recorded value. In accordance with the sales agreements, there is no limitation on the maximum potential future payments or expiration of the Company’s recourse obligation. No loans were required to be repurchased during the quarters and six months ended June 30, 2013 or 2012.

During 2012, the Company entered into two forward commitments with the FHLB to take advantage of low interest rates for future funding. The advances have prepayment features allowing the Company to prepay the advances below par if the prepayment calculations indicate a discount.

Legal Proceedings

In 2011, the Bank was named in a purported class action lawsuit filed in the Circuit Court of Cook County, Illinois on behalf of certain of the Bank’s customers who incurred overdraft fees. The lawsuit is based on the Bank’s practices relating to debit card transactions, and alleges that these practices resulted in customers being assessed excessive overdraft fees. The plaintiffs seek an unspecified amount of damages and other relief, including restitution. No class has been certified. The Bank filed a motion to dismiss the plaintiffs’ complaint and, on January 23, 2013, the Circuit Court entered an order granting the Bank’s motion and dismissed the complaint with prejudice. The plaintiffs have appealed the Circuit Court’s ruling, and the appeal is currently pending with the Appellate Court of Illinois. The Company continues to believe that the Bank has meritorious defenses to the claims made by the plaintiffs.

There are certain other legal proceedings pending against the Company and its subsidiaries in the ordinary course of business. The Company does not believe that liabilities, individually or in the aggregate, arising from any legal proceedings, if any, would have a material adverse effect on the consolidated financial condition of the Company as of June 30, 2013.

12. FAIR VALUE

Fair value represents the amount received to sell an asset or paid to transfer a liability in its principal or most advantageous market in an orderly transaction between market participants at the measurement date. In accordance with fair value accounting guidance, the Company measures, records, and reports various types of assets and liabilities at fair value on either a recurring or non-recurring basis in the Consolidated Statements of Financial Condition. Those assets and liabilities are presented below in the sections titled “Assets and Liabilities Required to be Measured at Fair Value on a Recurring Basis” and “Assets and Liabilities Required to be Measured at Fair Value on a Non-Recurring Basis.”

Other assets and liabilities are not required to be measured at fair value in the Consolidated Statements of Financial Condition, but must be disclosed at fair value. Refer to the “Financial Instruments Not Required to be Measured at Fair Value” section of this footnote. Any aggregation of the estimated fair values presented in this footnote does not represent the value of the Company.

Depending on the nature of the asset or liability, the Company uses various valuation methodologies and assumptions to estimate fair value. GAAP provides a three-tiered fair value hierarchy based on the inputs used to measure fair value. The hierarchy is defined as follows:

·	Level 1 – Quoted prices in active markets for identical assets or liabilities.

·	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.

·	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. These inputs require significant management judgment or estimation, some of which use model-based techniques and may be internally developed.

Assets and liabilities are assigned to a level within the fair value hierarchy based on the lowest level of significant input used to measure fair value. Assets and liabilities may change levels within the fair value hierarchy due to market conditions or other circumstances. Those transfers are recognized on the date of the event that prompted the transfer. There were no transfers of assets or liabilities between levels of the fair value hierarchy during the periods presented.

Assets and Liabilities Required to be Measured at Fair Value on a Recurring Basis

The following table provides the fair value for assets and liabilities required to be measured at fair value on a recurring basis in the Consolidated Statements of Financial Condition by level in the fair value hierarchy.

Recurring Fair Value Measurements

(Dollar amounts in thousands)

	June 30, 2013						December 31, 2012
	Level 1		Level 2		Level 3		Level 1		Level 2		Level 3
Assets:
Trading securities:
Money market funds	$	1,291	$	-	$	-	$	1,554	$	-	$	-
Mutual funds		14,160		-		-		12,608		-		-
Total trading securities		15,451		-		-		14,162		-		-
Securities available-for-sale:
U.S. agency securities		-		503		-		-		508		-
CMOs		-		536,423		-		-		400,383		-
Other MBSs		-		126,772		-		-		122,900		-
Municipal securities		-		490,759		-		-		520,043		-
CDOs		-		-		14,917		-		-		12,129
Corporate debt securities		-		15,107		-		-		15,339		-
Hedge fund investment		-		2,741		-		-		1,616		-
Other equity securities		27,454		8,810		-		43		9,442		-
Total securities available- for-sale		27,454		1,181,115		14,917		43		1,070,231		12,129
Mortgage servicing rights (1)		-		-		1,352		-		-		985
Derivative assets (1)		-		241		-		-		-		-
Liabilities:
Derivative liabilities (2)	$	-	$	1,971	$	-	$	-	$	2,270	$	-

(1)	Included in other assets in the Consolidated Statements of Financial Condition.
(2)	Included in other liabilities in the Consolidated Statements of Financial Condition.

The following sections describe the specific valuation techniques and inputs used to measure financial assets and liabilities at fair value.

Trading Securities

The Company’s trading securities consist of diversified investment securities held in a grantor trust and are invested in money market and mutual funds. The fair value of these money market and mutual funds is based on quoted market prices in active exchange markets and is classified in level 1 of the fair value hierarchy. Changes in the fair value of trading securities are included in other noninterest income in the Condensed Consolidated Statements of Income.

Securities Available-for-Sale

Where quoted prices are available in an active market, securities are classified in level 1 of the fair value hierarchy. The Company’s available-for-sale securities are primarily fixed income instruments that are not quoted on an exchange, but may be traded in active markets. The fair values are based on quoted prices in active markets or market prices for similar securities obtained from external pricing services or dealer market participants and are classified in level 2 of the fair value hierarchy. Quarterly, the Company evaluates the methodologies used by its external pricing services to develop the fair values to determine whether the results of the valuations are representative of an exit price in the Company’s principal markets and an appropriate representation of fair value.

The Company’s hedge fund investment is classified in level 2 of the fair value hierarchy. The fair value is derived from monthly and annual financial statements provided by hedge fund management. The majority of the hedge fund’s investment portfolio is held in securities that are freely tradable and are listed on national securities exchanges.

CDOs are classified in level 3 of the fair value hierarchy. The Company estimates the fair values for each CDO using discounted cash flow analyses with the assistance of a structured credit valuation firm. This methodology relies on credit analysis and review of historical financial data for each of the issuers of the securities underlying the individual CDO (the “Issuers”) to estimate the cash flows. These estimates are highly subjective and sensitive to several significant, unobservable inputs, including prepayment assumptions, default probabilities, loss given default assumptions, and deferral cure probabilities. The cash flows for each Issuer are then discounted to present values using LIBOR plus an adjustment to reflect the higher risk inherent in these securities given their complex structures and the impact of market factors. Finally, the discounted cash flows for each Issuer are aggregated to derive the estimated fair value for the specific CDO. Information for each CDO, as well as the significant unobservable assumptions, is presented in the following table.

Characteristics of CDOs and Significant Unobservable Inputs

Used in the Valuation of CDOs as of June 30, 2013

(Dollar amounts in thousands)

	CDO Number
	1		2		3		4		5		6
Characteristics:
Class		C-1		C-1		C-1		B1		C		C
Original par	$	17,500	$	15,000	$	15,000	$	15,000	$	10,000	$	6,500
Amortized cost		7,140		5,598		12,377		13,922		1,317		6,178
Fair value		3,539		318		3,669		4,773		833		1,785
Lowest credit rating (Moody’s)		Ca		Ca		Ca		Ca		C		Ca
Number of underlying Issuers		44		55		60		61		56		78
Percent of Issuers currently performing		77.3%		78.2%		78.3%		55.7%		60.7%		66.7%
Current deferral and default percent (1)		15.8%		16.1%		11.3%		34.8%		41.9%		28.7%
Expected future deferral and default percent (2)		17.6%		17.9%		15.2%		25.2%		27.4%		14.7%
Excess subordination percent (3)		-		-		-		-		-		1.9 %
Discount rate risk adjustment (4)		14.3 %		15.3 %		14.3 %		13.3%		14.3%		12.8%
Significant unobservable inputs, weighted average of Issuers:
Probability of prepayment		15.2%		7.6%		5.6%		5.9%		7.2%		4.4%
Probability of default		21.7%		26.2%		21.7%		27.6%		39.3%		30.6%
Loss given default		88.0%		90.2%		89.4%		92.8%		92.6%		95.3%
Probability of deferral cure		38.1%		32.6%		26.3%		53.0%		38.1%		43.6%

(1)	Represents actual deferrals and defaults, net of recoveries, as a percent of the original collateral.
(2)	Represents expected future net deferrals and defaults, net of recoveries, as a percent of the remaining performing collateral. The probability of future defaults is derived for each Issuer based on a credit analysis. The associated assumed loss given default is based on historical default and recovery information provided by a nationally recognized credit rating agency and is assumed to be 90% for banks, 85% for insurance companies, and 100% for Issuers that have already defaulted.
(3)	Represents additional defaults that the CDO can absorb before the security experiences any credit impairment. The excess subordination percentage is calculated by dividing the amount of potential additional loss that can be absorbed (before the receipt of all expected future principal and interest payments is affected) by the total balance of performing collateral.
(4)	Cash flows are discounted at LIBOR plus this adjustment to reflect the higher risk inherent in these securities.

Most Issuers have the right to prepay its securities on the fifth anniversary of issuance and under other limited circumstances. To estimate prepayments, a credit analysis of each Issuer is performed to estimate its ability and likelihood to fund a prepayment. If a prepayment occurs, the Company receives cash equal to the par value for the portion of the CDO associated with that Issuer.

The likelihood that an Issuer who is currently deferring payment on the securities will pay all deferred amounts and remain current thereafter is based on an analysis of the Issuer’s asset quality, leverage ratios, and other measures of financial viability.

The impact of changes in these key inputs could result in a significantly higher or lower fair value measurement for each CDO. The timing of the default, the magnitude of the default, and the timing and magnitude of the cure probability are directly interrelated. Defaults that occur sooner and/or are greater than anticipated have a negative impact on the valuation. In addition, a high cure probability assumption has a positive effect on the fair value, and, if a cure event takes place sooner than anticipated, the impact on the valuation is also favorable.

Management monitors the valuation results of each CDO on a quarterly basis, which includes an analysis of historical pricing trends for these types of securities, overall economic conditions (such as tracking LIBOR curves), and the performance of the Issuers’ industries. Management also reviews market activity for the same or similar tranches of the CDOs, when available. Annually, management validates significant assumptions by reviewing detailed back-testing performed by the structured credit valuation firm.

A rollforward of the carrying value of CDOs for the quarters and six months ended June 30, 2013 and 2012 is presented in the following table.

Rollforward of the Carrying Value of CDOs

(Dollar amounts in thousands)

	Quarters Ended June 30,				Six Months Ended June 30,
	2013		2012		2013		2012
Beginning balance	$	12,924	$	13,685	$	12,129	$	13,394
Total income (loss):
Non-cash credit impairment included in earnings (1)		-		(1,405)		-		(2,126)
Included in other comprehensive income (2)		1,993		(1,198)		2,788		(186)
Ending balance (3)	$	14,917	$	11,082	$	14,917	$	11,082
Change in unrealized losses recognized in earnings related to securities still held at end of period	$	-	$	(1,405)	$	-	$	(2,126)

(1)	Included in net securities gains (losses) in the Condensed Consolidated Statements of Income and related to securities still held at the end of the period.
(2)	Included in unrealized holding gains (losses) in the Consolidated Statements of Comprehensive Income.
(3)	There were no purchases, issuances, or settlements of CDOs during the periods presented. One CDO with a carrying value of zero was sold during the quarter ended June 30, 2013, resulting in a gain of $101,000.

Mortgage Servicing Rights

The Company services loans for others totaling $177.7 million as of June 30, 2013 and $109.7 million as of December 31, 2012. These loans are owned by third parties and are not included in the Consolidated Statements of Condition. The Company estimates the fair value of mortgage servicing rights by using a discounted cash flow analysis and classifies them in level 3 of the fair value hierarchy. Additional information regarding the Company’s mortgage servicing rights can be found in Note 22, “Fair Value,” in the Company’s 2012 10-K.

Derivative Assets and Derivative Liabilities

The Company enters into interest rate swaps that are executed in the dealer market, and pricing is based on market quotes obtained from the counterparty. The market quotes were developed using market observable inputs, which primarily include LIBOR. Therefore, derivatives are classified in level 2 of the fair value hierarchy. For its derivative assets and liabilities, the Company also considers non-performance risk, including the likelihood of default by itself and its counterparties, when evaluating whether the market quotes from the counterparty are representative of an exit price. The Company also enters into derivative transactions with customers and simultaneously enters into an offsetting interest rate derivative transaction with a third party, which are valued using market consensus prices.

Pension Plan Assets

Although pension plan assets are not consolidated in the Company’s Consolidated Statements of Financial Condition, the fair value of pension plan assets is required to be measured at fair value on an annual basis. Additionally, pension plan assets were remeasured as of June 30, 2013 as a result of the amendment to freeze the benefit accruals under the Pension Plan. Refer to Note 9, “Employee Benefit Plans” for additional discussion regarding this change. The fair value of pension plan assets is presented in the following table by level in the fair value hierarchy.

Fair Value Measurements for Pension Plan Assets

(Dollar amounts in thousands)

	June 30, 2013						December 31, 2012
	Level 1		Level 2		Total		Level 1		Level 2		Total
Pension plan assets:
Mutual funds (1)	$	21,445	$	-	$	21,445	$	16,009	$	-	$	16,009
U.S. government and government agency securities		5,626		6,940		12,566		6,510		7,295		13,805
Corporate bonds		-		5,794		5,794		-		8,653		8,653
Common stocks		14,889		-		14,889		15,001		-		15,001
Common trust funds		-		9,568		9,568		-		10,033		10,033
Total pension plan assets	$	41,960	$	22,302	$	64,262	$	37,520	$	25,981	$	63,501

(1)	Includes mutual funds, money market funds, cash, cash equivalents, and accrued interest.

Mutual funds, U.S. government agency securities, and common stocks are based on quoted market prices in active exchange markets and classified in level 1 of the fair value hierarchy. Corporate bonds and U.S. Treasury securities are valued at quoted prices from independent sources that are based on observable market trades or observable prices for similar bonds where a price for the identical bond is not observable and, therefore, are classified as level 2 of the fair value hierarchy. Common trust funds are valued at quoted redemption values on the last business day of the Plan’s year end and are classified as level 2 in the fair value hierarchy.

Assets and Liabilities Required to be Measured at Fair Value on a Non-Recurring Basis

The following table provides the fair value for each class of assets and liabilities required to be measured at fair value on a non-recurring basis in the Consolidated Statements of Financial Condition by level in the fair value hierarchy.

Non-Recurring Fair Value Measurements

(Dollar amounts in thousands)

	June 30, 2013						December 31, 2012
	Level 1		Level 2		Level 3		Level 1		Level 2		Level 3
Collateral-dependent impaired loans	$	-	$	-	$	18,164	$	-	$	-	$	61,454
OREO (1)		-		-		7,468		-		-		11,956
Loans held-for-sale (2)		-		-		1,589		-		-		-
Assets held-for-sale (3)		-		-		1,027		-		-		1,668

(1)	Includes OREO and covered OREO with fair value adjustments subsequent to initial transfer.
(2)	Included in other assets in the Consolidated Statements of Financial Condition.
(2)	Included in premises, furniture, and equipment in the Consolidated Statements of Financial Condition.

Collateral-Dependent Impaired Loans

Certain collateral-dependent impaired loans are subject to fair value adjustments to reflect the difference between the carrying value of the loans and the value of the underlying collateral. The fair values of collateral-dependent impaired loans are primarily determined by current appraised values of the underlying collateral. Based on the age and/or type, appraisals may be adjusted in the range of 0% - 20%. In certain cases, an internal valuation may be used when the underlying collateral is located in areas where comparable sales data is limited or unavailable. Accordingly, collateral-dependent impaired loans are classified in level 3 of the fair value hierarchy.

Collateral-dependent impaired loans for which the fair value is greater than the recorded investment are not measured at fair value in the Consolidated Statements of Financial Condition and are not included in this disclosure.

OREO

The fair value of OREO is measured using the current appraised value of the properties. In certain circumstances, a current appraisal may not be available or may not represent an accurate measurement of the property’s fair value due to outdated market information or other factors. In these cases, the fair value is determined based on the lower of the (i) most recent appraised value, (ii) broker price opinion, (iii) current listing price, or (iv) signed sales contract. Given these valuation methods, OREO is classified in level 3 of the fair value hierarchy. Any valuation adjustments for reductions in the fair value of OREO are recognized in the Company’s operating results in the period in which they occur.

Loans Held-for-Sale

As of June 30, 2013 loans held-for-sale consisted of multiple commercial and 1-4 family mortgage loans. The loans were transferred into the held-for-sale category at the sales contract price and classified as level 3 in the fair value hierarchy. The Company had no loans classified as held-for-sale as of June 30, 2012.

Assets Held-for-Sale

As of June 30, 2013, assets held-for-sale consisted of two former bank branches that are no longer in operation, which were transferred into the held-for-sale category at their recorded investment as an approximation of fair value. Therefore, they are classified in level 3 of the fair value hierarchy.

Valuation Adjustments Recorded for

Assets Measured at Fair Value on a Non-Recurring Basis

(Dollar amounts in thousands)

	Quarters Ended June 30,				Six Months Ended June 30,
	2013		2012		2013		2012
Charged to allowance for loan and covered loan losses:
Collateral-dependent impaired loans	$	4,426	$	17,674	$	11,208	$	36,414
Loans held-for-sale		1,560		-		1,560		3,135
Charged to earnings:
OREO		19		1,824		586		2,514

Financial Instruments Not Required to be Measured at Fair Value

For certain financial instruments that are not required to be measured at fair value in the Consolidated Statements of Financial Condition, the Company must disclose the estimated fair values and the level within the fair value hierarchy as shown in the following table.

Financial Instruments Not Required to be Measured at Fair Value

(Dollar amounts in thousands)

		June 30, 2013				December 31, 2012
	Fair Value Hierarchy Level	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Assets:
Cash and due from banks	1	$	130,992	$	130,992	$	149,420	$	149,420
Interest-bearing deposits in other banks	2		653,113		653,113		566,846		566,846
Securities held-to-maturity	2		30,373		32,071		34,295		36,023
FHLB and Federal Reserve Bank stock	2		35,161		35,161		47,232		47,232
Net loans	3		5,365,316		5,312,948		5,288,124		5,305,286
FDIC indemnification asset	3		23,158		15,802		37,051		27,040
Accrued interest receivable	3		27,626		27,626		27,535		27,535
Investment in BOLI	3		207,081		207,081		206,405		206,405
Other interest earning assets	3		8,336		8,904		9,923		10,640
Liabilities:
Deposits	2	$	6,866,747	$	6,864,899	$	6,672,255	$	6,674,510
Borrowed funds	2		196,603		198,184		185,984		189,074
Senior and subordinated debt	1		214,843		226,335		214,779		216,686
Accrued interest payable	2		2,623		2,623		2,884		2,884
Standby letters of credit	2		559		559		740		740

Management uses various methodologies and assumptions to determine the estimated fair values of the financial instruments in the table above. The fair value estimates are made at a discrete point in time based on relevant market information and consider management’s judgments regarding future expected economic conditions, loss experience, and specific risk characteristics of the financial instruments.

Short-Term Financial Assets and Liabilities - For financial instruments with a shorter-term or with no stated maturity, prevailing market rates, and limited credit risk, the carrying amounts approximate fair value. Those financial instruments include cash and due from banks, interest-bearing deposits in other banks, and other short-term investments, accrued interest receivable, and accrued interest payable.

Securities Held-to-Maturity - The fair value of securities held-to-maturity is based on quoted market prices or dealer quotes. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.

FHLB and Federal Reserve Bank Stock - The carrying amounts approximate fair value.

Net Loans - Net loans includes loans, covered loans, and the allowance for loans and covered loan losses. The fair value of loans is estimated using the present value of the future cash flows of the remaining maturities of the loans. Prepayment assumptions that consider the Company’s historical experience and current economic and lending conditions were included. The discount rate was based on the LIBOR yield curve with adjustments for liquidity and credit risk. The primary impact of credit risk on the fair value of the loan portfolio was accommodated through the use of the allowance for loan and covered loan losses, which is believed to represent the current fair value of estimated inherent losses for purposes of the fair value calculation.

The fair value of the covered loan portfolio is determined by discounting the estimated cash flows at a market interest rate, which is derived from LIBOR swap rates over the life of those loans. The estimated cash flows are determined using the contractual terms of the covered loans, net of any projected credit losses. For valuation purposes, these loans are placed into

groups with similar characteristics and risk factors, where appropriate. The timing and amount of credit losses for each group are estimated using historical default and loss experience, current collateral valuations, borrower credit scores, and internal risk ratings. For individually significant loans or credit relationships, the estimated fair value is determined by a specific loan level review utilizing appraised values for collateral and projections of the timing and amount of cash flows.

FDIC Indemnification Asset - The fair value of the FDIC indemnification asset is calculated by discounting the cash flows expected to be received from the FDIC. The future cash flows are estimated by multiplying expected losses on covered loans and covered OREO by the reimbursement rates in the FDIC Agreements.

Investment in BOLI - The fair value of BOLI approximates the carrying amount as both are based on each policy’s respective CSV, which is the amount the Company would receive upon liquidation of these investments. The CSV is derived from monthly reports provided by the managing brokers and is determined using the Company’s initial insurance premium and earnings of the underlying assets, offset by management fees.

Other Interest-Earning Assets - The fair value of other interest-earning assets is estimated using the present value of the future cash flows of the remaining maturities of the assets.

Deposits - The fair values disclosed for demand deposits, savings deposits, NOW accounts, and money market deposits are equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). The fair value for fixed-rate time deposits was estimated using the future cash flows discounted based on the LIBOR yield curve, plus or minus the spread associated with current pricing.

Borrowed Funds - The fair value of FHLB advances is estimated by discounting the agreements based on maturities using the rates currently offered for repurchase agreements of similar remaining maturities adjusted for prepayment penalties that would be incurred if the borrowings were paid off on the measurement date. The carrying amounts of federal funds purchased, repurchase agreements, federal term auction facilities, and other borrowed funds approximate their fair value due to their short-term nature.

Senior and Subordinated Debt - The fair value of senior and subordinated debt was determined using quoted market prices.

Standby Letters of Credit - The fair value of standby letters of credit represents deferred fees arising from the related off-balance sheet financial instruments. These deferred fees approximate the fair value of these instruments and are based on several factors, including the remaining terms of the agreements and the credit standing of the customers.

Commitments - The Company estimated the fair value of commitments outstanding to be immaterial based on the following factors: (i) the limited interest rate exposure of the commitments outstanding due to their variable nature, (ii) the short-term nature of the commitment periods, (iii) termination clauses provided in the agreements, and (iv) the market rate of fees charged.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

INTRODUCTION

First Midwest Bancorp, Inc. (the “Company”) is a bank holding company headquartered in the Chicago suburb of Itasca, Illinois with operations throughout the greater Chicago metropolitan area as well as northwest Indiana, central and western Illinois, and eastern Iowa. Our principal subsidiary is First Midwest Bank (the “Bank”), which provides a broad range of commercial and retail banking and wealth management services to consumer, commercial and industrial, commercial real estate, or municipal customers through approximately 90 banking offices. We are committed to meeting the financial needs of the people and businesses in the communities where we live and work by providing customized banking solutions, quality products, and innovative services that fulfill those financial needs.

The following discussion and analysis is intended to address the significant factors affecting our results of operations and financial condition for the quarters and six-months ended June 30, 2013 and 2012. When we use the terms “First Midwest,” the “Company,” “we,” “us,” and “our,” we mean First Midwest Bancorp, Inc., a Delaware Corporation, and its consolidated subsidiaries. When we use the term “Bank,” we are referring to our wholly owned banking subsidiary, First Midwest Bank. Management’s discussion and analysis should be read in conjunction with the consolidated financial statements and accompanying notes presented elsewhere in this report, as well as in our 2012 Annual Report on Form 10-K (“2012 10-K”). The results of operations for the quarter and six months ended June 30, 2013 are not necessarily indicative of future results.

Our primary sources of revenue are net interest income and fees from financial services provided to our customers. Our largest expenses include interest expense, compensation expense, and various other noninterest expense items.

Our results of operations are affected by various factors, many of which are beyond our control, including interest rates, local and national economic conditions, business spending, consumer confidence, certain seasonal factors, legislative and regulatory changes, and changes in real estate and securities markets. Our management evaluates performance using a variety of qualitative and quantitative metrics. The primary quantitative metrics used by management include:

Pre-Tax, Pre-Provision Operating Earnings - Pre-tax, pre-provision operating earnings, a non-GAAP financial measure, reflects our operating performance before the effects of credit-related charges, securities gains, losses, and impairments, and certain unusual, infrequent, or non-recurring revenues and expenses. We believe this metric is useful because it helps investors to assess the Company’s operating performance. A reconciliation of pre-tax, pre-provision operating earnings to GAAP can be found in Table 1.

Net Interest Income - Net interest income, our primary source of revenue, equals the difference between interest income and fees earned on interest-earning assets and interest expense incurred on interest-bearing liabilities.

Net Interest Margin - Net interest margin equals net interest income divided by total average interest-earning assets.

Noninterest Income - Noninterest income is the income we earn from fee-based revenues, BOLI and other income, and non-operating revenues.

Asset Quality - Asset quality represents an estimation of the quality of our loan portfolio, including an assessment of the credit risk related to existing and potential loss exposure, and can be evaluated using a number of quantitative measures, such as non-performing loans to total loans.

Regulatory Capital - Our regulatory capital is classified in one of the following two tiers: (i) Tier 1 capital consists of common equity, retained earnings, and qualifying trust-preferred securities, less goodwill and most intangible assets and (ii) Tier 2 capital includes qualifying subordinated debt and the allowance for credit losses, subject to limitations.

Unless otherwise stated, all earnings per common share data included in this section and throughout the remainder of this discussion are presented on a diluted basis.

CAUTIONARY STATEMENT PURSUANT TO THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995

We include or incorporate by reference in this Quarterly Report on Form 10-Q, and from time to time our management may make, statements that may constitute “forward-looking statements” within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are not historical facts, but instead represent only management’s beliefs regarding future events, many of which, by their nature, are inherently uncertain and outside our control. Although we believe the expectations reflected in any forward-looking statements are reasonable, it is possible that our actual results and financial condition may differ, possibly materially, from the anticipated results and financial condition

indicated in such statements. In some cases, you can identify these statements by forward-looking words such as “may,” “might,” “will,” “should,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “probable,” “potential,” or “continue,” and the negative of these terms and other comparable terminology. We caution you not to place undue reliance on forward-looking statements, which speak only as of the date of this report or when made. We do not undertake any obligation to update any forward-looking statements to reflect circumstances or events that occur after the date of this quarterly report or the date on which the forward-looking statement is made.

Forward-looking statements are subject to known and unknown risks, uncertainties, and assumptions and may contain projections relating to our future financial performance including our growth strategies and anticipated trends in our business. For a detailed discussion of these and other risks and uncertainties that could cause actual results and events to differ materially from such forward-looking statements, you should refer to the sections entitled “Risk Factors” and “Management’s Discussion and Analysis of Results of Operations” in this report and in our 2012 Annual Report on Form 10-K as well as our subsequent periodic and current reports filed with the U.S. Securities and Exchange Commission (“SEC”). However, these risks and uncertainties are not exhaustive. Other sections of this report describe additional factors that could adversely impact our business and financial performance.

CRITICAL ACCOUNTING POLICIES

Our consolidated financial statements are prepared in accordance with GAAP and are consistent with general practices in the banking industry. Critical accounting policies are policies that management believes are the most important to our financial position and results of operations. Application of critical accounting policies requires management to make estimates, assumptions, and judgments based on information available as of 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 may affect amounts reported in the financial statements.

For additional information regarding critical accounting policies, refer to “Summary of Significant Accounting Policies,” presented in Note 1 to the Consolidated Financial Statements and the section titled “Critical Accounting Policies” in Management’s Discussion and Analysis of Financial Condition and Results of Operations included in the Company’s 2012 10-K. There have been no significant changes in the Company’s application of critical accounting policies related to the allowance for credit losses, valuation of securities, and income taxes since December 31, 2012.

PERFORMANCE OVERVIEW

Table 1

Selected Financial Data

(Dollar and share amounts in thousands, except per share data)

	Quarters Ended June 30,					Six Months Ended June 30,
	2013		2012		% Change	2013		2012		% Change
Operating Results
Interest income	$	71,753	$	75,518	(5.0%)	$	142,798	$	150,786	(5.3%)
Interest expense		(6,823)		(8,814)	(22.6%)		(14,020)		(18,900)	(25.8%)
Net interest income		64,930		66,704	(2.7%)		128,778		131,886	(2.4%)
Fee-based revenues		26,008		23,651	10.0%		51,766		46,243	11.9%
Other noninterest income (1)		1,217		235	N/M		3,034		3,019	0.5%
Noninterest expense (1)		(61,454)		(58,630)	4.8%		(123,757)		(120,625)	2.6%
Pre-tax, pre-provision operating earnings (2)		30,701		31,960	(3.9%)		59,821		60,523	(1.2%)
Provision for loan and covered loan losses		(5,813)		(22,458)	(74.1%)		(11,487)		(40,668)	(71.8%)
Net gains on securities sales		216		1,556	(86.1%)		216		1,350	(84.0%)
Securities impairment losses		-		(1,405)	100.0%		-		(2,142)	100.0%
Gain on early extinguishment of debt		-		-	-		-		256	(100.0%)
OREO valuation adjustments		(19)		(1,824)	(99.0%)		(586)		(2,514)	(76.7%)
Net gains (losses) on OREO sales		307		(703)	N/M		93		(316)	N/M
Adjusted amortization of FDIC indemnification asset		(750)		-	N/M		(1,500)		-	N/M
Severance-related costs		(511)		-	N/M		(1,491)		(315)	N/M
Income before income tax		24,131		7,126	N/M		45,066		16,174	N/M
Income tax expense		(7,955)		(761)	N/M		(14,248)		(1,917)	N/M
Net income		16,176		6,365	N/M		30,818		14,257	N/M
Net income applicable to non-vested restricted shares		(219)		(76)	N/M		(431)		(215)	N/M
Net income applicable to common shares	$	15,957	$	6,289	N/M	$	30,387	$	14,042	N/M
Weighted average diluted common shares outstanding		74,024		73,659			73,950		73,582
Diluted earnings per common share	$	0.22	$	0.09		$	0.41	$	0.19
Performance Ratios (3)
Return on average common equity		6.66%		2.59%			6.42%		2.90%
Return on average assets		0.79%		0.32%			0.76%		0.36%
Net interest margin – tax equivalent		3.70%		3.88%			3.73%		3.88%
Efficiency ratio		64.27%		60.56%			65.38%		62.58%

N/M – Not meaningful.

(1)	Excludes certain non-operating noninterest items.
(2)	Our accounting and reporting policies conform to GAAP and general practices within the banking industry. As a supplement to GAAP, we provided this non-GAAP performance result, which we believe is useful because it assists investors in evaluating our operating performance. This non-GAAP financial measure should not be considered an alternative to GAAP and may not be comparable to similar non-GAAP measures used by other companies.
(3)	All ratios are presented on an annualized basis.

	June 30, 2013		December 31, 2012		June 30, 2012		June 30, 2013 Change From
	June 30, 2013		December 31, 2012		June 30, 2012		December 31, 2012		June 30, 2012
Balance Sheet Highlights
Total assets	$	8,343,325	$	8,099,839	$	8,099,355	$	243,486	$	243,970
Total loans, excluding covered loans		5,287,565		5,189,676		5,298,026		97,889		(10,461)
Total loans, including covered loans		5,459,426		5,387,570		5,528,073		71,856		(68,647)
Total deposits		6,866,747		6,672,255		6,627,743		194,492		239,004
Transactional deposits		5,555,489		5,272,307		5,121,261		283,182		434,228
Loans-to-deposits ratio		79.5%		80.7%		83.4%
Transactional deposits to total deposits		80.9%		79.0%		77.3%

	June 30, 2013		December 31, 2012		June 30, 2012		June 30, 2013 Change From
	June 30, 2013		December 31, 2012		June 30, 2012		December 31, 2012		June 30, 2012
Asset Quality Highlights (1)
Non-accrual loans	$	89,193	$	84,534	$	198,508	$	4,659	$	(109,315)
90 days or more past due loans (still accruing interest)		3,832		8,689		8,192		(4,857)		(4,360)
Total non-performing loans		93,025		93,223		206,700		(198)		(113,675)
Accruing TDRs		8,287		6,867		7,811		1,420		476
OREO		39,497		39,953		28,309		(456)		11,188
Total non-performing assets	$	140,809	$	140,043	$	242,820	$	766	$	(102,011)
30-89 days past due loans (still accruing interest)	$	21,756	$	22,666	$	23,597	$	(910)	$	(1,841)
Allowance for credit losses		82,595		90,750		117,700		(8,155)		(35,105)
Allowance for credit losses as a percent of loans		1.56%		1.75%		2.22%
Allowance for credit losses to non-accrual loans		92.60%		107.35%		59.29%

(1)

Excludes covered loans and covered OREO. For a discussion of covered loans and covered OREO, refer to Note 5 of “Notes to Condensed Consolidated Financial Statements” in Part I, Item 1 of this Form 10-Q. Asset quality, including covered loans and covered OREO, is included in the “Loan Portfolio and Credit Quality” section below.

Net income applicable to common shareholders for the second quarter of 2013 was $16.0 million, or $0.22 per share, compared to $6.3 million, or $0.09 per share, for the second quarter of 2012. For the first six months of 2013, net income applicable to common shareholders was $30.4 million, or $0.41 per share, compared to $14.0 million, or $0.19 per share, for the same period in 2012.

Pre-tax, pre-provision operating earnings of $30.7 million for the second quarter of 2013 decreased by 3.9% compared to the second quarter of 2012. Pre-tax, pre-provision operating earnings for the first six months of 2013 was $59.8 million, decreasing from $60.5 million for the first six months of 2012. The decline from both prior periods resulted from a reduction in net interest income and a rise in non-interest expense, which was substantially offset by growth in noninterest income. A discussion of noninterest income and noninterest expense is presented in the following section titled “Earnings Performance.”

Non-performing assets, excluding covered loans and covered OREO, were $140.8 million at June 30, 2013, remaining stable compared to $140.0 million at December 31, 2012 and decreasing from $242.8 million at June 30, 2012. Compared to June 30, 2012, the significant decline in non-performing assets resulted from the disposal of $64.5 million of original carrying value of certain non-accrual loans through bulk loan sales completed during the fourth quarter of 2012, in addition to other accelerated credit remediation actions taken in 2012. Refer to the “Loan Portfolio and Credit Quality” section below for further discussion of non-accrual loans, 90 days past due loans, TDRs, and OREO.

EARNINGS PERFORMANCE

Net Interest Income

Net interest income is our primary source of revenue and is impacted by interest rates and the volume and mix of interest-earning assets and interest-bearing liabilities. The accounting policies for the recognition of interest income on loans, securities, and other interest-earning assets are presented in Note 1 to the Consolidated Financial Statements of our 2012 10-K.

Our accounting and reporting policies conform to GAAP and general practices within the banking industry. For purposes of this discussion, both net interest income and net interest margin have been adjusted to a fully tax-equivalent basis to more appropriately compare the returns on certain tax-exempt loans and securities to returns on taxable interest-earning assets. Although we believe that these non-GAAP financial measures enhance investors’ understanding of our business and performance, they should not be considered an alternative to GAAP. The effect of this adjustment is at the bottom of Tables 2 and 3.

Table 2 summarizes our average interest-earning assets and interest-bearing liabilities for the quarters ended June 30, 2013 and 2012, the related interest income and interest expense for each earning asset category and funding source, and the average interest rates earned and paid. Table 2 also details differences in interest income and expense from the prior year and the extent to which any changes are attributable to volume and rate fluctuations. Table 3 presents this same information for the six months ended June 30, 2013 and 2012.

Table 2

Net Interest Income and Margin Analysis

(Dollar amounts in thousands)

	Quarters Ended June 30,										Attribution of Change in Net Interest Income (1)
	2013					2012					Attribution of Change in Net Interest Income (1)
	Average Balance		Interest		Yield/ Rate	Average Balance		Interest		Yield/ Rate	Volume		Yield/ Rate			Total
Assets:
Other interest-earning assets	$	674,849	$	468	0.28%	$	432,036	$	258	0.24%	$	163	$	47	$	210
Trading securities		15,610		24	0.61%		16,090		26	0.65%		(1)		(1)		(2)
Investment securities (2)		1,256,813		10,164	3.23%		1,238,767		11,172	3.61%		166		(1,174)		(1,008)
FHLB and Federal Reserve Bank stock		40,998		342	3.34%		46,750		354	3.03%		(66)		54		(12)
Loans (2)(3)		5,383,891		63,829	4.76%		5,511,085		67,032	4.89%		1,630		(4,833)		(3,203)
Total interest-earning assets (2)		7,372,161		74,827	4.07%		7,244,728		78,842	4.37%		1,892		(5,907)		(4,015)
Cash and due from banks		124,996					122,165
Allowance for loan and covered loan losses		(98,006)					(122,723)
Other assets		860,502					869,572
Total assets	$	8,259,653				$	8,113,742
Liabilities and Stockholders’ Equity:
Savings deposits	$	1,144,093		208	0.07%	$	1,042,099		269	0.10%		29		(90)		(61)
NOW accounts		1,166,227		168	0.06%		1,064,054		179	0.07%		21		(32)		(11)
Money market deposits		1,274,062		434	0.14%		1,176,723		465	0.16%		45		(76)		(31)
Time deposits		1,331,499		2,193	0.66%		1,548,410		3,765	0.98%		(476)		(1,096)		(1,572)
Borrowed funds		204,449		385	0.76%		195,934		490	1.01%		22		(127)		(105)
Senior and subordinated debt		214,828		3,435	6.41%		231,123		3,646	6.34%		(262)		51		(211)
Total interest-bearing liabilities		5,335,158		6,823	0.51%		5,258,343		8,814	0.67%		( 621)		(1,370)		(1,991)
Demand deposits		1,880,476					1,797,854
Other liabilities		83,518					80,491
Stockholders’ equity - common		960,501					977,054
Total liabilities and stockholders’ equity	$	8,259,653				$	8,113,742
Net interest income/margin (2)			$	68,004	3.70%			$	70,028	3.88%	$	2,513	$	(4,537)	$	(2,024)
Net interest income (GAAP)			$	64,930				$	66,704
Tax equivalent adjustment				3,074					3,324
Tax-equivalent net interest income			$	68,004				$	70,028

(1)	For purposes of this table, changes which are not due solely to volume changes or rate changes are allocated to these categories on the basis of the percentage relationship of each to the sum of the two.
(2)	Interest income and yields are presented on a tax-equivalent basis, assuming a federal income tax rate of 35%.
(3)	Includes covered interest-earning assets consisting of loans acquired through the Company’s Federal Deposit Insurance Corporation (“FDIC”)-assisted transactions with loss share agreements and the related FDIC indemnification asset. For additional discussion, please refer to Note 5 of “Notes to the Condensed Consolidated Financial Statements” in Part I, Item 1 of this Form 10-Q.

Table 3

Net Interest Income and Margin Analysis

(Dollar amounts in thousands)

	Six Months Ended June 30,										Attribution of Change in Net Interest Income (1)
	2013					2012					Attribution of Change in Net Interest Income (1)
	Average Balance		Interest		Yield/ Rate	Average Balance		Interest		Yield/ Rate	Volume		Yield/ Rate			Total
Assets:
Other interest-earning assets	$	629,761	$	902	0.29%	$	440,912	$	533	0.24%	$	257	$	112	$	369
Trading securities		14,987		60	0.80%		15,337		62	0.81%		(1)		(1)		(2)
Investment securities (2)		1,216,163		20,104	3.31%		1,201,053		22,906	3.81%		292		(3,094)		(2,802)
FHLB and Federal Reserve Bank stock		44,098		681	3.09%		49,641		684	2.76%		33		(36)		(3)
Loans (2)(3)		5,377,995		127,279	4.77%		5,459,470		133,217	4.91%		(8,071)		2,133		(5,938)
Total interest-earning assets (2)		7,283,004		149,026	4.12%		7,166,413		157,402	4.41%		(7,490)		( 886)		(8,376)
Cash and due from banks		117,576					115,941
Allowance for loan and covered loan losses		(98,543)					(123,195)
Other assets		863,961					876,307
Total assets	$	8,165,998				$	8,035,466
Liabilities and Stockholders’ Equity:
Savings deposits	$	1,125,755		455	0.08%	$	1,019,027		552	0.11%		69		(166)		(97)
NOW accounts		1,155,912		343	0.06%		1,057,962		397	0.08%		43		(97)		(54)
Money market deposits		1,262,712		904	0.14%		1,180,520		986	0.17%		79		(161)		(82)
Time deposits		1,352,894		4,621	0.69%		1,585,167		8,256	1.05%		(1,085)		(2,550)		(3,635)
Borrowed funds		202,183		827	0.82%		199,741		1,005	1.01%		12		(190)		(178)
Senior and subordinated debt		214,812		6,870	6.45%		239,678		7,704	6.46%		(795)		(39)		(834)
Total interest-bearing liabilities		5,314,268		14,020	0.53%		5,282,095		18,900	0.72%		(1,677)		(3,203)		(4,880)
Demand deposits		1,811,036					1,694,526
Other liabilities		86,379					85,135
Stockholders’ equity - common		954,315					973,710
Total liabilities and stockholders’ equity	$	8,165,998				$	8,035,466
Net interest income/margin (2)			$	135,006	3.73%			$	138,502	3.88%	$	(5,813)	$	2,317	$	(3,496)
Net interest income (GAAP)			$	128,778				$	131,886
Tax equivalent adjustment				6,228					6,616
Tax-equivalent net interest income			$	135,006				$	138,502

(1)	For purposes of this table, changes which are not due solely to volume changes or rate changes are allocated to these categories on the basis of the percentage relationship of each to the sum of the two.
(2)	Interest income and yields are presented on a tax-equivalent basis, assuming a federal income tax rate of 35%.
(3)	Includes covered interest-earning assets consisting of loans acquired through FDIC-assisted transactions with loss share agreements and the related FDIC indemnification asset. For additional discussion, please refer to Note 5 of “Notes to the Condensed Consolidated Financial Statements” in Part I, Item 1 of this Form 10-Q.

Total interest-earning assets for the second quarter of 2013 increased $127.4 million from the second quarter of 2012 and $116.6 million for the first six months of 2013 compared to the same period in 2012. Growth was driven by other interest-earning assets and investment securities. Compared to the prior periods, growth in the loan portfolio, primarily in the commercial and industrial, agricultural, and 1-4 family categories, was offset by the disposal of $172.5 million of original carrying value of certain non-performing and performing potential problem loans through bulk loan sales completed during the fourth quarter of 2012 (“the bulk loan sales”).

For the second quarter of 2013, total interest-bearing liabilities increased by $76.8 million from the second quarter of 2012 and $32.2 million for the first six months of 2013 compared to the same period in 2012. Total interest-bearing liabilities grew in both periods due to a rise in interest-bearing transaction deposits, which more than offset the decline in time deposits.

For the second quarter and first six months of 2013, tax-equivalent net interest income decreased $2.0 million and $3.5 million, respectively, compared to the same periods in 2012. These decreases were due primarily to the decline in the yield earned on the Company’s investment securities and loan portfolios, which was partially offset by a reduction in the cost of time deposits, an increase in demand deposits, and a more favorable interest-bearing liability mix.

Tax-equivalent net interest margin for the second quarter and first six months of 2013 was 3.70% and 3.73%, respectively, a decline of 18 basis points from the second quarter of 2012 and 15 basis points from the first six months of 2012. Both periods reflect the continued repricing of maturing investment securities and loans at lower interest rates, which was mitigated by a reduction in rates paid on borrowed funds and a shift from higher paying time deposits to lower paying deposit products.

Noninterest Income

A summary of noninterest income for the quarters and six months ended June 30, 2013 and 2012 is presented in the following table.

Table 4

Noninterest Income Analysis

(Dollar amounts in thousands)

	Quarters Ended June 30,					Six Months Ended June 30,
	2013		2012		% Change	2013		2012		% Change
Service charges on deposit accounts	$	9,118	$	8,848	3.1%	$	17,795	$	17,508	1.6%
Card-based fees (1)		5,547		5,312	4.4%		10,623		10,332	2.8%
Wealth management fees		6,126		5,394	13.6%		11,965		10,786	10.9%
Mortgage banking income		1,040		-	100.0%		3,006		-	100.0%
Merchant servicing fees		2,899		2,908	(0.3%)		5,453		5,230	4.3%
Other service charges, commissions, and fees		1,278		1,189	7.5%		2,924		2,387	22.5%
Total fee-based revenues		26,008		23,651	10.0%		51,766		46,243	11.9%
Other income (2)(6)		1,003		810	23.8%		1,784		2,193	(18.7%)
Net trading gains (3) (6)		214		(575)	N/M		1,250		826	51.3%
Net gains on securities sales (4)		216		1,556	(86.1%)		216		1,350	(84.0%)
Securities impairment losses (4)		-		(1,405)	100.0%		-		(2,142)	100.0%
Gain on early extinguishment of debt (5)(6)		-		-	-		-		256	(100.0%)
Total noninterest income	$	27,441	$	24,037	14.2%	$	55,016	$	48,726	12.9%

N/M – Not meaningful.

(1)	Card-based fees consist of debit and credit card interchange fees for processing transactions as well as various fees on both customer and non-customer automated teller machine (“ATM”) and point-of-sale transactions processed through the ATM and point-of-sale networks.
(2)	Other income consists of various items, including BOLI income, safe deposit box rentals, miscellaneous recoveries, and gains on the sales of various assets.
(3	Net trading gains result from changes in the fair value of diversified investment securities held in a grantor trust under deferred compensation arrangements and are substantially offset by nonqualified plan expense for each period presented.
(4)	For a discussion of these items, see the “Investment Portfolio Management” section below. These line items are included in net securities gains (losses) in the Condensed Consolidated Statements of Income.
(5)	The gain on early extinguishment of debt relates to the repurchase and retirement of $21.1 million in trust preferred junior subordinated debentures.
(6)	These line items are included in other income in the Condensed Consolidated Statements of Income.

Total noninterest income for the second quarter of 2013 increased by $3.4 million, or 14.2%, compared to the second quarter of 2012. For the first six months of 2013, total noninterest income rose $6.3 million, or 12.9%, from the same period in 2012.

Fee-based revenues increased compared to both prior periods presented, driven primarily by mortgage banking income from mortgage loan sales, growth in wealth management fees, and a rise in other service charges, commissions, and fees.

During the second quarter and first six months of 2013, we sold $28.0 million and $82.0 million of 1-4 family mortgage loans, respectively, which accounted for the growth in mortgage banking income. Growth in mortgage banking income reflects market conditions and the expansion of our mortgage lending sales force that began in the second quarter of 2012.

Wealth management fees increased 13.6% from the second quarter of 2012 and 10.9% from the first six months of 2012 due to higher levels of assets under management driven by new customer relationships and improved market performance.

The increases in other service charges, commissions, and fees compared to the second quarter and first six months of 2012 resulted primarily from transaction fees generated by derivative transactions.

Noninterest Expense

The following table presents the components of noninterest expense for the quarters and six months ended June 30, 2013 and 2012.

Table 5

Noninterest Expense Analysis

(Dollar amounts in thousands)

	Quarters Ended June 30,					Six Months Ended June 30,
	2013		2012		% Change	2013		2012		% Change
Compensation expense:
Salaries and wages (1)(5)	$	26,553	$	24,446	8.6%	$	54,392	$	50,145	8.5%
Nonqualified plan expense (2)(5)		267		(594)	N/M		1,391		964	44.3%
Retirement and other employee benefits (1)		6,101		5,714	6.8%		13,707		12,507	9.6%
Total compensation expense		32,921		29,566	11.3%		69,490		63,616	9.2%
Net OREO expense:
OREO valuation adjustments		19		1,824	(99.0%)		586		2,514	(76.7%)
Net (gains) losses on OREO sales (3)		(307)		703	N/M		(93)		316	N/M
Net OREO operating expense		1,372		1,597	(14.1%)		2,390		3,158	(24.3%)
Net OREO expense		1,084		4,124	(73.7%)		2,883		5,988	(51.9%)
Professional services:
Loan remediation costs		2,547		3,594	(29.1%)		4,686		6,382	(26.6%)
Other professional services (1)		3,048		3,311	(7.9%)		6,127		6,152	(0.4%)
Total professional services		5,595		6,905	(19.0%)		10,813		12,534	(13.7%)
Net occupancy expense (7)		5,598		5,300	5.6%		11,578		11,505	0.6%
Equipment expense (7)		2,195		2,213	(0.8%)		4,362		4,339	0.5%
Technology and related costs		2,884		2,851	1.2%		5,367		5,709	(6.0%)
FDIC premiums		1,704		1,659	2.7%		3,446		3,378	2.0%
Advertising and promotions (6)		2,033		1,032	97.0%		3,443		1,902	81.0%
Merchant card expense (6)		2,321		2,324	(0.1%)		4,365		4,120	5.9%
Cardholder expenses (6)		1,043		980	6.4%		1,972		2,022	(2.5%)
Adjusted amortization of FDIC indemnification asset (6)		750		-	N/M		1,500		-	N/M
Other expenses (6)		4,299		4,203	2.3%		8,022		8,657	(7.3%)
Total noninterest expense	$	62,427	$	61,157	2.1%	$	127,241	$	123,770	2.8%
Full-time equivalent employees		1,672		1,758	(4.9%)		1,699		1,769	(4.0%)
Efficiency ratio (4)		64.27%		60.56%			65.38%		62.58%

N/M – Not meaningful.

(1)	In the second quarter of 2013, the Company recorded a $511,000 charge for severance-related costs, of which $443,000 is included in salaries and wages. For the six months ended June 30, 2013, severance-related costs totaled $1.4 million, of which $1.3 million was included in salaries and wages.
(2)	Nonqualified plan expense results from changes in the Company’s obligation to participants under deferred compensation agreements.
(3)	For a discussion of sales of OREO properties, refer to the “Non-performing Assets and Potential Problem Loans” section below.
(4)	The efficiency ratio expresses noninterest expense, excluding OREO expense, as a percentage of tax-equivalent net interest income plus total fee-based revenues, other income, trading gains (losses), and the tax-equivalent adjustment on the increase in BOLI.
(5)	These expenses are included in salaries and wages in the Condensed Consolidated Statements of Income.
(6)	These line items are included in other expenses in the Condensed Consolidated Statements of Income.
(7)	These line items are included in net occupancy and equipment expense in the Condensed Consolidated Statements of Income.

Total noninterest expense for the second quarter of 2013 increased 2.1% from the second quarter of 2012. For the first six months of 2013, noninterest expense rose 2.8% compared to the same period in 2012.

The increase in salaries and wages for the second quarter and first six months of 2013 compared to both prior periods presented was driven primarily by annual merit and incentive compensation increases, commissions, severance expense, and a reduction in deferred salaries.

Retirement and other employee benefits increased from the quarter ended June 30, 2012 due to higher insurance costs. Compared to the first six months of 2012, the rise in retirement and other employee benefits resulted from an increase in pension expense, profit sharing contributions, and insurance costs.

Net OREO expense decreased 73.7% from the second quarter of 2012 and 51.9% from the first six months of 2012, primarily from lower valuation adjustments and real estate tax payments. In addition, gains realized on the sale of OREO properties in the second quarter and first six months of 2013 compared to losses on sales during the same periods in 2012 contributed to the decline in expense.

Loan remediation costs decreased 29.1% and 26.6% compared to the quarter and six months ended June 30, 2012. Management’s accelerated credit remediation actions in the third and fourth quarters of 2012 significantly reduced non-performing and performing potential problem credits resulting in lower legal expenses and appraisal costs in subsequent periods. In addition, the positive variance was also impacted by lower servicing costs for our covered loan portfolio.

The rise in advertising and promotions expense compared to both prior periods presented was driven by the launch of our “Banking with Momentum” branding campaign in the second quarter of 2013.

Adjusted amortization of the FDIC indemnification asset results from changes in the timing and amount of future cash flows expected to be received from the FDIC under loss sharing agreements based on management’s periodic estimates of future cash flows on covered loans.

Compared to the first six months of 2012, the decline in other expenses was driven primarily by a $500,000 reduction in the reserve for unfunded commitments during the first quarter of 2013.

Income Taxes

Our provision for income taxes includes both federal and state income tax expense. An analysis of the provision for income taxes is detailed in the following table.

Table 6

Income Tax Expense Analysis

(Dollar amounts in thousands)

	Quarters Ended June 30,				Six Months Ended June 30,
	2013		2012		2013		2012
Income before income tax expense	$	24,131	$	7,126	$	45,066	$	16,174
Income tax expense:
Federal income tax expense	$	5,553	$	126	$	9,913	$	971
State income tax expense		2,402		635		4,335		946
Total income tax expense	$	7,955	$	761	$	14,248	$	1,917
Effective income tax rate		33.0%		10.7%		31.6%		11.9%

Federal income tax expense and the related effective income tax rate are influenced by the amount of tax-exempt income derived from investment securities and bank-owned life insurance in relation to pre-tax income and state income taxes. State income tax expense and the related effective tax rate are driven by the amount of state tax-exempt income in relation to pre-tax income and state tax rules related to consolidated/combined reporting and sourcing of income and expense.

Income tax expense was $8.0 million and $14.2 million for the second quarter and first six months of 2013 compared to $761,000 and $1.9 million for the same periods in 2012. These increases in income tax expense, and related increases in effective tax rates, resulted primarily from higher levels of 2013 income subject to tax at statutory rates.

Our accounting policies for the recognition of income taxes in the Consolidated Statements of Financial Condition and Income are included in Notes 1 and 14 to the Consolidated Financial Statements of our 2012 10-K.

FINANCIAL CONDITION

Investment Portfolio Management

Securities that we have the positive intent and ability to hold until maturity are classified as securities held-to-maturity and are accounted for using historical cost, adjusted for amortization of premiums and accretion of discounts. Trading securities are carried at fair value with changes in fair value included in other noninterest income. Our trading securities consist of securities held in a grantor trust for our nonqualified deferred compensation plan and are not considered part of the traditional investment portfolio. All other securities are classified as securities available-for-sale and are carried at fair value with unrealized gains and losses net of related deferred income taxes, recorded in stockholders’ equity as a separate component of accumulated other comprehensive loss.

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 mitigate the impact of changes in interest rates on net interest income.

From time to time, we adjust the size and composition of our securities portfolio based on a number of factors, including expected loan growth, anticipated changes in collateralized public funds on account, the interest rate environment, and the related value of various segments of the securities markets. The following table provides a valuation summary of our investment portfolio.

Table 7

Investment Portfolio Valuation Summary

(Dollar amounts in thousands)

	June 30, 2013							December 31, 2012
	Fair Value		Net Unrealized Gains (Losses)		Amortized Cost		% of Total Amortized Cost	Fair Value		Net Unrealized Gains (Losses)		Amortized Cost		% of Total Amortized Cost
Securities Available-for-Sale
U.S. agency securities	$	503	$	-	$	503	-	$	508	$	-	$	508	-
CMOs		536,423		(6,771)		543,194	43.4%		400,383		3,237		397,146	35.6%
Other MBSs		126,772		1,999		124,773	10.0%		122,900		5,115		117,785	10.6%
Municipal securities		490,759		8,669		482,090	38.5%		520,043		24,137		495,906	44.5%
CDOs		14,917		(31,615)		46,532	3.7%		12,129		(34,404)		46,533	4.2%
Corporate debt securities		15,107		2,105		13,002	1.0%		15,339		2,333		13,006	1.2%
Equity securities		39,005		26,374		12,631	1.0%		11,101		1,411		9,690	0.8%
Total available-for-sale securities		1,223,486		761		1,222,725	97.6%		1,082,403		1,829		1,080,574	96.9%
Securities Held-to-Maturity
Municipal securities		32,071		1,698		30,373	2.4%		36,023		1,728		34,295	3.1%
Total securities	$	1,255,557	$	2,459	$	1,253,098	100.0%	$	1,118,426	$	3,557	$	1,114,869	100.0%

	June 30, 2013			December 31, 2012
	Effective Duration (1)	Average Life (2)	Yield to Maturity (3)	Effective Duration (1)	Average Life (2)	Yield to Maturity (3)
Securities Available-for-Sale
U.S. agency securities	0.33%	0.33	0.20%	0.90%	0.92	0.20%
CMOs	4.01%	4.13	1.53%	2.22%	2.93	1.19%
Other MBSs	3.70%	4.75	2.41%	1.97%	3.62	2.79%
Municipal securities	5.29%	3.55	5.55%	4.49%	3.69	5.56%
CDOs	0.25%	8.26	N/A	0.25%	8.36	N/A
Corporate debt securities	5.23%	7.69	6.38%	5.51%	8.09	6.37%
Equity securities	N/A	N/A	N/A	N/A	N/A	N/A
Total available-for-sale securities	4.35%	4.16	3.18%	3.20%	3.65	3.37%
Securities Held-to-Maturity
Municipal securities	5.53%	8.26	4.55%	6.30%	10.53	5.26%
Total securities	4.38%	4.26	3.21%	3.29%	3.86	3.43%

(1)	The effective duration represents the estimated percentage change in the fair value of the securities portfolio given a 100 basis point increase or decrease in interest rates. This measure is used to gauge the portfolio’s price volatility at a single point in time and is not intended to be a precise predictor of future fair values since those values will be influenced by a number of factors.
(2)	Average life is presented in years and represents the weighted-average time to receive all future cash flows using the dollar amount of principal paydowns, including estimated principal prepayments, as the weighting factor.
(3)	Yields on municipal securities are reflected on a tax-equivalent basis, assuming a federal income tax rate of 35%.

Portfolio Composition

As of June 30, 2013, our securities portfolio totaled $1.3 billion, an increase of 12.3% compared to December 31, 2012. The growth in CMOs during the first six months of 2013 resulted from the redeployment of cash and cash equivalents. During the first six months of 2013, available-for-sale securities purchases of $289.7 million more than offset $125.5 million in maturities and $5.2 million in premium amortization. Our available-for-sale securities portfolio is comprised primarily of

U.S. agency securities, municipal securities, CMOs, and other MBSs. The remainder of the portfolio consists of six CDOs with a total fair value of $14.9 million and miscellaneous other securities with fair values equaling $54.1 million.

Investments in municipal securities comprised 40.1%, or $490.8 million, of the total available-for-sale securities portfolio at June 30, 2013 and declined 5.6% from $520.0 million at December 31, 2012. The majority consists of general obligations of local municipalities. Our municipal securities portfolio has historically experienced very low default rates and provides a predictable cash flow.

The average life and effective duration of our available-for-sale securities portfolio as of June 30, 2013 are elevated from the December 31, 2012 metrics due primarily to purchases of CMOs during the six months ended June 30, 2013. The decline in the yield to maturity from December 31, 2012 was impacted by purchases and repricing of securities in the CMO and other MBSs portfolios.

Securities Gains and Losses

Net securities gains for the second quarter and first six months of 2013 were $216,000, resulting from sales of $19.5 million in CMOs and other MBSs. In addition, we sold a CDO that had a carrying value of zero and fair value of zero. There were no impairment charges recognized during the second quarter and first six months of 2013.

Second quarter 2012 net securities gains were $151,000, which was net of an OTTI charge of $1.4 million associated with our investment in two CDOs. Net securities losses were $792,000 for the six months ended June 30, 2012 due primarily to gains of $1.6 million from the sale of $9.4 million in municipal securities, which was offset by an OTTI charge of $2.1 million on two CDOs.

Unrealized Gains and Losses

Unrealized gains and losses on securities available-for-sale represent the difference between the aggregate cost and fair value of the portfolio. These amounts are presented in the Consolidated Statements of Comprehensive Income and reported as a separate component of stockholders’ equity in accumulated other comprehensive loss on an after-tax basis. This balance sheet component will fluctuate as current market interest rates and conditions change and affect the aggregate fair value of the portfolio. Net unrealized gains at June 30, 2013 were $761,000 compared to $1.8 million at December 31, 2012.

As of June 30, 2013, net unrealized gains in the available-for-sale municipal securities portfolio totaled $ 8.7 million compared to $24.1 million as of December 31, 2012. Substantially all of these securities carry investment grade ratings with the majority supported by the general revenues of the issuing governmental entity and supported by third-party bond insurance or other types of credit enhancement. We do not believe the unrealized loss on any of these securities represents an OTTI.

Net unrealized gains on equity securities totaled $26.4 million as of June 30, 2013 compared to $1.4 million as of December 31, 2012. The increase in net unrealized gains related to a cost method investment in a company that completed an initial public offering (“IPO”) of common stock during the second quarter of 2013. As a result, our investment in the common stock of this company was classified as available-for-sale and is now being valued using the closing stock price reported by the New York Stock Exchange. We are restricted from selling any of our shares for six months following the completion of the IPO.

Our investments in CDOs are supported by the credit of the underlying banks and insurance companies. The unrealized loss on these securities declined $2.8 million since December 31, 2012. The unrealized loss reflects the difference between amortized cost and fair value that we determined did not relate to credit and reflects the illiquid nature of these particular investments. We do not believe the unrealized losses on the CDOs as of June 30, 2013 represent OTTI related to credit deterioration. In addition, we do not intend to sell the CDOs with unrealized losses, and we do not believe it is more likely than not that we will be required to sell them before recovery of their amortized cost basis, which may be at maturity. Our estimation of fair values for the CDOs was based on discounted cash flow analyses as described in Note 12 of “Notes to the Condensed Consolidated Financial Statements,” in Part I, Item 1 of this Form 10-Q.

CMOs and other MBSs are either backed by U.S. government-owned agencies or issued by U.S. government-sponsored enterprises. We do not believe any individual unrealized loss on these types of securities as of June 30, 2013 represents OTTI since the unrealized losses are not attributed to credit quality.

LOAN PORTFOLIO AND CREDIT QUALITY

Loans Held-for-Investment

Our loan portfolio is comprised of both corporate and consumer loans with corporate loans representing 86.7% of total loans, excluding covered loans, at June 30, 2013. Consistent with our emphasis on relationship banking, the majority of our loans are made to our multi-relationship customers.

Table 8

Loan Portfolio

(Dollar amounts in thousands)

	June 30, 2013		% of Total	December 31, 2012		% of Total	Annualized % Change
Commercial and industrial	$	1,743,139	33.0%	$	1,631,474	31.5%	13.7%
Agricultural		288,632	5.4%		268,618	5.2%	14.9%
Commercial real estate:
Office		449,641	8.5%		474,717	9.1%	(10.6%)
Retail		383,447	7.3%		368,796	7.1%	7.9%
Industrial		486,761	9.2%		489,678	9.4%	(1.2%)
Multi-family		306,182	5.8%		285,481	5.5%	14.5%
Residential construction		50,384	1.0%		61,462	1.2%	(36.0%)
Commercial construction		117,116	2.2%		124,954	2.4%	(12.5%)
Other commercial real estate		759,367	14.3%		773,121	14.9%	(3.6%)
Total commercial real estate		2,552,898	48.3%		2,578,209	49.6%	(2.0%)
Total corporate loans		4,584,669	86.7%		4,478,301	86.3%	4.8%
Home equity		374,406	7.1%		390,033	7.5%	(8.0%)
1-4 family mortgages		291,770	5.5%		282,948	5.5%	6.2%
Installment		36,720	0.7%		38,394	0.7%	(8.7%)
Total consumer loans		702,896	13.3%		711,375	13.7%	(2.4%)
Total loans, excluding covered loans		5,287,565	100.0%		5,189,676	100.0%	3.8%
Covered loans (1)		171,861			197,894		(26.3%)
Total loans	$	5,459,426		$	5,387,570		2.7%

(1)	For a detailed discussion of our covered loan portfolio, refer to Notes 1 and 5 of “Notes to the Condensed Consolidated Financial Statements” in Part I, Item 1 of this Form 10-Q.

Total loans, excluding covered loans, of $5.3 billion grew by $97.9 million from December 31, 2012. Strong annualized growth in the commercial and industrial, agricultural, retail, and multi-family loan categories continues to reflect our targeted repositioning of the loan portfolio. In addition, sales personnel have been focused on expansion into specialized lending areas, such as agribusiness and asset-based lending, which contributed to the increases. This growth was offset by declines in the office, residential and commercial construction, other commercial real estate, and home equity portfolios. Overall, the loan portfolio benefited from well balanced growth reflecting credits of varying size and diverse geographic locations within our markets.

During the first six months of 2013, we sold $82.0 million of 1-4 family mortgage loans in the secondary market, which contributed to the decrease in the consumer portfolio. We continue to generate solid new mortgage volume, reflecting the expansion of our mortgage lending sales force that began in the second quarter of 2012.

Commercial, Industrial, and Agricultural Loans

Commercial, industrial, and agricultural loans represent 38.4% of loans, excluding covered loans, and totaled $2.0 billion at June 30, 2013, an increase of $131.7 million, or 13.9% annualized, from December 31, 2012. Our commercial and industrial loans are a diverse group of loans to middle market businesses generally located in the Chicago metropolitan area with purposes that range from supporting seasonal working capital needs to term financing of equipment. The underwriting for these loans is primarily based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. Most commercial and industrial loans are secured by the assets being financed or other business assets, such as accounts receivable or inventory, and may incorporate a personal guarantee. As part of our targeted portfolio distribution strategy, we are developing and growing specialized lending platforms, such as healthcare, agribusiness, and asset-based lending. Agricultural loans generally provide seasonal support and are secured by facilities and equipment in addition to crop production, which is usually covered by crop insurance.

Commercial Real Estate Loans

All commercial real estate loans are subject to underwriting standards and processes similar to commercial and industrial loans, in addition to those standards specific to real estate loans. Commercial real estate lending typically involves higher loan principal amounts, and the repayment of these loans depends on the successful operation of the property securing the loan or the business conducted on the property securing the loan. This category of loans may be more adversely affected by conditions in the real estate market or in the general economy. The properties securing our commercial real estate portfolio are diverse in terms of type and geographic location within the Company’s markets. Management monitors and evaluates commercial real estate loans based on cash flow, collateral, geography, and risk rating criteria. Owner-occupied real estate loans are viewed primarily as cash flow loans (similar to commercial and industrial loans) and secondarily as loans secured by real estate. Our long-term objective for the commercial real estate portfolio is to expand loans secured by owner-occupied real estate.

The following table presents commercial real estate loans by owner-occupied or investor status and category.

Table 9

Commercial Real Estate Loans

(Dollar amounts in thousands)

	June 30, 2013						December 31, 2012
	Owner- Occupied		Investor		Total		Owner- Occupied		Investor		Total

Office, retail, and industrial:
Office	$	152,998	$	296,643	$	449,641	$	167,221	$	307,496	$	474,717
Retail		120,979		262,468		383,447		115,570		253,226		368,796
Industrial		260,881		225,880		486,761		270,484		219,194		489,678
Total office, retail, and industrial		534,858		784,991		1,319,849		553,275		779,916		1,333,191
Multi-family		-		306,182		306,182		-		285,481		285,481
Residential construction		-		50,384		50,384		-		61,462		61,462
Commercial construction		-		117,116		117,116		-		124,954		124,954
Other commercial real estate:
Rental properties (1)		34,794		85,908		120,702		26,902		94,272		121,174
Service stations and truck stops		86,325		19,594		105,919		95,794		18,727		114,521
Warehouses and storage		65,093		35,650		100,743		77,290		33,077		110,367
Hotels		-		59,059		59,059		-		73,347		73,347
Restaurants		63,244		18,150		81,394		62,921		17,509		80,430
Automobile dealers		35,000		6,325		41,325		39,392		5,729		45,121
Mobile home parks		-		26,418		26,418		-		27,147		27,147
Recreational		42,192		7,659		49,851		32,804		8,254		41,058
Religious		30,574		878		31,452		28,301		895		29,196
Medical		-		804		804		-		816		816
Multi-use properties		14,656		59,489		74,145		14,295		48,825		63,120
Other		33,427		34,128		67,555		32,401		34,423		66,824
Total other commercial real estate		405,305		354,062		759,367		410,100		363,021		773,121
Total commercial real estate	$	940,163	$	1,612,735	$	2,552,898	$	963,375	$	1,614,834	$	2,578,209
Commercial real estate loans, excluding multi-family and construction loans	$	940,163	$	1,139,053	$	2,079,216	$	963,375	$	1,142,937	$	2,106,312
Percent of total (2)		45.2%		54.8%				45.7%		54.3%

(1)	Owner-occupied rental properties primarily represent home-based businesses.
(2)	The percent reported does not include multi-family or construction loans since the owner-occupied classification is not relevant to these categories.

Commercial real estate loans represent 48.3% of total loans, excluding covered loans, and totaled $2.6 billion at June 30, 2013, a decline of $25.3 million from December 31, 2012, due primarily to decreases in the office, construction, and other commercial real estate portfolios. Over half of our commercial real estate loans consist of loans for industrial buildings, office buildings, and retail shopping centers.

Consumer Loans

Our consumer loan portfolio consists mainly of loans or lines of credit to individuals for residential or other personal expenditures. Home equity loans and lines of credit and 1-4 family mortgages are primarily secured by senior or junior liens

on the borrower’s personal residence. Underwriting standards for these loans are heavily influenced by statutory requirements, which include loan-to-value and affordability ratios, risk-based pricing strategies, and documentation requirements. Loan-to-value ratios on home equity and 1-4 family mortgages are based on the current value of the appraised collateral.

Non-performing Assets and Potential Problem Loans

The following table presents our loan portfolio by performing and non-performing status. A discussion of our accounting policies for non-accrual loans, TDRs, and loans 90 days or more past due can be found in Note 1 of “Notes to the Condensed Consolidated Financial Statements” in Part 1, Item 1 of this Form 10-Q.

Table 10

Loan Portfolio by Performing/Non-Performing Status

(Dollar amounts in thousands)

					Accruing
	Total Loans		Current		30-89 Days Past Due		90 Days Past Due		TDRs		Non-accrual
As of June 30, 2013
Commercial and industrial	$	1,743,139	$	1,703,389	$	10,473	$	425	$	695	$	28,157
Agricultural		288,632		287,679		167		-		-		786
Commercial real estate:
Office		449,641		444,500		586		147		-		4,408
Retail		383,447		375,587		449		13		628		6,770
Industrial		486,761		473,481		30		-		-		13,250
Multi-family		306,182		302,505		425		131		1,053		2,068
Residential construction		50,384		46,553		-		-		500		3,331
Commercial construction		117,116		112,218		1,020		-		-		3,878
Other commercial real estate		759,367		739,421		2,525		99		4,300		13,022
Total commercial real estate		2,552,898		2,494,265		5,035		390		6,481		46,727
Total corporate loans		4,584,669		4,485,333		15,675		815		7,176		75,670
Home equity		374,406		361,620		4,027		2,222		160		6,377
1-4 family mortgages		291,770		283,272		1,716		767		951		5,064
Installment		36,720		34,272		338		28		-		2,082
Total consumer loans		702,896		679,164		6,081		3,017		1,111		13,523
Total loans, excluding covered loans		5,287,565		5,164,497		21,756		3,832		8,287		89,193
Covered loans		171,861		110,043		5,650		27,700		-		28,468
Total loans	$	5,459,426	$	5,274,540	$	27,406	$	31,532	$	8,287	$	117,661
As of December 31, 2012
Commercial and industrial	$	1,631,474	$	1,598,342	$	4,534	$	2,138	$	519	$	25,941
Agricultural		268,618		266,991		79		375		-		1,173
Commercial real estate:
Office		474,717		471,242		871		197		-		2,407
Retail		368,796		358,945		2,415		626		-		6,810
Industrial		489,678		475,416		255		-		-		14,007
Multi-family		285,481		283,415		479		153		-		1,434
Residential construction		61,462		56,850		-		-		-		4,612
Commercial construction		124,954		124,081		-		-		-		873
Other commercial real estate		773,121		749,114		1,053		1,534		5,206		16,214
Total commercial real estate		2,578,209		2,519,063		5,073		2,510		5,206		46,357
Total corporate loans		4,478,301		4,384,396		9,686		5,023		5,725		73,471
Home equity		390,033		375,804		6,349		1,651		40		6,189
1-4 family mortgages		282,948		270,784		4,241		1,947		1,102		4,874
Installment		38,394		35,936		2,390		68		-		-
Total consumer loans		711,375		682,524		12,980		3,666		1,142		11,063
Total loans, excluding covered loans		5,189,676		5,066,920		22,666		8,689		6,867		84,534
Covered loans		197,894		145,751		6,514		31,447		-		14,182
Total loans	$	5,387,570	$	5,212,671	$	29,180	$	40,136	$	6,867	$	98,716

The following table provides a comparison of our non-performing assets and past due loans to prior periods.

Table 11

Non-Performing Assets and Past Due Loans

(Dollar amounts in thousands)

	2013				2012
	June 30		March 31		December 31		September 30		June 30
Non-performing assets, excluding covered loans and covered OREO
Non-accrual loans	$	89,193	$	95,397	$	84,534	$	99,579	$	198,508
90 days or more past due loans		3,832		5,552		8,689		12,582		8,192
Total non-performing loans		93,025		100,949		93,223		112,161		206,700
Accruing TDRs		8,287		2,587		6,867		6,391		7,811
OREO		39,497		39,994		39,953		36,487		28,309
Total non-performing assets	$	140,809	$	143,530	$	140,043	$	155,039	$	242,820
30-89 days past due loans	$	21,756	$	22,222	$	22,666	$	20,088	$	23,597
Non-accrual loans to total loans		1.69%		1.84%		1.63%		1.91%		3.75%
Non-performing loans to total loans		1.76%		1.95%		1.80%		2.15%		3.90%
Non-performing assets to loans plus OREO		2.64%		2.75%		2.68%		2.95%		4.56%
Non-performing covered assets (1)
Non-accrual loans	$	28,468	$	20,912	$	14,182	$	16,372	$	14,540
90 days or more past due loans		27,700		24,934		31,447		34,554		33,288
Total non-performing loans		56,168		45,846		45,629		50,926		47,828
Accruing TDRs		-		-		-		-		-
OREO		13,681		14,774		13,123		8,729		9,136
Total non-performing assets	$	69,849	$	60,620	$	58,752	$	59,655	$	56,964
30-89 days past due loans	$	5,650	$	10,655	$	6,514	$	9,241	$	7,593
Non-performing assets, including covered loans and covered OREO
Non-accrual loans	$	117,661	$	116,309	$	98,716	$	115,951	$	213,048
90 days or more past due loans		31,532		30,486		40,136		47,136		41,480
Total non-performing loans		149,193		146,795		138,852		163,087		254,528
Accruing TDRs		8,287		2,587		6,867		6,391		7,811
OREO		53,178		54,768		53,076		45,216		37,445
Total non-performing assets	$	210,658	$	204,150	$	198,795	$	214,694	$	299,784
30-89 days past due loans	$	27,406	$	32,877	$	29,180	$	29,329	$	31,190
Non-accrual loans to total loans		2.16%		2.17%		1.83%		2.13%		3.85%
Non-performing loans to total loans		2.73%		2.74%		2.58%		3.00%		4.60%
Non-performing assets to loans plus OREO		3.82%		3.77%		3.65%		3.92%		5.39%

(1)

Covered loans and covered OREO are covered by FDIC Agreements that substantially mitigate the risk of loss. Past due covered loans in the tables above are determined by borrower performance compared to contractual terms, but are generally considered accruing loans since they continue to perform in accordance with our expectations of cash flows. For a discussion of covered loans and covered OREO, refer to Note 5 of “Notes to the Condensed Consolidated Financial Statements” in Part I, Item 1 of this Form 10-Q.

Non-performing loans, excluding covered loans and covered OREO, were $93.0 million at June 30, 2013, comparable to $93.2 million at December 31, 2012.

Non-performing assets, excluding covered loans and covered OREO, were $140.8 million at June 30, 2013, consistent with $140.0 million at December 31, 2012. Compared to June 30, 2012, the significant decline in non-performing assets,

excluding covered loans and covered OREO, resulted from management’s accelerated credit remediation activities, including the bulk loan sales.

TDRs

Loan modifications may be performed at the request of the individual borrower and may include reductions in interest rates, changes in payments, or maturity date extensions. We occasionally restructure loans at other than market rates or terms to enable the borrower to work through financial difficulties for a period of time, and these restructures remain classified as TDRs for the remaining terms of the loans.

Table 12

TDRs by Type

(Dollar amounts in thousands)

	June 30, 2013			December 31, 2012			June 30, 2012
	Number of Loans	Amount		Number of Loans	Amount		Number of Loans	Amount
Commercial and industrial	9	$	16,394	6	$	3,064	15	$	1,555
Commercial real estate:
Office	-		-	-		-	-		-
Retail	2		628	-		-	1		220
Industrial	1		365	2		2,407	1		620
Multi-family	5		1,317	1		150	8		1,758
Residential construction	2		500	-		-	-		-
Commercial construction	-		-	-		-	1		14,006
Other commercial real estate	8		5,303	7		9,855	11		11,908
Total commercial real estate loans	18		8,113	10		12,412	22		28,512
Total corporate loans	27		24,507	16		15,476	37		30,067
Home equity	7		380	7		274	7		416
1-4 family mortgages	15		1,850	16		2,041	18		2,189
Installment	-		-	-		-	-		-
Total consumer loans	22		2,230	23		2,315	25		2,605
Total TDRs	49	$	26,737	39	$	17,791	62	$	32,672
Accruing TDRs	23	$	8,287	19	$	6,867	18	$	7,811
Non-accrual TDRs	26		18,450	20		10,924	44		24,861
Total TDRs	49	$	26,737	39	$	17,791	62	$	32,672
Year-to-date charge-offs on TDRs		$	1,788		$	10,003		$	822
Valuation allowance related to TDRs		$	2,195		$	2,794		$	1,156

TDRs totaled $26.7 million at June 30, 2013, increasing $8.9 million from December 31, 2012. The June 30, 2013 total includes $8.3 million in loans that were restructured at market rates and terms and are accruing interest compared to $6.9 million as of December 31, 2012.

Accruing TDRs rose 20.7% from December 31, 2012, driven primarily by $3.5 million of new restructures at market rates and terms and the reclassification $4.0 million of non-accrual TDRs to accruing TDR status based on the continued performance of these loans. In addition, $5.0 million of accruing TDRs were returned to performing status after exhibiting sufficient performance.

At June 30, 2013, non-accrual TDRs totaled $18.5 million compared to $10.9 million at December 31, 2012. TDRs are reported as non-accrual because they are not yet performing in accordance with their modified terms or they have not yet

exhibited sufficient performance under their modified terms. The rise in non-accrual TDRs from December 31, 2012 was driven primarily by the restructure of one non-accrual credit during the second quarter of 2013.

Performing Potential Problem Loans

Performing potential problem loans consist of special mention loans and substandard loans. These loans are performing in accordance with contractual terms, but management has concerns about the ability of the borrower to continue to comply with loan terms due to the borrower’s potential operating or financial difficulties.

Table 13

Performing Potential Problem Loans

(Dollar amounts in thousands)

	June 30, 2013						December 31, 2012
	Special Mention (1)		Substandard (2)		Total Performing Potential Problem Loans		Special Mention (1)		Substandard (2)		Total Performing Potential Problem Loans
Commercial and industrial	$	31,029	$	9,169	$	40,198	$	37,833	$	8,768	$	46,601
Agricultural		-		-		-		331		-		331
Commercial real estate:
Office, retail, and industrial		53,574		22,510		76,084		57,271		16,746		74,017
Multi-family		1,921		787		2,708		1,921		-		1,921
Residential construction		10,029		7,920		17,949		11,870		11,588		23,458
Commercial construction		8,747		18,853		27,600		14,340		14,174		28,514
Other commercial real estate		9,875		19,278		29,153		14,056		30,149		44,205
Total commercial real estate		84,146		69,348		153,494		99,458		72,657		172,115
Total performing potential problem corporate loans	$	115,175	$	78,517	$	193,692	$	137,622	$	81,425	$	219,047

(1)	Loans categorized as special mention exhibit potential weaknesses that require the close attention of management. If left uncorrected, these potential weaknesses may result in the deterioration of repayment prospects at some future date.
(2)	Loans categorized as substandard continue to accrue interest, but exhibit a well-defined weakness or weaknesses that may jeopardize the liquidation of the debt. The loans continue to accrue interest because they are well secured and collection of principal and interest is expected within a reasonable time.

Performing potential problem loans totaled $193.7 million as of June 30, 2013, down $25.4 million, or 11.6%, from December 31, 2012, with improvement across the majority of corporate loan categories. As of June 30, 2013, approximately 50% of potential problem loans were comprised of 10 commercial loan relationships each having balances greater than $5.0 million.

OREO Activity

OREO consists of properties acquired as the result of borrower defaults on loans. OREO, excluding covered OREO, was $39.5 million at June 30, 2013, comparable to December 31, 2012, and increasing $11.2 million from June 30, 2012.

Table 14

OREO Properties by Type

(Dollar amounts in thousands)

	June 30, 2013			December 31, 2012			June 30, 2012
	Number of Properties	Amount		Number of Properties	Amount		Number of Properties	Amount
Single family homes	31	$	3,388	15	$	2,054	17	$	2,941
Land parcels:
Raw land	5		3,244	5		3,244	4		2,765
Farmland	-		-	1		207	1		207
Commercial lots	21		12,356	22		12,355	18		5,595
Single-family lots	24		3,163	29		4,970	26		5,333
Total land parcels	50		18,763	57		20,776	49		13,900
Multi-family units	13		976	10		796	4		362
Commercial properties	29		16,370	32		16,327	17		11,106
Total OREO, excluding covered OREO	123		39,497	114		39,953	87		28,309
Covered OREO	59		13,681	62		13,123	39		9,136
Total OREO properties	182	$	53,178	176	$	53,076	126	$	37,445

Table 15

OREO Disposals and Write-Downs

(Dollar amounts in thousands)

	Six Months Ended June 30, 2013						Six Months Ended June 30, 2012
	OREO		Covered OREO		Total		OREO		Covered OREO		Total
OREO sales
Proceeds from sales	$	7,035	$	3,872	$	10,907	$	21,471	$	16,512	$	37,983
Less: Basis of properties sold		6,989		3,825		10,814		21,912		16,387		38,299
Net (gains) losses on sales of OREO	$	(46)	$	(47)	$	(93)	$	441	$	(125)	$	316
OREO valuation adjustments	$	555	$	31	$	586	$	2,383	$	131	$	2,514

For the six months ended June 30, 2013, we sold $7.0 million of OREO, excluding covered OREO. These sales consisted of 33 properties with the majority classified as single-family homes and commercial properties.

OREO sales, excluding covered OREO, consisted of 43 properties for the six months ended June 30, 2012, with the majority classified as raw land and commercial units.

Allowance for Credit Losses

Methodology for the Allowance for Credit Losses

The allowance for credit losses is comprised of the allowance for loan and covered loan losses and the reserve for unfunded commitments and is maintained by management at a level believed adequate to absorb estimated losses inherent in the existing loan portfolio. Determination of the allowance for credit losses is inherently subjective since it requires significant estimates and management judgment, including the amounts and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans, and consideration of current economic trends.

While management utilizes its best judgment and information available, the ultimate adequacy of the allowance for credit losses depends on a variety of factors beyond the Company’s control, including the performance of its loan portfolio, the economy, changes in interest rates and property values, and the interpretation of loan risk classifications by regulatory

authorities. Management believes that the allowance for credit losses is an appropriate estimate of credit losses inherent in the loan portfolio as of June 30, 2013.

The accounting policy for the allowance for credit losses is discussed in Note 1 of “Notes to the Condensed Consolidated Financial Statements” in Part I, Item 1 of this Form 10-Q.

Table 16

Allowance for Credit Losses

and Summary of Loan Loss Experience

(Dollar amounts in thousands)

	Quarters Ended
	2013					2012
	June 30			March 31		December 31		September 30		June 30
Change in allowance for credit losses
Beginning balance	$		100,457	$	102,812	$	104,945	$	118,682	$	118,764
Loan charge-offs:
Commercial and industrial			(3,021)		(3,085)		(2,425)		(43,099)		(6,405)
Agricultural			(95)		(90)		-		(4,531)		(18)
Office, retail, and industrial			(1,453)		(1,262)		(361)		(29,370)		(2,570)
Multi-family			(213)		(165)		(119)		(2,758)		(344)
Residential construction			(850)		(565)		(239)		(9,368)		(3,598)
Commercial construction			-		-		(100)		(11,037)		(2,616)
Other commercial real estate			(547)		(2,535)		(1,865)		(23,473)		(2,952)
Home equity and installment			(2,254)		(1,966)		(1,915)		(2,470)		(2,489)
1-4 family mortgages			(269)		(398)		(831)		(572)		(255)
Total loan charge-offs			(8,702)		(10,066)		(7,855)		(126,678)		(21,247)
Recoveries of loan charge-offs:
Commercial and industrial			573		2,089		647		1,318		535
Agricultural			-		-		177		-		-
Office, retail, and industrial			35		2		266		2		307
Multi-family			30		5		110		3		31
Residential construction			5		-		105		126		-
Commercial construction			-		2		-		-		-
Other commercial real estate			329		1,030		79		21		18
Home equity and installment			169		105		205		119		245
1-4 family mortgages			244		2		5		3		5
Total recoveries of loan charge-offs			1,385		3,235		1,594		1,592		1,141
Net loan charge-offs, excluding covered loans			(7,317)		(6,831)		(6,261)		(125,086)		(20,106)
Net covered loan charge-offs			(1,977)		(698)		(1,465)		(442)		(2,434)
Net loan charge-offs			(9,294)		(7,529)		(7,726)		(125,528)		(22,540)
Provision for loan and covered loan losses:
Provision for loan losses			1,682		4,811		1,463		102,934		20,035
Provision for covered loan losses			4,131		1,014		4,131		9,212		10,215
Less: expected reimbursement from the FDIC			-		(151)		(1)		(355)		(7,792)
Net provision for covered loan losses			4,131		863		4,130		8,857		2,423
Provision for loan and covered losses			5,813		5,674		5,593		111,791		22,458
Reduction in reserve for unfunded commitments (1)			-		(500)		-		-		-
Total provision for loan and covered loan losses and other			5,813		5,174		5,593		111,791		22,458
Ending balance		$	96,976	$	100,457	$	102,812	$	104,945	$	118,682

(1)	Included in other noninterest expense in the Consolidated Statements of Income.

	Quarters Ended
	2013				2012
	June 30		March 31		December 31		September 30		June 30
Allowance for credit losses
Allowance for loan losses	$	79,729	$	85,364	$	87,384	$	93,048	$	115,200
Allowance for covered loan losses		14,381		12,227		12,062		9,397		982
Total allowance for loan and covered loan losses		94,110		97,591		99,446		102,445		116,182
Reserve for unfunded commitments		2,866		2,866		3,366		2,500		2,500
Total allowance for credit losses	$	96,976	$	100,457	$	102,812	$	104,945	$	118,682
Amounts and ratios, excluding covered loans
Average loans	$	5,180,608	$	5,148,343	$	5,160,576	$	5,353,911	$	5,213,944
Net loan charge-offs to average loans, annualized		0.57%		0.54%		0.48%		9.29%		1.55%
Allowance for credit losses at end of period as a percent of:
Total loans		1.56%		1.70%		1.75%		1.83%		2.22%
Non-accrual loans		92.60%		92.49%		107.35%		95.95%		59.29%
Non-performing loans		88.79%		87.40%		97.35%		85.19%		57.42%
Amounts and ratios, including covered loans
Average loans	$	5,357,945	$	5,339,749	$	5,367,121	$	5,575,406	$	5,454,295
Net loan charge-offs to average loans annualized		0.70%		0.57%		0.57%		8.96%		1.66%
Allowance for credit losses at end of period as a percent of:
Total loans		1.78%		1.87%		1.91%		1.93%		2.15%
Non-accrual loans		82.42%		86.37%		104.15%		90.51%		55.71%
Non-performing loans		65.00%		68.43%		74.04%		64.35%		46.63%

Activity in the Allowance for Credit Losses

The allowance for credit losses was $97.0 million as of June 30, 2013, a decline of $5.8 million from December 31, 2012 and $21.7 million from June 30, 2012. The allowance for credit losses was 1.78% of total loans at June 30, 2013 compared to 1.91% at December 31, 2012 and 2.15% at June 30, 2012, reflecting significant improvement in credit quality over the past 12 months.

Net loan charge-offs, excluding covered loan charge-offs, and the provision for loan and covered loan losses during the second quarter of 2013 remained stable or decreased compared to the prior periods presented. The decline in charge-offs compared to the second quarter of 2012 reflected improved credit quality due to management’s accelerated credit remediation actions that occurred during the third and fourth quarters of 2012, including the bulk loan sales.

Covered loan charge-offs reflect the decline in estimated cash flows of certain acquired loans. Management re-estimates cash flows periodically, and the present value of any decreases in expected cash flows from the FDIC is recorded as either a charge-off in that period or an allowance for covered loan losses is established. Any increases in expected cash flows are recorded through prospective yield adjustments over the remaining lives of the specific loans.

FUNDING AND LIQUIDITY MANAGEMENT

The following table provides a comparison of average funding sources for the quarters ended June 30, 2013, December 31, 2012, and June 30, 2012. We believe that average balances, rather than period-end balances, are more meaningful in analyzing funding sources because of the inherent fluctuations that may occur on a monthly basis within most funding categories.

Table 17

Funding Sources – Average Balances

(Dollar amounts in thousands)

	Quarters Ended						Second Quarter 2013 % Change From
	June 30, 2013		December 31, 2012		June 30, 2012		Fourth Quarter 2012	Second Quarter 2012
Demand deposits	$	1,880,476	$	1,808,522	$	1,797,854	4.0%	4.6%
Savings deposits		1,144,093		1,066,611		1,042,099	7.3%	9.8%
NOW accounts		1,166,227		1,133,740		1,064,054	2.9%	9.6%
Money market accounts		1,274,062		1,268,046		1,176,723	0.5%	8.3%
Transactional deposits		5,464,858		5,276,919		5,080,730	3.6%	7.6%
Time deposits		1,308,997		1,418,689		1,519,945	(7.7%)	(13.9%)
Brokered deposits		22,502		29,229		28,465	(23.0%)	(20.9%)
Total time deposits		1,331,499		1,447,918		1,548,410	(8.0%)	(14.0%)
Total deposits		6,796,357		6,724,837		6,629,140	1.1%	2.5%
Securities sold under agreements to repurchase		89,880		70,805		83,434	26.9%	7.7%
FHLB advances		114,569		114,585		112,500	-	1.8%
Total borrowed funds		204,449		185,390		195,934	10.3%	4.3%
Senior and subordinated debt		214,828		214,764		231,123	-	(7.1%)
Total funding sources	$	7,215,634	$	7,124,991	$	7,056,197	1.3%	2.3%
Average interest rate paid on borrowed funds		0.76%		1.07%		1.01%
Weighted-average maturity of FHLB advances		35.6 months		20.8 months		26.6 months
Weighted-average interest rate of FHLB advances		1.34%		1.72%		1.71%

Average funding sources for the second quarter of 2013 increased $90.6 million from the fourth quarter of 2012 and $159.4 million from the second quarter of 2012. Compared to the prior year periods, growth across transactional deposit products more than offset the decline in time deposits, resulting in a more favorable funding mix.

The reduction in average senior and subordinated debt compared to second quarter of 2012 was attributed to the repurchase and retirement of $4.3 million of junior subordinated debentures and $12.0 million of subordinated notes during the fourth quarter of 2012.

Table 18

Borrowed Funds

(Dollar amounts in thousands)

	June 30, 2013			June 30, 2012
	Amount		Weighted- Average Rate	Amount		Weighted- Average Rate
At period-end:
Securities sold under agreements to repurchase	$	82,038	0.03%	$	77,024	0.01%
FHLB advances		114,565	1.34%		112,500	1.71%
Total borrowed funds	$	196,603	0.79%	$	189,524	1.02%
Average for the year-to-date period:
Securities sold under agreements to repurchase	$	87,610	0.03%	$	87,241	0.01%
FHLB advances		114,573	1.44%		112,500	1.76%
Total borrowed funds	$	202,183	0.82%	$	199,741	1.01%
Maximum amount outstanding at the end of any day during the period:
Securities sold under agreements to repurchase	$	104,115		$	103,591
FHLB advances		114,581			112,500

Average borrowed funds totaled $202.2 million for the first six months of 2013, relatively unchanged from the same period in 2012.

Securities sold under agreements to repurchase generally mature within 1 to 90 days from the transaction date.

MANAGEMENT OF CAPITAL

Capital Measurements

A strong capital structure is required under applicable banking regulations and is crucial in maintaining investor confidence, accessing capital markets, and enabling us to take advantage of future profitable growth opportunities. Our capital policy requires that the Company and the Bank maintain capital ratios in excess of the minimum regulatory guidelines. It serves as an internal discipline in analyzing business risks and internal growth opportunities and sets targeted levels of return on equity. Under regulatory capital adequacy guidelines, the Company and the Bank are subject to various capital requirements set by the federal banking agencies. These requirements specify minimum capital ratios, defined as Tier 1 and total capital as a percentage of assets and off-balance sheet items that were weighted according to broad risk categories and a leverage ratio calculated as Tier 1 capital as a percentage of adjusted average assets. We manage our capital ratios for both the Company and the Bank to consistently maintain these measurements in excess of the Federal Reserve’s minimum levels to be “well-capitalized,” which is the highest capital category established.

The following table presents our consolidated measures of capital as of the dates presented and the capital guidelines established by the Federal Reserve to be categorized as “well-capitalized.” All regulatory mandated ratios for characterization as “well-capitalized” were exceeded as of June 30, 2013 and December 31, 2012.

All other ratios presented in the table below are capital adequacy metrics used and relied on by investors and industry analysts; however, they are non-GAAP financial measures for SEC purposes. These non-GAAP measures are valuable indicators of a financial institution’s capital strength since they eliminate intangible assets from stockholders’ equity and retain the effect of accumulated other comprehensive loss in stockholders’ equity. Reconciliations of the components of those ratios to GAAP are also presented in the table below.

Table 19

Capital Measurements

(Dollar amounts in thousands)

	June 30, 2013		December 31, 2012		Regulatory Minimum For “Well- Capitalized”	Excess Over Required Minimums at June 30, 2013
Reconciliation of capital components to regulatory requirements:
Total regulatory capital, as defined in federal regulations	$	790,822	$	755,264
Tier 1 capital, as defined in federal regulations	$	693,509	$	652,480
Trust preferred securities included in Tier 1 capital		(59,965)		(59,965)
Tier 1 common capital	$	633,544	$	592,515
Risk-weighted assets, as defined in federal regulations	$	6,536,368	$	6,348,523
Average assets, as defined in federal regulations		7,910,936		7,768,967
Regulatory capital ratios:
Total capital to risk-weighted assets		12.10%		11.90%	10.00%	21%	$	137,185
Tier 1 capital to risk-weighted assets		10.61%		10.28%	6.00%	77%	$	301,327
Tier 1 common capital to risk-weighted assets (1)		9.69%		9.33%	N/A(2)	N/A(2)		N/A(2)
Tier 1 leverage to average assets		8.77%		8.40%	5.00%	75%	$	297,981
Reconciliation of capital components to GAAP:
Total stockholder’s equity	$	974,653	$	940,893
Goodwill and other intangible assets		(279,421)		(281,059)
Tangible common equity		695,232		659,834
Accumulated other comprehensive income		10,299		15,660
Tangible common equity, excluding accumulated other comprehensive income	$	705,531	$	675,494
Total assets	$	8,343,325	$	8,099,839
Goodwill and other intangible assets		(279,421)		(281,059)
Tangible assets	$	8,063,904	$	7,818,780
Tangible common equity ratios:
Tangible common equity to tangible assets		8.62%		8.44%	N/A(2)	N/A(2)		N/A(2)
Tangible common equity, excluding other accumulated comprehensive income, to tangible assets		8.75%		8.64%	N/A(2)	N/A(2)		N/A(2)
Tangible common equity to risk-weighted assets		10.64%		10.39%	N/A(2)	N/A(2)		N/A(2)

(1)	Excludes the impact of trust-preferred securities.
(2)	Ratio is not subject to formal Federal Reserve regulatory requirements.

The Board of Directors reviews the Company’s capital plan each quarter, considering the current and expected operating environment as well as an evaluation of various capital alternatives.

Basel III Capital Rules

In July 2013, the Federal Reserve, the primary federal regulator of the Company and the Bank, published final rules (the “Basel III Capital Rules”) establishing a new comprehensive capital framework for U.S. banking organizations. The rules implement the Basel Committee’s December 2010 framework commonly known as “Basel III” for strengthening international capital standards as well as certain provisions of the Dodd-Frank Act. The Basel III Capital Rules substantially revise the risk-based capital requirements applicable to bank holding companies and depository institutions, including the Company and the Bank, compared to the current U.S. risk-based capital rules. The Basel III Capital Rules define the components of capital and address other issues affecting the numerator in banks’ regulatory capital ratios. The Basel III Capital Rules also address risk weights and other issues affecting the denominator in regulatory capital ratios and replace the existing risk-weighting approach with a more risk-sensitive approach. In addition, the Basel III Capital Rules implement the requirements of Section 939A of the Dodd-Frank Act to remove references to credit ratings from the federal banking agencies’ rules. The Basel III Capital Rules are effective for the Company and the Bank on January 1, 2015 (subject to a phase-in period).

The Basel III Capital Rules, among other things, (i) introduce a new capital measure called “Common Equity Tier 1” (“CET1”), (ii) specify that Tier 1 capital consist of CET1 and “Additional Tier 1 capital” instruments meeting specified requirements, (iii) narrowly define CET1 by requiring that most deductions/adjustments to regulatory capital measures be made to CET1 and not to the other components of capital, and (iv) expand the scope of the deductions/adjustments compared to existing regulations. Bank holding companies with less than $15.0 billion in consolidated assets as of December 31, 2009, such as the Company, are permitted to include trust-preferred securities in Additional Tier 1 Capital on a permanent basis and without any phase-out. As of June 30, 2013, the Company had $61.8 million of trust-preferred securities.

When fully phased in on January 1, 2019, the Basel III Capital Rules will require the Company and the Bank to maintain (i) a minimum ratio of CET1 to risk-weighted assets of at least 4.5%, plus a 2.5% “capital conservation buffer” (resulting in a minimum ratio of CET1 to risk-weighted assets of at least 7% upon full implementation), (ii) a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the capital conservation buffer (resulting in a minimum Tier 1 capital ratio of 8.5% upon full implementation), (iii) a minimum ratio of Total capital (that is, Tier 1 plus Tier 2) to risk-weighted assets of at least 8.0%, plus the capital conservation buffer (resulting in a minimum total capital ratio of 10.5% upon full implementation) and (iv) a minimum leverage ratio of 4%, calculated as the ratio of Tier 1 capital to average assets.

The capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a ratio of CET1 to risk-weighted assets above the minimum, but below the conservation buffer will face constraints on dividends, equity repurchases and compensation based on the amount of the shortfall. The implementation of the capital conservation buffer will begin on January 1, 2016 at the 0.625% level and be phased in over a four-year period (increasing by that amount on each subsequent January 1 until it reaches 2.5% on January 1, 2019).

The Basel III Capital Rules provide for a number of deductions from and adjustments to CET1 beginning on January 1, 2015 and will be phased-in over a four-year period (beginning at 40% on January 1, 2015 and an additional 20% per year thereafter). Examples of these include the requirement that mortgage servicing rights, deferred tax assets dependent upon future taxable income and significant investments in non-consolidated financial entities be deducted from CET1 to the extent that any one such category exceeds 10% of CET1 or all such categories in the aggregate exceed 15% of CET1. Under current capital standards, the effects of accumulated other comprehensive income items included in capital are excluded for the purposes of determining regulatory capital ratios. Under the Basel III Capital Rules, the effects of certain accumulated other comprehensive items are not excluded; however, non-advanced approaches banking organizations, including the Company and the Bank, may make a one-time permanent election to continue to exclude these items.

The Basel III Capital Rules prescribe a standardized approach for risk weightings that expand the risk-weighting categories from the current four Basel I-derived categories (0%, 20%, 50%, and 100%) to a much larger and more risk-sensitive number of categories depending on the nature of the assets, generally ranging from 0% for U.S. government and agency securities, to 600% for certain equity exposures, and resulting in higher risk weights for a variety of asset categories.

We are currently evaluating the impact of the capital adequacy requirements under the Basel III Capital Rules on the Company and the Bank.

The Basel III Capital Rules adopted in July 2013 do not address the proposed Liquidity Coverage Ratio Test and Net Stable Funding Ratio Test called for by the proposed Basel III framework. See “Item 1. Business – Supervision and Regulation – Liquidity Requirements” in the Company’s 2012 10-K for more information on these proposed requirements.

ITEM 3. QUANTITATIVE AND QUALITATIVE

DISCLOSURES ABOUT MARKET RISK

Market risk is the risk of loss arising from adverse changes in the fair value of financial instruments due to changes in interest rates, exchange rates, and equity prices. Interest rate risk is our primary market risk and is the result of repricing, basis, and option risk. A description and analysis of our interest rate risk management policies is included in Part II, Item 7A, “Quantitative and Qualitative Disclosures about Market Risk,” in our 2012 10-K.

We seek to achieve consistent growth in net interest income and net income while managing volatility that arises from shifts in interest rates. The Bank’s Asset and Liability Committee (“ALCO”) oversees financial risk management by developing programs to measure and manage interest rate risks within authorized limits set by the Bank’s Board of Directors. ALCO also approves the Bank’s asset and liability management policies, oversees the formulation and implementation of strategies to improve balance sheet positioning and earnings, and reviews the Bank’s interest rate sensitivity position. Management uses net interest income and economic value of equity simulation modeling tools to analyze and capture short-term and long-term interest rate exposures.

Net Interest Income Sensitivity

The analysis of net interest income sensitivities assesses the magnitude of changes in net interest income resulting from changes in interest rates over a 12-month horizon using multiple rate scenarios. These scenarios include, but are not limited to, a most likely forecast, a flat or unchanged rate environment, a gradual increase and decrease of 200 basis points that occur in equal steps over a six-month time horizon, and immediate increases of 200 and 300 basis points and decreases of 100 and 200 basis points.

This simulation analysis is based on actual cash flows and repricing characteristics for balance sheet and off-balance sheet instruments and incorporates market-based assumptions regarding the effect of changing interest rates on the prepayment rates of certain assets and liabilities. This simulation analysis includes management’s projections for activity levels in each of the product lines we offer. The analysis also incorporates assumptions based on the historical behavior of deposit rates and balances in relation to interest rates. Because these assumptions are inherently uncertain, the simulation analysis cannot definitively measure net interest income or predict the impact of the fluctuation in interest rates on net interest income. Actual results may differ from simulated results due to timing, magnitude, and frequency of interest rate changes as well as changes in market conditions and management strategies.

We monitor and manage interest rate risk within approved policy limits. Our current interest rate risk policy limits are determined by measuring the change in net interest income over a 12-month horizon.

Analysis of Net Interest Income Sensitivity

(Dollar amounts in thousands)

	Gradual Change in Rates (1)				Immediate Change in Rates
	-200		+200		-200		-100		+200		+300
June 30, 2013:
Dollar change	$	(14,247)	$	11,759	$	(18,835)	$	(10,316)	$	18,893	$	32,366
Percent change		-5.41%		+4.47%		-7.16%		-3.92%		+7.18%		+12.30%
December 31, 2012:
Dollar change	$	(10,678)	$	12,933	$	(19,173)	$	(13,502)	$	19,766	$	33,786
Percent change		-4.05%		+4.93%		-7.27%		-5.12%		+7.49%		+12.81%

(1)	Reflects an assumed uniform change in interest rates across all terms that occurs in equal steps over a six-month horizon.

Overall, in rising interest rate scenarios, interest rate risk volatility is less positive at June 30, 2013 compared to December 31, 2012 and, in declining interest rate scenarios, interest rate risk volatility is generally less negative at June 30, 2013 compared to December 31, 2012. In rising interest rate scenarios, the positive impact from the increase in short-term investments and variable rate loans was more than offset by the lengthening of the fixed rate portion of the loan portfolio, which was driven by the assumption of slower prepayment speeds. Slower than anticipated prepayment speeds are expected to result in lower levels of the repricing of loans, which will increase exposure.

Economic Value of Equity

In addition to the simulation analysis, management uses an economic value of equity sensitivity technique to understand the risk in both shorter-term and longer-term positions and to study the impact of longer-term cash flows on earnings and capital. In determining the economic value of equity, we discount present values of expected cash flows on all assets, liabilities, and off-balance sheet contracts under different interest rate scenarios. The discounted present value of all cash flows represents our economic value of equity. Economic value of equity does not represent the true fair value of asset, liability, or derivative positions because certain factors are not considered, such as credit risk, liquidity risk, and the impact of future changes to the balance sheet.

Analysis of Economic Value of Equity

(Dollar amounts in thousands)

	Immediate Change in Rates
	-200		-100		+200		+300
June 30, 2013:
Dollar change	$	(67,057)	$	(9,796)	$	51,955	$	73,057
Percent change		-4.92%		-0.72%		+3.81%		+5.36%
December 31, 2012:
Dollar change	$	(134,704)	$	(86,090)	$	130,148	$	181,210
Percent change		-10.96%		-7.00%		+10.59%		+14.74%

As of June 30, 2013, the estimated sensitivity of the economic value of equity to rising interest rates is less positive compared to December 31, 2012, and the estimated sensitivity to falling rates is less negative compared to December 31, 2012. The change from December 31, 2012 is due to the impact of the steepened yield curve on the securities portfolio during the second quarter of 2013, which increased price volatility and impacted the duration of the portfolio. In addition, the assumption of lower loan prepayment speeds described in the previous section also drove the change from December 31, 2012.

ITEM 4. CONTROLS AND PROCEDURES

At 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 President and Chief Executive Officer and its Executive Vice President and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rules 13a-15(e) and 15d-15 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based on that evaluation, the President and Chief Executive Officer and Executive Vice President 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 most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

The nature of the business of the Bank and the Company’s other subsidiaries ordinarily results in a certain amount of claims, litigation, investigations, and legal and administrative cases and proceedings, that are considered incidental to the normal conduct of business. In managing such matters, management considers the merits and feasibility of all options and strategies available to the Company, including litigation prosecution, arbitration, insurance coverage, and settlement. Generally, if the Company determines it has meritorious defenses to a matter, it vigorously defends itself.

In August of 2011, the Bank was named in a purported class action lawsuit filed in the Circuit Court of Cook County, Illinois on behalf of certain of the Bank’s customers who incurred overdraft fees. The lawsuit is based on the Bank’s practices relating to debit card transactions, and alleges that these practices resulted in customers being assessed excessive overdraft

fees. The plaintiffs seek an unspecified amount of damages and other relief, including restitution. No class has been certified. The Bank filed a motion to dismiss the plaintiffs’ complaint and, on January 23, 2013, the Circuit Court entered an order granting the Bank’s motion and dismissed the complaint with prejudice. The plaintiffs have appealed the Circuit Court’s ruling, and the appeal is currently pending with the Appellate Court of Illinois. The Company continues to believe that the Bank has meritorious defenses to the claims made by the plaintiffs.

ITEM 1A. RISK FACTORS

The Company provided a discussion of certain risks and uncertainties faced by the Company in its Annual Report on Form 10-K for 2012. However, these factors may not be the only risks or uncertainties the Company faces.

Based on currently available information, the Company has not identified any additional material changes in the Company’s risk factors as previously disclosed, except as discussed above.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

The following table summarizes the Company’s monthly common stock purchases during the second quarter of 2013. The Board approved a stock repurchase program on November 27, 2007. Up to 2.5 million shares of the Company’s common stock may be repurchased, and the total remaining authorization under the program was 2,494,747 shares as of June 30, 2013. The repurchase program has no set expiration or termination date.

Issuer Purchases of Equity Securities

(Number of shares in thousands)

	Total Number of Shares Purchased (1)	Average Price Paid per Share		Total Number of Shares Purchased as Part of a Publicly Announced Plan or Program	Maximum Number of Shares that May Yet Be Purchased Under the Plan or Program
April 1 – April 30, 2013	-	$	-	-	2,494,747
May 1 – May 31, 2013	1,731		12.74	-	2,494,747
June 1 – June 30, 2013	-		-	-	2,494,747
Total	1,731	$	12.74	-

(1)

Consists of shares acquired pursuant to the Company’s share-based compensation plans and not the Company’s repurchase program. Under the terms of these plans, the Company accepts shares of common stock from option holders if they elect to surrender previously owned shares upon exercise to cover the exercise price of the stock options or, in the case of restricted shares of common stock, the withholding of shares to satisfy tax withholding obligations associated with the vesting of restricted shares.

ITEM 6. EXHIBITS

Exhibit Number	Description of Documents
3.1	Restated Certificate of Incorporation of First Midwest Bancorp, Inc. is herein incorporated by reference to Exhibit 3.1 to the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on February 27, 2009.
3.2	Restated By-laws of First Midwest Bancorp, Inc. is herein incorporated by reference to Exhibit 3.2 to the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on February 28, 2012.
10.4	First Midwest Bancorp, Inc. Omnibus Stock and Incentive Plan (as amended and restated May 14, 2013) is incorporated herein by reference to Annex A to the Company’s Proxy Statement filed with the Securities and Exchange Commission on April 9, 2013.
11	Statement re: Computation of Per Share Earnings - The computation of basic and diluted earnings per common share is included in Note 7 of the Company’s Notes to the Condensed Consolidated Financial Statements included in “ITEM 1. FINANCIAL STATEMENTS” of this document.
15	Acknowledgment of Independent Registered Public Accounting Firm.
31.1	Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 (1)	Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 (1)	Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
99	Report of Independent Registered Public Accounting Firm.
101	Interactive Data File.

(1)	Furnished, not filed.

SIGNATURES

Pursuant to the requirements 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.

First Midwest Bancorp, Inc.

/s/ PAUL F. CLEMENS

Paul F. Clemens

Executive Vice President, Chief Financial Officer,

and Principal Accounting Officer*

Date: August 9, 2013

* Duly authorized to sign on behalf of the registrant.

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First Midwest Bancorp (ONBPP) 10-Q2013 Q2 Quarterly report

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